Successor Liability After Bankruptcy Sales: Actual Knowledge v. Constructive Notice, at U.S. Supreme Court

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Actual Knowledge v. Constructive Notice

By: Donald L. Swanson

Imagine buying assets out of bankruptcy at a fair price, only to have a previously-unknown liability tag along.

–Surprise, surprise!

The U.S. Supreme Court has an opportunity to weigh-in on such a “Surprise, surprise” issue.  A petition for writ of certiorari is pending in a case where this could happen—complete with a $63 million surprise, surprise!

–Actual Knowledge v. Constructive Notice Standards

The case starts with a trial court exonerating the purchaser from liability, based on a lack of actual knowledge of the claim in dispute.

A reversal on appeal occurs, leaving the purchaser liable for large obligations based on constructive notice.

The U.S. Supreme Court has an opportunity to step in and address this actual knowledge v. constructive notice split.

–The Case

A “Petition for Writ of Certiorari” is pending in Noble Energy, Inc. v. ConocoPhillips Co., Supreme Court Case No. 17-1438.  With Respondent’s opposition brief and an amicus curiae brief on file, it is set for Conference on September 24, 2018.

Background

The dispute began with a sale of debtor’s assets, free and clear of liens and encumbrances, under a confirmed Chapter 11 plan and a pre-confirmation auction.

A decade later, the purchaser is surprised by a $63 million contingent liability under an indemnity provision in an executory contract that was, (i) neither disclosed by the debtor prior to sale nor specifically mentioned in the purchase agreement, but (ii) included by catch-all language assuming all executory contracts not specifically rejected.

–Pre-Bankruptcy Exchange Agreement

In 1994, ConocoPhillips enters into an Exchange Agreement, agreeing to transfer its interests in certain petroleum leases to Alma Energy Corp., who agrees to transfer its interests in other petroleum leases to ConocoPhillips, and each indemnifies the other for hazardous waste on the land being transferred.

At closing, ConocoPhillips becomes the assignee of Alma’s petroleum leases and Alma becomes assignee of ConocoPhillips’s leases.

–Bankruptcy Sale

On June 10, 1999, Alma Energy Corp. files chapter 11 bankruptcy in the Eastern District of Louisiana (Case No. 99-12688) and auctions its assets, resulting in an Asset Purchase Agreement with catch-all language for assumption and assignment of executory contracts.

The Asset Purchase Agreement did not specifically mention the Exchange Agreement or its indemnity obligation—nor did Debtor’s bankruptcy schedules, disclosure statement or plan. And ConocoPhillips did not file a proof of claim.

In August 2000, debtor confirms a Chapter 11 plan, providing for assumption and assignment of executory contracts to East River, including such catch-all language as:

–all leases or executory contracts not specifically rejected “shall be assumed by the Debtors and assigned to East River.”

Thereafter, Noble Energy, Inc. (the “Petitioner” in the Supreme Court Case) steps into the shoes of East River as purchaser.

Litigation

–More Facts

Back on September 22, 1998, Alma Energy had an oil well blowout, spilling large volumes of oil into Louisiana’s Lake Grande Ecaille. The resulting oil slicks and sheens covered several thousand acres of wetlands and surface water in and around Lake Grande Ecaille and the Gulf of Mexico.  The U.S. Coast Guard directed and monitored cleanup activities, with state and federal agencies participating.

–Environmental Lawsuit

In May 2010 (a decade after the bankruptcy sale), the State of Louisiana sues ConocoPhillips in Louisiana state court for environmental damage and contamination. ConocoPhillips demands that Noble Energy provide a defense and indemnity under the Exchange Agreement. Noble Energy refuses.

ConocoPhillips settles the Louisiana lawsuit for $63 million.

–Indemnity Lawsuit & Appeals In State Courts

Then, ConocoPhillips sues Noble Energy in Texas state court for indemnity under the assigned Exchange Agreement. The trial court dismisses the lawsuit on summary judgment.

ConocoPhillips appeals to the Fourteenth Court of Appeals for the State of Texas, which reverses, ruling:

“Noble owes ConocoPhillips a duty of defense and indemnity” under the Exchange Agreement, which was assigned under the Asset Purchase Agreement.

Noble Energy appeals to the Supreme Court of Texas, which rules (in a 5 to 3 decision) that the Exchange Agreement and indemnity obligation were assumed and assigned to Noble Energy under the confirmed plan and Asset Purchase Agreement, using clear and sufficient language to make Noble Energy liable.  Specifically:

–“Noble had at least constructive notice of the Exchange Agreement.”

Three dissenting Justices insist that:

Noble Energy did not expressly assume the Exchange Agreement or the indemnity obligation in it—and should, therefore, have no liability; and

Because Alma Energy “did not disclose the Exchange Agreement as required by bankruptcy law,” Noble Energy should not be liable for the undisclosed obligation.

The majority Justices respond directly to the dissent with this point:

–Noble Energy may have “had no actual knowledge” of the Exchange Agreement or its indemnity obligation, but “it certainly had constructive knowledge” thereof.

–Petition for Certiorari

Noble Energy then files the pending Petition for Writ of Certiorari with the U.S. Supreme Court. It will be interesting to see how the Supreme Court deals with this Petition.

Conclusion

Here are clichés for purchasers at bankruptcy sales to live by:

“Buyer beware”
“Never let your guard down”
“Do your due diligence.”

And . . . let’s add this one to the list: “Beware of catch-all language assuming executory contracts.”

It’s easy and comforting for purchasers to believe that a bankruptcy sale free and clear of liens and encumbrances will provide a shield against successor liability claims.  Here’s why: the shield works. But the shield does not work in all circumstances.

–The trick is to tell the difference between the two.

It would be helpful, in distinguishing between the two, to know whether the standard for successor liability is actual notice or constructive notice.

–Perhaps the Supreme Court will step-in and help us make that distinction.

** If you find this article of value, please feel free to share. If you’d like to discuss, let me know.

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