2012 showed a sustained rate of merger and acquisition activity that was nearly equal to the annualized $200 billion in transactions seen yearly before the 2009 recession. This year will likely experience a similar level of buy-sell activity, given estimates that between $2 trillion and $5 trillion dollars of private equity is sitting on the sidelines in the form of cash reserves. As market uncertainty and depressed interest rates keep this capital on the sidelines, private equity investors are left to search for more lucrative ventures.
In our increasingly litigious climate, financing for mergers and acquisitions requires substantial demonstration that the deal will yield solid returns. Investors wont give up their dollars without comprehensive due diligence being performed on the proposed deal. The 30-day deal is a thing of the past for all but the simplest of transactions.
Transactional due diligence comes in many different forms, including legal, financial and environmental, and is akin to letting a certified mechanic evaluate a used car before you buy it. This article focuses primarily on the environmental aspects of due diligence, but also touches on how it integrates into other disciplines.
Rooted in Regulations
Environmental due diligence has been around since at least the early 1980s, when it began humbly as a brief site audit with the goal of looking for obvious signs of environmental contamination and mismanagement. Under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA), commonly known as Superfund, financial responsibility for environmental liabilities is placed with the current site owner and operator. CERCLA also provides a mechanism to assign liability to historic property owners in the event that the most current owner becomes insolvent.
The due diligence process took shape as a possible way to avoid CERCLA liability via an innocent land owner defense, if unknown, preexisting environmental liabilities were discovered post-transaction. The due diligence process became more formalized by ASTM through its procedural guidance E-1527 in 1990. Thanks to this guidance document, there is a standardized environmental due diligence process involving interviews, records searches, and historical site information. These steps are known generally as a Phase I Environmental Site Assessment (ESA).
Under the ASTM standard, environmental liabilities involving past, current or potential releases to the environment are typically identified as either Recognized Environmental Conditions (RECs) or suspect RECs. Per E-1527, a REC refers to the presence or likely presence of hazardous substances or petroleum products on a property under conditions that indicate an existing release, a past release, or a material threat of a release of any hazardous substances or petroleum products into the structures on the property or into the ground, ground-water, or surface water of the property.
Some Phase I ESAs also take into consideration items that may represent a Business Environmental Risk (BER), including compliance with environmental and safety regulations.
However, since the publication of the ASTM guidance, the environmental due diligence process has evolved to meet the needs, objectives and end-goals of the industry. Today, Phase I ESAs are only the beginning of what is typically necessary to secure financial backing.
The cost of addressing environmental issues can be quite significant; not only in terms of dollars, but also in terms of time, resources, and public perception. Therefore, it is not surprising that environmental due diligence is becoming an increasingly predominant aspect of acquisitions, mergers, divestitures and closures. In addition – and prior to waste shipment – companies routinely perform due diligence on non-owned disposal facilities such as landfills, incinerators and recyclers, to protect against potential future CER-CLA claims.
Acquiring businesses may also conduct due diligence to determine accurate cash flows, to assess risk associated with disposal facilities, and to make informed and responsible business decisions. A wide-ranging due diligence effort identifies and quantifies financial liability, environmental liability and the potential for third-party claims.
This type of due diligence may be well beyond the scope of an ASTM Phase I ESA, but should not be overlooked when weighing profit and growth potential against risk and liability, or when making other vital business decisions. These decisions may include acquisitions and mergers, divestiture and closure of a facility, selection of a non-owned treatment and disposal facility, refinancing and compliance. A well qualified, third-party environmental consultant can help determine and quantify transactional risks. This places you in a position of well informed strength when entering into pivotal negotiations.
Case Studies: What Can Happen?
In a number of cases, Potentially Responsible Party groups (PRPs) were required by the U.S. Environmental Protection Agency to retain contractors to perform CER-CLA removal and decontamination actions at several abandoned industrial facilities and centralized water-treatment operations. These parties were identified as having shipped varying amounts of waste to the facilities; some aggregate totals were as small as single 55-gallon drums of waste material.
Typically, the PRPs entered into an Administrative Order on Consent with the EPA, which is a voluntary agreement stipulating required activities for proper site cleanup and decommissioning. These remedial and environmental actions included:
Evacuation of millions of gallons of waste contained in concrete structures.
Removal/disposal of thousands of gallons of oily sludges impacted by poly-chlorinated biphenyls (PCBs).
Transport and disposal of hundreds of drums and totes of unused product and hazardous waste.
Stormwater treatment and management.
On-site hazardous waste treatment and stabilization.
Follow-on intrusive environmental investigations at the facilities.
Although removal and investigation actions resulted in timely and successful termination of the Administrative Order of Consent, implementation costs to the PRPs were significant.
How can exposure to these types of removal action costs and possible remediation costs be minimized and managed? The answer is evaluating sites from the outset.
Trihydro was recently approached by a company preparing to consummate a $100-million-plus acquisition of numerous production facilities located in multiple states. The client was seeking a combination of due diligence, insurance and engineering support services to facilitate the transaction.
Trihydro recognized that the likelihood of identifying liabilities was high, but also understood that the goal of our effort was not to scuttle the deal. Rather, it was to quantify the environmental risk such that it could be properly factored into the transaction.
By identifying this goal up front, we were able to review site data, visit each site, complete a compliance evaluation, provide insurance support, and generate environmental defect cost estimates that were then used in reducing the purchase price – all in a matter of weeks. While there are no absolutes or guarantees, well-orchestrated and implemented due diligence activities bring to reality the concept of managed risk.
Whats Right for My Situation?
Due diligence should not be thought of as a one-size-fits all approach. Types of due diligence can include ASTM Phase I ESAs, or Phase II assessments which involve invasive testing. There are also compliance audits, safety audits, non-owned disposal facility audits, or an approach tailored to a specific need.
A few common-sense best practices can help ensure the success of environmental due diligence endeavors:
1. Define the Objective. The due diligence process should begin with the end in mind. Setting clear goals can ensure expectations are met. When defining the goals of the due diligence, all disciplines (e.g., financial, legal, business, environmental) and stakeholders should be consulted to assure each team members concerns are addressed.
2. Share and Summarize Information. Legally require all environmental information to be shared. If possible, establish a data repository and systematically review and capture highlights of the data so that it can quickly be summarized and shared with the entire team. Establishment of an online or electronic war room is one suggested approach.
3. Regulatory and Records Review. During the first stages of due diligence, review of historical Phase I and Phase II ESAs is clearly the most logical starting place and may eliminate some duplicative effort. State and federal databases, and internet and publication searches can be used to expand the regulatory and records review stage of due diligence. When evaluating historical site documentation, be aware of the possible data gaps that may be present. For instance, vapor intrusion issues have become prevalent only in recent years, and certain environmental media may not have even been previously considered. Additionally, new and pending regulations may create a liability that formerly was nonexistent.
4. Ask the Right Questions. Do the legwork and prepare for site assessments and interviews to ensure proper focus on objectives and goals that were defined at the project outset. A carefully developed checklist or audit form is a simple and valuable tool that can preclude oversights and omissions. Facility health and safety programs and compliance history can provide valuable insight to legacy concerns, and possibly steer future actions. A jaded enforcement history may be the tale-tell sign of costly underlying environmental issues. Lastly, the stakeholders should develop and agree upon a list of personnel who will be consulted/interviewed during the due diligence effort.
5. Collect Data with Purpose. If intrusive assessments and sampling are necessary, carefully consider how the end data will be evaluated and for what purpose. Make multimedia data gathering efficient, and sufficient to allow relevant comparisons with published screening criteria, while minimizing the need for supplemental mobilizations. Prior to collection, consider how a dollar value can be assigned to liabilities resulting from unfavorable data. Avoid seeking just the smoking-gun, but rather focus on quantifying whatever future liability it could possibly create. If the worst-case results of the data are not going to be a cost driver, consider focusing due diligence dollars elsewhere.
6. Quantify All Information. Information gathered during environmental due diligence must be concisely summarized, and quantified, and reduced to its simplest defensible terms. The due diligence report may end up in a room full of lenders, attorneys and business interests who are not environmental experts. Properly quantifying and tabulating liabilities is a powerful negotiating tool.
Dont Let Environmental Kill the Deal
Environmental due diligence has advanced to the point where it is now more of a tool to help structure a deal than a way of killing a deal outright. Gone are the days where a minor soil stain scuttles a multimillion dollar deal.
Use the information gathered in the due diligence process to your advantage. Consider that quantified liability can be managed through a variety of mechanisms: escrow, remediation agreements, liability agreements, and/or adjustments in the purchase price. Environmental insurance is also a vehicle available to mitigate the risk in these transactions.
Environmental due diligence, in all its forms, is a versatile and powerful tool to use during transactions. Properly executed, it can assist in facilitating nearly any deal, and can allow stakeholders to make informed business decisions that will enhance their bottom line.