The Importance Of Product Liability Risk Assessment In Business Valuation And Acquisitions

Sunday, May 1, 2005 - 01:00

"Products liability and environmental issues pose unique and dangerous risks to any professional attempting to evaluate those topics.These are not areas that can, or should, be handled by a junior corporate lawyer or banker."

It has become axiomatic that any analysis or critical evaluation of a business must take into account all the potential variables and uncertainties - known and unknown, foreseeable and unanticipated - that may exist or may come to exist in the life of a business.Indeed, companies pay investment bankers and lawyers substantial sums to identify and quantify those risks.Troubles can occur, however, when those professionals fail to properly recognize all the pitfalls and hidden risks attendant to a business concern.Further problems arise when the same professionals do not have the requisite experience to identify logical risk factors or ascribe accurate valuations to those subjects.

The term "due diligence" has long been bandied about as one of many thresholdrequirements for the completion of any corporate analysis or transaction.Due diligence is not considered a pleasant task and is often handed down to the most junior-level attorneys and consultants.War stories abound concerning protracted "road trips" and "document rooms" where often unseasoned lawyers are holed up for days or weeks on end developing a scorched earth methodology towards understanding a company's risks.The problem with this approach, however, is that it can be inefficient and unproductive.These relatively inexperienced professionals often do not understand the nuances of what they are reading and hearing.In fact, even much more seasoned and experienced transactional experts might not understand subtle nuances of certain potential liabilities, especially where those liabilities relate to specialized areas of the law.

Products liability and environmental issues pose unique and dangerous risks to any professional attempting to evaluate those topics.These are not areas that can, or should, be handled by a junior corporate lawyer or banker.Nor, most often, can an experienced transactional professional confidently and accurately identify all the nuances of product liability law that may present themselves in any given transaction.These areas of the law require consultation with experienced products liability/environment litigators who have spent years analyzing, scrutinizing and counseling clients on these issues. Only experienced environmental and products liability attorneys should handle diligence concerning the litigation risks associated with those types of acquisitions because of the potential ramifications to a company if litigation risks are missed or misunderstood.Such consultation need not always be prolonged or extensive; sometimes a quick discussion of the salient issues will be enough to help identify risks or quell concerns.But failing to take reasonable measures to determine a company's potential exposure in these areas can yield costs that could ultimately swallow a solvent, financially stable business.For example, countless articles have been written about companies that have acquired businesses with "very small potential asbestos liabilities that really shouldn't be a factor."As we now know, many of those incidental acquisitions - where the tainted area of the business comprised only a small percent of the total transaction - resulted in the bankruptcy of the entire acquirer.Perhaps a detailed discussion with product liability counsel would have caused some of those deals not to be made and otherwise untainted companies to remain free of those liabilities.

When engaging a product liability or environmental lawyer to provide expert counseling, it is critical to utilize someone who is not afraid to call balls and strikes and provide cold, hard advice even when it is not what the transactional lawyers and bankers want to hear.Consulting with a lawyer who feels pressured to minimize risks in favor of not upsetting a client or breaking up a potential transaction is almost worthless.Most experienced product liability lawyers can recognize and succinctly explain the risks in a way that gives clear guidance to their client.Moreover, skilled counsel can help suggest alternative structures for the transaction - perhaps fencing off the offending product, leaving liability with the seller, creating a claims bucket, building an acceptable insurance profile or any of many other acceptable alternatives to a straight acquisition of a liability-laden portfolio.

Effective risk assessment, by experts in the field, can decrease the likelihood of bankruptcy or other unpleasant surprises in the form of large liability.This assessment transcends the traditional notions of transactional due diligence and requires seasoned expertise. Any company contemplating an acquisition, or in the process of diligence, should insist on having attorneys with expertise in the relevant fields conduct an analysis that includes, at the very least the following:

1. An Assessment of the Relevant Products .An attorney evaluating the products of a target company should analyze all products manufactured, sold or distributed and should determine, among other things, the number of units sold, the geographic trends in sales and any recent design changes to the product.

2. An Assessment of the Legal Arena Surrounding the Product .An attorney should determine which government regulations and government agencies have jurisdiction over the products, and whether the product complies with all applicable regulations.Any investigations by agencies, such as the CPSC (Consumer Product Safety Commission), the FDA (Food and Drug Administration) or the EPA (Environmental Protection Agency) should be evaluated.Similarly, an attorney should review the history of the products to determine whether there have been past recalls, whether punitive damages have been awarded in cases involving similar products and whether warning labels have been deemed adequate.

3. Assessment of Litigation History .In order to evaluate potential future liability, an attorney must know the complete litigation history surrounding the product or product line.This includes an analysis of jurisdiction and causes of action and damages, among other aspects of litigation.The lawyer must understand the company's philosophy regarding settlement, what defenses have been successfully employed, whether "bad documents" or turncoat witnesses have appeared in multiple jurisdictions and a host of similar concerns.

4. Evaluation of Available Insurance .Counsel must be able to truly appreciate the nuances of any insurance that may be available to cover any potential claims.The policy must be thoroughly understood so as to ensure that the acquirer is not leaving coverage on the table or, even worse, operating under a misapprehension of coverage that is not available.

Additional areas may require attention and expertise, depending upon the type of company being acquired and the complexity of the transaction.

Attorneys knowledgeable in products liability and environmental litigation trends can also help evaluate unknown risks.Because they regularly follow these trends for other clients, these attorneys are able to readily appreciate whether the target company's product line risks becoming the next asbestos or Fen-Phen.Then, these attorneys can allow acquiring companies to make more educated decisions based on the potential risks associated with their proposed transactions.

In sum, whenever product liability or environmental risks may exist, diligence must extend beyond having junior lawyers comb through documents.Any company seriously interested in an acquisition, or a critical risk assessment of a business that could foreseeably have any product liability exposure should ask its counsel to engage experienced litigators to weigh in with an analysis of the risks associated with the business or its product lines.The reward to completing such an analysis can be the livelihood of the acquiring company; the risks associated with failing to do proper risk assessment can be devastating, and, as has been seen on countless occasions, can even lead to bankruptcy.

Peter A. Antonucci is the Director of the Product Liability/Mass Tort/Environmental Law practice at Weil, Gotshal & Manges, LLP.Peter concentrates his practice in product liability, toxic torts, crisis management and internal corporate investigations. Lianne S. Pinchukis an Associate in the Litigation/Regulatory department at Weil, Gotshal & Manges, LLP.Lianne specializes in products liability and mass torts and assists corporate attorneys in assessing the risks associated with proposed transactions.

Please email the authors at peter.antonucci@weil.com or lianne.pinchuk@weil.com with questions about this article.