United States: 5 Tips For Environmental Due Diligence In Business Transactions

Virtually all business transactions involve some level of environmental risk. The key is to identify all of the potential risks and collect sufficient information about them early in the due diligence period of a transaction. This proactive approach to environmental due diligence will help the buyer determine whether the risks are acceptable in light of the overall transaction and develop a strategy for managing them, both in the contract negotiations prior to acquisition and after the transaction is complete.

How much and to what extent businesses should conduct environmental due diligence typically depends on the nature of the transaction and the anticipated use of the property after purchase.

Below are five tips for buyers to consider when determining the appropriate level of environmental due diligence that should be performed in business transactions.

Although the tips are geared toward buyers, sellers should also consider them so that they can better anticipate the types and level of due diligence that a buyer may perform (and understand their reasons for doing so). Identifying and correcting environmental problems in advance of the transaction may help prevent buyer demands for purchase price reductions or substantial escrows to cover potential environmental liabilities.

1. Identify the types of environmental liabilities that could be implicated

The most common types of environmental liability and costs associated with businesses and their properties include:

  • Cleanup of contamination on owned or leased property;
  • Cleanup of contamination on nearby property owned by others, where contamination has migrated from a company property;
  • Cleanup of contamination on property where the company's waste has been sent for treatment or disposal;
  • Tort liability (bodily injury and property damage resulting from exposure to hazardous substances);
  • Fines/penalties for violations of environmental laws and permits associated with the company's operations;
  • Capital expenditures necessary to achieve or maintain compliance with environmental laws and permits applicable to company operations;
  • Increased costs of demolition or site redevelopment associated with contamination of the property, the presence of asbestos or other hazardous materials in site structures, or the presence of wetlands or other sensitive environmental conditions on the property; and
  • Legacy environmental liabilities associated with former properties, operations and businesses of the company.

When purchasing a property with no operations or structures from an unrelated third party, the environmental concerns may be limited to contamination on or emanating from the property. A Phase I environmental site assessment (Phase I ESA) that does not identify any environmental contamination concerns may be sufficient in that context. This scenario, however, is rare.

A buyer planning to redevelop a property with existing structures will be concerned about the potential for added costs and delays associated with hazardous materials in the structure and conditions that may require special permits or design modifications. Purchasers of property who will continue the same operations will be concerned about the company's compliance with environmental laws and permits and whether substantial expenditures may be necessary for the operations to achieve or maintain compliance. Stock purchasers and, as discussed in Tip 4, some asset purchasers will be concerned about all of these potential liabilities, including legacy environmental liabilities.

2. Understand the limitations of a Phase I Environmental Site Assessment

A Phase I ESA is a non-intrusive investigation into past and current uses of a property to evaluate the potential existence of hazardous substance or petroleum contamination on or migrating from the property.

A Phase I ESA generally consists of the following activities by an environmental professional:

  1. a review of publicly available records;
  2. a site visit;
  3. interviews of owners, occupants and government officials; and
  4. a report describing the results of the investigation and the environmental professional's opinion as to whether there is specific evidence of, or reason to believe, that the property is contaminated.

Although it may contain general information about the property and facility operations, a Phase I ESA does not specifically address whether the operations comply with environmental laws and permits or whether there are site conditions that could affect the buyer's development plans. A Phase I ESA also does not address the company's potential liability for off-site waste disposal or legacy environmental liabilities.

3. Consider using additional due diligence methods

Given that a Phase I ESA does not address many of environmental liabilities that a buyer may be concerned about, what other environmental due diligence methods are available? Below are a few of the most common additional due diligence methods.

Phase II Environmental Site Assessments – testing of soil/groundwater to determine whether the property is, in fact, impacted.

Environmental compliance audits – evaluation of the facility operations to determine whether all required permits have been obtained and the operations comply with the permits and environmental regulations.

Asbestos surveys – identification and testing of building materials suspected to contain asbestos (Building materials that contain asbestos must be removed by a licensed asbestos contractor prior to any renovation or demolition activity.)

Wetland surveys – identification of wetlands subject to federal or state regulation in connection with construction and development activities

Computer database searches – third-party database search services may be used to research the company's former properties and businesses as well as determine whether it has been named a potentially responsible party (PRP) at Superfund sites

4. Remember that asset purchasers are not immune from a seller's environmental liabilities

Following a stock transaction, the surviving corporation will obtain all of the liabilities and obligations of the merging corporation. That's why environmental due diligence in a stock deal should be comprehensive and include not only current properties and operations of the company, but also its former properties and operations, as well as any businesses that have been acquired/divested.

Buyers often assume that if the transaction is structured as an asset deal rather than a stock deal, they need not worry about environmental liabilities that are unrelated to the purchased assets. While the general common law rule is that asset purchasers are not liable for debts and obligations of the seller corporation, there are four exceptions:

  1. The purchaser expressly or impliedly agrees to assume seller's liabilities;
  2. The transaction is a de facto merger;
  3. The purchaser is a "mere continuation" of the seller; or
  4. The transaction is a fraudulent effort to escape liability.

Many federal and state courts have found, applying especially the second and third exceptions, that a purchaser of substantially all of the assets of a company will assume the company's environmental liabilities, whether or not they are associated with the purchased assets.

Regardless of the exceptions applied, court decisions on successor liability for asset purchasers are made on a case-by-case basis and tend to involve fact-intensive analyses. The following factors have been relied on in finding that successor liability applies to asset purchasers.

  • The purchase includes all or substantially all of the seller's assets.
  • Shareholders of the seller become shareholders of the buyer as a result of the transaction.
  • Officers/directors of the seller continue to serve in the same capacity for the buyer.
  • The seller ceases all operations and rapidly dissolves after the sale
  • The buyer produces the same product and continues the same operations/processes as the seller
  • The buyer uses the same name, same locations and same employees of the seller
  • The buyer uses the same trade names, trademarks, technology and intellectual property of the seller
  • The buyer uses the same management and supervisory personnel
  • The buyer's customers are the same as the seller's
  • The buyer assumes all contractual obligations of the seller ordinarily necessary for uninterrupted continuation of normal business operations
  • Company press releases characterize the transaction as an acquisition of the seller
  • The buyer holds itself out to the public as being the same company as before the transaction

Each of these factors should serve as potential red flags to the buyer that its asset purchase may make it a successor of the seller — one who is now responsible for all of the seller's environmental liabilities. If one or more of these factors are present following a transaction, the buyer should investigate the gamut of seller's potential environmental liabilities, including its compliance history and that of its former properties, businesses and operations.

5. Talk to your environmental attorney early in the transaction

Last, but not least, consult with an environmental attorney early in the transaction. Be sure to provide the attorney with all available details about the proposed structure of the transaction and the plans for the property and operations after the closing. The attorney can assist in developing a strategy and timetable for completing the appropriate environmental due diligence. Often, an attorney can also advise on steps that can be taken before and after the transaction to minimize or manage environmental risk.

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.

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