New York’s highest court has ruled that a buyer assumed the liability for certain asbestos-related claims under a sale contract when it bought the boiler business of plaintiff American Standard Inc. back in 1970. American Standard Inc. v. Oakfabco Inc., 2010 WL 1286394 (N.Y., 4/6/10).

The court said that the issue here was whether the buyer of a boiler business assumed the seller’s liabilities for tort claims based on boilers sold before the business was acquired, even where the tort claimants were not exposed/injured until after the acquisition. In 1970, American Standard, Inc. sold its Kewanee Boiler division to OakFabco, Inc. The parties entered an asset purchase and sale agreement in which the buyer assumed certain liabilities. The boilers manufactured by Kewanee had been insulated with asbestos, and as a result many tort claims were brought in the years and decades following the purchase of the business.

Some of those claims were brought by plaintiffs who had suffered injuries after the closing of the transaction, allegedly attributable to boilers manufactured and sold before the closing. In this declaratory judgment action brought by American Standard against OakFabco, the issue was whether liabilities for such injuries were among the liabilities that OakFabco assumed.  OakFabco argued that the definition of the liabilities OakFabco assumed was limited to “existing and outstanding” liabilities as of the Closing Date. According to OakFabco, a tort claim cannot be “existing and outstanding” before the tort plaintiff has been exposed and injured, because until then it is not possible for a tort lawsuit to be brought.

The court found, however, that the overall contract language meant that the buyer would deal with any problems customers had after the closing date with boilers that had been installed previously. It would have been absurd for OakFabco, said the court, to tell a customer whose boiler failed after the closing that, since the customer’s claim was not “existing and outstanding” on the closing date, it was not OakFabco’s problem. By including warranty, service, repair and return claims in the definition of liabilities, the parties demonstrated that they were not reading the words “existing and outstanding” as OakFabco now did.

The court therefore concluded that the liabilities assumed by OakFabco included claims brought by tort claimants injured after the closing date by boilers installed before that date.

The case is a timely reminder that 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, such as in asbestos, 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. It is crucial that the language be clearly drafted to reflect the parties’ agreement on the allocation of such liability.

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, or contract language assuming liability, 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’ other 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.