Below is a list that M&A professionals may find useful in determining whether environmental issues are likely to impact a pending deal. Because we are most familiar with United States law, the illustrations are drawn largely from U.S. environmental laws. Similar principles apply under the laws of most countries. However, there are differences. Generally speaking, environmental enforcement is harsher in the U.S., and the liability of current or former owners or operators of facilities that in the past disposed of hazardous substances, is greater in the U.S than in most other countries.

Timing – It is important to identify as soon as possible whether there are environmental issues in a deal. If you wait for final due diligence, those issues may force the deal to be restructured, re-priced, or both. At a minimum such late discovery is likely to delay closure and increase costs, and may cause the deal to collapse. You would not structure a deal without consideration of the tax implications. Our point is that it is best not to structure deals until you also have at least a preliminary understanding of the environmental issues and their potential costs, liabilities and operational risks.

Disclaimer – The below list is a simplified tool. It will not work for every deal, will not apply to every situation and is for general information only. It is not intended as legal advice. Legal advice should be obtained from a licensed professional with knowledge of the specific facts and applicable law.1

The Six Basics

1. Does the company or the facility that is the subject of the deal:

1. have ongoing emissions into the air?
2. have ongoing direct discharges to water bodies (rivers, bays, )?

 1 It is important to understand that environmental engineers and environmental lawyers come from different backgrounds and approach problems differently. The best result will generally come from a team approach that does not rely solely on one to the exclusion of the other. 

1. have ongoing indirect discharges through sewer systems (other than normal sanitary waste)?
2. have ongoing shipments off site of solid or liquid waste that could be considered hazardous?
3. have permits for (a)-(d) above?
4. as to companies or facilities located in the U.S., has the company or its predecessors in the past arranged for the disposal of solid or hazardous substances, or in the past owned or operated a facility that disposed of hazardous substances?

If the answer to any of these questions is “yes” – the deal is likely to have environmental impacts that will require review by an environmentally trained lawyer.

Examples:

An investment in an insurance brokerage firm or the acquisition of an advertising agency is not likely to have any of these characteristics.

An investment in an auto parts manufacturer or a printing or packaging firm, is likely have all or most of these characteristics. The parts manufacturer likely uses solvents and solvent based paints that will emit hazardous air pollutants (for example, volatile organic compounds (VOCs)). The printing or packaging firm likely uses solvent based inks (also emitting VOCs) and has heat sources that emit compounds of Nitrogen (NOx). Both likely discharge treated liquid waste to either a sanitary sewer or river and are also likely to dispose off-site wastes that may be classified as hazardous. All of these activities would be subject to environmental regulation.

 

2. Is the property owned (or operated) by the company contaminated – – whether due to its actions or the actions of its predecessors? If so, the deal may well involve inheriting the liability for cleanup costs. Sometimes it is possible to structure a deal to minimize these types of risk.

Examples:

Acquisition of a “green field” site acquired from a farmer. The property records of course need to be checked as to whether the site or adjacent properties were previously used for industrial purposes, and the soils and groundwater would need to be checked for residues of pesticides, fungicides or other farm related chemicals. If there was no such prior industrial use and agricultural chemical residues are not a problem, the acquisition may not pose the risks that would be posed by a similar acquisition of property in older industrialized (or formally industrialized areas).

Acquisition of a company that is operating on potentially contaminated property. The seller offers to solve the problem by (a) structuring the deal as an asset purchase rather than a stock deal and/or (b) providing an indemnity for environmental issues. Structuring a deal as a purchase of assets (rather than stock) may or may not work depending on the facts. If the acquiring company is going to continue operations at the same location, buys most of the assets including for example customer lists, and there is at least some continuity of equity interest in the business between some members of the buyer and seller teams, it may under U.S. law be considered a “de facto merger” in which liability passes from buyer to seller. The indemnity may become worthless if the seller goes bankrupt. And the buyer may not, under

U.S. law, be able to get out from under its cleanup liability as the current owner by itself going bankrupt.

Acquisition of a “Brownfield Site” for construction of a new hotel. The term Brownfield Site basically means a site that is known or highly likely to be contaminated because of historic use. (For example, if it was the site of a gasoline station that had underground storage tanks and has not been recently remediated.) In the U.S., many states have programs to encourage redevelopment of such Brownfield Sites. Typically, those programs set parameters for cleanup, provide government oversight of the work, and some provide generous tax credits and liability protection for claims by the state when the agreed cleanup goals are met.

3. Is the company in a highly regulated industry?

Examples:

In the U.S., the pesticide industry is subject to regulation under the Federal Insecticide, Fungicide and Rodenticide Act (FIFRA). The term pesticide is broadly construed to include such things as disinfectants. Electric Utilities are subject to special regulations under the Clean Air Act and petrochemical facilities are heavily regulated under both the Clean Air and Clean Water Acts. Gasoline mileage requirements apply to the auto-manufacturing sector.

In the EU, heavy industry is limited in CO₂emissions under the EU carbon trading scheme. In the U.S., except for specially regulated industries (e.g., automotive mileage requirements and CO₂ emissions from electric utilities), CO₂ emissions are largely unregulated by the federal government.2 However, similar limits may be indirectly imposed through other mechanisms. For example, large industrial sized furnaces (including in hospitals and hotels) may have nitrogen oxides (NOx) limits under the U.S. Clean Air Act. As a

2 Some U.S. states either individually or in groups have established their own carbon trading programs.

practical matter, those restrictions may require special equipment (e.g., low NOx burners to meet the NOx limits) that also reduce CO₂ emissions.

4. Does the project utilize partial governmental funding or require a federal governmental permit?

Examples:

In the U.S., the National Environmental Policy Act (NEPA) requires a detailed environmental assessment (EA) and an Environmental Impact Statement (EIS) if a federal governmental agency is involved in a project. Involvement may be direct, in the form of partial federal funding, or indirect (for example where certain federal permits are needed). These assessments, if required, are time consuming, expensive, subject to public notice and comment, and may include social and economic (not just environmental) impacts. The studies may also need to review alternatives to the project, and the minimization of environmental impacts. In many cases, EPA has delegated such reviews to individual States. Given the delays and cost of these types of studies, the initial deal review needs to focus on whether NEPA (or a State’s analog to NEPA) is applicable and whether any of the exemptions apply.

5. Even if a company is in full compliance with its existing permits, can environmental regulations change the future value of the deal? When rules are changing or new commitments are required, the answer is “yes”.

Examples:

In December 2017, EPA notified each State as to areas that it believes are not in compliance with the new ozone regulations that were adopted in 2015 but are only now being implemented. Final ozone non-attainment designations are expected this Spring. (Please see our Executive Summary on these far- reaching regulations and their potential impact on M&A). Industry estimates indicate that more than 500 counties will be affected. Once final designations are made, restrictions on Clean Air Act permits will immediately go into effect that will make it more difficult to construct new facilities or expand existing facilities in a way that will increase emissions of VOCs or NOx.

Numerous manufacturing, printing, packaging and other industries will be impacted. Over time, facilities in those areas will also be required to reduce VOC and NOx emissions in a way that may impact capital needs, cash flows and business valuations.

There will be winners and losers. For example, if you or your client are investing in or acquiring a company covered by the new ozone rule that is located in an “attainment” area, that company may have an advantage over competitors located in a “non-attainment” areas and be subject to less stringent regulation enabling it to increase market share and/or improve profitability over time. Conversely, if you are acquiring or investing in a company located in a “non-attainment” area and have not consider the full impact of the new ozone regulations, you may overpay.

6. Can environmental considerations help to provide financing? Yes, there is a growing market for “Green Bonds”.

Examples:

In 2017, the Green Bond market exceeded $100 billion. Demand has outpaced supply and the issuance of Green Bonds may be a useful source of funding in an M&A deal that can show environmental benefits. In the EU, Luxemburg has opened an exchange for the trading of Green Bonds and a February 2018 report by NatWest Markets indicates issuance of Green Bonds can raise the value of a company’s debt in the secondary market. The demand is there because many large pension funds and other institutional investors have earmarked a percentage of their investment portfolio for “green” investments.

There are some generally accepted criteria including in most cases the need for third-party certification of the project. In some instances, projects that would be financed anyway are repackaged as “green” to take advantage of the liquidity of the market.

The issuance of Green Bonds is about one-third by quasi-public authorities (for example the New York Transit Authority), one-third by regional development banks (for example the European Development Bank) and one third by individual companies (for example Toyota and Apple). Issuers and the development banks generally give themselves flexibility as to the types of projects they will cover with the funds raised. Examples would be modernization of facilities to reduced environmental impacts and save on energy consumption, or measurable reduction in water consumption or reduced effluent discharge. In the M&A context, tying the deal or at least part of it to environmental benefits, may open the way to this type of financing.

The degree of formality, reporting, and enforceability of the environmental commitments in these Green Bonds varies widely. Few, if any, treat use of proceeds for other purposes as an event of default. From a social perspective, if proceeds are later used for other purposes, the bond holder may not have much recourse. Of course, the bondholder may have traded away its bonds, or be focused on timely receipt of payment of interest and principal, and not much care.

If you would like more information about any of the topics addressed in this M&A Environmental Check List, please contact Norman W. Bernstein at [email protected]