Corporate Successorship: What You Don't Know Could Cost You

Corporate Successorship and Tort Liability

At its most basic level, a corporation is a distinct legal entity created by statute with the ability to own and hold property and be held civilly and criminally liable for its actions. Because a corporation is a recognized legal “person,” it is also capable of transferring all or some of its assets to another corporation. When this happens, the question often arises as to which corporation bears the tort liability when someone is injured by the original corporation's product. The answer turns, in large part, on the mechanism by which the assets are transferred and the ongoing viability of the original corporation.

There are three primary ways of effecting an acquisition: 1) a statutory merger; 2) a stock sale; or 3) an asset sale, each with its own rules regarding the transfer of tort liability.'

Statutory Mergers

A statutory merger is carried out in accordance with a state's merger statute, and effected when articles of merger are executed and filed with that state's Corporation Commission. Robert W. Wood, Corporate Acquisitions and Mergers (MB) ' 5B.01 (2012). In this type of acquisition, one corporation acquires the assets and liabilities of another, “target” corporation. As of the effective date of the merger, the target corporation ceases to exist and the acquiring corporation continues as the survivor with the assets and liabilities of both pre-merger companies. Id. By operation of law, the acquiring corporation assumes all of the rights and liabilities of the acquired company, including the liability for the injuries caused by the pre-existing corporation's products. Id. ' 5A.02. In fact, the acquiring corporation becomes liable for the prior obligations of the merged corporation, whether the obligations are known, unknown or contingent. As a result, the acquiring corporation assumes the risk that the merged corporation has unknown or undisclosed liabilities.

Stock Sales

A stock sale occurs when the acquiring corporation purchases shares of stock in the target corporation from the target's individual shareholders in exchange for cash, stock, securities or other property. Id. ' 5A.01. The acquiring corporation becomes the shareholder of the target corporation. Id. ' 5A.04. The form of the corporation does not change. Both of the companies continue to exist with the companies' respective pre-transaction rights and liabilities. The acquiring company simply owns the stock of the target corporation and its liability is therefore limited as a shareholder.

Asset Purchases

A sale of assets by one corporation to another is the most complex of the corporate transactions vis-'-vis tort liability and insurance issues. In such a sale, the acquiring corporation purchases all or part of the assets of the selling corporation in exchange for shares of stock, securities, cash or other property. Id. ' 5A.01. No specific statutory authority is needed for a corporation to buy the assets of another corporation and only those assets that are specifically conveyed will transfer to the buyer. Importantly, the liabilities associated with those assets will typically not transfer as part of the sale unless expressly assumed by the acquiring corporation. Id. ' 5A.03 Thus, in contrast to a statutory merger, there is no automatic transfer of assets and liabilities by operation of law and the corporation purchasing the assets is generally not liable for injuries caused by the selling corporation's products.

There are, however, several exceptions to this rule, where corporations purchasing another's assets could be held responsible for the selling corporation's products or conduct, including the following.

1. Assumption by Agreement: The acquiring corporation will be obligated to pay any of the transferor corporation's liabilities that it expressly assumes under the contract.

2. Fraudulent Conveyance: Even if the purchasing company does not expressly assume the liabilities associated with the purchased assets, the purchasing company may still be held liable if the transfer of assets between the two corporations is deemed fraudulent and the purchasing corporation is found to be complicit in the fraud. Fraudulent transfers (or conveyances) are characterized as transfers made to remove property from the reach of creditors, without adequate return. Honor S. Heath, Charles A. Heckman & Keara M. O'Dempsey, Business Torts (MB) ' 8.01 (2013).

3. De Facto Merger/Continuation of Predecessor: The phrase “de facto merger” describes a situation where the acquiring company obtains substantially all of the selling company's assets, dissolves the selling company, but gives the shareholders of the dissolved company new shares in the acquiring company. While structured as a sale of assets, this transaction may have the same basic economic effect as a statutory merger. The selling corporation no longer exists as a separate entity and both of the corporations' interests are joined in the acquiring corporation. Wood, supra note 1, ' 5C.06.

In some jurisdictions, a court faced with such a transaction will find that the asset acquisition is a de facto merger or mere continuation of the transferor corporation. Id.
' 5C. A court will look for certain indicia of a statutory merger in making this determination. For example, did the purchaser acquire substantially all of the assets and leave no operating lines of business in the selling corporation or did the purchasing corporation hold its business out as a continuation of the selling corporation's business to the public and continue to sell the same product under a similar name. In such circumstances, the de facto merger/continuation of predecessor exception prevents these purchasing companies from avoiding assumption of the selling companies' liabilities while reaping all the benefits of a statutory merger.

In addition to these three universally recognized exceptions, some courts also recognize two additional exceptions where they impose strict liability on the purchasing corporation: 1) the product line exception; and 2) the continuity of enterprise exception.

1. Product Line Exception: This exception is recognized in only five jurisdictions, most notably California, and applies when a company acquires a manufacturing business and continues the output of the line of products. See Ray v. Alad Corp., 560 P.2d 3 (Cal. 1977). In such circumstances, the acquiring company can be held strictly liable to plaintiffs who are injured by a product manufactured by the predecessor, selling corporation. Thomas Fegan, Products Liability Practice Guide (MB) ' 9.03 (2013). In general, this exception is applied when the successor corporation purchases substantially all of the assets of the selling corporation, the products liability arises from the selling corporation's product line, the predecessor corporation ceases to exist so that there is no remedy against the predecessor, and the successor used the goodwill of the predecessor. Diane L. Polscer, Successor Liability: Liability and Coverage Implications, 55 Fed'n Def. & Corp. Couns. Q. 107 (2004).

2. Continuity of Enterprise Exception: The continuity of enterprise exception, adopted in just three states, (Alabama, Alaska and Michigan) represents an expansion of the traditional mere continuation exception to products liability cases. David J. Marchitelli, Liability of Successor Corporation for Injury or Damage Caused by Product Issued by Predecessor, Based on Mere Continuation or Continuity of Enterprise Exceptions to Nonliability, 13 A.L.R. 6th 355 (2006). The “continuation of predecessor” exception, described above, relies on the continuation of the entire legal entity of the predecessor corporation as a justification for imposing liability on the successor corporation. Id.

In contrast, the “continuity of enterprise” exception allows for the imposition of liability on a successor corporation that just continues the business operations of the predecessor. Id. For courts applying this exception, primary considerations include “(1) whether there was continuity of management, personnel, physical location, assets, and general business operations of the selling corporation; (2) whether the selling corporation ceased its ordinary business operations, liquidated, and dissolved as soon as legally and practically possible; (3) whether the purchasing corporation assumed those liabilities and obligations of the seller ordinarily necessary for the uninterrupted continuation of normal business operations to the selling corporations; and (4) whether the purchasing corporation held itself out to the world as the effective continuation of the seller corporation.” Id.

Corporate Successorship and the Potential Transfer of Insurance Coverage

When a successor corporation can collect under insurance policies issued to the original corporation, an insurer can face an increased level of risk. As a result, most occurrence-based general liability insurance policies contain some type of anti-assignment provision. The typical anti-assignment provision generally provides that the policyholder's rights and duties under a policy may not be transferred without the insurer's consent. The purpose of an anti-assignment provision is to protect the insurer from any unforeseen changes in risk.

There are, however, exceptions to this anti-assignment rule, where courts refuse to enforce the anti-assignment clauses.

Operation of Law

Despite the inclusion of an anti-assignment provision in an insurance contract, the insurer's consent is not needed in the event of a statutory merger. The statute governing a merger transaction usually provides that the assets and liabilities vest immediately with the surviving corporation upon consummation of the transaction. As a result, rights and benefits under a liability insurance policy previously belonging to the target corporation transfer, by operation of law, to the surviving corporation.

A minority of courts have also held that insurance rights transfer by operation of law when the corresponding liabilities also transfer by operation of law, whether or not there is a statutory merger. Most notably, in Northern Insurance Company v. Allied Mutual Insurance Company, the Ninth Circuit held that the insurance rights at issue were transferred by operation of law where the liabilities transfer by operation of law under California's rule of product-line successor liability. 955 F.2d 1353, 1358 (9th Cir. 1992). The court reasoned that “non-assignment” clauses are designed to protect an insurer from risk that is unforeseen when deciding to provide coverage. When the loss at issue occurs before the transfer of liability, the insurer, in that court's view, covers only the risk it evaluated when issuing the policy, irrespective of any transfer. Id.

This holding in Northern Insurance has been rejected by many courts, which recognize that tort liability is distinct from contractual insurance liability. For example, in General Accident Insurance Company v. Superior Court, the California court rejected a transfer of an insurance policy by operation of law as “a violation of the basic principles of contract and ' bad public policy.” 64 Cal. Rptr. 2d 781, 788 (Cal. Ct. App. 1997).

Post-Loss Assignment

In another exception to the anti-assignment rule, some courts refuse to enforce ant-assignment clauses in situations when a loss took place prior to the assignment. In such cases, the courts hold that the right being assigned by the policyholder is the right to recovery of insurance proceeds. The courts reason that since the purpose of an anti-assignment clause is to protect an insurer from increased liability, if the events giving rise to the insurer's liability have already taken place, the insurer's risk is not increased by a change in the insured's identity. 3 Couch on Insurance ' 35:7 (3d ed. 2004). Indeed, courts have held that transfer of such a right does not increase the insurer's risk because the only remaining duty of the insurer is to make payment on the loss.

However, although this exception is generally recognized, it is not uniformly applied by the courts in the context of third party liability coverage. Indeed, in the last decade, we have seen a sharp divide in the courts as to what constitutes the “loss” that must take place prior to the assignment. On the one hand, insurers assert that the exception is only valid when the liability of the policyholder has been established and judgment entered. At that point, the only remaining thing for the insurer to do is to pay the insurance proceeds. On the other hand, policyholder advocates argue that transfer of coverage should be permitted whenever the underlying injury to the third party has already taken place.'

In 2003, the California Supreme Court addressed this issue in Henkel Corporation v. Hartford Accident & Indemnity Company and held that the insurance had not transferred to the successor corporation on the basis that any assignment of the insurance policy was ineffective because, at the time of the attempted transfer, the original policyholder's liability was not reduced to a monetary amount and the insurer had not consented to the assignment. 62 P.3d 69, 71 (Cal. 2003). Henkel Corp. had acquired the metallic chemical product line of Amchem Products Inc., assumed all related liabilities and was later sued on those liabilities. Id.

Henkel Corp. then sought coverage under an insurance policy purchased by Amchem Products. Id. at 72. Henkel Corp. argued that the insurer's consent to the assignment was not required because, under an occurrence policy, “benefits can be assigned without consent once the event giving rise to liability has occurred.” Id. at 75. The California court rejected this argument on the grounds that there was no assignable chose in action since the underlying “claims had not been reduced to a sum of money due or to become due under the policy.” Id. The Henkel court also rejected the argument that there was no additional risk to the insurer, explaining that an “additional burden may arise whenever the predecessor corporation still exists or can be revived because of the ubiquitous potential for disputes over the existence and scope of the assignment.” Id.

Three years later, the Supreme Court of Ohio reached a different conclusion. When faced with the question of whether the anti-assignment provisions applied when a corporate successor sought environmental coverage under an insurance policy issued to a predecessor, the court in Pilkington North American v. Travelers Casualty & Surety Company held that a “chose in action” was transferable to the purchasing corporation irrespective of the anti-assignment clause. 861 N.E.2d 121, 126 (Ohio 2006). While the Ohio Supreme Court agreed that coverage rights do not follow liability by operation of law when the liability is assumed under contract, the Ohio court refused to follow the California Supreme Court's decision in Henkel with respect to the time when a chose in action arises. Id. In contrast to the Henkel court's determination that a chose in action arises when the claim has been reduced to the sum of money owed, the court in Pilkington relied on Ohio precedent to conclude that a chose in action arises at the time the underlying bodily injury or property damage takes place. Id.

More recently, in the case of Travelers Casualty & Surety Co. v. U.S. Filter, the Indiana Supreme Court addressed the issue of anti-assignment clauses and post-loss assignment and followed the requirement set forth in Henkel that “for an insured loss to generate an assignable coverage benefit, the loss must be identifiable with some precision. It must be fixed, not speculative.” 895. N.E.2d 1172, 1180 (Ind. 2008). However, the court in Filter did note that anti-assignment clauses would not preclude transfer without consent of the insurer if the occurrence of the loss ' i.e., a judgment against the insured ' had preceded the assignment. Id.

The sharp divide between Henkel, Pilkington, Filter, and other cases on the issue of when a chose in action arises and can be transferred, notwithstanding the lack of insurer consent, leads to considerable uncertainty with respect to whether insurance coverage transfers when the assets of a business are sold. Many jurisdictions have yet to weigh in on the issue, and even where they have, we have not necessarily heard the last word on the subject. Indeed, the California Supreme Court may itself revisit its Henkel decision this year. See Fluor Corp. v. Superior Court, 146 Cal. Rptr. 3d 527 (Cal. Ct. App.), leave to appeal granted, 149 Cal. Rptr. 3d 675 (2012).

Best Practices

Know Your Policyholder

In light of the numerous circumstances in which insurance rights will not transfer to a corporate successor, it is important for an insurer to thoroughly vet the entity seeking coverage. Along those lines, answering the following questions may help:

1. Is the entity claiming coverage really the same entity that you insured? Although the answer to such a question may be obvious in most instances, it is important to remember that a company's name is an asset that can be sold to a new company just like any other asset. A quick check with the entity's state of incorporation can verify whether “Policyholder A, Inc.” is the same “Policyholder A, Inc.” that you insured or whether it is a different entity that just purchased the right to use the corporate name in order to obtain the goodwill associated with it.

2. Do the transaction documents purport to transfer insurance coverage? In an asset sale, insurance policies typically will not transfer absent an express intention by the original insured to transfer or share insurance rights, and there can be many reasons that a company selling assets will want to retain all of those rights for itself. Therefore, it is of utmost importance to review the transaction documents to determine whether the parties even intended to transfer coverage in the first place.

3. Who else may claim coverage under the policies? In many instances, a corporation's policy may provide coverage for its divisions and wholly-owned subsidiaries. In today's world of complex mergers, acquisitions, divestitures and reorganizations, that means an insurer may face claims under a policy from numerous entities that now have no affiliation with each other. Understanding which entities may have a legitimate claim to coverage under the policy at the outset may reduce the risk of future claims alleging that the policy proceeds were wrongly paid to an uninsured entity.”'

Know Your Jurisdiction and Focus on Choice of Law

As discussed above, enforcement of anti-assignment provisions varies significantly among jurisdictions and the laws of different states. In addition, a number of states have yet to weigh in on the issue. Given the inconsistent state of the law in this area, it is especially important that insurers focus on which state's law will govern the insurance policies in question and the transactions undertaken by the companies insured. Such analysis should be factored into any decisions on alleged coverage rights.

In sum, it is important to know whether a successor corporation is going to be held liable for the torts or alleged misconduct of its predecessor. But it is also important to remember that just because a successor corporation might be liable for harms traceable to its predecessor, that successor does not necessarily have a right collect on insurance policies issued to the predecessor corporation, even if that was the intent of the two companies. Rather, an anti-assignment clause may preclude coverage.

Jennifer R. Devery is a litigation partner in the Insurance/Reinsurance Group of Crowell & Moring LLP. She handles complex commercial litigation focusing on the insurance and reinsurance industry. Rachel Gart is a recent graduate of Harvard Law School and joined the firm's Insurance/Reinsurance Group as an associate in fall, 2013.

In today's increasingly complex and fluid corporate world, insurers are routinely presented with claims from companies with no apparent connection to the insured named in the policy. These heretofore unknown companies nevertheless claim to be corporate successors to the original insured, and demand coverage under the policy. However, as discussed below, a corporate successor's right to coverage under a predecessor's policy is not a foregone conclusion. Rather, the outcome depends heavily on the specific circumstances of the corporate transaction, along with the particular jurisdiction and state law under which the question is posed. Thus, to protect against paying claims in error, an insurer's first line of defense is awareness of the issues.

Identifying these issues typically involves two questions. The first has to do with the underlying tort law: Will a successor corporation be held liable or responsible for harms that can be traced back to the products or conduct of an original corporation? The second question relates to insurance law: Assuming the successor corporation is held liable or responsible for the original corporation's products or conduct, can the successor corporation collect under insurance policies issued to the original insured?

Accordingly, this summary first looks at the tort law question and explains how the liability of the successor corporation typically depends upon the type of corporate transaction between the original and successor corporation. Then, in the next section, we discuss how the types of corporate transactions may also determine whether the successor corporation faced with the tort liability of the original company can collect under insurance policies issued to the original company. Finally, we close by suggesting some practical underwriting considerations that may enable an insurer to protect itself from inadvertently paying uncovered, unjustified claims.

Corporate Successorship and Tort Liability

At its most basic level, a corporation is a distinct legal entity created by statute with the ability to own and hold property and be held civilly and criminally liable for its actions. Because a corporation is a recognized legal “person,” it is also capable of transferring all or some of its assets to another corporation. When this happens, the question often arises as to which corporation bears the tort liability when someone is injured by the original corporation's product. The answer turns, in large part, on the mechanism by which the assets are transferred and the ongoing viability of the original corporation.

There are three primary ways of effecting an acquisition: 1) a statutory merger; 2) a stock sale; or 3) an asset sale, each with its own rules regarding the transfer of tort liability.'

Statutory Mergers

A statutory merger is carried out in accordance with a state's merger statute, and effected when articles of merger are executed and filed with that state's Corporation Commission. Robert W. Wood, Corporate Acquisitions and Mergers (MB) ' 5B.01 (2012). In this type of acquisition, one corporation acquires the assets and liabilities of another, “target” corporation. As of the effective date of the merger, the target corporation ceases to exist and the acquiring corporation continues as the survivor with the assets and liabilities of both pre-merger companies. Id. By operation of law, the acquiring corporation assumes all of the rights and liabilities of the acquired company, including the liability for the injuries caused by the pre-existing corporation's products. Id. ' 5A.02. In fact, the acquiring corporation becomes liable for the prior obligations of the merged corporation, whether the obligations are known, unknown or contingent. As a result, the acquiring corporation assumes the risk that the merged corporation has unknown or undisclosed liabilities.

Stock Sales

A stock sale occurs when the acquiring corporation purchases shares of stock in the target corporation from the target's individual shareholders in exchange for cash, stock, securities or other property. Id. ' 5A.01. The acquiring corporation becomes the shareholder of the target corporation. Id. ' 5A.04. The form of the corporation does not change. Both of the companies continue to exist with the companies' respective pre-transaction rights and liabilities. The acquiring company simply owns the stock of the target corporation and its liability is therefore limited as a shareholder.

Asset Purchases

A sale of assets by one corporation to another is the most complex of the corporate transactions vis-'-vis tort liability and insurance issues. In such a sale, the acquiring corporation purchases all or part of the assets of the selling corporation in exchange for shares of stock, securities, cash or other property. Id. ' 5A.01. No specific statutory authority is needed for a corporation to buy the assets of another corporation and only those assets that are specifically conveyed will transfer to the buyer. Importantly, the liabilities associated with those assets will typically not transfer as part of the sale unless expressly assumed by the acquiring corporation. Id. ' 5A.03 Thus, in contrast to a statutory merger, there is no automatic transfer of assets and liabilities by operation of law and the corporation purchasing the assets is generally not liable for injuries caused by the selling corporation's products.

There are, however, several exceptions to this rule, where corporations purchasing another's assets could be held responsible for the selling corporation's products or conduct, including the following.

1. Assumption by Agreement: The acquiring corporation will be obligated to pay any of the transferor corporation's liabilities that it expressly assumes under the contract.

2. Fraudulent Conveyance: Even if the purchasing company does not expressly assume the liabilities associated with the purchased assets, the purchasing company may still be held liable if the transfer of assets between the two corporations is deemed fraudulent and the purchasing corporation is found to be complicit in the fraud. Fraudulent transfers (or conveyances) are characterized as transfers made to remove property from the reach of creditors, without adequate return. Honor S. Heath, Charles A. Heckman & Keara M. O'Dempsey, Business Torts (MB) ' 8.01 (2013).

3. De Facto Merger/Continuation of Predecessor: The phrase “de facto merger” describes a situation where the acquiring company obtains substantially all of the selling company's assets, dissolves the selling company, but gives the shareholders of the dissolved company new shares in the acquiring company. While structured as a sale of assets, this transaction may have the same basic economic effect as a statutory merger. The selling corporation no longer exists as a separate entity and both of the corporations' interests are joined in the acquiring corporation. Wood, supra note 1, ' 5C.06.

In some jurisdictions, a court faced with such a transaction will find that the asset acquisition is a de facto merger or mere continuation of the transferor corporation. Id.
' 5C. A court will look for certain indicia of a statutory merger in making this determination. For example, did the purchaser acquire substantially all of the assets and leave no operating lines of business in the selling corporation or did the purchasing corporation hold its business out as a continuation of the selling corporation's business to the public and continue to sell the same product under a similar name. In such circumstances, the de facto merger/continuation of predecessor exception prevents these purchasing companies from avoiding assumption of the selling companies' liabilities while reaping all the benefits of a statutory merger.

In addition to these three universally recognized exceptions, some courts also recognize two additional exceptions where they impose strict liability on the purchasing corporation: 1) the product line exception; and 2) the continuity of enterprise exception.

1. Product Line Exception: This exception is recognized in only five jurisdictions, most notably California, and applies when a company acquires a manufacturing business and continues the output of the line of products. See Ray v. Alad Corp. , 560 P.2d 3 (Cal. 1977). In such circumstances, the acquiring company can be held strictly liable to plaintiffs who are injured by a product manufactured by the predecessor, selling corporation. Thomas Fegan, Products Liability Practice Guide (MB) ' 9.03 (2013). In general, this exception is applied when the successor corporation purchases substantially all of the assets of the selling corporation, the products liability arises from the selling corporation's product line, the predecessor corporation ceases to exist so that there is no remedy against the predecessor, and the successor used the goodwill of the predecessor. Diane L. Polscer, Successor Liability: Liability and Coverage Implications, 55 Fed'n Def. & Corp. Couns. Q. 107 (2004).

2. Continuity of Enterprise Exception: The continuity of enterprise exception, adopted in just three states, (Alabama, Alaska and Michigan) represents an expansion of the traditional mere continuation exception to products liability cases. David J. Marchitelli, Liability of Successor Corporation for Injury or Damage Caused by Product Issued by Predecessor, Based on Mere Continuation or Continuity of Enterprise Exceptions to Nonliability, 13 A.L.R. 6th 355 (2006). The “continuation of predecessor” exception, described above, relies on the continuation of the entire legal entity of the predecessor corporation as a justification for imposing liability on the successor corporation. Id.

In contrast, the “continuity of enterprise” exception allows for the imposition of liability on a successor corporation that just continues the business operations of the predecessor. Id. For courts applying this exception, primary considerations include “(1) whether there was continuity of management, personnel, physical location, assets, and general business operations of the selling corporation; (2) whether the selling corporation ceased its ordinary business operations, liquidated, and dissolved as soon as legally and practically possible; (3) whether the purchasing corporation assumed those liabilities and obligations of the seller ordinarily necessary for the uninterrupted continuation of normal business operations to the selling corporations; and (4) whether the purchasing corporation held itself out to the world as the effective continuation of the seller corporation.” Id.

Corporate Successorship and the Potential Transfer of Insurance Coverage

When a successor corporation can collect under insurance policies issued to the original corporation, an insurer can face an increased level of risk. As a result, most occurrence-based general liability insurance policies contain some type of anti-assignment provision. The typical anti-assignment provision generally provides that the policyholder's rights and duties under a policy may not be transferred without the insurer's consent. The purpose of an anti-assignment provision is to protect the insurer from any unforeseen changes in risk.

There are, however, exceptions to this anti-assignment rule, where courts refuse to enforce the anti-assignment clauses.

Operation of Law

Despite the inclusion of an anti-assignment provision in an insurance contract, the insurer's consent is not needed in the event of a statutory merger. The statute governing a merger transaction usually provides that the assets and liabilities vest immediately with the surviving corporation upon consummation of the transaction. As a result, rights and benefits under a liability insurance policy previously belonging to the target corporation transfer, by operation of law, to the surviving corporation.

A minority of courts have also held that insurance rights transfer by operation of law when the corresponding liabilities also transfer by operation of law, whether or not there is a statutory merger. Most notably, in Northern Insurance Company v. Allied Mutual Insurance Company, the Ninth Circuit held that the insurance rights at issue were transferred by operation of law where the liabilities transfer by operation of law under California's rule of product-line successor liability. 955 F.2d 1353, 1358 (9th Cir. 1992). The court reasoned that “non-assignment” clauses are designed to protect an insurer from risk that is unforeseen when deciding to provide coverage. When the loss at issue occurs before the transfer of liability, the insurer, in that court's view, covers only the risk it evaluated when issuing the policy, irrespective of any transfer. Id.

This holding in Northern Insurance has been rejected by many courts, which recognize that tort liability is distinct from contractual insurance liability. For example, in General Accident Insurance Company v. Superior Court, the California court rejected a transfer of an insurance policy by operation of law as “a violation of the basic principles of contract and ' bad public policy.” 64 Cal. Rptr. 2d 781, 788 (Cal. Ct. App. 1997).

Post-Loss Assignment

In another exception to the anti-assignment rule, some courts refuse to enforce ant-assignment clauses in situations when a loss took place prior to the assignment. In such cases, the courts hold that the right being assigned by the policyholder is the right to recovery of insurance proceeds. The courts reason that since the purpose of an anti-assignment clause is to protect an insurer from increased liability, if the events giving rise to the insurer's liability have already taken place, the insurer's risk is not increased by a change in the insured's identity. 3 Couch on Insurance ' 35:7 (3d ed. 2004). Indeed, courts have held that transfer of such a right does not increase the insurer's risk because the only remaining duty of the insurer is to make payment on the loss.

However, although this exception is generally recognized, it is not uniformly applied by the courts in the context of third party liability coverage. Indeed, in the last decade, we have seen a sharp divide in the courts as to what constitutes the “loss” that must take place prior to the assignment. On the one hand, insurers assert that the exception is only valid when the liability of the policyholder has been established and judgment entered. At that point, the only remaining thing for the insurer to do is to pay the insurance proceeds. On the other hand, policyholder advocates argue that transfer of coverage should be permitted whenever the underlying injury to the third party has already taken place.'

In 2003, the California Supreme Court addressed this issue in Henkel Corporation v. Hartford Accident & Indemnity Company and held that the insurance had not transferred to the successor corporation on the basis that any assignment of the insurance policy was ineffective because, at the time of the attempted transfer, the original policyholder's liability was not reduced to a monetary amount and the insurer had not consented to the assignment. 62 P.3d 69, 71 (Cal. 2003). Henkel Corp. had acquired the metallic chemical product line of Amchem Products Inc., assumed all related liabilities and was later sued on those liabilities. Id.

Henkel Corp. then sought coverage under an insurance policy purchased by Amchem Products. Id. at 72. Henkel Corp. argued that the insurer's consent to the assignment was not required because, under an occurrence policy, “benefits can be assigned without consent once the event giving rise to liability has occurred.” Id. at 75. The California court rejected this argument on the grounds that there was no assignable chose in action since the underlying “claims had not been reduced to a sum of money due or to become due under the policy.” Id. The Henkel court also rejected the argument that there was no additional risk to the insurer, explaining that an “additional burden may arise whenever the predecessor corporation still exists or can be revived because of the ubiquitous potential for disputes over the existence and scope of the assignment.” Id.

Three years later, the Supreme Court of Ohio reached a different conclusion. When faced with the question of whether the anti-assignment provisions applied when a corporate successor sought environmental coverage under an insurance policy issued to a predecessor, the court in Pilkington North American v. Travelers Casualty & Surety Company held that a “chose in action” was transferable to the purchasing corporation irrespective of the anti-assignment clause. 861 N.E.2d 121, 126 (Ohio 2006). While the Ohio Supreme Court agreed that coverage rights do not follow liability by operation of law when the liability is assumed under contract, the Ohio court refused to follow the California Supreme Court's decision in Henkel with respect to the time when a chose in action arises. Id. In contrast to the Henkel court's determination that a chose in action arises when the claim has been reduced to the sum of money owed, the court in Pilkington relied on Ohio precedent to conclude that a chose in action arises at the time the underlying bodily injury or property damage takes place. Id.

More recently, in the case of Travelers Casualty & Surety Co. v. U.S. Filter, the Indiana Supreme Court addressed the issue of anti-assignment clauses and post-loss assignment and followed the requirement set forth in Henkel that “for an insured loss to generate an assignable coverage benefit, the loss must be identifiable with some precision. It must be fixed, not speculative.” 895. N.E.2d 1172, 1180 (Ind. 2008). However, the court in Filter did note that anti-assignment clauses would not preclude transfer without consent of the insurer if the occurrence of the loss ' i.e., a judgment against the insured ' had preceded the assignment. Id.

The sharp divide between Henkel, Pilkington, Filter, and other cases on the issue of when a chose in action arises and can be transferred, notwithstanding the lack of insurer consent, leads to considerable uncertainty with respect to whether insurance coverage transfers when the assets of a business are sold. Many jurisdictions have yet to weigh in on the issue, and even where they have, we have not necessarily heard the last word on the subject. Indeed, the California Supreme Court may itself revisit its Henkel decision this year. See Fluor Corp. v. Superior Court , 146 Cal. Rptr. 3d 527 (Cal. Ct. App.), leave to appeal granted, 149 Cal. Rptr. 3d 675 (2012).

Best Practices

Know Your Policyholder

In light of the numerous circumstances in which insurance rights will not transfer to a corporate successor, it is important for an insurer to thoroughly vet the entity seeking coverage. Along those lines, answering the following questions may help:

1. Is the entity claiming coverage really the same entity that you insured? Although the answer to such a question may be obvious in most instances, it is important to remember that a company's name is an asset that can be sold to a new company just like any other asset. A quick check with the entity's state of incorporation can verify whether “Policyholder A, Inc.” is the same “Policyholder A, Inc.” that you insured or whether it is a different entity that just purchased the right to use the corporate name in order to obtain the goodwill associated with it.

2. Do the transaction documents purport to transfer insurance coverage? In an asset sale, insurance policies typically will not transfer absent an express intention by the original insured to transfer or share insurance rights, and there can be many reasons that a company selling assets will want to retain all of those rights for itself. Therefore, it is of utmost importance to review the transaction documents to determine whether the parties even intended to transfer coverage in the first place.

3. Who else may claim coverage under the policies? In many instances, a corporation's policy may provide coverage for its divisions and wholly-owned subsidiaries. In today's world of complex mergers, acquisitions, divestitures and reorganizations, that means an insurer may face claims under a policy from numerous entities that now have no affiliation with each other. Understanding which entities may have a legitimate claim to coverage under the policy at the outset may reduce the risk of future claims alleging that the policy proceeds were wrongly paid to an uninsured entity.”'

Know Your Jurisdiction and Focus on Choice of Law

As discussed above, enforcement of anti-assignment provisions varies significantly among jurisdictions and the laws of different states. In addition, a number of states have yet to weigh in on the issue. Given the inconsistent state of the law in this area, it is especially important that insurers focus on which state's law will govern the insurance policies in question and the transactions undertaken by the companies insured. Such analysis should be factored into any decisions on alleged coverage rights.

In sum, it is important to know whether a successor corporation is going to be held liable for the torts or alleged misconduct of its predecessor. But it is also important to remember that just because a successor corporation might be liable for harms traceable to its predecessor, that successor does not necessarily have a right collect on insurance policies issued to the predecessor corporation, even if that was the intent of the two companies. Rather, an anti-assignment clause may preclude coverage.

Jennifer R. Devery is a litigation partner in the Insurance/Reinsurance Group of Crowell & Moring LLP. She handles complex commercial litigation focusing on the insurance and reinsurance industry. Rachel Gart is a recent graduate of Harvard Law School and joined the firm's Insurance/Reinsurance Group as an associate in fall, 2013.