Safety Nets

Protecting Your Business from Acquiring Known and Unknown Liabilities
April 05, 2015

It is vital to include environmental considerations early in your thought processes and actions when moving towards a new acquisition. This is true, whether you are completely risk adverse or can tolerate a certain level of liability; and whether you are leasing a daycare center or purchasing an industrial manufacturing operation. The fact is, environmental liability risk lurks in practically every transaction. With appropriate levels of diligence, and intelligent contract development by seasoned environmental professionals, these risks can be bracketed, and your comfort-levels established well before final negotiations.

We have previously written about strategies for conducting appropriate levels of environmental due diligence  (EDD), thus the focus of this piece is on what you can do to protect yourself from identified, suspected and unknown environmental liabilities.

First, it is not advisable to wait until you have negotiated the primary deal terms to commence the EDD process. In fact, where the purchase involves an entity or property with potentially significant and/or well-documented environmental problems, such knowledge might influence the type of deal structure you put in place (e.g. asset purchase with no legacy liability vs a merger). Getting a read on the potential for environmental liability early on will also help determine if you want to push for a strong environmental indemnity and/or be aggressive in your pricing strategy. Developing your stance on these strategic issues as early as possible helps avoid unfavorable terms from being baked into early versions of the deal document that may be difficult to extract or walk back later.

Once you have established the basic deal structure and terms, the ongoing flow of EDD data helps color several other sections of the contract. For instance, if the seller is not providing definitive information on the environmental condition of the property or operation, the buyer should insist on strong, non-caveated representations and warranties supported by equally strong and financially supported breach of rep indemnity provisions as a key method for shifting the risk for unknown or undisclosed liabilities to the seller. Developing effective seller representations for environmental matters is an art form that requires years of experience to master: single words and seemingly innocuous phrases can make a significant difference. For instance, it has not always been a violation to dispose of hazardous materials by pouring them on ground or into rivers and landfills. Thus, if the seller representation only states that the it has not disposed of hazardous materials in violation of law, the buyer will get no coverage or beneficial risk shifting for historic disposal activities that were not illegal at the time but are now deemed major violations and can create significant cleanup costs. Likewise, it is most desirable to have a flat representation stating that there have been no releases of hazardous materials at any of the relevant sites. In that way, if an unknown spill is later discovered, the risk for that discovery and concomitant liability has been shifted to the seller. The seller disclosures should be concise and correspond to specific representations, or the buyer risks losing any benefit gained by the strong set of seller reps.

Seller covenants for performance of post-closing obligations such as permit transfers, property transfer filing obligations, access for completing ongoing cleanups are also vital considerations and should be added in to the contract as indicated by the ongoing EDD process, so that post-closing commitments are executed smoothly. Often covenants are the last elements to be drafted and finalized, as the parties determine the scope of post-closing obligations, and the need for ongoing cooperation during the post-closing transition period. However, they should not be given short shrift.

As mentioned above, the ultimate protection and risk-shifting mechanism is the seller indemnity. A transaction contract can have a full range of strategic risk shifting language and covenants, but if there is no backbone to the indemnity (e.g. financial guarantee) then the risks likely will not be shifted anywhere. Thus it is important to understand what type of seller entity is entering into the agreement, their financial health and potential longevity. Where weaknesses exist, a buyer may be better off requiring performance guarantees in the form of escrow and trust accounts to backstop any damage due to a breach of deal terms. 

Reps and Warranty Insurance is increasingly being employed to give buyers additional comfort. Tellus can help advise and guide you through the pros and cons of indemnification backstops, as well as assist in drafting complex environmental indemnity provisions allocating cleanup liability and responsibilities.

The bottomline is to not underestimate the power of well-drafted environmental deal provisions in flushing out owner liabilities and allocating them. Don’t risk signing a new acquisition without having a seasoned environmental professional first analyze the liability risks and help to effectively allocate those risks. Tellus Law Group has nearly 15 years’ experience in the fine art of drafting and negotiating environmental deal provisions, and we look forward to assisting you.