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Buyers Beware!
California Confounds Corporate Policyholders

By William G. Passannante and Cathleen Cinella Tylis

Are you a corporate risk manager or corporate counsel for a company with any connection to California? Might your company buy or sell another entity in California? Does your company have any California-based operations? If so, you should “beware” of the California Supreme Court’s recent decision in Henkel Corporation v. Hartford Accident & Indemnity Co., et al., 129 Cal. Rptr. 2d 828 (Cal. 2003).

Henkel represents an extreme departure from California law with respect to insurance rights for pre-transaction liabilities. 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 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 February 3, 2003, the California Supreme Court reversed a favorable policyholder decision from the Court of Appeal, 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 the well-established “operation of law” theory and 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’s extreme decision was based on two findings: (1) the successor corporation’s liabilities for pre-sale injuries were assumed voluntarily by contract rather than imposed by law; and (2) an assignment of insurance benefits without the insurance companies’ consent violates the “no-assignment” clause in the policies.

The “No-Assignment” Clause In The Policy Should Not Prohibit Assignment After A Loss Has Taken Place

The “no-assignment” argument set forth in Henkel has been rejected by courts nationwide. The near-universal rule across the country 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 but merely involves the payment of a claim which 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 the one bargained for when it initially evaluated the risk. Accordingly, the benefits of the insurance policies are transferred by operation of law irrespective of whether the physical policies themselves were actually transferred. In other words, the right to indemnity follows the alleged liability rather than the policy itself. This is simply how liability insurance works.

Insurance companies will argue that Henkel narrows this long-standing rule by finding that an assignment is valid only when: (1) a claim against the policy has been “reduced to a claim for money due or to become due” or (2) the insurance company has breached a duty to the policyholder and the assignment constitutes a cause of action to recover damages for that breach. Insurance companies will use Henkel to incorrectly equate a “chose in action” with a claim that has been “reduced to a sum of money due or to become due.” Under this flawed argument, a chose in action is very narrowly defined as a claim resulting in a legal finding of liability. Yet, a chose in action is much broader. Black’s Law Dictionary defines a chose in action as “the right to bring an action to recover a debt, money, or thing” [emphasis added]. To establish a chose in action, a party need only show that a right to recovery exists.

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 2000-2001 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 2000-2001 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 for this very loss. In this scenario, the insurance company argues that it should pocket the $2 million premium and be released of any responsibility.

Insurance Companies Are Obligated To Defend And Indemnify Their Policyholders For “Incurred But Not Yet Reported” Losses

Insurance companies are well aware that they may be called upon to defend or indemnify their policyholders for incurred but not yet reported (“IBNR”) losses. Insurance companies deal every day with IBNR losses and even deduct IBNR losses from their federal and state income taxes. Standard insurance reference works define and discuss IBNR losses as follows:

IBNR losses: An estimate of the amount on an insurer’s (or self-insurer’s) liability for claim-generating events that have taken place but have not yet been reported to the insurer or self-insurer. The sum of IBNR losses plus incurred losses provide an estimate of the insurer’s eventual liabilities for losses during a given period.

Given the insurance industry’s familiarity with the concept of IBNR losses, insurance companies cannot argue that they did not expect to pay, years after the fact, for injuries which occurred during their policy periods.

The Henkel decision essentially eliminates bought and paid for insurance coverage for IBNR losses arising out of pre-transaction operations. Insurance companies will argue that this decision eliminates their policyholder’s already existing insurance coverage for potential IBNR losses. Courts should not act as underwriters after-the-fact, performing post-loss underwriting to undo the promise the insurance companies made when they sold the policies.

Conclusion

Insurance companies will argue that, under Henkel, buyers must either obtain new insurance coverage for losses that have already taken place or force their predecessor’s insurance company to consent to an assignment. Such an argument puts policyholders at a disadvantage when purchasing and selling businesses and allows insurance companies to improperly retain valuable insurance premiums while avoiding their coverage obligations. Although the nationwide 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 these extreme arguments. 

ABOUT THE AUTHORS

William G. Passannante is a senior shareholder in the New York office of Anderson Kill & Olick, P.C. and is Co-Chair of the firm’s insurance coverage practice group. He can be reached at 212-278-1328 or wpassannante@andersonkill.com. Cathleen C. Tylis is a junior shareholder in the New York office of Anderson Kill & Olick, P.C. Mr. Passannante and Ms. Tylis regularly represent policyholders in insurance coverage disputes. She can be reached at 212-278-1390 or ctylis@andersonkill.com.

riskVue | The webzine for risk management professionals
April 2003