By: Kenny Ogilvie
In today’s ultra-competitive deal environment, where sky high valuations and shortened exclusivity periods are the norm, it is essential for acquirers to perform thorough due diligence and use transactional tools to adequately protect themselves across all areas of the business. Proper use of these tools pre-close allows buyers or sellers to properly manage, reduce, or eliminate environmental risk and achieve profitable success post deal. Environmental risk management is no exception to this rule and liabilities can reach tens of millions of dollars. At EHS Support, our job is to not only help our clients identify and assess environmental liabilities during transactional due diligence, but also quantify and address how to manage that risk.
Depending on the deal structure, industry, and history, it is imperative to go above and beyond a standard ASTM Phase I environmental site assessment (which really just lists potential concerns with no context) and really understand critical questions needed to evaluate business risks and support transactions. In doing this, we have found that our clients are not always aware of all of the potential solutions available for preparing companies for integration and divestiture from an environmental perspective.
When it comes to environmental risks there are many mechanisms whereby liabilities can be secured, managed, reduced, or eliminated within transactional documents:
Environmental Liability Transfer Mechanisms:
- Purchase company assets only whereby the seller retains the land, and change the name (asset purchase only), or purchase only the structures and improvements to ground level. The property and subsurface remains with the seller.
- Require an escrow or create a set-aside (best case vs. reasonable worst case), funded from a portion of the purchase price, to cover liabilities that cannot be resolved pre-close. The escrow is typically released after the liability is addressed.
- Document current conditions pre-sale via sample results (i.e., Phase II baseline understanding of site conditions), and based on existing impacts, change operations to eliminate contribution to existing conditions. Document, using baseline assessment and detailed description of operational changes, how the “NEWCO” operations are different from past.
- Acquire environmental insurance to provide coverage of unacceptable exposures. For unknowns, look to seller to fund all or some portion of premium to reduce exposure. Unknowns are easier to ensure, but cost and likelihood of underwriting are based on specific issues and incidences.
- Create an allocation model over time. For example, a 20-year model with decreasing percentages for responsibility of the seller over each year (e.g., 100, 95, 90, 85, etc..); 5 year model (20% down each year), etc. This mechanism requires fairly detailed knowledge of the site conditions and the required steps and timeline to achieve closure.
- Seller to retain full environmental liability, depending on entity that will remain. Savvy strategic sellers have found that retaining and managing the environmental liabilities is more cost effective than future lawsuits and costs of improperly addressed liabilities that may boomerang back through CERCLA.
- Seller to retain known and predictable environmental liability.
- Seller to retain 3rd party liability including Superfund that covers their period of ownership.
- Seller to retain workers comp liability, pension liability, etc.
- Environmental, health and safety (EH&S) compliance audits performed as part of due diligence with set-asides to have the facilities in compliance before the new entity starts post-close. Regulatory compliance can represent a material risk to long term operations. When insufficient time is available to determine regulatory compliance, a common approach is to include post-close compliance audits as a condition of sale. The funding of the audits, as well as the threshold responsibilities for the buyer and seller, are clearly outlined in the sales agreement.
- Liability Transfer: identified environmental liabilities are transferred to a thirrd party entity that is either funded based on an estimate of the lifecycle liability or through value of redeveloped real-estate. The liability transfer to a third party allows for the liability to be “moved off” the company’s books.
- Purchase price reduction: when liabilities are quantifiable from both a likely trigger event and cost to complete, a purchase price reduction is less complicated than other vehicles that require post-close interaction between the buyer and seller.
For information on how EHS Support can help you manage environmental due diligence and risk transfer mechanisms, please contact Kenny Ogilvie.
Over the past 27 years Kenny Ogilvie has been providing environmental management consulting support working with corporate environmental health and safety (EHS) and financial industry managers to design and integrate value measurement techniques, cost savings measurements, and corporate programs for mergers and acquisitions, divestitures… Read More