November 23, 2007

Mergers and Acquisitions Raise Questions About Who Assumes Responsibility For Products

Article reprinted with permission from the September 1, 1995 edition, page 109
Bicycle Retailer and Industry News

A Legal Viewpoint

By Steven W. Hansen

With the trend toward consolidation in the bicycle industry, it is worth examining the liability concerns that arise when a company buys or merges with another. There are lots of products on the market that may be around for years before anything goes wrong with them. For one company buying another, there is no way of cutting off liability for those products.

Most states, however, have provisions for dissolving corporations. Bankruptcy is one form of dissolving a business that has been used effectively by corporations facing enormous class-action litigation. Dow Corning is trying the approach in silicon breast implant litigation.

Unlimited Liability. Dow Corning had to make the move into bankruptcy when hundreds of plaintiffs opted out of the company's $1 billion class-action settlement. The action had the effect of exposing the company to unlimited liability. Corporations can file for two kinds of bankruptcy, either Chapter7 liquidation or Chapter 11 reorganization. It is also possible for a corporation to dissolve without bankruptcy and possibly re-incorporate as anew entity. A corporation can merge with another corporation or have its assets and liabilities acquired by another corporation. In product litigation, the primary issue is whether the injured party can recover damages from the new or dissolved entity.

Former Shareholder Liability. A number of states have laws that authorize action against former shareholders of dissolved corporations on claims arising prior to dissolution. Claims made after the corporation is dissolved are barred. Otherwise, a corporation would live indefinitely through its shareholders. Buyers do not assume the liabilities, unless they agree to the contrary. The law can require buyers to assume liabilities if the transaction amounts to a merger, or if the business is a mere continuation, or the transfer of assets was for the fraudulent purpose of escaping liability.

Two California cases illustrate where a court decided whether a successor corporation is responsible for the liabilities of the company they bought.

In Ray versus Alad Corporation, a consumer was injured by a ladder manufactured by Alad. But the injury occurred after Alad had been purchased and renamed Alad II. The first corporation had been dissolved as part of the purchase.

The court did not find that there was a de facto merger, nor that Alad II was a mere continuation of Alad, because adequate compensation was paid for Alad, and there were no common shareholders or officers in the two companies. The court made an exception to the general rule for several reasons. The plaintiff’s lack of opportunity to file against the original manufacturer, and the successor's ability to purchase insurance, played a part in the decision. The court also recognized the fairness of requiring Alad II to assume the burden that came with the good will obtained from Alad.

De Facto Merger. In another case, Marks versus 3M, the plaintiff had received defective breast implants manufactured by McGahn Medical Corporation. 3M acquired McGahn, and McGahn was dissolved. In the purchase agreement, 3M took on some of McGahn's liabilities, but the agreement excluded all unknown liabilities, including the plaintiff's suit, which was unknown at the time of the sale.

The court ruled in favor of the plaintiff, holding that a de facto merger had occurred because only stock was paid for the purchase. 3M had continued as the same enterprise and there were common shareholders. The seller had liquidated and 3M had assumed the liabilities necessary to carry on the McGahn business.

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