UPDATE. Insurance Coverage

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1 UPDATE Insurance Coverage MARCH 2003 The Insurance Coverage Risks Involved in Corporate Asset Transfers A Review of the California Supreme Court s Henkel Decision INTRODUCTION Acquisitions of businesses or product lines are often accomplished through asset purchase and sale agreements. In some instances, internal restructurings are accomplished through asset transfers. A recent California Supreme Court decision, Henkel Corporation v. Lloyd s of London, 1 illustrates the perils such asset agreements may pose for a purchaser that is liable for claims arising out of the historical operations of the seller. In sum, Henkel Corporation was liable for long-tail chemical exposure claims arising out of products made by a business, the assets of which Henkel purchased years after the underlying claimants were injured. Yet the California Supreme Court held that Henkel had no rights to the historical liability insurance policies of the seller that covered the seller s products and operations during the relevant years. Significantly, Henkel was faced with these uninsured liabilities by virtue of a pre-acquisition restructuring transaction by its seller, a transaction to which the historical insurers were not requested (as the court ruled they should have been) to consent. While Henkel will obviously be of interest in ongoing and future insurance coverage disputes, the decision should also command the careful attention of corporate counsel. The decision, for example, could have important implications for the allocation of risk in pending and future asset transactions. Furthermore, corporations undertaking internal reorganizations through asset transactions should take note of the decision to ensure that their internal transactions do not have unintended insurance consequences. Finally, depending upon the circumstances, past transactions (particularly internal ones) may warrant reexamination and possible amendment in light of the Henkel decision. After presenting a brief overview of the Henkel decision, therefore, we offer some considerations for corporations and their counsel in connection with pending and historical asset transactions. BACKGROUND Corporate asset acquisitions are often desirable because they can afford the buyer in some situations the opportunity to acquire the assets of a business free from its historical liabilities. Transaction dynamics, however, may require a buyer to assume liabilities voluntarily in certain transactions. Further, after a transaction, some purchasers may find themselves deemed by operation of law to be a successor to the liabilities of the seller or otherwise liable for the liabilities arising out of historical operations. 2 Finally, in internal restructurings, where businesses are being segregated for purposes of sales, for example, liabilities also may be expressly assumed. In all of these cases, purchaser liability raises the question of whether the purchaser may access historic insurance policies that covered the operations of the seller. 1 Henkel Corp. v. Hartford Accident & Indem. Co., No. S098242, 2003 Cal. LEXIS 873, at *2 (Cal. 2003). 2 E.g., Ray v. Alad, 560 P.2d 3 (1977) (holding that successor was liable for defective product of predecessor); Smithkline Beecham Corp. v. Rohm & Haas Co., 89 F.3d 154 (3d Cir. 1996) (holding that successor and predecessor were jointly and severally liable for CERCLA cleanup).

2 In Henkel, this question arose in the specific context of liabilities assumed by contract (i.e., in an asset purchase agreement), and the decision was expressly limited to the context of a contractual assumption of liabilities and transfer of assets. The case involved a series of complicated transactions, but the relevant one for the insurance coverage issue was the contractual separation of two product lines of what was then a wholly-owned subsidiary of Union Carbide Corporation. Union Carbide acquired Amchem Products, Inc., which manufactured and sold agricultural and metallic chemicals, in After Union Carbide acquired it in 1979, Amchem Products, Inc., a Pennsylvania corporation ( Amchem No. 1 ), created a new Delaware corporation of the same name ( Amchem No. 2 ). 3 Amchem No. 1 then transferred all of its rights, title and interest in and to its domestic assets utilized in its metalworking business to Amchem No The board of Amchem No. 2 unanimously accepted Amchem No. 1 s transfer of assets, liabilities and goodwill utilized in its metalworking chemical activities. 5 The Henkel court treated the 1979 resolutions as a contract between Amchem No. 1 and No. 2. Henkel Corporation ultimately became the successor to Amchem No. 2 by its 1980 acquisition of all of Amchem No. 2 s stock and the subsequent merger of the two entities. Amchem No. 1 s successor was Rhone Poulenc, Inc., by virtue of its purchase of the stock of Amchem No. 1 in 1986 and the 1992 merger of Rhone Poulenc and Amchem No These transactions set the stage for the question of which entity or entities, Henkel, Rhone Poulenc, or both, could claim the benefits of the historical insurance assets of Amchem Products, Inc. for liabilities arising out of the historical metalworking chemical operations. Claims arising out of those operations were asserted in a suit brought in 1989 by current and former Lockheed employees against Henkel and Amchem Products, Inc. The Lockheed plaintiffs alleged injuries arising out of exposure to metallic chemicals between The reference to Amchem Products, Inc. did not make clear whether Amchem No. 1 or Amchem No. 2 was the intended target of the lawsuit, but the plaintiffs did not serve Rhone Poulenc (i.e., the successor to Amchem No. 1) until 1992, some three years after they filed suit. Henkel tendered its defense to the insurers that issued policies to Amchem No. 1 during , as well as to its own insurers. All denied coverage. After the plaintiffs served Rhone Poulenc, it moved to quash service. The plaintiffs ultimately agreed to Rhone Poulenc s motion, because they were presented with documents that established that Henkel was answerable for the metalworking chemical liabilities at issue. Rhone Poulenc was therefore no longer a defendant, and Henkel ultimately settled with the Lockheed plaintiffs for $7.65 million in 1995 and sued the insurers for declaratory relief. 8 Because of Henkel s merger with Amchem No. 2, the trial court found that Henkel was responsible for all of Amchem No. 2 s liabilities, including those assumed from Amchem No. 1 in the 1979 asset acquisition. 9 Henkel contended that along with the liabilities, Amchem No. 2 also acquired assets, including insurance coverage for the liabilities. The trial court disagreed, ruling that any assignment of Amchem No. 1 s policies would be void without the insurers consent and entered summary judgment against Henkel. 10 The court of appeal reversed, holding that the right to indemnity followed the liability rather than the policy itself. Therefore, because Amchem No. 2 acquired the liabilities of Amchem No. 1, it also acquired the insurance policies covering such liabilities. The decision was based, in part, upon Northern Insurance Co. v. Allied Mutual Insurance Co., which held that even though the parties did not assign [the predecessor insurance] policy in the agreement, the right to indemnity under the policy transferred to [the successor corporation] by operation of law Henkel, 2003 Cal. LEXIS 873, at * Id. at *4. 5 Id. 6 Id. at *5. 7 Id. 8 Id. at * Id. at * Id. at *8. 11 Id. at *8, (quoting Northern Insurance Co. v. Allied Mut. Ins. Co., 955 F.2d 1353, 1357 (9th Cir. 1993)). 2 KIRKPATRICK & LOCKHART LLP INSURANCE COVERAGE UPDATE

3 THE SUPREME COURT DECISION The California Supreme Court characterized Henkel s principal arguments as follows: first, that insurance coverage should follow liability when liability is imposed by operation of law; 12 and, second, that policy benefits under occurrence policies may be assigned without insurer consent once the events giving rise to the liability have taken place. 13 The court rejected both arguments. Was Liability Imposed by Law? Turning to the first, the court outlined three circumstances by which liability may be imposed on an asset purchaser by operation of law. If Henkel s situation fell within any of the three categories, then the question of whether or not insurance coverage followed the liability as a matter of law would be presented. The court did not reach this question, however, because it found that liability was not imposed by operation of law. First, the court noted that an asset purchaser may be subjected to liability under three broad criteria that focus upon the transaction itself: (1) when the transaction amounts to a consolidation or merger of the two corporations; (2) when the purchasing corporation is a mere continuation of the seller; or (3) when the transfer of assets is for the fraudulent purpose of escaping liability. 14 Reviewing each prong of this test briefly, the court found that none of these situations applied to Henkel. Second, the court noted that a company that acquires a product line may be held liable as a matter of law for injuries caused by its predecessor s defective products if the injured party has no remedies against the original company. 15 The court ruled this exception inapplicable as well, because Rhone Poulenc, as the successor to Amchem No. 1, could respond to any suit based on pre-1979 toxic exposure. Further, it ruled that even if Amchem No. 1 dissolved after the transfer of the metallic division to Amchem No. 2, under California law a plaintiff still could assert a claim against Amchem No. 1 for the purpose of accessing its liability policies. 16 Third, the court noted some statutes, including CERCLA, 17 impose liability as a matter of law on successor corporations without regard to contract. No such statute existed with regard to the liabilities at issue in the underlying suit. In sum, the court ruled that Amchem No. 2 assumed the liabilities of Amchem No. 1 voluntarily by contract and was not subjected to the imposition of the liabilities by operation of law. 18 Because none of the criteria for imposition of liabilities as a matter of law applied, the court did not address the important question presented in such cases of whether or not insurance rights also are transferred as a matter of law to the deemed successor. 19 Was Insurer Consent Required? Having concluded that Amchem No. 2 assumed by contract the historical liabilities at issue in the Lockheed plaintiffs suit, the court ruled that Henkel s rights, as successor to Amchem No. 2, to any benefits under the insurance policies depend on the terms of the 1979 contract by which Amchem No. 2 acquired the assets of Amchem No Although ruling that the question was a contractual one, the court did not address whether or not the broad asset transfer language set forth in the board resolutions that formed the basis of the contract between Amchem No. 1 and Amchem No. 2 were intended to transfer insurance policy rights. It reached this conclusion by ruling that any contractual assignment would be invalid because it lacked the insurer s consent. 21 The court held that a policy provision purporting to prohibit assignment of interest under the policy without the insurer s consent endorsed on the policy 22 was effective to preclude the assignment. In doing so, the court rejected Henkel s argument that insurer consent was unnecessary for several reasons Henkel, 2003 Cal. LEXIS 873, at *9. 13 Id. at * Id. at * Id. at * Id. at * Id. at *12; Comprehensive Environmental Response, Compensation, and Liability Act, 42 U.S.C. 9601, et seq. (2002). 18 Henkel, 2003 Cal. LEXIS 873, at * Northern Insurance Co. v. Allied Mut. Ins. Co., 955 F.2d 1353, (9th Cir. 1993) (holding that a successor has the rights to a predecessor s policies, including a defense, after liabilities have been imposed by law). 20 Henkel, 2003 Cal. LEXIS 873, at * Id. at * Id. 23 Id. at * MARCH 2003

4 Henkel initially argued that consent was not necessary because the insurance rights were transferred to it as a matter of law; as noted above, the court rejected this argument. In addition, Henkel argued that insurer consent was not necessary because policy benefits under occurrence-based policies may be assigned without consent after the event giving rise to the liability has occurred. In considering this argument, the court noted the general principle that contractual and legal prohibitions on assignment do not preclude the assignment of money due or to become due under a contract or assignment of claims for breach thereof. The court ruled, however, that even if the general principle applied to liability insurance policies, it did not apply to the circumstances of the Henkel case. In rejecting Henkel s argument, the court reasoned that Amchem No. 2 assumed Amchem No. 1 s liabilities before the duty to defend and indemnify the claims of the Lockheed plaintiffs became an assignable chose in action. The claims had not been reduced to a sum of money due, and the court reasoned that there was not a wrongful failure to defend or indemnify the Lockheed plaintiffs claims prior to the 1979 transaction, because the claims had not yet been asserted. Thus, the court ruled that the right to defense and indemnity for the Lockheed plaintiffs claim could not be assigned without the insurers consent. Henkel also argued that assignment of the policies, even without insurer consent, would not place an additional risk on the insurers. Since the claims involved the risks contemplated by the insurers upon the issuance of the policies, Henkel contended that the assignment would not affect either the liability of the insurers, or the policy limits. The court disagreed, stating that an additional burden might arise if the predecessor corporation still existed or could be sued. In such cases, the court argued that an insurer might be faced with the costly task of defending both the predecessor and successor corporations. 24 Further, the court suggested that the mere dispute over which party was covered may also create an additional burden for the insured. Because of these perceived additional burdens, the court rejected the argument that consent was not necessary. 25 The Dissent The Henkel ruling provoked a spirited dissent, albeit by a single justice. According to the dissent, the majority failed to recognize and follow California case law that permits the assignment of insurance coverage after a loss has occurred. 26 Further, the dissent argued that the majority mischaracterized the nature of a chose in action. According to the California Civil Code, a chose in action is defined as a right to recover money or other personal property by a judicial proceeding. 27 The dissent reasoned that a chose in action is not, as the majority stated, a claim reduced to a monetary judgment. Further, the dissent disagreed with the majority s contention that an assignment of the policy resulted in greater liability for the insurer. To the contrary, an insurer s risk cannot be increased by a change in the insured s identity. 28 Because liability is fixed (in an occurrence policy) when the event giving rise to the injury occurs, an assignment of the policy to another entity after the event cannot give rise to greater liability. 29 Quoting Northern Insurance, the dissent stated: [w]hen the loss occurs before the transfer, however, the characteristics of the successor are of little importance: regardless of any transfer, the insurer still covers only the risk it evaluated when it wrote the policy. 30 Under the dissent s view, liability could not, as the majority contended, be increased if the predecessor still existed, because any right to the policy would have been transferred to the successor. IMPLICATIONS OF THE HENKEL DECISION Henkel has a number of important implications for transactions involving asset acquisitions Id. at * Id. at * Id. at * Id. at *25-26, (quoting Cal. Civ. Code 953 (2003)). 28 Id. at * Id. at * Id. at *31-32, citations omitted. 31 Of course, as with any transaction, the particular circumstances of the deal may render some or all of these suggestions inapplicable. Furthermore, other aspects of the transaction may outweigh consideration of these insurance issues. 4 KIRKPATRICK & LOCKHART LLP INSURANCE COVERAGE UPDATE

5 If deal dynamics require the assumption of a seller s liabilities, there is no clear path (if Henkel applies) for the buyer clearly to acquire the seller s insurance rights without insurer consent. There may, however, be creative ways to increase the possibility that a buyer would obtain the benefit of historical insurance assets. One such possibility may include a transaction under which: (i) the buyer assumes the seller s uninsured liabilities; (ii) the buyer agrees to advance funds for insured liabilities; (iii) the buyer s advancement of funds for the insured liabilities would be subject to a right to recover from the seller any insurance coverage proceeds the seller obtains from its historical insurers; and (iv) the buyer agrees to fund, and has the right to control, the pursuit of that historical insurance coverage. Purchasers of a business, even where stock is being acquired, should perform careful due diligence regarding prior internal transactions to determine whether (as in Henkel) a corporation being purchased had earlier assumed liabilities for which historical insurance assets may not be available. that could result in the assumption of liabilities but not the transfer of insurance rights. A review of historical transactions that may have negative insurance implications for the purpose of potential corrective amendments may be in order. Finally, corporations should not assume that the rule articulated in Henkel will necessarily apply outside of California. Courts have taken conflicting approaches to the issue in Henkel and to related disputes regarding a successor s rights to the insurance coverage of a predecessor. 32 A corporation s perspective on Henkel in insurance coverage disputes will obviously vary depending upon whether it retained insurance rights or whether it may find itself without insurance rights it believed it possessed. For pending and future transactions, however, the decision clearly suggests that the asset buyer who assumes historical liabilities should carefully consider how best to reduce the risk of not acquiriing the benefits of the corresponding historical insurance policies. Corporations should consider carefully the insurance implications of internal restructurings DAVID F. MCGONIGLE dmcgonigle@kl.com The Insurance Coverage practice group at Kirkpatrick & Lockhart LLP is one of the nation s largest policyholderoriented practices. Its attorneys have authored Policyholder s Guide to the Law of Insurance Coverage and currently edit the Journal of Insurance Coverage. FOR ADDITIONAL INFORMATION about these issues, please consult any of Kirkpatrick & Lockhart s office contacts listed below: Boston John M. Edwards jedwards@kl.com Dallas Robert Everett Wolin rwolin@kl.com Harrisburg Raymond P. Pepe rpepe@kl.com Los Angeles David P. Schack dschack@kl.com Miami Daniel A. Casey dcasey@kl.com Newark Anthony P. La Rocco alarocco@kl.com New York Peter J. Kalis pkalis@kl.com Pittsburgh Peter J. Kalis pkalis@kl.com San Francisco Edward P. Sangster esangster@kl.com Washington Matthew L. Jacobs mjacobs@kl.com MEGHAN L. DAUGHERTY mdaugherty@kl.com D.F. McGonigle, Long-Tail Successor Liability and the Right to Access a Predecessor s Insurance Coverage: Conflicting Responses from California Courts, J. of Ins. Coverage, Vol. 4, No. 4, 71, 77 (Autumn 2001). The article refers to Gopher Oil Co. v. Amer. Hardware Mut. Ins. Co., 588 N.W.2d 756 (Minn. Ct. App. 1999) which holds that a successor is entitled to coverage under a predecessor s policy. However, the article also makes reference to Red Arrow Products Co., Inc. v. Employers Ins. of Wausau, 607 N.W.2d 294 (Wis. Ct. App. 2000) in which the court denies coverage to the successor because they were neither a party to the original insurance contract, nor an assignee of the policy. See also B.S.B. Diversified Co., Inc. v. Am. Motorists Ins. Co., 947 F. Supp. 1476, 1482 (W.D. Wash. 1996) (holding that a contractual sale of assets is an effective transfer of both liabilities and insurance coverage). Challenge us. BOSTON DALLAS HARRISBURG LOS ANGELES MIAMI NEWARK NEW YORK PITTSBURGH SAN FRANCISCO WASHINGTON... This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer KIRKPATRICK & LOCKHART LLP. ALL RIGHTS RESERVED.