Panel Discusses Managing Environmental Risks in Complex Transactions

When dealing with complex transactions, lawyers often are called upon to do more than simply perform basic due diligence, environmental lawyers said at a recent conference.

Certain corporate deal structures, especially those involving substantial environmental risk or legacy environmental liability, frequently require much more, the panel said.

The panel, focused on managing environmental risks in spin-offs and other complex transactions, spoke at the American Bar Association’s Section of Environment, Energy and Natural Resources Spring Conference in Austin, Tex.

Team Approach Critical

Spin-offs and other unique transactions, especially those involving substantial environmental risk or legacy environmental liability, often are best tackled in tandem by in-house and outside counsel, said Stephanie M. Haggerty, Senior Corporate Counsel at Pfizer Inc. in New York.

“Getting in-house counsel involved as early as possible allows counsel to assist the client with determining how the environmental liabilities and responsibilities should be allocated, how environmental support and transition services will be provided, and what due diligence should be conducted” in the transaction, said Paul Tanaka, a partner with Kirkland & Ellis LLP in San Francisco.

Tanaka's work focuses on the firm’s environmental transactional practice.

Involving a corporation's in-house counsel also is important since they “are the ones that have to live with the deal long-term,” Haggerty said. “They really do need to be involved from day one.”

Haggerty cautioned, however, that these transactional matters often are “really broad, really dense and can absorb a ton” of an in-house team's time. Outside counsel often is necessary to move a potential deal forward, she said.

Once a team of both in-house and outside counsel is in place, the “business or deals team can meet with the company's internal EHS group to make sure everyone dealing with the transaction is aware of any potential EHS issues that could arise.”

Environmental Liabilities Abound

The most critical thing when dealing with complex transactions of this nature is properly tailoring environmental due diligence to identify potential environmental risks, said Jeff Civins, Senior Counsel with Haynes and Boone, LLP in Austin, Tex.

Haggerty agreed that the specific scope of due diligence is just as important as the structure of the deal, saying “a good transactional team will structure the due diligence to the extent it is appropriate to the specific transaction.”

Ensuring the proper level of due diligence, which easily can be overlooked, yields enormous benefits, namely, identifying all potential environmental risks to ensure all parties involved in the transaction are aware of potential sources of environmental liabilities.

The types of environmental liabilities vary widely; Civins differentiated between factual sources of environmental liabilities and legal sources of environmental liabilities.

Factual sources often take the form of environmental conditions, which can either be bad (as in the presence of lead paint or PCBs) or good (such as endangered species on the site or the presence of wetlands). They also can be environmental activities, such as the discharge of waste or ongoing business activities.

Legal sources of environmental liabilities, on the other hand, involve environmental statutes, like the Comprehensive Environmental Response, Compensation, and Liability Act, or common law causes of action, such as trespass, negligence or nuisance.

Liabilities are unique to each individual party to a transaction.

For example, lenders face indirect liabilities, including the borrower's ability to pay back a loan, a diminution in the value of collateral through the institution of land-use restrictions, or a subordination of their security interest to an environmental lien.

Extra-Contractual Mitigation

While traditional environmental due diligence primarily is focused on liability, the potential costs of compliance, noncompliance (referring to civil and criminal penalties and injunctive relief) and investigation and remediation that may be necessary to the deal also are considerations that should not be overlooked, Civins said.

Civins spoke of a “number of extra-contractual ways” to manage or mitigate these environmental risk-based costs.

Options include environmental indemnity agreements, which contain contractual protections for a lender against certain environmental risks and occurrences related to the property securing a loan.

Another option is the use of environmental liability transfers (ELTs), discussed at length by Randall Jostes on an earlier conference panel.

An ELT is a mechanism in which responsible and potentially responsible parties contractually transfer away all environmental liabilities associated with a site .

The panel discussed several hypothetical complex transactions where these tools potentially could be implemented. For example, a company could determine that managing environmental contamination is outside its core business and decide to transfer its environmental liabilities.

Insurance Useful Tool

Tanaka also discussed the use of environmental insurance as a “backstop” of additional risk mitigation.

Pollution legal liability insurance is a useful tool in mitigation environmental risk; it typically covers cleanup costs, third-party bodily injury, property damages and natural resource damages, as well covering unknown conditions.

Representation and warranty (R&W) insurance coverage, which protects against breaches of contractual representations and warranties in a contract, is a relatively new insurance product that is becoming increasingly common in merger and acquisition deals.

An R&W policy can supplement a seller’s indemnity for breach of representations or serve as a buyer’s only recourse.

Although some policies cover the full range of environmental representations, some policies have full exclusions or cover environmental compliance representations except those that cover releases of or exposure to hazardous substances. As a result, a party may not be able to cover environmental risks just by using an R&W policy.

The bottom line, Tanaka said, is to recognize that spin-offs and other complex environmental transactions are complicated and often require a specialized collaborative approach to ensure a successful deal.