OUTSIDE PERSPECTIVES

Legacy Liability Management:

The Role Of Common Law Indemnification
P
arties to a stock or asset
purchase often proceed as if
only written contract terms
define financial responsibility for
post-sale contingent liabilities. Not
so. The common law may supply
indemnity terms even if the con-
tract does not. The applicable
rules depend on the type of trans-
action, state of incorporation, place
of sale, contract law selected, na-
ture of the pre-sale relationship
between the parties and other
similar facts.
The recent decision in finwoong
Inc. v-finwoong, Inc., 310 F.3d 962
(7th Cir. 2002), discusses several
potentially applicable common law
indemnification rules. These com-
mon law rules create opportunities
for gains or losses, and the out-
comes that occur depend in part
on knowing the rules and when to
invoke them. This article discusses
seven of the common law rules.
Rules 1 and 2-
When Common Law
Indemnity May Apply
When does common law
indemnity may apply? Judge
Posner, writing for the court,
explained the rules as follows:
1) "For indemnity to be ...
"implied" in a contract the parties
must have already had a relation-
ship when the tort giving rise to
AS CORPORATE COUNSF.L 1-'EilRUARY 2003
the liability occurred--for remember
that the function of the doctrine of
implied indemnity is to fill out the
parties' contract; it is not to create
a contract where none existed:'
2) "[A] corporate relation
[parent/subsidiary] itself was not
the preexisting relation that the
cases require; if the corporations
though affiliated were not dealing
with each other, imposition of
implied indemnity would be an
end run around limited corporate
liability, which with immaterial
exceptions applies even between
affiliated corporations:
The finwoong rule, therefore
requires a pre-existing relationship
but being of the same corporate
family is not enough.
Rules 3 and 4- Typically
Require Indemnities from
Manufacturers
A relationship such as manu-
facturer and distributor usually
is deemed sufficient to require
indemnity:
3) "A retailer or other distributor
of a product who had absolutely
nothing to do with its manufacture,
and is held strictly liable to a cus-
tomer injured by a defect in the
product solely by virtue of doctrines
of implied warranty or strict prod-
ucts liability, can ... obtain indemni-
ty from the manufacturer, on the
theory that the latter, even if not neg-
ligent made the defective product
and so in a sense caused the defecC
Even this ''manufacturer indemni-
fies" rule, however, is not that sim-
ple. The finwoong court suggested
that the definition of manufacturer
may have some play in the joints:
4) '1n addition, the party on
whom the duty to indemnify is
sought to be imposed must have
been in some (though often an atten-
uated) sense 'at fault' and the other
party blameless though liable--that is
to say, only strictly liable, by virtue of
respondeat superior, implied warran-
ty, strict products liability, or some
other legal principle that imposes
liability regardless of fault ... TI1e
underlying principle is that the party
that is in the better position to avoid
liability is given an incentive to do so
by being made responsible for the
consequences:
The product in finwoongwas a
defective stake, manufactured by an
umelated entity, included with a tent
Even though the indemnity defendant
did not physically make the slakes, it
was deemed somewhat at fault -and
thus liable for indemnity to the dis-
tributor because it had inspected the
slakes but had not found the flawed
slake. Under this rule, persons man-
aging legacy liabilities will have to
carefully examine the entire supply
chain to identify potential indemni-
tors or potential obligations.
Rule 5- A Lesson for
Contract Drafting
jinwoong demonstrates that terms
omitted from contracts sometimes
may be as important as those ex-
pressed:
5) "But even if the parties fail to
include an indemnity provision in
their contract, if it is apparent that
they would have done so had the
point occurred to them, the courts
will read it into their contract unless
it is disclaimed. ... It reduces transac-
tion cosis and gives the parties an
approximation to if they were
omniscient they would have provid-
ed respecting every jlOSSlble contin-
gency that might arise in the course
of performance of the contract:'
If the original contract did not in-
clude a "disclaimer" and time has
passed, an unintended result may
OCCUL Thus, if a buyer paid a low
price in return for no indemnities, but
then asserts indemnity claims years
later when underlying liabilities arise,
the seller is risk because rourts may
imply a right to indemnity even
though plainly that was not "the
deal:'
Rule 6 - May Make a
Difference to Indemnity
Administration
Contracts that include indemnifi-
cation obligations typically include at
least some terms regarding claim
administration. There are no such
terms for common law indemnities.
When rommon law indemnities are
involved, therefore, the "due process''
rule stated in finwoong creates an op-
portunity for gain or loss:
6) ''But when as in this case in-
demnity is not sought on the basis of
an insurance contract or some other
rontract of indemnity, no formalities
are prescribed (for there is no con-
tract to prescribe formalities and no
C0Mf'LX BUSIN66 LITIGATION
statute to do so as we are deal-
ing with a rommon law doctrine) or
are required. 71te only question is
whether the party seeking indemnity
ga:ve theotherparty (oral least the
other party had) a fair opportunity w
profct its interests. Due process ll'
quires no less, but no more either. "
(emphasis added)
In jinwoong there was no formal
tender of the underlying case for
defense or indemnity, and the under-
lying case was settled without
involving the indemnitor. The
court held that the indemnitor was
nonetheless bound because it had
actual notice of the underlying law-
suit Thus, the indemnitor lost the
right to control the underlying litiga-
tion, trial or settlement and the in
demnitee was protected despite the
absence of formal notice. Fatlure to
consider these potential results may
be costly, especially when ''mass
torf' litigation is involved.
Rule 7- Implicates
Rights and Duties to
Shareholders
jinwoong goes on to state an
indemnity-related rule that impli-
cates shareholder rights:
7) "ITJhe subsidiary [was] not a
wholly owned one, so its board of
directors had obligations to minori-
ty shareholders, especially in a
case that involved a conflict with
the parent; it may also have had
obligations to creditors who by
virtue of the principle of limited lia-
bility could not look to the parent
to pay [the subsidiary's] debts. One
obligation of [the subsidiary] to its
minority shareholders was to en-
force any right of indemnity that
BUTLER RUBIN
the law gave it or rather not to
refuse to enforce it merely because
the right was against its parene
Thus, persons managing contin-
gent liability claims need to look
carefully at the facts regarding
stock ownership before deciding
whether or not to seek indemnity.
And, if a company Is in the vicinity
of insolvency, at least judge Posner
counsels the possibility that the
claims managers need to think
about whether to make indemnity
claims in order to satisfy possible
obligations to creditors.
Conclusion
Tho many legacy liability issues
are analyzed only with reference to
past transaction documents. The
common Jaw provides another
source of potential claims or risks,
and must be carefully considered as
part of a legacy liability manage-
ment strategy.
Kirk Hartley and Patrick Lamb
are senior trial partners with
Butler Rubin Saltarelli & Boyd,
a Chicago litigation boutique.
Both have substantial experience
with product liability and mass
tort defense. In addition, both
have substantial post merger and
acquisition litigation experience,
and now devote substantial time
to the convergence area, legacy li-
ability management and defense.
excellence in litigation
CORPORATE COUNSEL FEBRUARY 2003 A6