Dangers Of Buying At A Bankruptcy Auction

By: John J. Barrett, Jr.

Businesses filing for bankruptcy often sell their equipment and assets at an auction. These sales can be very tempting for competitors of the bankrupt company who frequently use similar types of equipment and the assets can be acquired for ostensibly a great bargain. Unfortunately, such assets can carry hidden costs for buyers that do not arise until years later.

The potential dangers to bargain hunters include exposure to future product liability claims. For example, Company A, a manufacturer of truck bodies, acquired assets at the bankruptcy sale of Company B, another manufacturer in the similar line of business. The sale was authorized by the bankruptcy court pursuant to Section 363 of the Bankruptcy Code, which authorizes the sale of such assets “free and clear” of liens, claims, etc. Company A purchased the assets of Company B thinking that it was getting exactly what the court order said: assets that were free and clear of all liens and claims.

Unexpectedly, years after the purchase, Company A was sued by a Plaintiff who was seriously injured because of what she claimed to be a defective product manufactured by the bankrupt Company B — a product the asset purchaser, Company A, had nothing to do with. Company A was nonetheless sued on a state law successor liability theory, which argued that as a purchaser of assets from the bankrupt Company B, Company A could effectively be treated as a successor, and could be liable for claims against the bankrupt, which was by then dissolved and no longer in existence.

Company A, of course, raised the court order under which it purchased the assets as a defense, pointing out that the court order specifically said it would not be subject to successor liability claims such as this. A state and a federal court disregarded that court order, and both courts held that the order was ineffective to bar the claim because the injured party was not given notice of the bankruptcy proceeding, which resulted in the order, and given the opportunity to object. The fact that giving such notice was impossible because the accident didn’t happen until five years after the sale was deemed irrelevant, and the suit was permitted to proceed.

The case presented two Federal constitutional issues that were squarely opposed to each other: the due process rights of the individual vs. the delegation to the U.S. Congress of the exclusive power to regulate bankruptcies. This was the same conflict presented by the asbestos product liability cases, as well as the recent bankruptcies of GM and Chrysler, but in all of those instances the conflict was avoided by the creation of channeling trusts for asbestos claims and contractual assumptions of liability in GM and Chrysler.

Company A ultimately settled the case for a significant amount of money, because the risk was simply too great to go to trial. The lesson learned, however, was assets purchased at a bankruptcy auction sale are risky — no matter what the court order says!

For questions, comments or additional information, please contact Jack Barrett, Partner in our Bankruptcy & Creditor's Rights Group, at jbarrett@regerlaw.com or via phone at 215.495.6548.