​California Supreme Court Re-Establishes Corporate Seller’s Ability to Assign Right to Coverage for Legacy Liabilities

On August 20, 2015, the California Supreme Court held that a seller in an asset sale transaction may assign to the purchaser the right to coverage for pre-existing, but undiscovered, liabilities without running afoul of the anti-assignment provisions uniformly included in liability insurance policies. Fluor Corp. v. Superior Court, No. S205889, 2015 WL 4938295 (Cal. Aug. 20, 2015). The Fluor decision overrules the same court’s notorious decision in Henkel Corp. v. Hartford Accident and Indemnity Co., 62 P.3d 69 (2003), in which the court had held an anti-assignment provision operated to prohibit a seller from assigning to the purchaser the right to coverage for legacy liabilities. Because insurers have consistently relied on Henkel in seeking to avoid their coverage obligations in courts in other states, Fluor is being heralded as a significant development in the law on this issue with potential nationwide impact.

To appreciate the significance of the decision, consider the following: Odds are that in the course of due diligence in any merger or acquisition, outside and in-house counsel for both the seller and the purchaser will be asked to consider how to best address so-called “legacy liabilities” of the company or business line being acquired—liabilities arising from claims that will be asserted in the future based on existing, but undiscovered, liabilities of the acquired company or business line (typically asbestos, environmental, or other “long tail” claims based on latent injuries). And, odds are that one of the answers counsel will consider is to structure the deal such that whatever insurance coverage exists as of the deal’s closing for such liabilities is transferred in the sale to the purchaser who faces the prospect of such legacy liabilities.

However, in recent years, transferring the right to such coverage to the purchaser has proven problematic where the deal is structured as an asset purchase. In asset purchase transactions, the transfer typically is performed pursuant to an assignment of the right to coverage. And insurers contend that such assignments violate the anti-assignment clauses uniformly included in liability policies.

Twelve years ago, the Henkel court adopted the insurer’s contention, holding that the seller in an asset sale cannot assign to the purchaser the right to insurance coverage for pre-existing, undiscovered liabilities (e.g., a claimant's exposure to asbestos) of the acquired company or business line unless either (a) the acquired company’s insurer consents to the assignment; or (b) the loss already has been reduced to judgment (i.e., a sum certain). The court reasoned that the assignment of coverage for such liabilities not only violated the anti-assignment provision of the policy, but may also impermissibly increase the risk to the insurer that a covered loss will occur.

Since then, courts in other states have relied on Henkel to reach the same result, disregarding prior judicial precedent holding that an anti-assignment provision does not prevent the assignment of rights to coverage for liabilities based on accidents that had already occurred, whether they had been discovered and resulted in a claim; such provisions prohibit the policyholder from assigning rights to coverage for liabilities based on events that have not yet occurred and might be more likely to occur post-sale depending on how the purchaser conducts the business. As to accidents that have already occurred, the risk of liability has become fixed; it does not increase regardless of when the claim is discovered and asserted. Moreover, refusing to honor the assignment of rights to coverage for such pre-existing, but undiscovered, liabilities deprives both the policyholder (who surrendered the right to coverage by assigning it) and the purchaser of coverage in exchange for which the insurer received premiums, granting the insurer a windfall.

Fortunately, as of last week, it appears that Henkel’s reign is over. Fluor re-establishes a seller’s ability to assign to a purchaser the right to coverage for injuries that have already occurred as of the date of the assignment, whether such injuries have been discovered and resulted in a claim being asserted against the acquired company. By overruling the principal decision on which insurers have relied in sowing seeds of confusion across the country, the Fluor court has removed a significant obstacle to courts in other states continuing to honor well-established judicial precedent supporting the free alienation of coverage for pre-existing but undiscovered liabilities based on latent injuries.

Nevertheless, insurers will attempt to distinguish the Fluor decision on the grounds that the result turned not on a rethinking of the Henkel analysis, but instead, on the discovery of a statute overlooked (by all parties, amicus, and the court) in Henkel. And to a limited extent, this is true: The Fluor court overruled Henkel because the decision cannot be reconciled with the Cal. Insurance Code Section 520, which states that “[a]n 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 Fluor court held the effect of the statute is to void the anti-assignment provision as to losses that predate the policyholder’s assignment of coverage and, further, that the statutory text “after a loss has happened” refers to the period afterthe injury to a third party, not the time at which liability is reduced to a sum certain judgment.

However, far from relying exclusively on the statute, the Fluor court expressly acknowledged that the Henkel analysis is simply wrong. The court expressly held that, unlike the rule announced in Henkel, “[t]he rule embodied in section 520 is consistent with the overwhelming majority of cases decided before and since Henkel.” Moreover, the court held that “[t]he principle reflected in those cases—precluding an insurer, after a loss has occurred, from refusing to honor an insured’s assignment of the right to invoke policy coverage for such a loss—has been described as a venerable one, borne of experience and practice, facilitating the productive transformation of corporate entities, and thereby fostering economic activity.” Accordingly, it is clear that while section 520 gave the Fluor court a convenient way to easily correct its earlier decision in Henkel,the result depended less on the statute and more on the court’s revised understanding that the Henkel analysis and result simply cannot be squared with the “overwhelming majority of cases” and the “venerable” principle “borne of experience and practice” that a policyholder may freely assign its right to coverage under occurrence-based liability policies for existing, though undiscovered, losses and liabilities.

Because of Fluor, the path to a clearly stated, uniform rule permitting assignment of insurance coverage for pre-existing events, accidents, and injuries is much more secure now than it was a week ago, notwithstanding that some of the damage done by the Henkel decision may not yet be undone (decisions from other states relying on Henkel are still good law, after all) and Fluor leaves open the question of what language a seller must use to effectively assign the right to coverage for pre-existing events, accidents, or injuries to a purchaser.

For any questions, please contact Patrick Murphy at (414) 277-5459/patrick.murphy@quarles.com, Alex Shortridge at (414) 277-5443/alexandra.shortridge@quarles.com, or your local Quarles & Brady attorney.