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Wednesday, December 11, 2019 njlj.com Assessing Potential Risk: Due Diligence for Acquisition of Product Manufacturers

By Michelle M. Bufano and This article addresses the areas Peter J. Schaeffer that should be explored when eval- uating a transaction from the per- ith an increase in recent years spective of both a products liability Wof mass tort litigations and lawyer and a corporate transactional runaway jury verdicts, the scope lawyer, and highlights the benefits and complexity of product liability of involving experienced products and mass torts litigation continues liability lawyers to assist with due to expand. The result: product diligence in connection with an manufacturers face ever-growing acquisition or merger. Issues relat- Credit: sommthink/Shutterstock.com potential risk and exposure. While ing to products liability for con- prove the existence of such a duty in the past, manufacturers may have sideration during corporate acqui- as the law assumes the duty exists. viewed products liability litigation sition due diligence include: (1) There are three theories of liability as an inherent risk of doing busi- basic information about the product under strict products liability: (1) ness, the current legal climate has at issue; (2) the target company’s manufacturing defect; (2) design resulted in products liability liti- reputation regarding the product; defect; and (3) failure to warn. gation being far from business as (3) past and current litigation and/ Other theories of liability include, usual. or claims involving the product; inter alia: breach of express or As this legal landscape contin- (4) litigations involving similar implied warranty; negligence; and ues to shift, due diligence investiga- products; (5) applicable state law consumer fraud. tions concerning products liability and venue of future litigations; (6) Basic information gathered dur- issues can be critically important for availability of insurance coverage; ing due diligence should relate to companies considering corporate and (7) available steps that may the theories of liability mentioned acquisitions—especially acquir- mitigate risk through transaction above, with a focus on manufactur- ers who may not have experienced structure and the terms of the trans- ing, design, and warning informa- the time and expense that can be action agreements. tion. A standard diligence request involved in U.S. litigation. Though Basic information about list should request the following they typically spend most of their the product. information about the target’s prod- time litigating, products liability Most product liability claims in ucts: (1) name and purpose; (2) a lawyers can leverage their litigation the U.S. are strict liability claims. list of ingredients or component experience to assist in evaluating Because strict liability imposes a parts; (3) locations where the prod- potential products liability exposure duty on product manufacturers to uct is manufactured, assembled, when a target company is a product produce safe products, plaintiffs sold or distributed; (4) the identity manufacturer. suing under strict liability need not of vendors and manufacturers of ingredients and component parts; (2) information about resolution liability cases, that will factor into (5) a list of all models, updates of any of the past litigations or the risk calculus. In such cases, the and variations; (6) all manufac- claims; (3) the factual predicate/ acquirer may decide, for example, turing designs and specifications, allegations at issue; (4) the alleged to make relocation of the target’s and the identities of the individu- injuries at issue; and (5) defenses headquarters part of the deal. als involved in the designs; (7) all asserted. This information will not Available insurance to cover alternative designs; and (8) sales only help predict future litigations product liability claims. information going back at least 10 or claims involving the products, Acquirers must also ascertain years. This basic product informa- but also help quantify the poten- the existence and extent of insur- tion helps assess the viability and tial liabilities. In all cases, be ance available to the target company. extent of different types of potential aware of, and attentive to, the Insurance can be a useful tool in miti- products liability claims. An expe- possibility that pre-closing dis- gating acquired liabilities. Acquirers rienced products liability litigator closure to an acquirer regarding should consider the following insur- is uniquely qualified to use this pending litigation may need to be ance-related information: prior and information in forming a liability limited so as to prevent the unin- existing primary and excess insur- assessment. tentional waiver of attorney-client ance coverage (and if vendors have Target company’s reputation privilege. added the target company as an addi- with respect to the product. Litigations involving similar tional insured), claims histories with In the age of the internet, products. respect to the target company’s exist- obtaining basic information about While identifying the likeli- ing and historical insurance program the public perception of the target hood of potential products liability (commonly referred to as loss runs), company and its products is vital to exposure is critical, quantifying that and documentation and loss informa- predicting future risk. In addition exposure is equally important. In tion concerning areas that are self- to traditional news articles relating order to quantify risk, the litiga- insured by the target company. This to the target company, acquirers tion history with respect to similar information will be useful in per- should review social media with products may be useful. Acquirers forming a risk management evalua- respect to the target and its products. should examine success rates of tion, i.e., weighing existing insurance Investigating the target company defenses, verdict and settlement against estimates for potential expo- on social media sites may provide amounts, as well as any other nota- sure so as to determine if additional insight into the public perception of ble trends in similar litigation. insurance is necessary, feasible or the target company and its products. Likely applicable state law and cost effective. This information also This social media inquiry also may venue of future litigations. will be useful in ascertaining the reveal potential litigation. In the current age of plaintiff steps that will need to be taken to Past/current litigation or claims forum-shopping, it is difficult to preserve insurance coverage for pre- involving the product. predict the jurisdiction and venue of closing products liability claims— Of course, past and current a products liability suit—other than for example, by placing a products litigation and claims also can be that it likely will be in a jurisdic- liability insurance policy written on a predictor of future liability. As tion more favorable to the plaintiff a claims-made basis into an extended part of its due diligence investiga- and less favorable to the defendant. reporting period (commonly referred tion, an acquirer should obtain the If the target company is headquar- to as “tail” coverage). Also, if addi- following: (1) all current or past tered in a jurisdiction that is not tional insurance is needed to mitigate litigations involving the product; favorable to defendants in products products liability exposure, it may be prudent to ensure that the insurance that were identified during due dili- by the insurer as a matter of policy package covers unknown regulatory gence as being of particular con- in certain industries, or as a result and products liability issues that may cern (which might include product of diligence conducted during the arise. liability issues). A specific or stand- underwriting process; and (3) loss- Risk Mitigation Strategies alone product liability indemnity es arising from product liability Although M&A transaction would typically require the seller to claims may not be attributable to documents employ a range of risk indemnify the buyer for any losses any breach of a representation or mitigation strategies to address suffered by the buyer as a result of warranty of the seller. potentially significant, pre-closing product liability claims arising from Conclusion products liability exposure, perhaps the pre-closing activities of the sell- Mass tort and products liabil- the most common and effective are: er. The seller’s obligation would ity due diligence investigations (1) structuring the transaction to be without regard to whether such frequently involve estimating the avoid or minimize the risk of suc- losses are attributable to any breach number and value of claims likely cessor liability for pre-closing prod- of a representation, warranty, or to be brought in the future against a ucts liability claims (typically as an covenant of the seller in the opera- defendant, as well as valuing claims asset purchase); and (2) negotiating tive transaction documents, and are that are already pending. During the specific or stand-alone indemnity typically not subject to any indem- due diligence stage of the potential for pre-closing products liability nity deductible, basket or cap (or, if acquisition of a target company claims in the operative transaction subject to a cap, subject to a much that manufactures products, the documents. higher cap, sometimes set at total more information that can be gath- As to the structure of the trans- purchase price). Among the com- ered about the target company’s action, while the specifics of the plex issues that should be addressed product(s), the better. A products doctrine of successor liability are in contractual indemnity is: which liability litigator’s experience can beyond the scope of this article, as party controls the litigation or the be beneficial for the assessment a general matter, the liabilities of a settlement of the litigation. and analysis of risks involved in a seller will not usually be imposed While many M&A transac- potential acquisition. on a buyer in an asset sale transac- tions are moving toward a repre- tion. However, in addition to other sentation and warranty insurance Michelle Bufano is a part- exceptions to the general rule of model of allocating certain risks ner in the litigation department of successor liability, buyers in asset between the parties, coverage for Patterson Belknap Webb & Tyler transactions are potentially subject, product liability exposure may not in New York, where she represents in certain jurisdictions, to successor be possible under such policies for companies in complex products lia- products liability claims on a prod- a number of reasons, including: bility and mass tort litigation. Peter uct line theory. (1) certain product liability issues Schaeffer is a partner in the firm’s As to contractual indemnity, it is may be excluded from the policy corporate department, focusing his common for buyers in M&A trans- because they are known issues at transactional practice on private actions to negotiate for a specific closing; (2) product liability claims equity, venture capital and mergers or stand-alone indemnity for areas may be excluded from the policy and acquisitions.

Reprinted with permission from the December 11, 2019 edition of the NEW JERSEY LAW JOURNAL. © 2019 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877.257.3382, [email protected] or visit www.almreprints.com. # NJLJ-12112019-429478