Buying a Business? Don't Get Bitten by the Hidden Risk of Successor Liability

September 27, 2011

By: Steven C. Spronz

GACC Legal & Tax Newsletter

Thinking of buying a company or all the assets of a business? Done your due diligence? Convinced that the company or the assets are free of liabilities, liens and claims? Think that, because you are buying assets and not the shares of the company, you are not responsible for injuries and damage from business conducted by the seller prior the sale? Well, think again.

Successor Liability
In an effort to prevent reasonable claims from going uncompensated, courts have developed a number of theories under which “successor liability” will be imposed on the purchaser of a company or its assets. These theories result in liability for damages from events that occurred before the acquisition and that the purchaser had nothing to do with, even if the purchaser acquires only assets.

When the sale of a business formed as an entity (a corporation, for example) simply continues its business, as is the case in a merger of two entities, or the sale of all shares or a controlling interest in the purchased entity, the sale is effectively invisible to third parties. In that case, courts generally hold that the post-acquisition business is the same as the pre-sale business; therefore, the new owners of the post-acquisition business are liable for injuries sustained and damage done prior to the sale even if the claim is made after the sale.

Courts generally reach the same conclusion where the business, even if not formed as a corporate or similar entity, is exactly the same before and after the sale, though under new ownership. Additionally, a minority of states recognize a “product-line exception” to the old rule that where a purchaser buys only assets, the purchaser is not liable for injuries and damage from business conducted pre-sale. This exception imposes strict product liability on the buyer when the seller manufactured products sold to the public and the buyer continues manufacturing those products.

Insurance Policies
If, after digesting the successor liability problem, you sit back content in the thought that the insurance policies covering the pre-sale business will cover events occurring before and after the acquisition, think again.

Under current law, in the case of sales of shares and any type of merger, the seller’s insurance policies are generally deemed transferred to the new owner. However, in the case of sales of assets, there is a split of authority in the courts. In the majority of states, the courts have held that where the purchaser has successor liability for claims from the seller’s business, the purchaser is entitled to use the seller’s liability insurance coverage under “occurrence” policies for pre-acquisition claims even if there are anti-assignment provisions in the seller’s insurance policies. California is representative of a minority of jurisdictions holding that when a purchaser of assets has voluntarily assumed the seller’s liabilities under a written contract an anti-assignment provision contained in the seller’s liability insurance policy will be enforced. Under this holding, the purchaser of the seller’s assets will not be able to access the seller’s liability insurance for protection against the burden of successor liability without the insurer’s express consent.

Quick Tips

• Investigate what liabilities might come with the company or assets you are purchasing, and address those actual and potential liabilities head on.
• Negotiate a risk allocation between seller and buyer for post-acquisition claims relating to business conducted by the seller prior to the sale.
• Check the insurance policies, if any, that cover the seller’s business conducted prior to the sale.
• Discuss continuing coverage with the seller’s insurance carriers to determine whether or not they will provide coverage for post-acquisition claims from the pre-sale business.

Although none of this can guarantee a risk-free acquisition on the question of successor liability, it can go a long way toward reducing surprise and disappointment once the deal is closed.