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States Active in Recent Mega Bankruptcies

Karen Cordry, NAAG Bankruptcy Counsel

In recent weeks, the states have been extremely active in several major bankruptcies, often on very short notice, and on a wide variety of topics. Huge bankruptcies, such as GM and Chrysler are processed as pre-packaged cases, with the main assets being scheduled for sale within six weeks of the filing. As such, these developments underscore the need for offices to develop bankruptcy expertise so that they can hit the ground running when these cases are filed. Moreover, in light of the major impact these cases have on state economies and the state of the law in future bankruptcy cases, the involvement of the Attorneys General has been critical in making changes in the terms of the agreements.

In the Circuit City case, after the company carried out its massive going out of business sales at its physical stores, it moved to sell its intellectual property, Internet domains, logos and the like, as well as its customer data. This is a new trend by which bricks and mortar retailers shut down, but their virtual shell is sold to a new party that resumes selling under the same name strictly as an Internet business. The states had two concerns with the proposed sale first, that while the sale appeared to resurrect the prior company, the new owner insisted that the sale order state that it was not a successor, and second, that the sale of customer information might violate laws on consumers privacy rights.

The latter issue first emerged in the Toysmart bankruptcy in 2000 a case involving a Web site catering to children (and gathering information from them) that proposed to sell all of its consumer data to the highest bidder in violation of a promise that it would not sell that data. Both the states and the Federal Trade Commission (FTC) initially objected that the proposed sale violated their unfair and deceptive acts and practices (UDAP) laws. The FTC, though, later offered to settle the case by allowing the sale to a qualified buyer, i.e., a legitimate party in the same line of business that would protect the data. The states though, continued to object, holding that a sale to any party would still be unlawful if it were made without the consumer s consent. In the end, the motion was withdrawn, the settlement was never approved, and the data was, in fact destroyed. The states then worked with Congress to have language added to the bankruptcy amendments that were eventually enacted in 2005. Under those changes, before information could be sold if a privacy policy was in effect, a consumer privacy ombudsman ( CPO ) must be appointed to investigate the issues and report to the court, and the court must find that the terms of the sale did not violate nonbankruptcy law.

The Circuit City case was the first where states became generally aware of a proposed sale of consumer data although prior sales had taken place without notice to state regulators. The states learned from this case (as well as similar developments in Chrysler and GM) that some CPOs have concluded that the FTC s Toysmart contested approach should, nevertheless, be treated as governing law. Because prior orders were entered without notice to, or discussion with, the states, it appears that those CPOs were not fully informed of the states position on these issues. The CPO in Circuit City initially planned to use the limited Toysmart approach, but after many conference calls (attended by dozens of states), the final result was a sales order with much stronger privacy protections than originally proposed. It clarified that no data of the type that would trigger states data breach laws would be transferred, required opt-out rights for the contact data that was transferred, and had the opt out conducted by an independent third party. As to the first issue the revival of the liquidated business the states ensured that the opt-out notices and Web site contained conspicuous disclosure of the new entity. In addition, the order required that information about the change in ownership be sent to sites that rated Web sites, so they could let consumers know that the old ratings did not apply to the new site. NAAG s Bankruptcy counsel helped coordinate the discussions and appeared for the states at the sale hearing to let the court know the basis for resolution of the states objections.

Chrysler and GM Bankruptcies

Since the beginning of May, the states have been consumed with numerous issues arising out of the Chrysler and GM bankruptcies, all of which have had to be dealt with at lightning speed. Among the issues have been: ensuring that the new entities would assume coverage for state lemon law liabilities; review of provisions for transfer of consumer data, ensuring workers compensation coverage, and treatment of states claims for taxes and environmental obligations. A full 140 staffers are now on the contact list for these cases as the number of issues to be addressed has grown. In Chrysler, the buyer eventually agreed to cover the vast majority of lemon law liability after many discussions with a working group made up of California, Connecticut, Florida, Iowa, Michigan, New Hampshire, New York and Ohio and to pick up workers compensation coverage in any state where it would continue to have employees. The states have also discussed concerns about the terms of a release for directors and officers, which they expect will be resolved consensually. (Ohio and Michigan filed short objections to formally note the concerns while those discussions are ongoing.)

Many of these same issues have arisen in the GM bankruptcy, and some discussions have been had with the debtor, although the results have not been as productive to date. As a result, a large number of states have objected to different aspects of the proposed sale order there. Texas kicked off with an initial objection, an omnibus objection was filed on June 19 by 37 states (a supplemental joinder was filed with four additional states) and numerous other states filed individual or joint objections dealing with various aspects of the order. In particular, Connecticut and Kentucky filed an objection (joined by 12 other states) that objected to the failure to transfer personal injury claims to the new company. At press time, it is still hoped that many of these matters would be worked out before the sale hearing on June 30.

The most controversial area in both the GM and Chrysler bankruptcies are their plans to cease relations with a large number of their dealers. Chrysler moved to reject dealer contracts, a bankruptcy process that is a form of breach of contract (with specified consequences for the damage claims arising therefrom). GM has proposed to assume its contracts with all of its dealers but only after they have been required to amend those agreements on pain of having them rejected. In both cases, the debtors sought to avoid application of dealer laws (enacted in all 50 states) that give dealers certain rights with respect to whether their contracts may be terminated and the remedies available to them if they are terminated.

In the states view, while the decision to reject an agreement is one for the debtor and the bankruptcy court, in general, the Bankruptcy Code does not provide that the rejection eliminates all laws that relate to the end of the relationship. The original rejection order purported to decide many issues relating to the effect of the rejection and to do so in ways that greatly undermined state law. As a result, states filed two objections one, by Ohio as the lead state that stated a short form objection, and the other, with Illinois as the lead state, that provided a more detailed analysis of the issues and the reasons why the relief sought by the motion was improper. The first was signed by 15 states, the second by seven states (some signed both). Eventually (again after much negotiation with the states and others), the debtors agreed to substantially modify the rejection order to remove virtually all language deciding the effect of the rejections, leaving such issues to be decided as damage claims or requests for alleged injunctive rights.

Illinois Counsel Jim Newbold, and NAAG Bankruptcy counsel appeared in the New York Bankruptcy Court on June 9 to explain why those changes appeared acceptable to resolve the states objections. In addition to correcting the order, the states also closely monitored Chrysler s efforts to ensure that cars at rejected dealers would be transferred to other dealers, eliminating those costs for the rejected dealers. While that was not precisely the remedy provided to dealers under their state laws, those reallocation efforts were directed at the same goal and provided a substantial portion of the relief that was authorized under those laws.

The states are now looking at similar issues arising out of the new contract language that GM has insisted dealers must sign in order to have their agreements assumed. That language includes at least some provisions that most states believe violate their laws such as placing continuing jurisdiction exclusively in the bankruptcy courts and requiring that the dealers waive any right to complain to the states. The states are also concerned that those waiver provisions are improper under their laws and that the very attempt to obtain them is also unlawful. In the omnibus objection (as well as the objection by Texas), the states argued that the Bankruptcy Code provisions on assuming contracts does not include any provision that immunizes such agreements from the normal application of nonbankruptcy law. Thus, to the extent that the agreements have unlawful terms or were obtained illegally, the states believe that the provisions would not be enforceable on a going-forward basis. A working group of Attorneys General, though, comprised of Jon Bruning (Neb.), John Suthers (Colo.), Richard Blumenthal (Conn.), Richard Cordray (Ohio), and Greg Abbott (Texas), have been engaged in discussions with the GM parties on these issues and hope that, as with Chrysler, a consensual resolution will be achieved.

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