InSight

Exit and Growth Strategies for Middle Market Businesses

Environmental Liability in M&A

By Dan Vermeire | Oct 23, 2018

Environmental concerns can be hugely important in an M&A deal, and are typically investigated as part of the due diligence process. But, for a business owner, that may be too late.

What’s at stake for your business?
It’s important to know that PLL (Pollution Legal Liability) can affect both the property owner and the tenant. Yes, a business that leases the property can still be responsible for environmental problems. Further, PLL can be from the historic uses, well before you owned or leased the property. And PLL can affect you because of an adjacent property, even if you don’t operate there.

PLL costs can be significant to identify and remediate problems. This may involve drilling and digging at the property, through the floors, parking lots, and open ground, to remove and dispose of contaminated soil. Far worse, if the environmental issue isn’t properly managed, it can be disruptive to your business if customers, employees and regulatory agencies draw the wrong conclusions.

How does the process work?
It is a three-step process, starting with a simple assessment and, if problems are found, progressing to more rigorous efforts. The initial step, Phase 1, reviews the property and creates the Environmental Site Assessment (ESA), which identifies potential or existing environmental contamination liabilities. Various engineering firms specialize in the practice of these reports, according to guidelines from the EPA. The assessment will look for any visible signs of contamination and review the historic uses of the property. If the ESA identifies areas of significant concern, then a Phase 2 is recommended which involves further analysis such as boring, collecting soil samples, and installing ground water monitoring wells. If the Phase 2 identifies significant issues, then a Phase 3 project will remediate the site. As you can see, each step costs more money, takes more time, and may create further disruption to your business.

How can you protect your business?
It is important that the business or property owner’s attorney order the ESA, not the buyer. Why? Because the report can be protected by attorney-client privilege. Should the ESA identify problems, then the information can be kept confidential. Most good law firms will have a working relationship with an engineering firm and keep the owner’s interests in mind, thereby avoiding overly aggressive, or “make work” recommendations.

There are several areas of the ESA that are somewhat subjective, such as the classifications of risks. Professional opinions can vary – one group may think action is needed, while others may not. For this reason, ESA’s are initially produced in a draft form and issues can be discussed. If it is warranted, you can get a second opinion, perhaps more favorable. If the process continues, eventually a report becomes final, and then can be made available to the buyer, banks, and regulatory agencies. A clean ESA has value to both the buyer and seller.

To stay ahead of any issues, you should consider ordering an ESA well before you start the M&A process. In that way, you can be aware of any potential risks and solve them before they become bigger problems.

Other ways to manage environmental risk include indemnification from the seller to the buyer. This approach may often require some meaningful security, such as continued equity, a note, escrow or insurance. Leasing may be considered as an alternative to buying property in an M&A deal. There may be other business reasons to control the property and leasing does not completely eliminate risk for the new owner, but this approach can help in many cases.

Last, but certainly not least, environmental insurance is a very good way to eliminate risk and should be considered in any PLL situation. Policies have been used for many years, are available from many respected providers and can have customized coverage. Many policies are transferrable to the new owner and will cover pre-existing conditions, both onsite and offsite contamination, claims for bodily injury and legal costs. In certain cases, policies will exclude voluntary digging, that is, don’t go looking for trouble. This restriction can be included in the lease or purchase agreement, too. Environmental insurance is affected by the findings in an ESA, so it is important to consider insurance before starting the process. Always work with your advisor to control the process and manage the information flow to the insurance market.

Environmental concerns continue to gain attention, as we move closer to a green planet. Any business that involves owning or leasing property should have an effective strategy to manage environmental risk. Our CFA professionals regularly lead programs that successfully avoid environmental pitfalls.


Leave a Comment