Learning To Play: The Liability Game

A. Jeffrey Seidman

Buying a business is not as simple as it once was. Once a merger or acquisition is complete, the new owner acquires more than the building, equipment and employees - they are also responsible for the myriad of potential environmental problems from years past.

As landfills struggle to meet EPA's Subtitle D regulations, landfill owners can not bear the costs alone. As a result, the entities involved, such as waste generators, are being held liable for the remediation costs. New business owners may be asked to contribute to a site's remediation where the old owners sent their bio-medical or hazardous wastes. The increase in hazardous and biomedical wastes (see chart) has placed emphasis on remediation liabilities.

A waste generator in full compliance with state and federal regulations can still be liable for events which occurred years earlier. For this reason, it is critical to understand the ramifications of successor liability.

Hazardous wastes generators may have to contribute to the cost of remediating a site, according to CERCLA. While corporate successor liability is not specifically cited in CERCLA, courts have ruled generators liable, saying that Congress intended it so. Courts also have found corporations liable for their predecessors' CERCLA violations, under traditional principles of successor liability. Now, new corporate owners may be liable for the CERCLA violations of the predecessor or acquired company.

Generally, a corporation purchasing all assets of another corporation does not assume its debts and liabilities. There are, however, four traditional exceptions to the rule of successor non-liability. The purchasing corporation will be liable when the:

* Successor corporation agrees to assume the predecessor's debts and liabilities;

* Predecessor is acquired through consolidation or de facto merger;

* Successor corporation is a continuation of the predecessor corporation; or

* Transaction is entered into fraudulently in order to escape liability.

While several other exceptions have been made, they've been rejected by the majority of states.

In general, the purchaser often agrees to assume the predecessor's debts and liabilities, which are found in specific indemnification clauses.

Several factors help determine if an asset acquisition amounts to a de factor merger. These include continuing the predecessor's business to provide a continuity of management, personnel, physical location, assets and the general business operations. A de facto merger exists when the former corporation's assets are sold for stock in the new owner's corporation and the shareholders of the predecessor becomes share- holders of the successor. Another example is when the old corporation either dissolves or ceases operations and is unable to satisfy its creditors' claims.

Finally, de facto mergers exist where the new corporation assumes the obligations necessary to continue the former business without inter ruption. In addition, there usually must be shareholder continuity by paying for the old corporation with shares of stock.

Several factors are used to determine whether a successor corporation is a continuation of the predecessor corporation. These include staff continuity, using the same or similar trade names, customer continuity, production of the same product or providing the same services and common identity of officers, directors and shareholders. Some courts have emphasized the last factor as being the most significant.

Several courts also have applied the "substantial continuity" test, which expands the traditional "mere continuation" exception. This focuses on the business operation's continuity, rather than using the continuity of shareholders, officers and directors. This exception only applies when the asset purchaser has knowledge of and responsibility for that liability. If the new corporation had no notice of the old corporation's potential CERCLA liability and the old corporation stopped operating before the asset sale, the requisite continuity won't be found.

The final exception is based upon traditional principles of fraud; for example, a collusive arrangement between the old and new owners to escape environmental liabilities. Since the environmental liabilities may not even be known, this situation may be rare at the time of the asset purchase.

If the new corporation ultimately is liable for the predecessor's CERCLA violations, the new owners may be covered for any potential liability under the former owner's insurance policies. The new corporation should obtain copies of all the former owner's insurance policies at the time of the asset purchase. If the policies aren't available, obtain a historical listing of all applicable insurance coverages. As a last resort, an insurance archaeologist could compile the lost or missing policies.

When the asset purchase involves merging one entity into another, leaving no existing predecessor, the new corporation normally is covered by the old corporation's insurance (purchased prior to the asset purchase). When the old corporation only sells a portion of its operations, the issue is not as clear.

When the purchase agreement covers the transfer of "all assets and "all liabilities," the new corporation can argue that the rights to insurance coverage for existing environmental damage are a transferred asset. Others argue the right to indemnity follows the liability itself. This prevents an insurer from walking away from a substantial portion of the original risk it assumed by issuing insurance to the old corporation.

Most liability policies' standard "no assignment" clause should not preclude coverage for the new corporation. These clauses typically state that the insurance may not be assigned unless the insurer consents. An assignment without the insurer's consent of the right to receive insurance benefits after the damage has occurred has been uniformly recognized as valid.

Even if the loss or damage is discovered after the assignment, an insurance policy is effective without the insurer's consent. Most courts have ruled that the new corporation is entitled to defense and indemnity by the old corporation's insurer for pre-acquisition damages caused by the old corporation. This recognizes there has been no change in the insurer's assumed risk.

These problems can be prevented or lessened when drafting the asset purchase agreement. The purchaser should state that the former owner's insurance policies are included among the purchased assets. A complete schedule of all policies should be attached to the agreement. The agreement should also require that the description include all the old corporation's policies ever purchased, whether or not listed on the attached schedule.

The agreement may also obligate the former owner to insure the new owner against any defense and indemnity costs.

After reviewing the appropriate state laws, the transaction can be drafted to avoid the exceptions to successor liability. Also consider purchasing a claims-made policy for the successor corporation.

With proper planning, new owners may go a long way in protecting themselves from sins of the past.