By: Kevin Robinson and Maureen Hodson
As more U.S. states move to legalize recreational and medicinal cannabis use, the spark in acquirers seeking to strategically enter the market has undeniably made cannabis-related businesses and their products a hot topic in the M&A community. Given the newness of the industry, and the evolving and varying regulations, how can these trailblazing cannabis business owners protect themselves from an environmental perspective after the deal closes?
Environmental Due Diligence is Essential in Cannabis Transactions
In order to understand and protect against the potential liabilities accompanying a deal with a cannabis company, it is essential that environmental due diligence be performed on the facility in question. Environmental due diligence can take the form of a limited desktop review involving interviews with facility personnel and review of publicly available information, or an ASTM Phase I Environmental Site Assessment where more in-depth interviews and a thorough site visit are conducted. Performing an ASTM Phase I is required in order for the buyer to be eligible for landowner liability protection under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). When extraction and distillation processes are involved, the importance becomes even greater as there are additional liabilities associated with handling the hazardous substances involved. During the due diligence period, the acquirer also has the opportunity to review the target’s compliance with environmental laws and permitting to identify areas of potential non-compliance. However only an environmental audit can provide enough detail to resolve the identified issues.
Environmental Audits Benefit Cannabis Cultivators and Manufacturers
Pre-acquisition, it’s important to understand that cannabis cultivation and product manufacturing is among today’s most heavily regulated industries. Participating businesses must comply with unique regulations associated with security, seed-to-sale tracking, zoning and product testing requirements. Even the federal tax statute that applies to cannabis businesses is unique and proper compliance is a challenging and costly task. However, most legal cannabis businesses strive to comply with these regulations as the risks of noncompliance (e.g., loss of licensure, IRS audit findings, etc.) far outweigh the cost of compliance.
Given the plethora and complexity of cannabis business-specific regulations, cultivators and product manufacturers often place a lower priority on compliance with environmental regulations. These regulations may not be as closely monitored by agencies administering the state cannabis programs and are often overlooked or misunderstood by participating cannabis businesses. However, environmental compliance regulations do apply to cannabis businesses and the cost of noncompliance can be high with penalties calculated on a per day/per violation basis. Compliance with environmental regulations typically includes keeping and reporting chemical inventories, registering storage tanks, developing chemical spill prevention programs and acquiring permits for pesticide use and generation of waste materials including stormwater, industrial wastewater, air emissions and hazardous wastes. Cannabis extraction facilities often generate hazardous wastes in the form of used solvents such as ethanol or butane.
If you discover in the course of due diligence that the cannabis company you have just purchased is operating without the necessary environmental permits and programs in place, you have two options:
- Assume the potential cost of penalties associated with noncompliance activities are lower than the cost of compliance and continue to operate without the necessary programs and permits; or
- Identify noncompliance areas and integrate necessary environmental programs and permits into operations prior to any regulatory inspections and/or enforcement actions.
Identification of noncompliance can be achieved by conducting an environmental audit. Environmental audits can be performed by the cannabis businesses’ environmental staff or third-party environmental consultants and generally include the following activities:
- Review of all relevant federal, state and local environmental regulations.
- Review of facility documentation including site plans, process diagrams, safety data sheets, storage tank and equipment specifications, existing permits, and spill records.
- Conduct a facility inspection to observe equipment conditions, site conditions, housekeeping, and general operations.
- Documentation and verification of noncompliance findings and recommended corrective actions.
Conducting a voluntary environmental audit may have significant benefits to cannabis companies, as regulatory agencies may incentivize voluntary environmental audits by reducing fines and penalties as a result of noncompliance findings, provided the audit results are promptly disclosed to appropriate agencies, and findings are promptly corrected and are prevented from occurring in the future. These programs give cannabis companies the opportunity to achieve compliance with environmental laws with the potential to have fines for non-compliance significantly reduced.
It is essential to involve environmental counsel prior to conducting an environmental audit with the goal or disclosing findings to regulators. Certain information included in voluntary audit reports can be kept privileged and confidential as long as counsel is engaged prior to conducting the voluntary audit. In order to maintain attorney-client privilege of audit-related communications and results, any third-party consultants must be assisting the attorney to understand non-legal concepts to aid counsel in providing legal advice or be performing work that the company lacks the in-house resources or expertise to perform on its own. Counsel must be included on all communications between the cannabis business and the third-party environmental consultant in order to maintain the privilege.
For more information on the potential environmental risks posed by the evolving regulatory landscape surrounding cannabis, please contact Kevin Robinson at Kevin.Robinson@ehs-support.com or Maureen Hodson at Maureen.Hodson@ehs-support.com.
The information in this article is for general information purposes only and does not constitute legal advice or establish an attorney-client relationship and should not be substituted for the advice of qualified environmental counsel.