The Seventh Circuit’s recent decision in Thornton v. M7 Aerospace, LP should serve as a reminder to companies that purchase or succeed to assets of a product manufacturer that liability may follow if they do not act cautiously and deliberately on a fully informed basis to protect themselves. Thornton v. M7 Aerospace LP, No. 14-1707 (7th Cir. Aug. 6, 2015).
Thornton arose out of a plane crash in May, 2005 in Queensland, Australia that killed all fifteen people on board. The estates of the deceased sued several companies and one individual in the Northern District of Illinois. According to the plaintiffs, the aircraft was defective because it allegedly had a Ground Proximity Warning System (GPWS) to warn the crew of terrain ahead, but lacked an improved version of this component known as an Enhanced Ground Proximity Warning System (EGPWS) that might have allowed the pilots to avoid the accident. The plaintiffs claimed that M7 was liable under negligence and strict products liability theories for failing to warn the purchaser of the aircraft, Transair, of this purported defect.
The aircraft at issue was a Fairchild Aircraft SA227-DC Metro 23. The plane was designed, manufactured, assembled, tested, and sold by Fairchild Aircraft, Inc. Fairchild stopped manufacturing that type of aircraft in 2000 and filed for bankruptcy in 2002. The bankruptcy court approved 4M LLC’s purchase of Fairchild’s assets. The Asset Purchase Agreement stated that the buyer assumed no “liability for personal injury or property damage arising at any time out of or in connection with goods manufactured, produced, distributed or sold by the Sellers prior to the Closing Date, including but not limited to any Product Liability claims.” In 2003, 4M assigned that Asset Purchase Agreement to M7 free and clear of any liens, claims and encumbrances. M7 thus never had any relationship with Fairchild. In fact, although it acquired the right to the Fairchild name and the Type Certificate designating it the Original Equipment Manufacturer (OEM) for the Metro fleet, it never manufactured any aircraft at all. M7 is instead in the business of building and assembling aircraft parts for other aerospace companies.
Plaintiffs nevertheless claimed M7 owed them a duty to warn because it purchased the “product line”. Agreeing with the district court’s analysis granting summary judgment, the Seventh Circuit found that none of the four factors required to establish a duty to warn as a product purchaser under Illinois law were satisfied. Id. Most fatal was that M7 did not have any service contracts with Transair and “the plaintiffs [did] not presented evidence of any relationship between M7 and Transair with respect to the aircraft”. Id. The Seventh Circuit specifically found that M7’s distribution of a catalogue of parts for the Metro aircraft, sale of flight, maintenance and inspection manuals to known Metro owners and operators and technical support was not evidence of a “relationship”. In so finding, the Seventh Circuit recognized that the existence of a “‘continuing relationship between the successor and the predecessor’s customers benefiting the successor’” has been deemed “‘the [most] critical element required for the imposing of this duty [to warn on successors].’” Id. citing Gonzalez v. Rock Wool Eng’g & Equipment Co., 453 N.E.2d 792, 795 (Ill. App. Ct. 1983). Although some jurisdictions impose a duty of care on a successor based solely on its acquisition and operation of a product line, that is not the case in Illinois. Thus, because M7 did not have a continuing relationship with the purchaser, it did not have a legal duty to warn as Fairchild’s corporate successor.
Plaintiffs had no more success arguing a duty to warn arose under the voluntary undertaking theory. Under a voluntary undertaking theory of liability, the duty of care is limited to the extent of the undertaking.” Bell v. Hutsell, 2011 IL 110724, 353 Ill. Dec. 288, 293-95, 955 N.E.2d 1099 (2011). More important to the Appellate Court’s reasoning, Illinois law requires proof of reliance; that is, proof that the operator (here, Transair) relied on the defendant’s voluntary undertaking of a duty to warn. See, e.g., Chisolm v. Stephens, 47 Ill. App. 3d 999, 7 Ill. Dec. 795, 365 N.E.2d 80, 86 (Ill. App. Ct. 1977). Here, the Appellate Court took note that plaintiffs did not produce any evidence that Transair relied on M7 for warnings about defects in the aircraft. For this reason, the Appellate Court agreed that the plaintiffs could not establish that any voluntary undertaking by M7 caused the accident and their injuries and upheld the dismissal of their claims.
Understanding the scope, depth and breadth of successor liability, particularly as it relates to the voluntary undertaking doctrine, can prove invaluable to those engaged in M&A activity on behalf of companies acquiring product lines, plants, assets and/or manufacturing facilities. The Seventh Circuit’s analysis and reasoning in this case can be used to help control exposure and avoid product liabilities with careful M&A strategy. Here are some things to take away from this decision:
- Deal Structure Is Critical. 4M acquired Fairchild’s assets out of bankruptcy free and clear of any liens, claims and encumbrances. M7 acquired those precise rights by way of assignment of the Asset Purchase Agreement. This played a key role in determining the scope of M7’s successor liability. If instead, there was a continuity of the business operations of Fairchild as it existed prior to the bankruptcy, with the same officers, directors, manufacturing operations, etc. only under new ownership, under the de facto merger doctrine, that transaction could have been treated as a merger or consolidation even though not formally defined as one, resulting in the transfer of the liabilities needed to continue normal business operations. See Gonzalez, 453 N.E.2d at 439. It is therefore essential to closely scrutinize the structure of corporate transactions to guard against disguised liabilities.
- Carefully Consider Choice of Law. The application of Illinois law was critical to the Thornton decision, and was specifically called for in the Asset Purchase Agreement. As discussed supra, Illinois law requires evidence of a continuing relationship between the successor and the predecessor’s customers. Moreover, Illinois courts refuse to impose a duty to warn solely based upon a successor’s relationship with the product line. There are however jurisdictions that do impose successor liability for negligence and strict products liability based only on the acquisition and operation of a product line irrespective of any relationship with the customer. Indeed, California follows an equitable product line exception which examines each case of “successor liability issues on their own unique facts.” Cleveland v. Johnson, 209 Cal. App. 4th 1315, 1331-33 (Cal. App. 2d Dist. 2012). Other jurisdictions, including Pennsylvania and New Jersey, similarly recognize the product line exception. See, e,g, Dawejko v. Jorgensen Steel Co., 290 Pa. Super. 15 (1981) (adopting product line exception); Ramirez v. Amsted Indus., Inc., 86 N.J. 332 (1981). Although it can be difficult to predict choice-of-law issues in advance, any company that purchases the assets of a manufacturer will have to consider the possible application of the law from a jurisdiction like California or Pennsylvania that can considerably expand its liability for the predecessor’s products.
- Be Mindful About Creating An Otherwise Non-Existent Duty. Even the most diligent and appropriate acquisition cannot completely guard against successor liability. The Seventh Circuit in Thornton explains that if M7 had reached out to the customers of its predecessor, like Transair, to facilitate continued business, even under Illinois law, liability would have followed. Successor entities must therefore carefully weigh the inherent interest in exploiting predecessor’s pre-existing relationships against the threat of liability for negligence and strict liability for claims related to the predecessor’s products. Even the voluntary provision of information about a predecessor’s products and availability of upgrades to those products can, according to Thornton, provide a basis for liability to the extent a customer relies upon such information. Thornton explained that reliance is key to establishing a duty of care under the voluntary undertaking doctrine. The voluntary undertaking doctrine, often called the Good Samaritan Rule, exists in some form across all jurisdictions. Thus, caution must be exercised everywhere because even the most benevolent conduct can open the door to liability.