Last month, we briefly discussed key considerations for buyers and sellers regarding environmental liability in mergers and acquisitions (M&A). Today, let’s discuss a few potential issues that can hinder a sale or purchase, delay closing, or add unnecessary angst to the deal.
Assembling the Right Environmental Due Diligence Team
Assembling an experienced environmental due diligence team, on both the buy and sell side, is essential to the deal’s success. From a buyer’s perspective, thorough due diligence can reduce future risk by obtaining pertinent information from the seller about operations, litigation risks, environmental liabilities and historic use, existing contracts, and much more. From a seller’s perspective, planning and dedicating resources to due diligence produces trust in the buyer and can facilitate a smooth road to closing the deal. With a defined process and communications plan, a knowledgeable due diligence team can identify what documents pertaining to the asset(s) are required, time frames and legal privileges tied to obtaining certain documents, and what those documents may reveal about compliance, contamination, and long-term liabilities.
Active and abandoned industrial sites, whether through a merger of companies, a Special Acquisition Company (SPAC) deal, or an acquisition of property, are usually complex. Each site can have a wide range of records, documents and data that must be reviewed to accurately assess potential non-compliance or whether a Recognized Environmental Condition(s) (RECs) exists at a site and to what extent. If this assessment uncovers a non-compliance issue that is material to the deal, proper documentation will help define the cost to closure. These records may be available either at the facility(s), the corporate office, or at the appropriate City or County office. If adequate records are not available, assumptions must be made as to the extent of the material threat(s).
Historically, our M&A assistance has primarily been for the buy side of industrial properties. Typically, this process begins with a request for a Phase I Environmental Site Assessment (ESA) and may include a limited Compliance Assessment. The due diligence team and the person requesting the Phase I ESA needs to know what the scope and limitations are of a Phase I ESA. The scope, under the ASTM E 1527 standard, is relatively limited (The Phase I ESA requires documentation that is Readily Available (i.e., within 20 days)). Therefore, if the due diligence period is limited such that certain historical documentation is not available, or if the seller and the buyer are not familiar with industrial operations, record keeping, building drawings, and other historical records, then the results of the Phase I ESA may not fully capture the potential for environmental liabilities at a given site. Information not available within the 20-day standard, in hindsight, may be crucial in defining REC(s) and ultimately allocating risks and costs between buyer and seller.
The assigned due diligence team must be aligned on expectations, schedules, and possible outcomes of the transaction, as well as the risk profile of the acquiring company, roles and responsibilities within the team, and management of the real-time data to make informed decisions. Many times, the seller, while anxious to sell, is not prepared for the due diligence or the results that the buyer may find. The seller is often unprepared for the pace and the demands of the buying team and providing those essential materials in an orderly fashion. The lines of communication between Buyer and Seller become important to the environmental professional to ultimately get the necessary information.
Case Study – Delayed and Unprepared – Due Diligence Process Must be Planned and Executed
A recent example of the ability to obtain information on which to base an opinion of RECs that are material to the acquisition is the case of Company X buying Company Y’s current manufacturing facility. This example brings to light the inadequacies of the due diligence process if not planned and set up properly.
The buyer, our client, Company X, had pre-existing conditions for the scope and timing of the due diligence activities. Company X did estimate remediation / corrective action costs that would be acceptable should Company Y, the seller, not correct issues that might be identified. The environmental consultants began the process of the Phase I ESA by requesting documentation from regulatory agencies, national database firms, and the selling entity.
The regulatory agency did not have electronic files readily available, and the time it would require for receipt of hard copy records extended far past the due diligence deadline for the client to produce escrow and make a significant monetary investment. Company Y, who had been in operation for over 70 years at the facility in question, appeared to run a well-organized and clean operation. The facility was in neat and in orderly condition, but they could not produce substantial records for what were suspected to be hazardous material and petroleum releases at the facility over the years.
Company Y’s facility personnel did not understand that historical building drawings of structures, past buildings, buried utilities, records of chemical use, past environmental reports and related documents were crucial for the buyer to understand what significant environmental liabilities required addressing should Company X follow through with the transaction. Company Y placed little information in the transaction Data Room, although it was obvious, from data base reviews that there was more material data, and there should have been more hard information provided by Company Y.
As more questions were asked, the seller started to produce additional documents to the Data Room, but this was piecemeal. Institutional knowledge of operational history and where pertinent information was located was lost over the long history of site operations and reorganization of the company. This information gap created tension and some distrust on the part of the buyer. Eventually, it was found that there was significant soil contamination and past contamination events that may have impacted groundwater at the site. There was no record of investigation or resolution for these soil and groundwater impact issues. This lack of transparency rung alarm bells for the buyer and prompted them to request a Phase II ESA.
While a Phase I ESA assesses the likelihood of an REC being present, a Phase II ESA confirms or denies if a condition is/was indeed present. Plans for the site investigation were drafted, costs estimated, and presented to the seller. The seller was adamant that a Phase II ESA not be performed. The seller’s obfuscation soured the entire negotiation for the buyer, and ultimately, led to them abandoning the entire deal.
Postmortem on the Due Diligence
Reviewing the transaction, the seller should have performed internal due diligence on their environmental matters which would have allowed them to be ready for the buyer’s requests long before going to market. The seller could not honor full disclosure and the piecemeal way environmental documents were provided led the buyer to question the viability of the transaction. While the seller may have acted with good intentions, agreeing to the additional soil and groundwater due diligence and covering the cost of any subsequent corrective actions could have saved the sale or displayed enough good faith to further enable negotiations. Typically, the seller has joint and several liabilities at the site and is considered a potentially responsible party for environmental contamination. In our experience, while the seller’s actions may seem counterproductive to closing the sale, it can lead to limiting the seller’s liability.
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