For today’s post, MassTortDefense takes a step away from our usual fare of recent decisions and current events to discuss a broader topic: evaluating mass torts in a merger or acquisition context.
Acquiring Litigation Liability and Structural Considerations
An important aspect of evaluating the possible acquisition of a target company is the potential litigation liability that may be acquired simultaneously. If a target company is involved, or could potentially become involved, in mass tort litigation, it presents both risk and opportunity to the acquirer. The threat of this type of litigation may result in the opportunity to acquire a target at a below-market valuation multiple, and the uncertainty caused by mass tort exposure can result in valuation discounts that make the attendant risk acceptable. There are potentially significant risks, however, associated with mass tort litigation exposure, and thus buyers must proceed carefully. In the private equity context, in particular, mass tort litigation exposure can adversely impact the ability to secure third-party debt financing and can have an adverse impact on investment exit. Private equity purchasers may have shorter investment time frames than strategic buyers, and mass tort litigation often takes a substantial amount of time to resolve itself.
The general rule of law, and the typical structure of an asset purchase agreement, is that an acquirer of the assets of another corporation for cash does not acquire the liability for prior injuries caused by products sold by the target company prior to closing. Even when the parties purport to allocate such liability to the target, however, the buyer may find itself responsible for the litigation through the operation of various legal doctrines that are exceptions to the general rule.
The Restatement (Third) of Product Liability Law notes that a business entity that acquires assets of a predecessor business entity is subject to liability for harm caused by a defective product sold by the predecessor if the acquisition results from a fraudulent conveyance to escape liability for the liabilities of the predecessor, or results in the successor becoming a mere continuation of the predecessor. A few states also add the so-called “product line” exception, which allows a plaintiff to recover for injuries caused by a defective product sold by the predecessor in cases in which the successor corporation has continued the predecessor’s product line.
Thus, even in the absence of an actual merger or stock acquisition, it may be that a buyer of corporate assets will still face exposure to product litigation liability risks. Attempting to structure the deal to try to minimize the possible application of such theories will often be the first line of defense. In an asset sale, the buyer may also want to seek a provision that the seller shall not dissolve for some set period of time, so that the mass tort plaintiffs’ remedies seemingly are not destroyed. Special indemnification by the seller for the underlying exposure is another alternative. This indemnification should survive for a sufficient period of time, and ideally would not be subject to a special cap higher than is typical for representations made by a “clean” company. The use of a special escrow to set aside funds for the litigation indemnification may be important.
When the target company is involved in mass tort litigation, the successor liability risks to the buyer must be examined even more carefully. Buyers must recognize that the successor liability determination may be made by a state court confronting thousands of tort suits and applying the law of the home state of the plaintiff who, absent a finding of successor liability, may be without an adequate remedy. It may not be possible for a buyer to negotiate indemnification that lasts long enough, or is backed by a large enough escrow to eliminate material risks. Thus, it may be a mistake to rely too readily on contractual safeguards without a clear understanding of the future litigation risks.
Mass Tort Risks
A mass tort’s numerous claims pose incredible financial risks, as evidenced by the bankruptcies of large, otherwise prosperous entities because of such litigation. A simple snapshot of any current litigation may understate the potential number of claims, especially if there is a long latency period—the time between exposure to the product at issue and manifestation of the disease allegedly caused by the product. Aggregation of many claims in one procedure, such as a class action, may create an all-or-nothing risk for defendants, compelling what some courts term “blackmail settlements.” Even if the risks of being found liable as a successor seem small, the magnitude of the possible harm generated by the mass tort dictates that the due diligence process carefully evaluate the potential liability.
Mass Tort Due Diligence: Goals and Methodology
The due diligence analysis to help answer the question “What am I buying into?” may involve actual data and dollars. But, requiring as it does judgments about the future litigation environment, it may not result in a precise numerical risk estimate. Thus, the buyer will ultimately make a business judgment about the range of risks that are acceptable in light of numerous factors, including assets available to cover the risks (such as insurance and indemnifications), and the financial benefits of the deal.
Experience has shown the optimal approach to the mass tort due diligence inquiry is to approach the risk question from numerous distinct perspectives, and then combine the learning from the approaches to help minimize the impact of gaps in knowledge. This allows extrapolations to be made with greater confidence.
In the next post, MassTortDefense will describe three such perspectives that can offer insight.