DealThink: Environmental Due Diligence: How Much Diligence is Due?

04/12/2013

You are general counsel of a publicly-traded medical device company. Your company’s Board has identified a publicly-held X-ray and CT scan component manufacturer that it would like to acquire. The target is a Delaware corporation based in California, with additional manufacturing facilities in Utah and Kentucky; within the past three years, it has sold two mothballed manufacturing facilities. It sends salespeople to 15 different states, but due to its Internet presence, it ships components worldwide. It also provides support services for its component parts within the continental United States. 

Through some initial data review, your in-house technical experts have found that the target’s manufacturing facility in Utah used to make X-ray film and developing solution, and the target may have dumped some related toxic materials on the plant site in the 1990s. The Board has asked you for guidance. Because the target is a public company, the target will not have any post-closing liability for environmental issues.

How can you diligence this?

Setting a “deal-oriented” scope. The key issue is setting a “deal-oriented” scope at the beginning of the process. Assembling a proper team of environmental experts should be your initial step. The team should consist of legal counsel with experience in environmental law and environmental professionals. These professionals may be within your own organization, but, especially if particular areas of experience are required, may be outside environmental professionals at environmental consulting firms. Assessing the environmental risk not only involves an analysis of the law, but also may involve an assessment of complex technical issues to determine whether a legal standard has been violated. For example, determining requirements for an air permit may require determinations of the amount and types of emissions.

Effective environmental due diligence – due diligence directed at the issues that matter for the transaction, giving consideration to the specific type of business, location of assets, and risk tolerance – should be a tailored undertaking based on discussions with your legal and technical advisors. Discussions with your team of environmental experts should address the nature and likelihood of the liabilities under environmental law (e.g., costs of compliance, costs of noncompliance, costs of investigation and remediation, natural resource damage, and damages to property and people), if any environmental issues have already been identified and your company’s future plans for the site, among other things. Often a judgment call has to be made as to how much review is enough to reasonably assess the risks.

For example, environmental due diligence for the issue of potential dumping may involve several components:

Phase I Environmental Site Assessment

  • A Phase I environmental site assessment is a standard of environmental due diligence that involves a records review for any reports of issues, such as past onsite dumping and a site visit, including a basic site walk through looking for readily apparent signs of contamination and interviews of a key site manager and the owner (but no intrusive sampling) to determine the existence of evidence of a release of hazardous substances or petroleum products on a site.
  • Conducting a Phase I that complies with the EPA’s “all appropriate inquiry” standard is a prerequisite to qualifying for certain transaction-related defenses to CERCLA (Comprehensive Environmental Response, Compensation, and Liability Act of 1980) or Superfund. These defenses can be important because CERCLA imposes upon certain classes of persons liabilities for the costs of investigation and remediation of hazardous substances, as well as associated natural resource damages from the contamination.

Phase II Environmental Site Assessment

  • A Phase II assessment may be recommended for an operating company, especially a company with a manufacturing component, or if the results from the Phase I indicate that further environmental diligence is necessary (e.g., to determine if rumored dumping discovered during the Phase I actually occurred). A Phase II typically involves some form of intrusive sampling at the site – sampling of soil, groundwater or perhaps air quality. The information from the Phase I can be helpful in determining areas that require further investigation. For example, the aerial photographs in the Phase I might reveal areas of disturbance from the 1990s or interviews might indicate where dumping would have occurred.

Is there an applicable statute of limitations for environmental liability?

Yes – but it may not protect your company in this situation.  Present owners of a contaminated facility may be liable under CERCLA (or an analogous state statute) even if they did not participate in the contamination.   Although CERCLA has a statute of limitations, the statute of limitations may not run until six years after initiation of construction for remedial actions and three years after completion of the removal action to address the contamination.  For the target’s Utah site, because neither a remedial or removal action has begun, the limitations period has not even started to run.

Your company’s plans for the target post-acquisition include expanding the Utah facility to increase manufacturing capacity. How does this affect the diligence process and the transaction as a whole?

Expanded due diligence will be required. As noted above, the Phase I is limited in scope.  There are many areas of risk implicated in expansion plans that the Phase I does not evaluate.  For example, the following additional environmental diligence matters should be assessed in light of the expansion plans:

  • Compliance: Compliance is a critical issue when purchasing an operating business in a heavily regulated industry.  Compliance is relevant not only in determining exposure to liability for past violations, whether continuing or not, but also in determining whether the plant can be expanded for the proposed purpose and comply prospectively as well as presently. For example, compliance diligence should evaluate if the expansion triggers new air quality permitting requirements and if so, the costs associated with obtaining and complying with a new permit?  In some instances, regulatory requirements may make an expansion economically infeasible.
  • Development restrictions: Various environmental programs may prohibit or restrict development in certain areas.  If, for example, a new building needs to be built at the Utah site, due diligence should evaluate the potential impact that the construction could have on waters of the U.S., which could require a permit, resulting in additional cost and time, and on a protected species or their habitats, which could preclude construction or make it more costly.

It is important that at the outset – when your company is first scoping environmental diligence – expansion or other future plans for sites be shared with the environmental team so that information provided at the end of diligence provides the answers needed to assess and allocate risk in the transaction.

If you have any questions, please contact one of the following attorneys:

Brian D. Barnard
817.347.6605
brian.barnard@haynesboone.com

Ricardo Garcia-Moreno
713.547.2208
ricardo.garcia-moreno@haynesboone.com

 

William R. Hays, III
214.651.5561
bill.hays@haynesboone.com

William B. Nelson
713.547.2084
bill.nelson@haynesboone.com 

Janice V. Sharry
214.651.5562
janice.sharry@haynesboone.com

 

W. Scott Wallace
214.651.5587
scott.wallace@haynesboone.com

 

 Jennifer T. Wisinski
214.651.5330
jennifer.wisinski@haynesboone.com

 

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