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Successor in interest issues: Thoughts on potential coverage implications

Depending on the circumstances and jurisdiction, the legal defense costs of a non-insured corporate acquirer may not be covered by the insurance policy of the acquiree.

By Michelle Gordon, Director of Management Liability Claims, and Nicholas Butovich, Director, Associate General Counsel, Coverage Counsel

When it comes to management liability insurance, corporate acquisitions can raise important coverage issues. Typically, when a company is acquired, its policy goes into runoff, and any pre-acquisition acts are covered under a runoff policy or an extended reporting period (ERP), while any post-acquisition acts are covered under the acquiring company’s policy. What happens, however, when a claim is first made and reported during the policy’s ERP, triggering coverage, but the acquiring company, which is not an insured under the acquired company’s policy, is also named in the claim? Is there any obligation to cover the defense costs of the non-insured party?

This article explores the case law surrounding the issues of whether coverage flows up, the subsequent defense obligations, and the allocation of attendant fees. These issues are not unique to any one product line.

For example, imagine you have a state lawsuit filed by a former employee of ABC Corp., naming ABC Corp. and its acquirer DEF Corp. The plaintiff was an employee of ABC, but was terminated prior to the company’s acquisition by DEF, and was never employed by DEF. The plaintiff alleges she was wrongfully terminated by ABC in retaliation for a request for reasonable accommodations following her hip surgery. DEF is not a named insured, additional insured, or subsidiary under ABC’s management liability policy, and thus is not covered under that policy. In addition, DEF does not have its own management liability policy.

The issue that has arisen in this hypothetical example is whether the defense fees of the non-insured party, DEF, are covered under the management liability policy of the insured, ABC. The answer depends on the jurisdiction and type of policy at issue.

“Some courts hold that an insurer that defends its insured has no financial obligation for a non-insured’s defense fees.”

See for example General Accident Ins. Co. v. Superior Court, 55 Cal.App.4th 1444 (1997) (California law), where the court held that following a corporate acquisition, successor liability in tort does not entitle the successor corporation, by operation of law, to coverage under the CGL policy of its predecessor. See also Santa’s Best Craft, LLC v. St. Paul Fire and Marine Ins. Co., 611 F.3d 339 (7th Cir. 2010) (Illinois law), which held the insurer was not responsible for the defense fees of the non-insured, even when the defense of the non-insured was “reasonably related” to the defense of the insured and benefitted the insured.

However, other courts have upheld the “reasonably related” rule in certain circumstances, including, notably, in the D&O (i.e., directors and officers) context. Specifically, if the defense of an insured is so intertwined, or “reasonably related,” with that of a non-insured, the predecessor’s insurer could be required to pay the defense fees of the non-insured successor. See for example Safeway Stores, Inc. v. National Union Fire Ins. Co. of Pittsburgh, 64 F.3d 1282 (9th Cir. 1995) (California law), where the court held that the insurer of directors and officers was required to reimburse the non-insured company’s defense fees, when the defense of the company was reasonably related to the defense of the directors and officers.

See also Continental Ins. Co. v. Daikin Applied Americas Inc., 998 F.3d 356 (8th Cir. 2021) (Minnesota law), where the court held that following a corporate acquisition, a commercial general liability (CGL) insurer of an acquired company could potentially have a duty to defend the acquiring company where complaint allegations make it “arguable” that the acquired company’s liabilities are implicated; however, the court also held that simply naming an acquiring company as a defendant in a complaint is insufficient to trigger the duty to defend. Importantly, the Daikin court did not ultimately resolve the issue of whether the complaint allegations at issue in that case actually did meet the “arguable” standard, having remanded the case for the District Court to make that determination.

In the above-referenced hypothetical employment scenario involving ABC and DEF, the same defense attorney typically represents both parties. As supported by the case law above, in this context, the non-insured entity’s defense fees would not be covered. For this reason, the next step is to agree to an allocation of expenses so that the insurer is covering only those expenses associated with the defense of its insured. Other times, the insurer may ask defense counsel to submit invoices only for work done for the insured party. This is not always straightforward, and issues can arise if work is done by the firm for both parties.

Given the above considerations, the best course of action for insureds is to have an “additional insured” endorsement added to a policy. What would work best is some sort of co-defendant endorsement, which typically provides coverage for a specific entity (e.g., DEF Corp.) only in certain circumstances, namely, when both parties are named in the claim and the non-insured entity is being named solely because of its status as the successor company, while the alleged wrongful acts arise from the predecessor insured’s activity. That is, the non-insured entity is not being named in the claim for any acts arising from its own activity. In this situation, the endorsement would provide coverage for the non-insured entity. In summary, this type of endorsement can offer protection to acquiring companies in these kinds of scenarios.