Recent cross-border M&A deals in the chemicals, manufacturing and other sectors have highlighted the environmental risks associated with US operations. Though US laws in the sector are sometimes viewed by foreign investors as misguided, burdensome, overly broad and inconsistently enforced, ignoring them can jeopardise the success of a transaction. Underestimating the impact of these laws can lead to significant contamination and compliance issues, as well as high-profile disputes with regulatory authorities and private parties.
As US environmental laws can differ dramatically from their counterparts, foreign investors, in particular, should ensure they understand the environmental risks associated with operations in the country. To avoid an investment–killer, investors should ask the following six questions before investing in a business with US activities:
1. Do I fully understand the broad scope of environmental liability?
Many US environmental laws have a broader liability scheme than their foreign counterparts. The federal Superfund law, for example, imposes liability for costs to clean up contaminated sites on numerous parties, notably the current and former owners and operators. Under certain circumstances, liability can extend to other parties, including shareholders, corporate parents and lenders.
Contamination issues at formerly owned or operated sites can also result in significant liability. Where there is a considerable risk of environmental liability associated with former sites, such as an acquisition of a manufacturer with a long history of divestitures and spin-offs, buyers should consider structuring their transaction as an asset sale or otherwise obtaining an indemnity from the seller for losses associated with former sites.
Because of the broad scheme, and because liability can be strict, joint and several, firms should adequately assess a company’s environmental risk prior to investment. They should consider reviewing environmental site assessments, compliance audits, investigation and remediation studies, notices of violation and other documents that could identify potentially important liabilities.
2. Can I focus my review on federal environmental laws?
When assessing environmental risks, some foreign investors mistakenly focus exclusively on the potential impact of federal laws. In many transactions, however, state regulations pose a more significant risk. Contamination issues will often necessitate negotiations with state, rather than federal, environmental authorities. In addition, certain states, such as California, have laws that are stricter than their federal counterparts. Investors should be keenly aware of how the relevant state deals with an environmental issue, as some states may be more accepting of a particular concern. A contamination issue that costs $1 million to remediate in one state may cost $5 million to remediate in another.
3. How important is it to understand the risk of private claims?
Understanding a company’s obligations to regulatory authorities is not enough. Companies in certain industries may face considerably greater risks associated with claims by private parties under state statutes or common law. Investors need to assess costs associated with existing, threatened and potential claims, such as those alleging personal injury from exposure to the company’s products. This may require a comprehensive review of court filings and other documents. Discussions with the company’s litigation counsel may help an investor box in potential costs.
4. What is the environmental impact on capex?
A company’s failure to comply with US environmental laws can result in potentially significant fines and penalties. However, some investors fail to consider that the cost to correct a violation may be greater than any penalties. While a company may pay tens of thousands of dollars in penalties, it may have to pay hundreds of thousands of dollars to buy pollution control equipment necessary to fix the alleged non-compliance, particularly for violations of the federal Clean Air Act. When a company is not complying with environmental laws, consider all potential costs, including capital expenditures.
5. The target has been identified as a Potentially Responsible Party. Now what?
Being described as a Potentially Responsible Party under the federal Superfund law does not automatically translate into significant liability. A company may be deemed a PRP if it disposes of waste at a third-party landfill that subsequently requires clean-up. Some investors incorrectly assume that designation as a PRP means a company’s potential liability is material. As liability for clean-up costs is often based on the percentage of hazardous waste a PRP contributed to a site, a PRP’s costs may be fairly modest if it disposed of only a small percentage.
6. What are the potential reputational risks?
Even relatively modest contamination or compliance issues can become headlines in the local press or the subject of negative online comment, and environmental advocacy groups may amplify these concerns. Investors that may be comfortable with the underlying costs associated with an environmental concern may be less comfortable with the associated reputational risks.
Though the patchwork of federal and state environmental laws, rules and regulations can seem overwhelming at first sight, investors who incorporate the right, focused questions into their due diligence process can avoid a potential pitfall.
Stuart Hammer is a counsel in the New York office of Debevoise & Plimpton LLP.