United States: California Supreme Court Clears Path For Transfer Of Insurance Rights In Corporate Transactions

Last Updated: August 28 2015
Article by   Orrick

Last week, in its long-anticipated decision in Fluor Corp. v. Superior Court, the California Supreme Court made it significantly easier to transfer insurance rights in corporate acquisitions and reorganizations. In a unanimous decision, the Court held that policyholders can assign their rights under liability insurance policies after the loss or injury has occurred and potential liability exists. To reach this result, the Court struck down as unenforceable insurance policy provisions that prohibit such assignments. The Court overturned its own prior decision in Henkel Corp. v. Harford Accident & Indemnity Co., which held—on nearly identical facts—that post-loss transfers were invalid unless the insurer gave consent. Henkel was decided in 2003, and for the past 12 years has frustrated efforts by deal counsel and coverage lawyers to ensure that the insurance rights would follow the potential liability in corporate transactions. The Fluor case topped our list of 2015 "Insurance Cases to Watch."

Fluor and Henkel both involved corporate transactions that transferred both assets and liabilities to newly formed companies. The liabilities transferred were substantial – in both cases there were hundreds of personal injury claims by workers who claimed exposure to hazardous substances while employed by the predecessor companies. In both cases, the parties to the transactions intended to transfer the relevant insurance coverage to the new company—so that insurance would follow the liability. When the new entities sought to collect on the insurance, however, the insurer denied coverage based on anti-assignment provisions in the insurance policies.

In Henkel, the Supreme Court agreed with the insurer and invalidated the policy transfers. It ruled that in an asset sale transaction, where liability is voluntarily assumed by the successor, liability policies can be transferred only through a valid assignment to the successor company. This is in contrast to an equity sale transaction, in which both liability and insurance transfer as a matter of law.

Based on this distinction, the Henkel court struck down the transfer of insurance rights because the injury had already occurred and the anti-assignment clauses in the policies prohibited assignments without insurer consent. The Court found that the only circumstance under which the policies could be transferred without insurer consent was after the loss had been reduced to a fixed sum of money.

One justice, Justice Moreno, dissented from Henkel, arguing that the intangible right to coverage could be freely transferred, and if the assignment were not permitted, the insurer would "secure an unfair windfall."

Henkel was widely criticized after its publication. It was at odds with court decisions in most other states, which upheld post-loss transfers of insurance rights. Policyholders and legal commentary criticized the decision for eliminating insurance rights for which the predecessor had paid and which were needed to cover losses that occurred prior to the assignment. Businesses operating in California were forced to restructure their transactions to avoid asset sales and to include elaborate mechanisms to collect on available insurance. Insurers, for their part, welcomed the decision and believed it would eliminate the risk that they could be caught in a coverage dispute between predecessor and successor or required to provide coverage for both.

In Fluor, the Court took a mulligan and reversed Henkel. The policyholder cited Insurance Code section 520 – which had not been addressed in Henkel – and claimed it trumped the common law principles on which the Henkel Court relied. Section 520 states: "An agreement not to transfer the claim of the insured against the insurer after a loss has happened, is void if made before the loss . . . ." The Court in Fluor found that the statute, first enacted in 1872 before the development of liability insurance, applied to both liability policies (which cover lawsuits against the policyholder) and property insurance policies (which cover damage to the policyholder's own property). It found, however, that the phrase "after a loss had happened" was ambiguous in the context of a liability policy. To determine the more reasonable interpretation, the Court embarked on a comprehensive analysis of the legislative history of section 520, early decisions on policy assignments, and more recent California cases discussing insurance concepts such as "loss" and "trigger of coverage."

The Court concluded that "after a loss has happened" in section 520 refers to a "loss sustained by a third party that is covered by the insured's policy, and for which the insured may be liable." That is, the loss occurs at the time of the accident or event that results in an injury. There is no requirement of a money judgment or settlement before a claim concerning a loss can be assigned without insurer consent. This interpretation, according to the Court, supports the expectations of the businesses involved in corporate sales and reorganizations. According to the Court:

Because any such new business entity typically will assume both the assets and the liabilities of the prior business entity, the new business entity will understandably expect to obtain the rights to claim defense and indemnification coverage for such liabilities triggered during the policy period. If the insurer could to prevent its insured from assigning rights to assert such claims unless first reduced to a money judgment or approved settlement, it would effectively exert . . . unjust and oppressive pressure on the insured . . . .

The Court in Fluor had little difficulty overruling precedent that had been in existence for over a decade, devoting only two paragraphs in its lengthy opinion to the issue of stare decisis. Its Henkel decision was reached without consideration of section 520, which had not been brought to its attention. As the Court remarked: "This reminds us that even with access to computer research technology, any human enterprise cannot be prefect; and that it is better that wisdom, or at least controlling authority, come to our attention late, rather than not at all."

In Fluor, unlike Henkel, the Court confirmed the policyholder's settled expectations that insurance should follow the liability. Fluor will make it easier to transfer insurance rights in corporate asset sales and reorganizations, and places California squarely in the mainstream view. It eliminated a procedural pitfall that could have resulted in the forfeiture of insurance if a deal transaction was not properly structured and documented. Corporate policyholders, thanks to Fluor, can now breathe a sigh of relief.

But Fluor left open another issue that could lead to future disputes. The Court did not address whether the liability policies in that case had been properly assigned to the successor in the first instance. The purchase agreement included a transfer of "any and all' assets" of the predecessor, and the parties disputed whether that language was meant to include an assignment of insurance. In the wake of Fluor, it will be wise to include language in asset sale agreements that expressly addresses the transfer of liability insurance for all pre-closing losses and liability. More general transfer language should be sufficient but could give rise to disputes.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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