Environmental Considerations in M&A Transactions
Environmental issues often play an important role in M&A transactions. The analysis of environmental issues can be challenging, given the somewhat unique nature of environmental liability, but most such issues are manageable if given proper attention and care.
Basics of Environmental Liability. The primary federal law on environmental liability is the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”, also referred to as “Superfund” ). CERCLA, along with the related Resource Conservation and Recovery Act (“RCRA” ), can impose liability for environmental contamination on current owners and operators of real estate, even if the owners or operators had nothing to do with the contamination. The responsibility is one of strict liability, is imposed on a joint and several basis, and is not limited to the value of the applicable real estate. In short, environmental liability under federal statutes can be significant and sometimes surprising.
In addition, certain state statutes impose liability for contamination, such as North Carolina’s Oil Pollution and Hazardous Substances Control Act, which applies to those “having control over” the involved contaminants “immediately prior to discharge.” In many states, including North Carolina, environmental claims also can be brought under common law theories such as nuisance, negligence, or trespass.
A purchaser of real property can seek to avoid CERCLA liability by qualifying for certain defenses, including the Innocent Landowner Defense and the Bona Fide Prospective Purchaser Defense. These defenses can have up to eight separate elements that must be satisfied, both before and after the purchase of real property, but both of the defenses require an owner or operator to have undertaken “all appropriate inquiry” into the history and condition of the property before taking title to or operating on the property. By law, “all appropriate inquiry” is defined as having had a Phase I Environmental Site Assessment (“Phase I” ) performed for the property, which Phase I meets certain specified requirements. Acquiring or operating real estate without a statutorily-compliant Phase I being completed, in addition to meeting the other requirements of the applicable defense, will subject the purchaser to strict liability for contamination on the property, even if the purchaser did not cause or know about the contamination. And while a purchaser may be tempted to rely on a previously conducted Phase I to save time and money, it is important to know that a Phase I must be less than a year old at the time of the acquisition of the property, and certain sections of a Phase I must be updated if they are more than 180 days old.
Implications in an M&A Context. If a buyer purchases a business that owns or has any interests in real property, it is important to consider the potential environmental liabilities when structuring and negotiating the deal, and to conduct due diligence on environmental issues.
Asset Acquisitions. Setting aside any other considerations for pursuing a particular deal structure, in considering environmental issues, most buyers would strongly prefer to structure a transaction as an asset purchase. This structure allows the buyer to avoid or limit environmental liabilities associated with the real estate of the acquired business through the use of one of the defenses referenced above. Because, in an asset deal, the Buyer is directly purchasing the real estate, such defenses are available and typically warrant having Phase Is conducted.
Stock Acquisitions. In a stock deal, a Phase I does not provide the buyer with the same liability protections since the buyer acquires the entity that already owns or operates the applicable real estate. Nevertheless, a Phase I still can be quite valuable to a buyer in a stock deal because the Phase I may uncover information important to the value of the real estate or the extent of the target entity’s exposure to potential environmental liabilities. This information may be helpful for the buyer in negotiating the purchase price, indemnification or other terms of the deal. Also, if the transaction involves a third party lender, the lender may require acceptable Phase Is as a condition to funding.
Regardless of the structure of an M&A transaction, in addition to conducting a basic Phase I for the reasons outlined above, the buyer may want to investigate items beyond the scope of a basic Phase I, such as the possible presence of asbestos-containing building materials, PCBs, mold, or lead-based paint. The presence of one of more of these materials on a property can significantly impact the fair market value of the property or result in significant remediation or clean-up costs. In addition, a consultant performing a Phase I also may be able to identify other conditions, such as the presence of jurisdictional wetlands on a property, which can hamper, or even block, future development.
If Contamination is Found. A transaction need not fail simply because contamination or other environmental issues are discovered during the due diligence process. It is increasingly common for such transactions to proceed using one or a combination of approaches, including a reduction in the purchase price, indemnification of the buyer for post-closing liabilities related to the contamination, the use of an escrow to secure the completion of any required environmental clean-up after closing, or the purchase of a pollution legal liability insurance policy to protect the buyer. Developments such as the increasing acceptance of so-called “risk-based” closures, which enable contaminated sites to be addressed in a more timely and cost-effective manner, can provide additional assurance to buyers that discovered contamination can be managed in a reasonable manner. “Brownfields” programs in many states also enable parties to acquire or operate a contaminated site with significantly reduced clean-up responsibility and with liability protections that can extend to tenants or even to future buyers, as long as the terms of a negotiated Brownfields agreement are honored.
Seller Considerations. On the seller side of an M&A transaction that includes real property as part of the business, the seller should carefully consider the scope of the diligence review being conducted by the buyer and whether to allow the buyer to conduct soil, groundwater, surface water or vapor sampling on a property. If a buyer discovers reportable levels of contamination through its due diligence, it may choose to abandon the transaction and leave the seller to address the discovered contamination. Further, it is important for a seller to take steps before engaging with a buyer to ensure that the business is in compliance with environmental requirements generally. Otherwise, in some cases the seller could foreclose certain remedies that would otherwise be available if contamination is later discovered. For example, in North Carolina, if a buyer discovered contamination from an underground storage tank but the seller was found to be delinquent in paying the annual tank operating fees, then the seller would forfeit the state underground storage tank trust fund coverage that otherwise would pay for the cleanup of the contamination.
Environmental laws evolve quickly, based in part on changes in the underlying science, and liability concerns in connection with M&A transactions therefore are often changing as well. Although it may be tempting to avoid or limit environmental due diligence and a close environmental review in the M&A process due to the costs and time required and the need to engage third party advisors, properly performed and scoped environmental due diligence is recommended because it can save a buyer a substantial amount of money, time, and frustration in the long run.
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Grady Shields and Rob Futrell are attorneys in the Environmental and M&A Practice Groups of Wyrick Robbins Yates & Ponton LLP, which represent clients across a broad range of industries. The M&A Practice Group publishes Practice Briefs periodically as a service to clients and friends. The purpose of this Practice Brief is to provide general information, and it is not intended to provide, and should not be relied upon as, legal advice.