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Occasionally buyers acquire more than they bargained for. A guest article from Dechert's Sean Wajert discusses best practices when it comes to dealing with the potential litigation liability of a target company.
An important aspect of evaluating a possible acquisition is the potential litigation liability that may be acquired simultaneously. If a company is involved, or could potentially become involved, in mass tort litigation, it presents both risk and opportunity to the acquirer.
The threat of this type of litigation may result in the opportunity to buy a target at a below-market valuation multiple, and the uncertainty caused by mass tort exposure can result in valuation discounts that make the attendant risk acceptable.
However, there are potentially significant risks associated with mass tort litigation exposure, and thus buyers would be wise to proceed carefully. In the private equity context, in particular, mass tort litigation exposure can adversely impact the ability to secure third-party debt financing and can have an adverse impact on investment exit. Private equity buyers may also have shorter investment time frames than strategic buyers, and mass tort litigation often takes a substantial amount of time to resolve itself.
The general rule of law, and the typical structure of an asset purchase agreement, is that an acquirer of the assets, using cash, does not assume the liability for injuries caused by products sold by the target company prior to closing. But even when the parties purport to allocate such liability to the target, the buyer may still find itself responsible for the litigation through the operation of various legal doctrines that are exceptions to the general rule.
The Restatement (Third) of Product Liability Law notes that a company that acquires assets of a business can be subject to liability for a defective product sold by the predecessor business entity. This occurs when the acquisition results from a fraudulent conveyance to escape liability for the liabilities of the predecessor, or results in the successor becoming a mere continuation of the predecessor. A few states also add the socalled "product line" exception, which allows a plaintiff to recover for injuries caused by a defective product sold by the predecessor in cases in which the successor corporation has continued the predecessor's product line.
Thus,...