Most environmental due diligence transactions today are nothing more than an administrative (typically last minute) function. They are usually done inexpensively and quickly, likely without any, or relatively minor, issues. This is pretty remarkable considering the liability protection they are intended to provide (i.e., Superfund).
With the above said, we should mention that we have been retained on occasions when routine due diligence missed major environmental issues leading to disputes and litigation. When this occurs, it can get sticky and expensive, as you have legal and technical issues involved.
Environmental Due Diligence When Buying a Manufacturing Plant and Continuing Operations
In this blog, we’ll look at environmental due diligence, or Phase I Environmental Site Assessments (ESAs), from the perspective of buying and continuing to operate an existing manufacturing business. This is a far different transaction than buying a vacant lot, buying a professional building, or refinancing a loan.
Aging Owners of Manufacturing Facilities
With aging demographics, especially among owners of manufacturing operations, it’s reasonable to expect more transactions as owners of these businesses divest and step into retirement. According to J.P. Morgan Chase, “The top three industries with the largest shares of business owners aged 55 and over are metal and machinery, high-tech manufacturing, and real estate – all industries that are more capital intensive.”
Environmental Advice For Investors
I’ve asked Dragun’s senior environmental scientist, Jeffery Bolin, M.S., CHMM, to help put some of these issues into perspective. Jeff has been doing transactional work for more than 30 years, including merger acquisition work.
What makes this type of transaction different than a routine Phase I ESA?
A “routine” Phase I ESA is framed around protecting a new purchaser of property from existing contamination at the time that they take ownership. It is a snapshot in time that basically says, this is the condition of the property when I bought it. The focus is to identify if the past use of the property included activities that may have resulted in releases of chemicals to the environment (soil, groundwater, surface water), referred to as recognized environmental conditions (RECs). If chemical contamination is identified (often in a Phase II ESA), the new owner can be confident defending that they did not cause the contamination, as their use of the property does not overlap the previous use.
When you are purchasing a manufacturing business where you will continue the same operations, your operations do overlap, and the differentiation of who caused what becomes more difficult. Often these clients are not necessarily expecting a clean site or a site with no RECs; rather, how big of an issue is it? The Phase I ESA is used to help focus additional efforts and supplemental site assessment of defining the nature and extent of contamination. Clients in this situation are trying to bracket their downside risk. That is, is it a $50,000, $500,000, or $5,000,000 problem? This is often used in negotiating price.
Will the Phase I ESA look at environmental compliance, and if not, should I consider this?
A typical Phase I ESA does not include environmental compliance. However, when you purchase an operating manufacturing facility, you are buying their operations (for better or worse). That’s why my advice is to consider some level of compliance assessment for these transactions. Fines for non-compliance with environmental regulations can be significant. Additionally, there could be expenses associated with bringing a site into compliance. For example, creating a spill plan, installing secondary containment, adding air-pollution-control equipment, etc.
Do I need to consider potential liability for off-site issues such as how they have handled general refuse or hazardous waste disposal?
A routine Phase I ESA deals with liability associated with the Comprehensive Environmental Response Compensation Liability Act (CERCLA or Superfund). If they are disposing waste by dumping it on an adjoining property, you definitely want to look at this. While this may have occurred in the past, it is much less prevalent today.
Waste disposal is regulated under the Resource Conservation Recovery Act (RCRA). Accordingly, an off-site disposal location where the manufacturer disposes solid and hazardous waste is not typically a key focus of the Phase I ESA. With that said, if you are acquiring their business and continuing to operate, it may be beneficial to look into the history of where they disposed wastes, as RCRA liability has a long reach.
The sellers have already disclosed that there is an area of subsurface contamination on the property where the contaminants were left in place. Should this concern me?
It may or may not be an issue, but it could be a concern. While the Phase I ESA will help you with liabilities associated with cleanup of existing contamination, it does not protect you from continuing obligations or due care. Depending upon the timeframe that the contamination was left in place, cleanup criteria are not static. Accordingly, if the cleanup criteria have become more stringent, you could have more obligations than under the previous criteria.
Even if an issue has been signed off by a regulating agency, this indemnity may not carry over to a new owner. All known contamination data should be evaluated relative to current regulations and criteria.
Are there any other environmental liability considerations?
When you are buying an existing manufacturing operation, you should not expect to do a typical or routine Phase I ESA. The scope of the Phase I ESA should be discussed (and sometimes coordinated) with legal counsel. Depending upon the nature of the deal, legal counsel will help focus the scope to include (or exclude) items such as compliance, asbestos, wetlands, permit review, etc., to name but a few. My professional advice is to know as much as you can and use that information to help you leverage your position in the transaction.
Avoiding downside risks when buying a business requires thoughtful deliberation and usually seeking out knowledgeable and experienced counsel. One of those key deliberations, especially when buying manufacturing companies, will likely be careful consideration of the environmental liabilities.
If you have any questions or would like to discuss a potential transaction, please contact Jeff Bolin at 248-932-0228, Ext. 125.
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