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Are you an attorney or corporate risk manager for a company with any connection to California? Might your company buy or sell an entity with a connection to California? If so, you should beware of the California Supreme Court’s 2003 decision in Henkel Corp. v. Hartford Accident & Indemnity Co. Henkel represents an extreme departure from California law with respect to insurance rights for liabilities that predate the transaction. Under Henkel, insurance companies will assert that bought and paid-for occurrence-based liability insurance may be eliminated by common changes in corporate form even without any change in their risk. While to date no other state supreme court has addressed this issue, insurance companies may well argue that other jurisdictions should look to Henkel for guidance. On Feb. 3, 2003, the California Supreme Court reversed a decision from the state appeals court, which had held that the right to indemnity for pre-transaction liabilities transferred by “operation of law” to a successor corporation, even though the insurance policies were not assigned in the purchase transaction. Henkel rejected that well-established theory and, instead, concluded that the successor corporation was not entitled to a defense or indemnity from the predecessor’s insurance companies for lawsuits alleging bodily injury as a result of exposure to the predecessor’s chemical products. Henkel arose from a series of complex corporate acquisitions involving Amchem Products Inc., a manufacturer of agricultural and metallic chemicals. In 1977, the Union Carbide Corp. bought the company and split it into two subsidiaries: Amchem I (agricultural products) and Amchem II (chemical products). Union Carbide sold Amchem 1 to Rhone Poulenc Inc. and Amchem 2 to the Henkel Corp. Amchem and Henkel were later sued for injuries arising from exposure to metallic chemical products between 1959 and 1976. Henkel tendered its defense to Amchem’s insurance companies, and all denied coverage. The appeals court held that the right to the insurance benefits under Amchem’s policies passed to Henkel automatically, even though the insurance policies were not assigned in the purchase transaction. Liability Previously assumed The California Supreme Court reversed. Its extreme decision in Henkel was based on two findings: The successor corporation’s liabilities for pre-sale injuries were assumed voluntarily by contract rather than imposed by law; and an assignment of insurance benefits without the insurance companies’ consent violates the no-assignment clause in the policies. What this decision ignores is that one of the main benefits — and selling points — of occurrence-based liability insurance is that it provides lasting protection. The benefits of occurrence-based insurance last as long as there is the possibility that someone might allege harm during the policy period. This protection against future claims is fundamental to the occurrence form of insurance policy. One can buy liability insurance protection at the time of a potentially loss-causing activity and be assured that, as long as the amount of insurance purchased is adequate, protection is in place against any future claims relating to that activity. In the language of the insurance trade, this valuable benefit is referred to as protection against losses that are “incurred but not reported” (IBNR in shorthand). Courts nationwide have rejected the “no-assignment” argument set forth in Henkel. The near-universal rule is that the right to recover for pre-transaction liabilities may be freely assigned without the insurance company’s consent, notwithstanding the supposed no-assignment clause in the policy. Such an assignment does not interfere with the insurance company’s right to choose its own indemnitee, because it merely involves the payment of a claim that has already accrued. Courts have concluded that because the alleged injury took place prior to the transfer of assets, the insurance company is not exposed to any greater or lesser risk than what it bargained for when it initially evaluated the risk. Accordingly, it makes sense for the benefits of the insurance policies to be preserved by operation of law, irrespective of whether the physical policies themselves were actually transferred. In addition to violating fundamental principles of insurance law, Henkel allows insurance companies to argue that they should receive a windfall reduction in coverage for the risk they have agreed to insure. For example, suppose an insurance company collects a $2 million premium from Company A for the 2000-01 policy year. In 2002, Company A sells all of its assets and liabilities to Company B. In 2003, Company B is sued for liabilities arising out of Company A’s 2000-01 operations. Under Henkel, the insurance company can argue that unless it consented to the assignment, it has no obligations under the policy, even though it collected premiums in anticipation of this very loss. In this scenario, the insurance company argues that it should pocket the $2 million premium and be released of any responsibility. NO UNEXPECTED LOSSES Insurance companies are well aware that they may be called upon to defend or indemnify their policyholders for IBNR losses. Insurance companies deal every day with IBNR losses and even deduct them from their federal and state income taxes. Furthermore, insurance companies routinely estimate their outstanding liability for occurrence-based policies. Thus, it would fly in the face of fact for insurance companies to argue that they did not expect to pay, even years after the fact, for injuries that occurred during their policy periods. There is no good reason for courts to absolve insurance companies of the promises that they made when they sold their policies. Legal, insurance and risk management professionals currently expect that IBNR insurance benefits regularly are transferred with potential IBNR liabilities in the sale of a business unit. As an indication of the widespread nature of the assumptions that Henkel violates, insurance companies have not identified one example of an insurance company having been asked to consent to the transfer of IBNR benefits under a closed occurrence policy, whether in conjunction with the sale of a business unit or otherwise. It is also important to note that these expectations of the policyholders and others have tangible economic consequences. The Henkel rule, if widely adopted, will serve as an artificial brake on the otherwise natural mergers and acquisitions that are a staple of a healthy national economy. Currently, outside of California, potential buyers know that they can routinely expect to acquire a company’s occurrence-based insurance along with the company’s other assets. But if buyers can no longer rely on that assumption, some will simply walk away from deals that are otherwise beneficial to the contracting parties – and to society at large. Other buyers will demand a discounted sale price to make up for the expected liabilities, a price that the seller might not be able to accommodate. In any event, it is clear that the Henkel rule guarantees an arbitrary obstacle to transactions that society should be promoting, not impeding. That’s especially true given our still-recovering economy. It is also clear that a legal rule that would require a company to obtain the consent of all the insurance companies that sold insurance policies in the past whenever the company sells a business unit ignores the nature of occurrence-based liability insurance policies. Entirely apart from the enormous practical problems that would be involved in obtaining the consent of all the insurance companies that ever sold liability insurance, adopting the insurance companies’ position would be fundamentally inconsistent with the occurrence form of liability insurance. Occurrence policies are based on the premise that the policyholder pays a premium today in return for a policy that provides protection for all future claims that arise from injury that takes place during the policy period (subject to exclusions in the policy and the limits of insurance) no matter when those claims are filed. Protection for IBNR claims is the essence of the protection provided by an occurrence policy. Expected ArgumentInsurance companies will argue that under Henkel, buyers must either pay for new insurance coverage for losses that have already taken place or force their predecessor’s insurance company to consent to an assignment. But this argument ignores the realities of the insurance market. In fact, insurance companies years ago began to write fewer and fewer occurrence-based policies. Furthermore, it is even more difficult, if not impossible, to buy occurrence-based coverage today for a coverage period in the past. Instead, buyers will need to pay additional premiums for claims-based policies — the common sort of coverage now issued that covers only claims that accrue during a given coverage period — year in and year out. In essence, the Henkel rule gives insurance companies not only the windfall of the claims they had budgeted to pay for but no longer need to, but also the additional windfall of annual new premiums going forward. That’s hardly a fair or rational result. Although the impact of this decision on other jurisdictions remains to be seen, corporations should beware that their rights to coverage may be eviscerated if their predecessor’s insurance company asserts the arguments that the Henkel rule allows for. What the Henkel decision does, in essence, is eliminate insurance coverage that has already been paid for, giving insurance companies a big windfall. Which is to say, courts have no business acting as after-the-fact underwriters, especially when they let insurance companies break their promises. This article originally appeared in Legal Times , a publication of American Lawyer Media.

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