Canada: Pragmatic Environmental Diligence Needed To Stay Competitive In Acquisition Race

Last Updated: March 28 2007

Article by Jeffrey Gracer, Bernays Barclay, and Andrew Schifrin

Originally published in Natural Gas & Electricity, April 2007.

Environmental diligence has long been viewed as a necessary component (some would say a necessary evil) of any power asset acquisition. Deal lawyers and businesspeople have been known to sink into despair as the environmental diligence process becomes a creature with its own nasty life, rather than a business-oriented exercise focused on getting the deal done.

Nowhere has this tension been greater than in the business of acquiring power-generating and transmission assets. Power assets are changing hands at an increasingly rapid rate. In recent years, we have seen new players enter the power asset acquisition arena, including financial institutions and foreign energy companies, as well as new private equity and hedge funds, all joining the race to acquire "infrastructure." To a slightly lesser extent, these factors are also driving increased acquisition activity and competition for local distribution companies and their assets. The entrance of these new players and the prices they are willing to pay has resulted in a furiously competitive seller’s market with no obvious end in sight, while at the same time compressing the time frame for completing transactions.

Under these circumstances, the slightest anticipation of delay in closing the deal can be determinative in the seller’s choice of a preferred buyer. Indeed, there is more pressure than ever before for bidders to simply accept the seller’s term sheet and purchase and sale agreement without additional or different conditions. Consequently, every member of the acquisition team must be commercially oriented, pragmatic, and able to act decisively within tight time frames based on limited information. That scenario presents a significant challenge for environmental professionals, who typically work in regulatory processes and time frames that are longer and far more deliberate.

Nonetheless, the job can be done on a commercial basis, and the right team can add significant value in a competitive bid scenario.

Traditional Versus Competitive Environmental Diligence

The contrast between traditional environmental diligence and diligence in a competitive auction is quite stark. Traditional environmental diligence typically unfolds over the course of six to twelve weeks. It begins with a detailed written request for documents, including environmental site assessments, internal compliance audits, permits, notices of violation, consent orders, correspondence with government regulators, environmental capital expenditure (capex) and operations expense (opex) budgets, and a multitude of detailed backup information. Until recently, it was common practice for the buyer also to retain its own environmental consultant to conduct an independent on-site environmental site assessment and compliance evaluation.

If the on-site assessment revealed potential subsurface contamination issues, a buyer might insist on intrusive sampling before it would consider purchasing the asset. However, it is fair to say that in most transactions today, that type of diligence, while arguably preferable from the standpoint of rigor, is simply not possible. It has become necessary to do more (or at least enough) with less, in less time.

Environmental diligence today typically takes place for the most part within an electronic universe defined by the seller. A virtual data room is created by the seller’s advisors, sometimes without significant input from the seller’s environmental professionals. The buyer is provided access to a set of documents that may or may not be complete, with limited ability to obtain significant additional documents or information. Concerns about confidentiality often make sellers reluctant to permit detailed on-site environmental assessments, and also result in prohibitions against contact with governmental agencies. To remain competitive, the environmental professionals on the deal team must bring experience, judgment, and focus to the exercise, and do it quickly on an integrated basis.

Fielding the Right Team

The starting point is assembling the right environmental team, preferably at the outset of the transaction, to ensure quick and decisive action once the data room opens. Ideally, that team should include a senior person within the buyer’s organization with environmental compliance experience (this is often possible in the case of a strategic buyer, but less likely to be possible in the case of a financial investor). The team also should include an environmental attorney and an environmental consultant who not only know the power industry, but also have proven experience working together on transactions. The ability to quickly identify, assess, and resolve a difficult issue can prove quite valuable under the time pressure of an auction, as high-level judgment and experience will often be the decisive factor in whether a material issue, once identified, causes the deal to founder, or is resolved on the basis of realistic and commercially reasonable options that would be accepted by a seller with multiple bidders.

Tapping Available Sources of Information

Although telephone conversations, in-person contact, or freedom of information requests to government agencies are typically off-limits in an auction, the Internet can provide significant useful information to supplement what is available in the data room. Federal and state Web sites often contain public information about environmental permits, compliance history, reported releases of contaminants, underground tanks, and whether a target site has been designated as a contaminated site that is subject to remediation. If the target is a public company, Securities and Exchange Commission (SEC) filings may contain reasonably detailed disclosure of environmental information, including analysis of pending enforcement actions and the financial exposures associated with identified environmental contingencies. Commercial databases also can provide aerial photographs, historic land-use and zoning information, and descriptions of prior operations—which will shed light on whether the real estate associated with a given power asset might have legacy contamination issues that could later become an environmental cleanup liability. Public databases also can provide information about environmental litigation, consent orders with environmental agencies, and the magnitude and frequency of environmental violations.

Site Visits

As noted above, traditional on-site environmental site assessments are becoming less common than they were in the past due to timing and other competitive pressures in most auction processes. However, there is no question that it is preferable to have an environmental consultant participate in the facility tour. One way to accomplish that objective is to integrate an environmental consultant into the business team that visits facilities as part of initial business-level site tours (assuming such tours are scheduled). All too often, by the time the environmental team has been assembled, these tours have already happened, and the ability to send out a second set of professionals has been lost.

This potential danger underscores the need for early integration of the environmental team into the diligence effort. Even if an environmental consultant dresses in business attire and tags along with the businesspeople, he or she can often glean important information that will be helpful in assessing the nature of the operations and likely material issues, just based on a walk around the facility and visual observation.

Defining Materiality

Nevertheless, the value-added part of environmental diligence is not about collecting information: the important part is about using that information in a focused manner to identify material issues for the businesspeople. It is therefore critically important for the environmental team, working the deal team, to define an acceptable materiality level. In a $6 billion transaction, for example, the businesspeople may determine that no issue under $1 million is worth analysis unless it has a reasonable potential to later exceed $1 million in costs. In a smaller transaction, it may be that the appropriate materiality threshold is $500,000, or $100,000, or even $50,000 in small transactions. Given the time pressure that everyone is under in an auction process, it is important to define materiality early and to discipline the environmental diligence process to adhere to the materiality level, while remaining attentive for issues that might be just below the radar but nonetheless potentially significant.

There is quite a bit of art as well as science to the proper application of materiality thresholds. Experience is critical. The cost implications of many issues are by now reasonably well understood. Those issues can be assessed based on industry experience, often without the need for environmental samples or detailed on-site analysis. Many environmental issues involve a low probability of a high-dollar impact. If every worst-case scenario is presented without reference to realistic outcomes, many environmental risks would be improperly perceived as showstoppers. The ability to frame an environmental risk in terms of its reasonable best- and worstcase outcome is what makes an environmental team competitive.

Identifying Bank and Investor Requirements

In defining materiality, as well as the scope of the environmental diligence effort, it is also important to understand whether the financial backers of the bidder have specific requirements that will have to be met in the diligence effort. Understanding these requirements, and discussing whether they are consistent with the auction process, is an early investment of time that pays off quite well. For example, a commercial bank may have an internal policy that all loans require a Phase I environmental site assessment that meets the Environmental Protection Agency’s new "all appropriate inquiry" standard, which requires contact with government agencies. However, auction ground rules may prohibit any such contact. It would become necessary in such circumstances to explain to the bank officer that if the policy is applied to the letter, the bidder would be precluded from participating in the auction.

Similarly, institutional investors may have internal guidelines to satisfy. Typically, if a credible alternative approach has been formulated by the environmental team, the bank or other investor can be made comfortable, especially if they are included early and often in the environmental diligence process. Managing the relationship in that manner helps to avoid last-minute surprises regarding financial institution requirements just before the bid is due.

Assessing The Seller’s Environmental Management System

Because detailed analysis of every issue is not possible in a competitive bid, it is often necessary to evaluate and, if justified, rely to a measured extent on the target’s existing environmental management system reports. Therefore, the diligence process should include review of the seller’s environmental management system policy documents, as well as, if possible, its recent annual reports to management. In a system that is working properly, these reports can provide a very useful road map to material issues, and also provide a sense of whether the company appears to be on top of its issues.

If possible, it is often useful to couple such a review with a telephone interview with the target’s senior environmental health and safety officer, to probe a bit beyond what appears on paper, and to assess how knowledgeable that person is about the company’s environmental issues. This level of review can provide substantial comfort if the company has the right people in place and a good environmental management system.

Identifying Air Compliance Issues

As is evident from California’s recently enacted climate-change legislation, air regulations present a dizzying array of federal, regional, state, and even local regulations that present multiple traps for the unwary in a power acquisition. Some of the issues that are sometimes overlooked include the following:

  • Air emission permits that have not been updated to conform to current levels of operation (such that the plant literally cannot comply with its permit limits)
  • Historic modifications to plant operations that could arguably give rise to enforcement actions under the "new source review" standards of the federal Clean Air Act
  • Facilities that have been categorized as "minor" sources that in fact should be permitted as "major" sources
  • Anticipated costs (capex and opex) associated with upcoming air toxic and anticipated greenhouse gas regulations and/or cap-and-trade systems
  • Hidden compliance issues arising from permit renewals and planned upgrades

It is important to have an environmental consultant on the team who is steeped in air permitting issues, so that these issues can be identified, quantified, and addressed during the compliance review. Most often, the question is not merely whether the plant is in compliance, but whether the plant will be competitive with other peer plants when anticipated greenhouse gas regulations go into effect, and the costs associated with purchasing necessary emission credits to operate the plant. Many of these issues are a bit too far into the future at present to be fully understood, but as these nascent regulations become more concrete and mature, even at the planning level, it will be important to understand their direction and anticipated costs.

Understanding Hidden Remediation Costs

Under applicable environmental laws in certain states, such as New Jersey, site investigation and remediation costs can be triggered directly by a contemplated transaction. In addition, investigation and cleanup can be triggered by government agency scrutiny or by claims that have been filed by private third parties.

The fact that a facility has not identified subsurface contamination as an issue does not mean that the facility is clean—it merely means there is no identified issue. Therefore, it is important to know about the past uses of the property (including especially historic fuel usage), to understand whether there has been any release of contaminants at the site or onsite waste disposal, and to arrive at an orderof- magnitude estimate regarding environmental investigation and remediation costs, as applicable. If the facility is slated for closure (not a likely scenario in most power deals), environmental exit costs may arise in connection with such closure.

Identifying Offsite Disposal Liabilities

Under federal Superfund legislation and comparable state law, any off-site disposal of material generated at the power plant could give rise to environmental liability. A potential buyer should ask whether the seller has received any requests for information or claims relating to potential responsibility for off-site disposal, and also understand the facility’s current and historic waste streams. For facilities in or near sensitive off-site receptors, such as lakes, rivers, and wetlands, attention also should be paid to potential claims for sediment remediation and/or natural resource damages.

Meshing Diligence With Contract Protections

In an auction context, the typical sellerfriendly agreement will have environmental representations and warranties that are qualified by knowledge, by items disclosed on schedules, and by materiality or material adverse effect. The auction document also may prevent recourse postclosing for a breach of representation and warranty, or limit such recourse to a relatively brief period (a year, for example). Although a variety of contractual mechanisms are available to manage environmental risk, including postclosing escrows, price adjustments, postclosing covenants, and environmental indemnities, in many instances buyers find that these mechanisms may not be achievable because of competitive pressures from other bidders. As the environmental protections in the contract are whittled down, that places much greater pressure on the quality of the environmental diligence, which is also typically being restricted by commercial pressures. Therefore, it is important to monitor the interaction between the level of diligence that has been conducted and the tradeoffs that are being made in the deal document to make sure that an acceptable level of protection is achieved for the client.

Remain Attentive to Public Disclosure Obligations

When representing a buyer that is a public company, the environmental aspects of the seller’s business will eventually be subject to public disclosure under applicable securities regulations and generally accepted accounting principles. Accordingly, the environmental diligence should assess the extent to which environmental disclosures meet these requirements.

The degree of compliance with the letter and spirit of securities regulations varies greatly in the environmental arena. Many companies have upgraded their disclosures to meet investor demands for increased transparency, including detailed disclosures about climate-change risks. Other companies have been alleged by environmental groups to be underreporting their environmental exposures. Understanding whether the seller has properly accounted for environmental risk through the lens of SEC disclosure requirements is therefore important for any public company buyer. It also can be helpful for financial investors that may later want to exit their investment through a public offering.

Consider Environmental Insurance

If a material environmental risk is identified, and the seller is unwilling to provide any postclosing recourse to protect the buyer, it may be possible for the buyer to purchase environmental insurance to cover that risk (with or without costs sharing on the premium and self-insured retention by the buyer). Such insurance is available on commercially reasonable terms, for example, to cover third-party environmental claims, to cover environmental remediation cost overruns, and to cover certain off-site disposal risks. Even when timing or the level of information provided by the seller does not permit insurance to be purchased before the bid is accepted, it is often possible to structure arrangements where additional information is provided between acceptance of the bid and closing, so that an insurance policy is in place to cover an identified risk. On the basis of fairly limited information, sophisticated environmental insurance brokers can advise clients whether an environmental risk is insurable and on what terms, within orders of magnitude, subject to confirmatory diligence after a bid has been accepted.

Key Takeaways

Environmental diligence is not an end in itself. It is one of the ways that bids can be won or lost. Accordingly, it is critically important to frame the environmental diligence exercise to fit the needs of the deal team. An experience- based pragmatic review that allows bidders to remain competitive is worth far more than an effort that gets details right but loses the bid.

It must be recognized that environmental issues, like other issues, can and must be quantified and analyzed in the commercial context in which environmental issues arise. They must be sorted based on materiality and significance and then be presented to the business team in a manner that facilitates good deal decisions. When that is done successfully, the odds of being a winning bidder can increase dramatically.

Jeffrey Gracer is a partner with the law firm of Sive, Paget & Riesel in New York City. Bernays Barclay and Andrew Schifrin are partners in the New York City office of the law firm of Torys LLP.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions