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Should parents consolidate new units' products coverage?

When a corporation acquires a subsidiary, it has several choices regarding the acquired company's risk management program. It can place all or part of the subsidiary's insurance, loss control and claims administration under its own risk management program or allow the new unit to operate its own program.

There are many reasons for keeping separate some or all of a subsidiary's insurance coverages. In some cases, the tax and regulatory systems of the jurisdiction in which the subsidiary is located necessitates the separation of coverages. In others, the parent company does not purchase some coverages required by the subsidiary, it does not want to expose its program to more volatile risks or its underwriters refuse to accept the subsidiary's risks. Another situation that may prevent consolidating coverages is if the subsidiary is on a retrospective rating plan that carries severe penalties for early cancellation. Furthermore, the subsidiary may have better or cheaper coverage than the parent or complete operating autonomy

When none of these factors exist, programs are usually consolidated. Often duplications can be eliminated and cost and coverage improved through economies of scale. Improved claims administration can be achieved as well.

Successor Liability

No matter what business the parent company is in, be it manufacturing, distribution or retailing, the risk management question is not whether a product liability exposure exists, but whether appropriate steps are being taken to protect the shareholders' assets from potential liabilities. One important question to consider is whether a subsidiary can stand alone from its parent, incur its own liabilities and not endanger the parent company in the process. The prevailing answer would seem to be no.

In many cases, the subsidiary is covered under the parent's product liability policy for reasons that often transcend cost and coverage issues. Despite separate legal status, many parent companies fear being perceived as a deep pocket. Not only can they be liable for the product liability of their subsidiaries after the date of sale, they can be held liable for harm caused by goods sold prior to the acquisition. Under traditional rules, liability could be imposed under the conditions that the successor expressly or implicitly assumed the predecessor's tort liabilities; the two corporations consolidated or merged; the successor was merely a continuation of the predecessor; or the transaction was intended to defraud creditors.

However, as product liability actions blossomed, so did two theories of liability, broadening the exposures of companies that manufactured or sold harmful products. The continuity of the enterprise theory, which stemmed from the 1976 case Turner v. Bituminous Casualty, states that the acquired company is the same as the old, now-defunct company regardless of any corporate restructuring. The product-line exception theory was borne out of the 1977 case Ray v. Alad Corp. In that case the court stated: "A party which acquires a manufacturing business and continues the output of its line of products .. assumes strict tort liability for defects in units of the same product line previously manufactured and distributed by the entity from which the business was acquired."

The continuity theory is followed in several states, but the product-line exception appears, at this point in time, to be itself an exception. In the 1987 case DeLapp v. Xtraman Inc., the court said, "The clear majority of courts which have squarely addressed the issue have declined the invitation to adopt the exception." Apparently, the courts prefer a legislative change in corporate law to a judicial decree. Part of the reason why adoption of these new theories has been hindered is because most product liability cases involve workplace injuries for which workers' compensation coverage provides an adequate remedy or one that is preferable to holding a successor company liable.

The decision to find liability is more often based on the type of purchase involved, such as whether the company was an asset or a stock purchase. In the February 1984 issue of For the Defense, Stephen Liebo, then managing editor, described the case of a Florida-based company that had purchased the stock of a truck equipment manufacturer and subsequently became liable for injuries caused by a garbage truck compactor manufactured by the predecessor. "While Florida law applies the traditional rule to determine successor liability, disregarding the financial responsibility of the predecessor, the successor corporation was liable because it stripped its subsidiary of assets for its own benefit," he wrote. "Parent company employees were placed in charge of the subsidiary, and the parent handled all insurance, accounting, payroll and bill payments. Moreover, when the parent later sold the subsidiary's assets, it kept the proceeds, leaving the subsidiary a shell."

One active area in this field of law involves Superfund cases. Early last year in Joslyn Manufacturing Co. v. TL. james & Co., the court ruled that parent companies should not be held responsible under the Superfund law for their subsidiaries' hazardous waste cleanup costs. In the case, Joslyn Manufacturing sued T.L. james under the Comprehensive Environmental Response Compensation and Liability Act and the Louisiana Environmental Quality Act seeking contribution for the costs of cleaning up a site in Louisiana on which a T.L. james subsidiary, Lincoln Creosoting Co., operated a plant. The ruling offered insight into how the court decided liability. As pointed out in the February 1990 issue of Insurance and Risk Management, "The facts in the case were extremely good for the parent corporation: James and Lincoln were in different towns, James used none of Lincoln's property and each company had its own employees, general manager, bank accounts and filed its own tax returns."

Piercing the Veil

When the subsidiary is structured as a separate corporation, the parent company is usually protected from its liabilities. The overriding purpose of the "corporate veil" is to promote investment by calming fears of losing corporate assets in a new venture. Conflicting with this purpose are popular causes, such as environmental cleanup and massive class action award payments, which contradict immunity and require piercing the corporate veil.

Monsanto recently lost a court decision in which the judge allowed the company to be named as a defendant in a suit against its G.D. Searle subsidiary. However, two leading toxic tort cases reached separate decisions regarding the parent's liability. In the 1989 case Kayser v. Roth, the judge ruled that a parent corporation controlling the management and operations of its wholly owned subsidiary can be held responsible for its subsidiaries' CERCLA liability without piercing the corporate veil.

However, in the Joslyn case the parent was immune even though it had 100 percent ownership, employed common directors and officers and made loans with its subsidiary. Yet the most well-known case is the 1979 Boggs v. Blue Diamond Coal, which established three criteria needed to pierce the veil. It had to be used to defraud creditors, create a monopoly and circumvent a statute. While the case is 12 years old, several jurisdictions are now looking at whether the veil would promote an injustice. If so, they do not hesitate going after the parent.

Company management is responsible for preserving stockholder value by protecting corporate assets. If it acts aggressively by insuring its subsidiaries separately, management can expect the corporate veil to remain intact. If it takes a conservative approach, it would consolidate the liability program despite cost allocation or large deductible adjustment problems.

The conservative approach is preferable for several reasons. For one, there is no clear defense against being deep pocketed in every state in which most clients operate, and standard practice in risk management overwhelmingly favors consolidation. There is also lower risk and cost of failure through consolidation. Under a separate program, several practical problems may arise. One is lack of a nationally coordinated claims handling service, along with little or no settlement authority. In addition, separate certificates of insurance, multiple renewal dates and greater claim frequency due to a lower deductible may also cause problems for the companies involved.

When a large deductible is applied to a new subsidiary, it is advisable to emphasize funding for an expected large loss in the new deductible area by setting aside the annual premium savings. This measure, combined with considering various premium allocation schemes, should ease the assimilation process. Andrew Lindblad is vice president of Marsh & McLennon Inc. in Chicago.
COPYRIGHT 1991 Risk Management Society Publishing, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1991 Gale, Cengage Learning. All rights reserved.

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Title Annotation:product liability insurance
Author:Lindblad, Andrew
Publication:Risk Management
Date:Feb 1, 1991
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