One component to a proactive environmental compliance approach is to conduct a compliance audit that will provide a facility owner or prospective owner with an accurate picture of the facility's compliance with environmental laws. However, a facility may identify non-compliance issues during an audit and this situation poses a potential problem of enforcement by the regulating agency. This situation may be further complicated when a compliance issue is identified during due diligence prior to a buy/sell transaction. The federal government and many states have established so called "Audit Policies" that, in many instances, allow businesses that identify and self-report such violations to avoid civil penalties. These government policies can substantially limit liability for self- disclosed violations. The U.S. Environmental Protection Agency ("EPA") has added incentives to the federal Audit Policy targeted to protect new owners of non-compliant businesses. Use of these Audit Policies is an important consideration in a business's approach to environmental compliance and to reducing risk when entering into buy/sell transactions. The seller of the business should also consider the buyer's use of the Audit Policy after sale since it can create liability for the seller.
EPA's Office of Enforcement and Compliance Assurance (OECA) recently released draft guidance for its enforcement priorities for FY 2013. This guidance indicated that EPA was considering reducing its focus Audit Policy. However, recent contact with the EPA on this issue indicated that the policy will remain in effect for the foreseeable future and EPA will announce any proposed changes to the Audit Policy in the federal register and seek comment before making any significant changes to that policy.
Audit Policy Applied to Existing Business.
EPA established its Audit Policy in 1995.1 The Audit Policy provides for mitigation from penalties resulting from violations of federal environmental laws when the violations are voluntarily discovered, promptly reported, and corrected by industry. The intent of the Audit Policy is to encourage self-reporting of violations by providing considerable benefits to businesses that make disclosures under the terms of the Audit Policy. To be eligible for up to 100% mitigation of certain penalties, potentially including criminal liability, the disclosing entity must meet nine eligibility criteria.
EPA's Audit Policy offers the potential for 100% mitigation of gravity-based penalties arising from environmental noncompliance that is self-disclosed to the EPA through the Audit Policy process. The Audit Policy does not allow mitigation of any economic advantage that a party has gained through noncompliance. EPA does not routinely request copies of the Environmental Audit report conducted by self-disclosing entities.
If a violation has not resulted in significant harm to the environment or allowed the business to gain an economic advantage over its competitors, EPA can substantially mitigate the penalty, sometimes resulting in no fine or penalty. Importantly, however, the only violations that are eligible for mitigation are those that the facility did not know about before the audit, or that were not previously subject to investigation by the EPA or a state agency.
The criteria a party must meet to take full advantage of Audit Policy benefits are as follows:
- Systematic Discovery: violations must be discovered systematically through an environmental audit or a compliance management system;
- Voluntary Discovery: violations must be discovered voluntarily, or by means not otherwise legally required by permit, statute, regulation or consent agreement;
- Prompt Disclosure: violations must be promptly disclosed within 21 days of discovery;
- Independent Discovery: violations must be discovered independently of action by a governmental or third-party plaintiff;
- Correction: violations must be promptly corrected within 60 days of discovery, unless EPA is notified before that time that additional time is necessary;
- Prevent Recurrence: steps must be taken to prevent recurrence of the violation;
- No Repeat Violations: the same violation or a closely-related violation must not have occurred at the facility within the past three years;
- No Actual Harm: the violation must not be one that presented an actual and imminent danger to human health or the environment;
- Cooperation: the entity must cooperate with the EPA to allow the agency to determine the Audit Policy's applicability.
Businesses that can demonstrate qualities 2.-9. may also take advantage of Audit Policy but mitigation may be less than 100%. In cases where a business has multiple facilities or complex environmental regulatory framework, a business may seek to enter into an Audit Agreement with EPA before initiating its self-audit. In an Audit Agreement, the business may be able to negotiate alternate disclosure and corrective action schedules that better suit its situation. When a business has facilities in more than one EPA Region, the Audit Agreement is negotiated with EPA headquarters and not the Region.
Many states in EPA Region 5, including Wisconsin, have similar policies for mitigating penalties for facilities that self-disclose violations (Wis. Stat. § 299.85, ) However, it is important to understand that the federal Audit Policy does not necessarily provide mitigation or immunity from state enforcement penalties and any self-disclosure to EPA should be coordinated with any similar state program. Therefore, for issues that are regulated by both the state and EPA, it is important to consider self-disclosure of any violations to both the state and EPA. There can be significant differences between state and federal programs and careful coordination of the self-disclosures is important.
Audit Policy Applied to "New Owners"
In 2008, EPA expanded its Audit Policy to include additional penalty mitigation incentives to new owners who identify and report violations of environmental laws at recently acquired facilities.2 The additional opportunities for penalty mitigation offered to qualifying new owners provide a considerable potential for protection from penalties arising from past violations at newly acquired facilities. The potential benefits that this expansion of the Audit Policy may have are an important consideration for all buy/sell transactions.
EPA included in the federal Audit Policy incentives that are specifically tailored to qualifying new owners of facilities. The following are highlights of the increased incentives for new owners:
- New owners may be eligible for mitigation of penalties for violations discovered through required monitoring that were previously ineligible for mitigation. For example, violations of monitoring requirements for the compliance certification under a Title V air permit.
- In certain circumstances, new owners may be eligible for mitigation of substantial "economic benefit" penalties that are ineligible for mitigation under the regular Audit Policy.
- Past violations of the same or similar laws will not exclude a facility under control of a new owner from eligibility for penalty mitigation.
- Except in the most egregious circumstances, EPA will not exclude facilities where the violation has resulted in serious actual harm to the environment.
To be eligible for consideration for the additional incentives for new owners requires that the prior nine eligibility criteria be achieved with the following modifications:
- Systematic Discovery: Violations discovered during pre-transaction due diligence or one-time post transaction audits are eligible for mitigation.
- Voluntary Discovery: Violations discovered through required monitoring are eligible if disclosed before the first monitoring report is due. This allows for a one time "catch-up" if a newly acquired facility has not been maintaining compliance with required monitoring. For example, this makes past noncompliance with monitoring and reporting requirements under the Clean Air Act or Clean Water Act eligible for mitigation.
- Prompt Disclosure: Pre-closing discoveries must be disclosed within 45 days of closing. Like the general Audit Policy, post-closing discoveries must be disclosed within 21 days of discovery. However, the option to enter into a Audit Agreement is available to New Owners.
- Independent Discovery: EPA may exercise discretion to reduce penalties where a new owner did not know of an on-going investigation of a recently acquired facility.
- Correction: No change to the existing policy; however, a new owner may negotiate an Audit Agreement to meet its specific needs.
- Prevent Recurrence: No change in the policy for New Owners; steps must be taken to prevent recurrence of the noncompliance.
- Repeat Violations: Violations prior to change of ownership are exempt from consideration and EPA will not consider a new owner's history of violations at other facilities.
- Actual Harm: Violations that result in actual harm to the environment are eligible except where they cause a fatality, community evacuation, or serious injury.
- Cooperation: Only cooperation that relates to the specific request for penalty mitigation is required. Non-cooperation at other facilities is not considered.
To qualify as a new owner, an entity must meet specific criteria that depend on prior ownership and control of the facility. The new owner must certify that it was not responsible for compliance at the facility, did not cause the violation, that the violation originated under the prior owner's control, and that there is or was no controlling corporate relationship between buyer and seller. Businesses must carefully consider the specific circumstances of a transaction to determine eligibility for the purposes of the Audit Policy.
The policy for New Owners allows for a 9-month window of opportunity after closing of a transaction for new owners. During this 9-month window, a facility is eligible to take advantage of the added incentives and relaxed criteria for new owners. During this period, a new owner has two options: (1) identify and promptly disclose violations while being aware of Clean Air Act and Clean Water Act reporting deadlines for monitoring and reporting; or (2) enter into a Audit Agreement with the EPA that will toll the prompt disclosure provision. For compliance issues identified prior to the transaction, it may be necessary to approach EPA with the 45-day post-transaction period allowed for reporting pre-closing discoveries.
In summary, the Audit Policy provides businesses an approach that can afford protection from considerable penalties for past violations of federal environmental laws. This is particularly true after ownership and control of a facility changes to a new owner. However, one last note: sellers beware, disclosure of past violations by new owners may provide EPA with information that could form a basis for enforcement actions against prior owners.
Originally published for the 2012 Wisconsin Association of Corporate Counsel program in May.
1 Incentives for Self-Policing: Discovery, Disclosure, Correction, and Prevention of Violations, 60 Fed. Reg. 66706 (Dec. 22, 1995) as revised 65 Fed. Reg. 19618 (Apr. 11, 2000).
2 Interim Approach to Applying the Audit Policy to New Owners, 73 Fed. Reg. 44991 (Aug. 1, 2008).
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.