In the frenzy of many corporate merger and acquisition negotiations, the concept of insurance coverage for pre-closing losses is often a topic that receives little attention. However, parties to a transaction are well-advised to pay particular attention not only towho will bear responsibility for pre-closing losses, but also to whether those losses can be addressed in the deal in such a way as to preserve insurance coverage for them. The Ohio Supreme Court provided some guidance on this issue in Pilkington North America v. Travelers Cas. & Sur. Co., 112 Ohio St.3d 482, 2006-Ohio-6551, 861 N.E. 2d 121 (Ohio 2006). Though the Court’s decision inPilkington was issued nearly a decade ago, it is worth repeating – with careful planning, parties to a transaction often can (and should) structure their deal to maximize the potential for insurance coverage.
In a typical corporate transaction, the seller may have been in business a number of years and, during that time frame, it likely purchased commercial general liability insurance to provide defense and indemnity coverage for third-party claims. These general liability policies usually provide coverage for claims asserting bodily injury or property damage against the policyholder, and are frequently written on an “occurrence” basis. An occurrence-based policy never really expires, but rather will provide coverage for injury or damage that happened during the policy period, even if the claim for such injury or damage is asserted long after the policy period ends. Therefore, occurrence-based general liability policies may cover claims arising from actions taken by the policyholder years or even decades before. Importantly, typical general liability policies also contain an anti-assignment provision, which may prevent the policyholder from assigning the policy to another entity without the insurer’s consent.
How does all of this relate to a corporate transaction? Assume a company that engaged in the manufacture of asbestos-containing products in the 1970s. This company now wishes to transfer its assets and liabilities to a willing purchaser, but the purchaser wisely has concerns regarding whether it will have insurance coverage for liabilities arising out of the former operations that crop up in the future. The company seeks permission from its insurance carriers to assign its policies to the purchaser, but the insurers refuse to consent. Is the company able to transfer any of the benefits of its insurance policies to the purchaser?
The Pilkington Decision
In Pilkington, the issue before the Court was the extent to which the right to access historical liability coverage may be transferred to a purchasing corporation, notwithstanding an anti-assignment provision in the applicable insurance policy. Each year between 1951 and 1972, Libbey-Owens Ford (“LOF”) purchased occurrence-type CGL insurance policies to cover it for current and future liability claims arising from its operations, including its glass manufacturing operations. During the years covered by those policies, LOF's glass manufacturing facilities generated and disposed of several hazardous industrial by-products.
Prior to 1986, the glass manufacturing business of LOF operated as an unincorporated operating division of LOF. In 1986, LOF created a newly formed subsidiary and transferred the assets and the environmental liabilities of its glass manufacturing business to the subsidiary, a separate entity called LOF Glass, Inc. Shortly thereafter, LOF sold all the shares of LOF Glass, Inc. to Pilkington Holdings, Inc. Pilkington Holdings, Inc. changed the name of the subsidiary to Pilkington North America, Inc.
In 2000, Pilkington was sued in a number of environmental lawsuits, all based on the pre-1972 waste disposal activities of its corporate predecessor – LOF. Pilkington notified the insurance companies that issued LOF's pre-1972 policies, but the companies denied coverage. Pilkington then filed suit in federal district court in 2001 to enforce coverage.
LOF’s insurers answered, asserting, among other arguments, that they had no legal obligation to defend Pilkington becausePilkington was not a named insured in the contracts of insurance under which coverage was being sought. The insurers asserted that their insurance contracts with LOF contained a specific clause stating that LOF could not “assign its interest” in those policies to another party without the prior approval of the insurer.
The federal district court certified the case for resolution of a question of law to the Ohio Supreme Court. The Ohio Supreme Court first decided when a chose-in-action arises. Stated another way, when does the claim against the insurer become a chose-in-action that is arguably transferrable? It decided that a chose-in-action arises under an occurrence-based insurance policy at the time of the covered loss. Other jurisdictions used a much later date, focusing on the date that the claim was reduced to a sum of money owed.
Next, the Court considered whether the chose-in-action could be transferred. The court noted that generally, contractual rights are transferable except when one of three circumstances exists: (1) if there if clear contractual language prohibiting the assignment; (2) if the assignment will materially change the duty of the obligor, or, in the case of insurance, increase the insurers' risk; and (3) if assignment is forbidden by statute of public policy. The court determined that while the first circumstance appeared to exist by virtue of the policies' anti-assignment clauses, the law had developed creating an exception for the assignment of insurance rights after the loss has occurred.
With respect to the second exception, the court determined that the insurer's duty to indemnify remained fixed, and an assignment did not materially change such duty. However, the duty to defend could be materially affected by an assignment, particularly where the original policyholder remains in existence. Accordingly the Court held that the chose-in-action with respect to the duty to indemnify could be assigned, but did not decide whether the chose-in-action with respect to the duty to defend could be assigned.
Finally, the Ohio Supreme Court turned to the question of whether insurance coverage should follow liabilities as a matter of law. The Court distinguished situations where the underlying liabilities are contractually assumed with situations where the liabilities are imposed on the second party by operation of law. The Court held that when a covered occurrence under an insurance policy occurs before liability is transferred to a successor corporation, coverage does not transfer to that corporation by operation of law when the liability was assumed by contract.
What It All Means
Pilkington was a seminal decision at the time it was issued. It remains an important one today and parties to a corporate transaction and their counsel should know the following:
Ohio law permits assignment of a chose-in-action in a corporate transaction, even if there is an anti-assignment provision in the policy, and the chose-in-action need not be reduced to a sum certain in order to be transferable.
However, a purchaser in a transaction should be mindful of the fact that the court left unresolved the issue of whether defense cost coverage could be assigned.The court indicated that the question would revolve around whether there was a material change in the risk to the insurer due to the assignment.
In addition, parties to corporate transactions should be aware that other jurisdictions treat the issue differently.The applicable state law is important.For example, in California a chose-in-action does not arise until the claim is reduced to a sum of money.IfPilkington had been brought in California, then, no chose-in-action would have arisen.
It is often worthwhile for experienced coverage counsel to examine specific corporate transaction provisions, to evaluate future coverage for pre-closing losses.