Corporations are being forced to confront so-called legacy liabilities. These legacies are hidden or unappreciated liabilties often associated with past merger and acquisition activity. To determine the source of liability, trace the targeted corporation's history.
Original Description:
Original Title
“Legacy Liabilities- Issue Spotting And Strategies” (Corporate Counsel, November 2002)
Corporations are being forced to confront so-called legacy liabilities. These legacies are hidden or unappreciated liabilties often associated with past merger and acquisition activity. To determine the source of liability, trace the targeted corporation's history.
Corporations are being forced to confront so-called legacy liabilities. These legacies are hidden or unappreciated liabilties often associated with past merger and acquisition activity. To determine the source of liability, trace the targeted corporation's history.
I ncreasingly, corporations are being forced to confront so- called legacy liabilities: liabili- ties that have nothing to do with current operations. These legacies are hidden or unappreciated liabil- ities often associated with past merger and acquisition activity. The threads common to these legacies are that the liabilities are difficult to cap or calculate, were not focused on during the transaction, and the dealmaker is no longer around to answer questions. These legacy liabilities frequently arise in asbestos and environmental litigation, as well as other areas. While many of these "legacy liability" claims assert that tort law makes one company a legal successor to an- other, others implicate contractual indemnity agreements. Indemnity terms are routine provisions in asset purchase agreements. Determining the Source of the Liability Unlike horseshoes and hand grenades, "close" is not good enough when identifying the source of legacy liabilities, Frequently, the underlying complaints do not specify whether a defendant is named as a successor or because of an indemnity obligation. Nevertheless, it is critical to determine AS CORPORATE 2002 precisely the source of the legacy liability. The issue, for example, may be critical to jurisdiction: indemnity obligations typically do not give rise to personal jurisdiction over the com- pany. Likewise, ceriain entities may have rights under an acquisition or other contract (such as indemnifica- tion or arbitration rights) that even related corporations do not have. To determine the source of liabili- ty, trace the targeted corporation's history. This should reveal whether it is targeted as a culpable party, a successor or an indemnitor. In true mergers, assuming there are no complicating transactions, the com- pany almost invariably is targeted as a successor. Where the liability trail follows an asset purchase agreement the liability may be as alleged suc- or both. It is essential to unearth the original transaction documents - and on occasion documents from earlier transactions - to begin the process of learning the path past liabilities followed to the present target company. Insurance Issues Few corporations that produced, sold or installed products were without insurance. As a result there may be substantial insurance for legacy liabilities. It is essential to fully investigate all available sources of insurance. The impor- tance of finding old insurance policies and the difficulty of doing so cannot be overstated. Frequent- ly, past corporate sellers are now out of business, have changed names or are no longer operating in the same fashion as they did at the time of the sale. Simply finding someone who controls the corpo- rate records can be a difficult and expensive task. In legacy liability situations, the issue of "shared" insurance frequent- ly arises. Corporations that were re- lated at one point and existed under a common insurance program may now have different owners. The in- surance demands of one corporation may far exceed that of the other - and couris are only now grappling with these issues. While generally decided to date on a first-come-first- serve basis, there are steps that may be considered in order to preserve insurdnce assets lest a former related corporation disproportionately consume an insurance benefit Avoiding coverage problems is another reason to find the prectse source of legacy liabilities and to insist that the proper parties are involved. If a parent is sued as a successor, but the real successor is a subsidiary into which the company with a legacy issue was merged, the parent may not have the best insur- ance coverage position because it was not the parent at the time of the allegedly wrongful conduct Before taking positions in court or out it is important to evaluate the potential ramifications of each poten- tial position For example, arguing that a corporate entity is not a succes- sor to a former entity may well de- prive the latter entity from the benefit of the former's insurance coverage. On the other hanf. tipping the scale in favor of the insurance coverage may well expose the successor entity to unforeseeable amounts of liability. Specifics Matter When Analyzin.g Transactions Confronted with a successorship claim for a legacy liability, some take comfort in the general rule of corporate law: when a corporation purchases the assets of another corporation, the buyer does not assume the seller's llabilities. Few asset purchase agreements are this clean, however particularly when the business is ongoing. Agreements frequently contain language that identifies liabilities being assumed by the successor entity. These provisions complicate the successorship analysis and fuel the minority view that the ongoing product line or continuity of enter- prise trumps the normal successor- ship rules. California and Michigan are notable states that follow the expanded exceptions to the traditional rule. Spin-offs require a fundamental- ly different analysis than asset purchase agreements 'JYpically, spin-offs involve the iransfer of various corporate entities into a new umbrella corporation The shares of the umbrella entity are then issued to the original entity's shareholders or sold for value inuring to the benefit of the selling shareholders. The differentiation COMPLEX BUSINESS LITIGATION of shareholders is critical Many courts have held that having identi- cal shareholders is a reason to find successor liability, but even the term successor does not accurately connote the legacy liability problem assoctated with spin-offs. While lia- bilities associated with operating subsidiaries may be well known and understood, many past spin-off transactions have involved scores of shell or non-operating corporate entities for tax reasons. Frequently, little due diligence was done with respect to these shell corporations, some of which have contractual indemnity obligations or other liability problems associated with past operations. Scope of Indemnity Issues In situations where one corpora- tion tenders the defense of claims to another pursuant to an indemni- ty agreement it is critical that the Indemnitor insist that the tendering entity carefully evaluate the scope of the obligation and precisely fol- low the contractual requirements For example, in some instances, there is an intermediate indemnitor along with an ultimate indemnitor. The intermediate indemnitor may hold the insurance and if the ten- dering party simply tenders to the ultimate indemnitor, the ability to draw on the insurance may be lost. If a corporation has agreed to a ''net of insurance" Indemnification, pre- serving and utilizing the intermedi- ate corporation's insurance is criti- cal. Equally critical is the extent of the indemnity (defense, manage- ment or repayment). BUTLER RUBIN Take a lol\.9 view Many companies against which legacy liabilities are asserted receive low settlement demands for the first cases. Faced with the alternatives of a settlement in the hundreds or thousands of dollars or legal fees in the tens or hundreds of thousands of dollars, companies or their insurers too often choose the former - to scrimp on investigation and to try to settle a few claims for low amounts. It is critical to avoid the tempta- tion to quickly settle the first few legacy claims because settlements can be had so cheaply. Where lega- cy claims may give rise to repetitive litigation, settling the first few claims may be used to argue that a company has acknowledged its obligation for a different company's liabilities. Doing so may void ceriain insurance rights. Equally problematic, once payments the demands never end and never go down. Bankruptcy courts now are littered with corporations that have died the death of a thousand cuts as the first few cheap settle- ments gradually mushroomed into much more costly ones. Patrick Lamb and Kirk Hartley are senior trial partners with Butler Rubin Saltarelli & Boyd, a Chicago litigation boutique. Both have substantial experience with prod- ud liability and mass tort defense. In addition, both have substantial post merger and acquisition litiga- tion experience, and now devote substantial time to the convergence area, legacy liability management and defense. excellence in litigation CORPORATE COU:-JSEL NOVE:0.1BER 2002 A6