United States: Avoiding The Hazards Of Acquisition: Due Diligence In The Merger Or Acquisition Of A Product Manufacturer

Product liability lawyers are most often asked to apply their skills in the courtroom. While they rarely find themselves negotiating deals in the boardroom, they can be an extremely valuable member of the corporate team as well.

In recent years, we have seen an explosion of activity in the world of mergers and acquisitions. As corporations continue to reshape at a rapid rate, due diligence groundwork concerning product liability issues can be critically important. Experienced product liability lawyers should be asked to assist in evaluating the potential exposure when a target company manufactures a product which has, or may be, the subject of tort and warranty claims.

This article addresses how deals can be structured, and the areas that need to be explored, when evaluating a potential deal from the perspective of product liability.

Deal Structure

Any product liability lawyer involved in advising on due diligence must have a basic understanding of how deal structure affects liability exposure. Whether a deal is structured as a stock or an asset purchase can have enormous ramifications for the buyer and its potential exposure to liability. Whether it is a purchase of the business entity itself ("Stock Purchase" or "Merger") or a purchase of the business' assets ("Asset Purchase"), the client will need to construct the contract in a way that best limits exposure to product liability.

Stock Purchase

In a Stock Purchase, the buyer purchases the equity from the owner(s) of the target company and the business is transferred to the buyer. Essentially, the buyer becomes the new owner of the seller. There are a number of reasons why a buyer may want to acquire a product manufacturer in this manner. For starters, the target company may have contracts that are not assignable without the consent of the target company's counter-party. Another reason might be that the sale of the target company's assets requires approval of the board of directors and shareholders.

Generally, when a transaction is structured as a Stock Purchase, the buyer assumes responsibility for all of the known and unknown liabilities of the target company. For example, if the target company has sold a defective product prior to the closing of the deal, the buyer may potentially be held liable for that product, notwithstanding the fact that it was sold before the deal was even contemplated.

What may appear to be a slam-dunk acquisition can quickly turn into years of litigation and substantial financial loss if proper due diligence is not effectuated. One way in which buyers seek to limit exposure is by structuring the deal as an Asset Purchase, as opposed to taking complete ownership of the target entity.

Asset Purchase

Unlike the Stock Purchase, where the buyer assumes the target company's liabilities by law, the Asset Purchase allows for the buyer to purchase specific assets of the target company without assuming liability. Traditionally, a corporation purchasing assets for cash is not liable for the conduct, acts and products of the seller. However, in structuring such a deal, it is necessary for the product liability lawyer to make sure that the express language of the contract is clear about which, if any, liabilities are being assumed by the buyer.

In an Asset Purchase, most of the target company's liabilities will be known and set forth in representations and warranties. The buyer can then negotiate which liabilities, if any, will be assumed. As for unknown liabilities, such as potential exposure resulting from product liability lawsuits, the buyer in an Asset Purchase can stipulate by contract that no such liabilities are to be assumed.

For the most part, the buyer can take solace in the fact that courts will generally respect the wishes of both parties in an Asset Purchase with regards to the transfer of liability. However, there is an important caveat: In certain circumstances, courts will nevertheless hold the buyer liable for the product liability of the seller, notwithstanding the express agreement of both parties to the contrary.

Successor Liability in Asset Purchases

While the Asset Purchase is the best avenue for avoiding the liabilities of the target company, there are still instances in which a court will impose successor liability despite the express intentions of both parties to the contrary. There are two major exceptions the product liability lawyer must consider — the de-facto merger doctrine; and the "mere continuation" doctrine.

De-Facto Merger

The de-facto merger doctrine came about due to concerns with corporations structuring deals which purported to be Asset Purchases, but in reality were merely mergers designed to look like an Asset Purchase. Courts generally will look to several factors when determining whether a transaction which is purported to be an Asset Purchase is actually a de-facto merger. The factors include continuity of ownership; cessation of business and the rapid dissolution of the purchased company; assumption by the purchaser of the liabilities necessary for the uninterrupted continuation of the business of the purchased company; and continuity of management, location, general business operation, etc. Courts have held that the presence of all factors is not necessary to find a de-facto merger.

Mere Continuation

Similar to the de-facto merger doctrine, the mere-continuation doctrine applies when there is a certain commonality between the buyer and the seller after the acquisition. Specifically, the mere-continuation doctrine may apply when there is a finding of one or both of the following: no adequate consideration was given to the seller for its assets; or one or more of the officers, directors, or stockholders of the seller became an officer, director, or stockholder of the buyer. Essentially, courts applying the mere-continuation doctrine evaluate whether the two entities have significant shared features such that the buyer is substantially the same as the seller. If the court finds that an Asset Sale is a mere continuation of the seller's operation, the court may hold the buyer liable for the acts of the seller despite any agreement between the parties to the contrary.

Thus, simply using the Asset Purchase as a way to avoid liability may end up causing the purchaser to be blindsided by litigation later down the road. Whether the client decides to structure the transaction as a Stock Sale or an Asset Sale, it is crucial for the product liability lawyer to uncover any and all potential product liability exposure before the closing of the deal.

Evaluating Liability Exposure

During the due diligence stage of a potential acquisition, the more information the product liability lawyer can gather about the target company, the better equipped the lawyer will be in assessing the risks involved in the potential purchase.

Here is a list of key questions for the product liability lawyer to consider:

1. What is the target company's claims history with regard to its products?

Due diligence should uncover the following: a) The allegations made, and outcome, of every claim against the company; b) A list of the type of injuries resulting from (or that might result from) the company's product offerings — are they immediate (e.g., explosions) or latent (e.g., toxic exposure)? c) The status of any unresolved claims and the potential defenses to those claims; d) The company's philosophy on settlement; and e) A list of any and all unsatisfied judgments.

2. What is the legal atmosphere surrounding the product?

a) The litigation history of competitors: Evaluating the claims history of competitor companies can be useful in assessing the possibility of lawsuits surfacing post-transaction. Even if the target company has not seen much litigation action, there may be a high likelihood that lawsuits could come in the near future. The claims history of competitors can provide a pattern of product defects and help forecast the likelihood of future claims; b) The success rates of defenses: There may be hundreds of claims filed, but if those claims are being routinely dismissed, the potential exposure might not be as threatening as it seems; and c) The trends in litigation within all potential jurisdictions. The attorney should be aware of how courts are leaning — in terms of tort reform, plaintiff-friendly verdicts and the like.

3. Does the company maintain a written record on all products manufactured and distributed by the company?

It is important for the product liability lawyer to obtain: a) A comprehensive list of all of the company's product offerings dating back at least six years; b) A summary of the results of all tests, studies and surveys regarding existing products and products under development; c) Any new designs or modifications to the products; d) A record of the manufacturing specifications and designs, and the identities of the individuals involved in the designs; e) A report on the number and models of units sold, by region; f) A list of all product recalls (and the costs involved); and g) A list of all vendors and alternate sources of supply.

4. Is the company carefully vetting the claims it is using on its labels and its advertising?

Words on labels and advertisements can also lead to litigation if found to be false or misleading. It is important to examine the regulations governing the products being manufactured by the target company. For example, a manufacturer in the food business needs to be aware that words like "natural," "healthy" and "organic" can have legal ramifications if the product itself does not align with regulatory requirements.

5. Does the company have insurance to cover product liability claims?

Due diligence should produce the following: a) Documentation of prior and existing primary and excess insurance coverage; b) Additional documentation if suppliers have added the target company as an additional insured; c) A risk management evaluation — weighing existing insurance against your estimates for potential exposure. Then decide whether additional insurance is necessary. Obtaining an insurance specialist might be useful in complex situations; and d) If additional insurance is needed to mitigate product liability, make sure that the insurance package covers unknown regulatory and product liability issues that may arise — including cyber claims and false advertising.

It may also be necessary to execute an indemnity agreement whereby the buyer will be provided liability coverage for a certain period of time prior to, and after, the purchase. Liability insurance and indemnity agreements can be very useful in situations like the Stock Purchase or de facto mergers, in which the buyer assumes liability by law.

6. How does the company size up in terms of publicity?

It is important to evaluate the target company's publicity as well as the overall public perception of the company. This is especially important, and perhaps easier, in this new age of information and social media. The product liability lawyer should pay close attention to: a) Any press releases relating to the target company within the past five years; b) Print and online articles, scholarly journals, and blogs mentioning the target company; and c) Social media coverage of the target company. Perusing the target company's "mentions" and "tags" on social media sites — such as Twitter, Facebook, and Instagram — can provide a unique insight into the public perception of the target company and its products. This may also uncover the threat of litigation before it happens. Some of the first reports of potential claims may appear via social media — as plaintiffs' lawyers troll for claims against the target company.

Conclusion

There is no single, one-size-fits-all approach to due diligence, as each company presents its own unique set of risks. However, the above recommendations can serve as a guide in developing a comprehensive due diligence program for the analysis of product liability issues potentially affecting an individual buyer. Effective counsel should be able to provide the buyer with advice on how to structure the deal in terms of assumed liability. The lawyer should also uncover as many known and unknown liabilities as possible, and provide advice on how to mitigate those risks moving forward.

What the client wants is not always the same as what the client needs. Lawyers often feel pressured to avoid standing between the client and a deal. With that in mind, product liability due diligence requires a certain level of brutal honesty. It is far more beneficial to have a disappointed client than to hear, months down the line, that the client is on the hook for a multi-million-dollar product liability suit because of your apprehensiveness. It is important to disclose any and all potential liability and perhaps offer solutions — such as a change in deal structure, an indemnification agreement or additional insurance. The future of the client's company may depend on your due diligence ... and your honesty.

This article was published in the February 2017 edition of Law Journal Newsletter's Product Liability Law & Strategy.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.