Corporate Spinoffs and Mass Tort Liability

Sunday, January 1st, 1995 at 12:00 am by Kevin M. Warsch
Kevin M. Warsch, Corporate Spinoffs and Mass Tort Liability, 1995 Colum. Bus. L. Rev. 675

Wall Street is wary of the potential for massive tort payments by cigarette manufacturers. The trend toward enterprise liability, the increasing classification of smoking as a “public risk,” and the legacy of the asbestos liability debacle serve to heighten the markets’ uneasiness regarding tobacco-related companies.

Although not a single penny has been paid in a tobacco-related suit, plaintiffs’ prospects for recovery in the so-called “third-wave”of lawsuits seem to be improving. Recent congressional testimony, press reports, court decisions and efforts by states to recoup health care costs all are placing a brighter spotlight on the tobacco industry. Corporate spinoffs, however, may yet rescue corporate shareholders from the need to transfer large equity stakes to contingent tort creditors.

Tort claimants’ ability to obtain compensation is constrained by a multitude of factors: time, expense, informational asymmetries and the corporate form, itself, among them. Thus, plaintiffs must consider more than the vigorous procedural and substantive defenses that will be erected by a cigarette manufacturer. The plaintiff may also be confronted by limited liability that protects a corporation from a mass tort award. If an award is sufficiently large so as to threaten the corporation’s existence, the managers and shareholders might strategically modify the firm’s operations to mitigate payment. In the case of potential mass tort liability, contract creditors and current tort creditors may even lend support to this corporate manipulation.

Commentators have largely focused their attention on corporate strategic reactions such as liquidations, bankruptcies and sell-offs. Yet, as recent events in the tobacco industry make clear, corporate spinoffs may be the strategic reaction of choice in the coming years.

Section II of the Paper briefly sets forth the mass tort landscape, noting the qualitative differences between these wrongs and more traditional tort “accidents.” Section III describes the factual and legal background, the issues and players that surround tobacco, potentially the largest mass tort product in history. In particular, this Section focuses on the acquisitions and corporate reorganizations of the two leading tobacco companies. In Section IV, spinoffs are proffered as a rational response to mass tort liability. This Section also describes the scarce legal treatment that corporate strategic reactions such as spinoffs have been afforded in the courts. From the use of spinoffs as takeover defense mechanisms to their emergence in the mass tort area, the legal claims that might be marshaled against spun off entities are reviewed. Section V presents a financial and empirical explanation for spinoffs, making reference to the tobacco companies’ recent strategic decisions. This Section attempts to show that the empirical work to-date fails to account adequately for gains that accrue to current equityholders at the expense of contingent tort creditors. Section VI presents a mathematical model of corporate spinoffs from which several key insights can be gleaned. Most notably, this Section attempts to isolate the reasons why managers and shareholders of companies with potential mass tort liability may increasingly undertake corporate spinoffs to the detriment of contingent tort creditors. Lastly, Section VII concludes with a normative analysis of corporate spinoffs. In spite of the theoretical and empirical transfer from future tort claimants to current equityholders, this Section argues that judicial intervention in cases like RJR Nabisco is ill-advised. Except in the most egregious cases, a “no-spinoff” rule for companies with contingent tort liability would negatively impact merger and acquisition activity.

Thus, one’s views of merger activity is likely to impact one’s views toward spinoffs. If mergers are largely value-enhancing, then spinoffs should be permitted. Companies are more likely to accept the risks of merging with another entity if they are able to “undo” the merger at minimal cost in subsequent years. If, however, mergers are adjudged merely to involve a transfer of a finite quantity of company resources among various constituencies, then a “no-spinoff” rule and the concomitant lessening of merger activity will not be a major cause of concern. Ultimately, this article urges rejection of a “no-spinoff” rule on the basis that it may actually hurt a subset of contingent tort creditors.

Author Information

J.D. cum laude Harvard University, 1995