GM Ignition Switch Recall: ‘New GM’ May Not Be Fully Protected From Liability For What ‘Old GM’ Did, Even With Post-Bankruptcy Liability Exemption

General Motors Co. (NYSE:GM) has yet to accept responsibility for the injuries and deaths that a faulty part caused before the carmaker emerged from bankruptcy in 2009, but victims may still go after GM based on how much the company knew about the defect, and when.

GM CEO Mary Barra said the company is focused on fixing the problem in existing cars. She told reporters in Detroit on Tuesday that after an internal investigation is complete, GM will “do what’s right.” Whether or not that means the company will take on any legal liabilities for the product defect is not clear.

GM last month issued a recall of 1.63 million cars, mostly in the U.S., to fix ignition switches that can allow the keys to slip out of the “run” positions, causing affected vehicles to shut down and disable air bags and power steering while moving. The problem affects seven GM models made between 2003 and 2007 (mostly Chevrolet Cobalts and Saturn Ions) and has been linked by GM to at least 12 deaths and 31 accidents.

But because this problem predates GM’s Chapter 11 reorganization, the new post-bankruptcy GM (General Motors Company) is free of most liabilities held by the old GM (General Motors Corporation), which effectively ceased to exist after the sale of its assets in July 2009, pursuant to a bankruptcy court order.

Under section 363 of the U.S. Bankruptcy Code, old GM sought and obtained permission from the courts to sell substantially all of its assets to new GM, free from what are typically referred to as liens, claims and encumbrances. The rationale for so-called free and clear section 363 sale orders is to preserve jobs and maximize the value of the bankruptcy estate.

To do that, bad assets and legal liabilities are often segregated, and separate trusts are established and funded to deal with claims against, and lingering legal liabilities of, the old entity, with the valuable assets being transferred to the new entity. This happened in GM’s case when trusts were set up to deal with future asbestos-related and environmental claims. But because the problem with the ignition switch wasn’t public at the time of the company’s 2009 bankruptcy, no trust was established to deal with injuries linked to that defect.

So what does this mean to people who were not able to settle with GM prior to the July 2009 sale? Are they barred under any circumstances from demanding compensation from the new GM?

International Business Times spoke to John Drucker, who specializes in corporate reorganization for the law firm Cole Schotz Meisel Forman & Leonard P.A. in New York City, to talk about the legal recourse for anyone injured in accidents linked to the ignition switch failure in light of GM’s protections against liabilities as dictated by the 363 sale order.

IBTimes: Is anyone who suffered injury prior to July 2009 simply out of luck in suing General Motors Company for any damages linked to the faulty ignition switch?

Drucker: The first question is whether there are limits to the protection the buyer [the new GM] can receive from future liability claims, notwithstanding a sale order that purports to make the sale free and clear of those claims. A number of legal and factual issues will need to be considered, and to recover, the claimants would likely have to assert and prove that the new GM is liable as a successor under applicable state law.

IBTimes: From a person-on-the-street perspective, it seems arbitrary. If you died in a crash linked to this faulty ignition switch on July 11, 2009 (post-sale), your family has a claim against the new GM for what the old GM did. But if that same accident had occurred on July 9, 2009 (pre-sale), then your family may not be able to recover on its claim because the old GM is effectively defunct and the new GM isn’t responsible.

Is it possible that a case could be made that GM knew about the problem and didn’t bring it up during Chapter 11 reorganization so it wouldn't have to set up a trust like it did for asbestos and environmental claims?

Drucker: Here the important albeit difficult question is whether the claim the claimants wish to assert against new GM is one of liability of old GM arising pre-sale. If the injury occurred pre-bankruptcy, generally the claim in a bankruptcy law context associated with that injury may be deemed to be against the old GM entity.

That contrasts with somebody who is going along happily not knowing there’s a defect in their car and then they’re injured post-sale as a result of that defect. In other words, victims who are injured after consummation of an asset sale, as a result of a defective product manufactured and sold by the debtor seller prior to the bankruptcy, may not have held claims in the bankruptcy context against old GM at the time of the sale and may not be barred from bringing their successor liability claim against new GM. There is legal precedent for this proposition in the Southern District of New York, which is where the GM bankruptcy case was conducted.

However, an added complicating and troubling factor, if true, that's raised in the context of the GM sale is whether at the time of the sale, old GM and new GM knew about a defect but did not disclose it so that it could be addressed as part of the sale. If there were known defects and there was disclosure, additional notice could have been provided and a mechanism, such as a trust, for unknown claimants could have been structured. Knowing about a defect and not disclosing it would not absolve either old GM or new GM from liability, and it could be a significant factor in determining liability.

IBTimes: So they would have to establish some significant knowledge on the part of new GM about a product defect prior to the sale order, and then use that to argue that new GM is liable?

Drucker: It’s my understanding that new GM moved forward with essentially the same management, same assets and same product lines. If both the buyer and the seller knew of a defect but did not disclose it, that would likely be a significant factor. A court could find that the sale order did not give new GM a free pass on future liability, especially if it knew about undisclosed defects. There are lots of factual issues that are going to have to be addressed. And each case could be different.

It appears that there may be a distinction between those who were injured pre-sale of the assets and those injured post-sale of the assets. Those injured post-sale of the assets will likely have a better chance of not being barred by the sale order in the bankruptcy case, but there are factors here -- including if there was knowledge by GM of this defect and it was not disclosed – that could give some leverage to even those who were injured pre-bankruptcy, especially if they were not aware of the cause of the accident prior to the post sale disclosure regarding the defect.

Even though they were injured pre-bankruptcy they may not have known that there was a reason linked to the defect in the vehicle that caused the injury. These factors raise due process constitutional issues that are going to have to be addressed in the courts.

John Drucker works in the New York City office of Cole Schotz Meisel Forman & Leonard P.A. as a member of the firm's Bankruptcy & Corporate Restructuring Department. The views and opinions expressed by Mr. Drucker do not necessarily reflect the views of the firm or its clients.