Environmental liabilities, such as liabilities arising from ground or air pollution or from the presence of asbestos in the buildings of the target, are often a predominant issue in the negotiations of deals in pollution-intensive industries. Buyers purchasing polluted or polluting assets must first identify the environmental liabilities. This is done during the due diligence process, usually with help of environmental experts. After the environmental liabilities have been identified, buyers must determine whether these liabilities will transfer with the purchased business (see section A) and, if so, try to obtain an indemnity from the seller (see section B).
A. The Transfer of Environmental Liabilities in M&A Transactions
1. In share deals, the situation is straightforward. All environmental liabilities stay with the target and their burden is therefore (indirectly) transferred to the buyer.
2. In asset deals, the situation is different. The environmental liabilities are initially on the seller and the general principle is that these liabilities stay with the seller. Liabilities arising from ground, water and other pollutions caused by business activities of the seller, including any obligation to pay for costs of investigation and/or clean-up measures ordered by authorities, do, in principle, not transfer to the buyer (even when the polluted or polluting asset is transferred to the buyer).
3. Environmental liabilities pass, along with the transferred asset(s), to the buyer in
exceptional cases, only when there is a legal basis providing for the transfer. Therefore, each environmental liability is to be looked at individually with its underlying regulation to see whether it transfers or not to the buyer.
4. There are mainly two sets of rules which provide for a transfer of environmental liabilities to the buyer:
(i) Certain environmental regulations attach liabilities to the ownership of an asset so that if the buyer acquires the asset he also automatically takes over the attached liabilities. For instance, regulations on ground pollution impose on the owner of a property with a polluted soil the obligation to perform any investigation, monitoring or clean-up measures ordered by governmental authorities and to take on part of the costs of these measures (in principle up to 30%; the remaining part of these costs being on the person whose activities caused the pollution; see n. 2 above). The purchaser of a property with a polluted soil automatically takes over (in its capacity of new owner of the property) these obligations.
(ii) M&A rules may also effect the transfer of environmental liabilities to the purchaser even when such transfer is not provided for in the underlying environmental regulation. For instance, if a business is transferred by way of merger under the provisions of the Federal Act of 3 October 2003 on Merger, Spin-Off, Conversion and Transfer of Assets and Liabilities (RS221.301) (Merger Act), all liabilities, including environmental liabilities, of the transferring entity are transferred to the surviving entity through universal succession. Environmental liabilities may also be transferred in a transaction under which a business, or part of it, is transferred by an entity to another one by way of spin-off or transfer of assets and liabilities under the provisions of the Merger Act. In order to be transferred, these liabilities must be "clearly" referred to by the transferor and the transferee in the inventory of transferred assets and liabilities that is to be submitted with the restructuring documents to the Commercial Register. Liabilities not mentioned in the inventory do not pass on to the transferee. For the rest, unlike certain Swiss legal authorities, we do not see that there is an overarching implied principle in Swiss (environmental or M&A) law under which environmental liabilities arising from harmful activities carried out by a business would automatically transfer to the transferee when this business is transferred.
B. The Allocation of the Environmental Risk Between Seller and Buyer in M&A Contracts (Environmental Indemnity Clauses)
5. As described in section A above, in an M&A transaction, environmental liabilities may stay on the seller or transfer to the buyer. This will depend on how the transaction is structured. For instance, in a share deal, environmental liabilities are taken over by the buyer (indirectly, via the target company) while in an asset deal certain environmental liabilities will remain on the seller. Regardless of how environmental liabilities are allocated under applicable law between seller and buyer, the parties are allowed to insert in their share or asset transfer agreement clauses reallocating the environmental risk between themselves. Even though these contractual clauses cannot interfere with the allocation to the seller or the buyer of environmental liabilities vis-à-vis governmental authorities or other third parties pursuant to applicable environmental regulations and/or M&A rules, these clauses are fully valid and enforceable between the parties.
6. Environmental liabilities are often contingent liabilities which may materialize in a distant time horizon, but which are nonetheless known to the buyer (in terms of the contingency being possible). Therefore, when, for instance, the parties agree that the burden of such liabilities is to remain on the seller, the arrangement has to be set forth in a so-called indemnity clause, rather than through seller's representations and warranties (R&W). The main reasons for this are that seller's R&W are usually qualified by the buyer's knowledge and that claims for breach of seller's R&W expire fairly quickly (one to two years from the closing date in Swiss M&A practice). On the other hand, indemnity clauses are provisions under which the seller undertakes to pay a certain amount to the buyer if a specific event occurs (e.g. the buyer or the target incurs costs because ground clean-up measures are imposed on it by governmental authorities) regardless of whether the parties were aware of the underlying risk and regardless of when such risk will materialize*. The limitation period for payment undertakings set forth in indemnity clauses is, under Swiss law, ten years. Ten years may be quite short for environmental issues which may remain latent for decades. However, under Swiss law, the ten-year limitation period starts running when the environmental risk materialize i.e., basically, when the buyer or the target incur the clean-up costs or other costs associated with measures ordered by environmental authorities. From that moment on, the buyer has ten years to enforce the payment undertaking against the seller. Environmental indemnity clauses may therefore survive for a very long, and even unlimited, period of time.
7. The main conclusions of this paper are as follows. First, in an M&A transaction structured as an asset deal, environmental liabilities transfer to the buyer only when there is specific legal basis providing so. This legal basis may essentially be found in the underlying environmental regulations or in M&A rules. Second, regardless of whether an environmental liability transfers to the buyer or
not, the parties may validly reallocate the burden of such liability between themselves via contractual arrangements. Environmental indemnity clauses, which (unlike R&W clauses) may survive for a very long period of time and are not qualified by the injured party's knowledge, are the most appropriate tool for reallocating the burden of environmental liabilities.
* An environmental indemnity clause could, e.g., read as follows: "Seller shall indemnify Buyer against, and hold it harmless from, any damages, costs or claims, incurred by, or which may be made against, Buyer and/or the Company in connection with a PreExisting Pollution".
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.