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Legacy Liabilities: Issue Spotting And Strategies

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
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
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
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
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).
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