Buyer Beware

Successor Companies Can Be Strictly Liable For Defective Products Manufactured By Predecessors

In this age of corporate mergers, takeovers and acquisitions, a company purchasing the assets of another needs to know exactly what it is buying into, especially if it is acquiring a company that manufactures a product. As the state court of appeal in Los Angeles reminded us recently, strict liability for manufacturing a defective product may be one of the things that the purchaser acquires.

The ruling last month in Rosales v. Thermex-Thermatron, Inc., 98 D.A.R. 9461 (1998), marks only the second time that a California court has found a successor company strictly liable based on the "product-line doctrine," which the California Supreme Court established more than twenty years ago in Ray v. Alad Corp., 19 Cal.3d 22 (1977). Indeed, the manufacturer argued on appeal that Ray ought to be overruled precisely because only one court had applied it to find liability in two decades. But if you think the fact that something has happened only once in a long while means it shouldn’t happen again . . . maybe you ought to talk to Mark McGwire and Sammy Sosa.

Before Ray, the general rule in California, as elsewhere, was that tort liability is not transferred even when the successor buys all of a company’s assets. This general rule was subject to four narrow exceptions, so that the liability of a corporation selling its assets could be imposed on the purchasing company only where: (1) the purchasing company agreed — whether expressly or impliedly — to assume tort liability; (2) the two companies had merged, not just transferred assets; (3) the purchaser was little more than a "mere continuance" of the seller; or (4) the whole deal was a fraudulent attempt to avoid liability, as where one corporation transfers its assets to another for inadequate consideration. Ortiz v. South Bend Lathe, 46 Cal.App.3d 842, 846 (1975); Ray v. Alad Corp., 19 Cal. 3d 22, 28 (1977); Beatrice Co. v. State Board of Equalization, 6 Cal.4th 767, 778 (1993).

In Ray, however, the California Supreme Court recognized that the doctrine of strict product liability changed the equities of the longstanding rule by requiring courts to look at the rule’s effect on an innocent consumer injured by a defective product. Noting that the doctrine of strict liability seeks to spread the costs of such injuries throughout society, the Supreme Court concluded that a special rule should apply to a successor corporation’s tort liability for the predecessor’s defective products.

With these principles in mind, the Court imposed liability where the plaintiff had been injured by a defective ladder manufactured by the defendant’s predecessor. Alad Corporation, which made the ladder, had sold all its assets (including inventory and goodwill) to another company, which continued to sell ladders under the name Alad Company. Because excusing the defendant from liability would have left the plaintiff out of luck, and because the defendant benefitted from the good will of its predecessor, the court imposed liability, and established a three-pronged analysis for future cases. Under this analysis, strict liability will be imposed on a successor where: (1) the acquisition of the original manufacturer’s assets cut off the plaintiff’s remedies against the original manufacturer; (2) the successor is in a position to assume the original manufacturer’s risk-spreading role; and (3) fairness and equity support requiring the successor to assume responsibility for defective products because the successor enjoys the good will associate with the continued operation of the business. Id. at 31.

After Ray, the First District Court of Appeal in Kaminski et al. v. Western MacArthur Company, et al., 175 Cal.App.3d 445 (1985) applied the product line doctrine to find successor liability against a distributor of asbestos, reasoning that when a distributor or retailer takes advantage of its good will and other corporate assets and facilities to inject the predecessor’s product line into the stream of commerce, it continues the overall marketing enterprise that should bear the cost of injuries resulting from defective products. Id. at 456. In Kaminski, the successor distributor argued that the product line doctrine should not apply to distributors because unlike manufacturers, distributors are not in a position to assume the risk spreading role by raising prices to spread the cost of compensation as a cost of doing business. While acknowledging the facial appeal of that argument, the court held it to be inconsistent with the policy of allowing injured consumers to sue all business entities the chain of production, especially since distributors have the remedy of seeking indemnity from the responsible manufacturer.

In Maloney v. American Pharmaceutical Co., 207 Cal. App. 3d 282, 287 (1988), the First District refused to expand the scope of the product line doctrine to negligence claims. Notably absent in this decision was the same thoughtful analysis of public policy considerations which formed the legal basis for expanding the doctrine in Kaminski. In fact, the court expressly refused even to consider plaintiffs policy arguments, choosing this time to interpret Ray narrowly.

California courts have continued to cite Ray as the leading authority for successor liability (See, Wright v. Stang Manufacturing Co., 54 Cal. App. 4th 1218, 1224 (1997); Stewart v. Telex Communications, Inc., 1 Cal. App. 4th 190, 195 (1991)). However, they all found ways to avoid application of the product line doctrine by distinguishing it factually, until Rosales. See, Quemetco, Inc. v. Pacific Automobile Ins. Co., 24 Cal. App. 4th 494, 499 (1994); Phillips v. Cooper Laboratories, Inc., 215 Cal. App. 3d 1648, 1657-58 (1989).

In Rosales, the plaintiff was seriously injured at work in 1993, while she was using a heat-sealing machine manufactured in 1969 by Sealomatic Electronics, a division of Solidyne Corporation. In 1981, Solidyne had shut down its Sealomatic division and transferred some of the equipment and materials used to manufacture Sealomatic machines to its Thermatron division. A few years after that, Solidyne’s heat-sealing machine divisions, including Thermatron, were consolidated into a new corporation, called Thermex-Thermatron.

When Solidyne was going out of business, some employees of Thermex-Thermatron bought that division’s assets and liabilities, including its manufacturing plant and machinery, paying the purchase price directly to a creditor of Solidyne’s.

Some time after that, Ms. Rosales was injured. She sued the new company, Thermex-Thermatron, Inc., alleging strict liability — even though it had neither manufactured nor sold the defective product. On appeal from a half-million-dollar verdict for the plaintiff, Thermex-Thermatron argued that it should not be liable for the obligations of Solidyne, citing the general rule that where a corporation purchases the assets of another corporation for adequate consideration, the purchaser does not become liable for the liabilities of the seller. Plaintiff, of course, relied on the product-line doctrine that the Supreme Court established in Ray.

Applying Ray’s three-pronged analysis, the Court of Appeal concluded that (1) the sale of the Solidyne’s Thermex-Thermatron subsidiary to TTI virtually destroyed plaintiff’s remedies against Solidyne because after the sale, Solidyne had no assets or any ability to satisfy debts; (2) Thermatron had basically the same ability to assess the risks as Solidyne since the new Thermex-Thermatron corporation obtained the physical plant, equipment and knowledge of the business from Solidyne; and (3) it was fair and equitable for Thermex-Thermatron, Inc. to assume responsibility for Solidyne’s defective products because Thermex-Thermatron, Inc. continued to benefit from Solidyne’s good will by using Solidyne’s customer lists and Solidyne’s name in its advertising.

The Second District’s reaffirmation of the 20-year-old product-line doctrine is important. It puts those overseeing the consolidation of industry and manufacturing on notice that public policy in California requires them to take the bad with the good when they acquire a company’s assets and good will. The alternative, as the Supreme Court explained in Ray, would be to leave the injured plaintiff without recourse.

But the import of this decision should not be exaggerated. It does no more than reaffirm existing — if rarely applied — law. In addition, the unique facts of this case fit squarely within the framework that the Ray test established: new owners continuing the business and enjoying its reputation. Equally important, the trial court had sanctioned the defendants for being evasive in their discovery responses to the questions that would have established their status as successors to the manufacturer. Recognizing this as an attempt to reap the benefits of being a successor without assuming its responsibilities, the Court of Appeal not only affirmed those sanctions, but also declared, "It is hard to think of a more compelling case for sanctions."

Thus, it would be hard to say that this one decision signifies a shift in California law. But neither is it safe to say a similar case won’t come up again. Just ask Roger Maris