1. Do thorough diligence
When a GP buys the stock of a portfolio company of another GP, without indemnification, it succeeds to all the company’s legacy environmental liabilities. Before the deal can be closed, thorough environmental diligence is crucial. This must include a comprehensive review of (i) current operations, (ii) all sites where the target company used to operate, (iii) all sites currently and historically used for disposal of material, and (iv) any active claims against the company.
2. Avoid undermining your own defenses
With an asset purchase, the buyer does not succeed to all the legacy liabilities of the business it is buying. However, there are ways buyers can undermine this defense to successor liability. Language in the acquisition agreement can either expressly or implicitly assume pre-existing environmental liability. Also, any overlap of equity holders before and after the transaction risks the transaction being considered a de facto merger or ‘mere continuation’. Even if these traps are avoided, in some jurisdictions, courts have held that where the resulting business presents itself to the public as continuing the predecessor business, it succeeds to the predecessor’s liabilities. Courts consider actions such as employee retention, and/or making and selling the same products at the same facility.
3. Be clear on what you’re buying
When buying a business unit or division of a public company, describe precisely the assets and liabilities that the GP is – and, perhaps more importantly, is not – acquiring. The seller may not have organized the business unit it is selling in exactly the same manner in which it is organized at the point of sale. Assuring that the purchase and sale agreement is clear on what assets are excluded can be very important.
4. Help your lenders understand
Lenders’ environmental counsel frequently have little time to study the environmental disclosures posted to a virtual data room, whereas sponsors’ counsel and consultants generally have more time to consider liability risks. By sharing its diligence reports, a GP can enable the lender’s environmental counsel to get up to speed quickly. As a result, GPs greatly increase the odds that their lender will share their understanding of the potential environmental liability risks.
5. Quantify identified risks
Environmental transactional counsel know that their clients – whether private equity sponsors or banks lending to sponsors – like to have environmental risks quantified. Lenders generally expect the GP to provide this. If the firm has its consultant provide an estimate for addressing an environmental condition, this should be shared promptly with the lender’s counsel. If counsel can report that the sponsor engaged a credible consulting firm, provided conservative estimates of corrective measures, and that those estimates are unlikely to be material to the financing, it will help move the financing along.
6. Maintain formalities between parent and subsidiary
The US Supreme Court has made clear that a parent company – for example, a private equity owner – can be directly liable for the acts or omissions of its subsidiary that give rise to environmental liability. It is important that the GP and the subsidiary maintain the right structural differentiation, so that there is no muddling of liabilities and due corporate governance is maintained.
7. Follow up on compliance findings
Compliance weaknesses identified in the due diligence process must be addressed. Years after closing, when the private equity fund plans to sell the business, the pre-acquisition diligence reports may be the only comprehensive environmental reviews of the portfolio company’s facilities. As a result, the fund may find itself compelled to disclose those reviews. It is a mark of good stewardship to show that attention has been given to the broad spectrum of environmental compliance – to include the high-profile, high penalty areas, as well as the overall compliance environment.
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The ‘dos’ and ‘don’ts’ listed here are not exactly ‘rocket science’ – but it is surprising how often they can be overlooked. Being mindful about these risks can save firms a lot of time and money in the long run, as well as building reputational goodwill.
Tom Mounteer practises environmental law in the Washington office of international law firm Paul Hastings