Winter 2004
INSURANCE
INSURANCE FOR SUCCESSOR BUSINESSES
In a recent case involving an insurance company client of
the firm, the Court of Appeal added yet another piece to the puzzle of when an
insurance policy
follows
corporate succession.
A common provision in liability policies, particularly
older policies, prohibits assignment of interest under the policy without the
consent of the insurance carrier. Thus, a question arises when a claim is made
against a successor corporation who had acquired the liabilities of a
predecessor corporation, either by common law, statutory law, or contract. Such
cases were particularly troublesome in the area of environmental coverage,
because liability for environmental contamination essentially has no statute of
limitations. A lawsuit can be filed many years after the policy period has
expired based on activity which occurred during the policy period and after the
named insured has been bought, sold, and/or merged into other companies, many
times.
A successor corporation can be liable for the torts of the predecessor under numerous theories. For example, under the common law of California, the buyer of corporate assets may be liable under a products liability theory for injuries caused by the sale of defective products. The successor can be liable for the damage caused by a predecessor’s product, where the transaction amounts to a consolidation or merger of the two corporations; the transfer of assets was for the fraudulent purpose of escaping liability for the seller’s debts; or where the buyer operates the business as a mere continuation of the seller. The theory for imposing liability on the successor is that the plaintiff has no remedy against the original manufacturer, because of the successor corporation’s acquisition of the business. (Ray v. Alad Corp.)
In General Accident Ins. Co. v. Western McArthur Co., the Court of Appeal held that this type of successor liability in tort was not sufficient to enable the successor corporation to succeed, as well, to the insurance policies issued to the prior corporation.
Similarly, in Quemetco, Inc. v. Pacific Auto Ins. Co., where a successor corporation merely purchases the assets of a predecessor corporation, and does not merge with the predecessor corporation, the insurance policies do not follow the successor corporation. This is so even if the assumption of liabilities is included in the contract of sale.
The Supreme Court, in the recent case of Henkel Corp. v. Hartford Accident & Indemnity Co., endorsed General Accident and Quemetco and found that a party who expressly agrees to assume the liabilities of the predecessor corporation is not, by virtue of that agreement, entitled to coverage under the insured’s liability insurance policies.
However, the court held, in Westoil Terminals Co. v. Harbor Ins. Co., where the acquisition takes the form of a merger between the predecessor company and the successor company, rather than a mere purchase of assets, then the insurance policies will provide coverage for the successor corporation.
Westoil was not overturned by Henkel. The rationale for Henkel is that, upon merger, the prior corporation wholly dissolves into the successor corporation and, in fact, “becomes” part of the successor corporation. Therefore, the court believed that there is really no change in the identity of the insured. In Westoil, a small family-owned business was dissolved, and a new corporation was created for tax purposes. The owners of the two corporations were the same, and, for all practical purposes, the two companies were, in fact, the same. In that instance, although not technically a “merger” under the Corporations Code, the court treated the transaction as a merger. The court appeared persuaded by the fact that the change was a mere formality and that the ownership of the first company was identical to the ownership of the second company. As a practical matter, the second company could not sue the first company for contribution or indemnity and, thus, create no additional burden on the insurer.
Another factor to consider, as the court recognized in Henkel, where the loss has been “fixed” prior to the alleged or purported transfer of the policy, then the insurer’s consent is not required to transfer interest under the policy. With respect to a liability policy, however, the court has not clarified when the loss becomes “fixed.” In the Supreme Court’s earlier decision in Montrose Chemical Corp., the court held that, under a liability policy, the loss does not become an uninsurable “known loss” until final judgment is entered. This makes sense because, under a first-party policy, the loss is “fixed” whenever the peril insured against actually occurs. If a fire burns down the insured building, it cannot matter to the insurance carrier to whom it is obligated to pay a sum certain, the named insured or the named insured’s assignee. With a liability policy, however, it certainly matters to the insurer which company it is supposed to defend, and which companies’ liability it is defending.
This is a particularly relevant concern when the predecessor corporation can still be sued either by the plaintiff, as an additional defendant, or in a cross-action by the successor corporation. And, as the Supreme Court noted in the case of Peñasquitos, even a dissolved corporation can be sued.
This is an important point because under various environmental laws, most notably CERCLA, liability is imposed upon the successor corporation, not because of contract or in tort, but as a matter of statutory law.
Henkel did not expressly decide the question of whether the policy follows the corporate succession when the successor corporation’s liability is imposed as a matter of law.
But, in an unpublished decision, the Court of Appeals, in a case recently handled by the firm, held that finding that insurance policies were transferred to a successor corporation, where liability is claimed under CERCLA, was not consistent with the Supreme Court’s decision in Henkel. Citing to Henkel, the court acknowledged that an assignment without the insurer’s consent may be allowed only when (1) at the time of the assignment, the benefit has been reduced to a claim for money due or to become due or (2) when, at the time of the assignment, the insurer has breached a duty to the insured, and the assignment is a cause of action to recover damages for that breach. This rule applies whether the liability transferred by operation of common law, statutory law, or contract.
The court relied upon General Accident and Quemetco, reaffirming the rule that the law cannot impose a contractual insurance relationship between an insurer and a stranger to the insurance contract. In the CERCLA context, where every successor corporation in the chain of ownership or operation can be liable, any contrary rule would be particularly burdensome. Where the insurance carrier may have insured one corporation, it could, if the rule were otherwise, end up defending ten or twenty corporations, each of which would be adverse to the other. The Court of Appeal recognized the unfairness of such a result.
The issue of whether a corporation’s insurance policies will be available to the successor corporation is one that should be considered by counsel when advising corporations to acquire the assets or liabilities of another corporation, either through sale or merger. The form of the acquisition may have significant consequences for the insurance available for torts which have a “long tail,” particularly in the environmental and products liability arena. It may be desirable for counsel structuring an acquisition to obtain the insurance carrier’s consent to assignment or to purchase additional coverage for damages arising out of the earlier company’s activities
Gwen Freeman
Barry Gammell
Ms. Freeman is a Director in the firm’s Insurance Coverage and Appellate Departments. Email: gf@kpclegal.com.
Mr. Gammell is a Principal in the firm’s Insurance Department. Email: bg@kpclegal.com.
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