Environmental Risks: A Crucial Part of Due Diligence in International Deals
Around the world, emerging and developed nations alike are placing greater emphasis on protecting the environment. Yet, many businesses seeking to build or acquire an international facility do not address the environmental exposures that may accompany a transaction until much later in the due diligence process. Putting off these issues, however, can increase the chances that the transaction will fall through after a great deal of resources have already been expended and heightens the risk of acquiring substantial environmental liabilities along with the property. By making environmental considerations a key part of due diligence from the start, along with more traditional financial and legal concerns, companies can mitigate these risks and increase their chances of long-term success.
As Trade Grows Globally, So Does Environmental Regulation
The question today for many growing companies is not whether to expand internationally, but where. Over the past two decades, investment by US companies abroad has grown sharply, reaching $4.45 trillion in 2012. New spending by US companies on businesses and real estate in foreign countries was estimated at $368 billion in 2013. Yet, establishing operations or acquiring existing facilities in a new country entails a complex array of risks. In a world that is increasingly focused on climate change and environmental protection, pollution and associated compliance risks are crucial considerations.
Around the world, many countries are enacting stricter regulations to protect the environment and preserve their natural resources. Those regulations are likely to become more rigorous over time. Companies also may face several layers of national and regional regulations. In Europe, the EU’s Environmental Liability Directive establishes a comprehensive liability standard, but individual EU countries may have stricter regulations. The risks may not be limited to fines and the costs of remediation. In Brazil, employees can risk jail time as well as fines in connection with pollution incidents. The exposures can extend beyond national borders. Even pollution incidents at remote facilities can quickly become global news and tarnish a company’s reputation at home and around the world.
Take These Steps to Evaluate Environmental Risks in Due Diligence
Environmental considerations add another layer of complexity to the due diligence process, particularly when a company is choosing between potential acquisitions in several countries. To ensure that due diligence provides a rigorous evaluation of the environmental risks, companies contemplating international deals should make these crucial steps an integral part of the process:
Include international environmental risk experts in the due diligence team from the start. A thorough environmental risk evaluation requires experts who understand the target industry and its environmental exposures as well as the country in which it is located, the applicable environmental laws, and the appropriate risk management measures. The due diligence team should include a company with international expertise in environmental risk assessment and management.
Identify the environmental data needed to make an informed decision. Historical data on a property, spills, regulatory actions and other environmental data are readily available in the U.S. In other countries, it is often difficult to establish the ownership history and to identify past uses that may create liabilities for a new owner. In Europe, for instance, potential liabilities could arise from how the property was used a century or more prior. In South America, there may be little in the way of official records. Obtaining historical environmental data will likely require more in-depth efforts to research the property and its history locally.
Establish the risk profile for the site or sites. This will vary depending on whether the project involves “greenfield” sites or sites with existing facilities. The risk profile should include past uses of the site, along with the operations and operating procedures of the former owners. It should address existing on-site environmental concerns such as air and water quality, waste management and storage tanks as well as any potential remediation to mitigate or eliminate the pollutant or pollutants.
Assess the current regulatory framework that applies to the site. This will include any requirements to bring the site into compliance with environmental regulations, any existing permits held by the current operator along with the permits that will be needed for the proposed operation. If it is a new operation, this should address the local, regional and national approvals that will be needed for site development and the proposed operations and required permitting for both.
Consider potential regulatory changes. Changes in environmental regulations can come quickly. In India, for instance, the Supreme Court ordered the national government in early 2014 to appoint a national regulator to oversee environmental assessment of projects. Such changes make it imperative to keep up on regulatory developments and the impact that proposed or likely changes may have on the site’s operations five or ten years in the future.
Physically inspect the property. In addition to researching all available records, it is crucial to walk the property and talk to the current operators, neighbors and local officials to get a better idea of any existing or past issues and identify other potential problems. The cost of actually inspecting the property will be very small in terms of the overall deal and the potential environmental liabilities.
Assess the environmental risks and set thresholds. Once the potential environmental liabilities become clearer, the company can assess any remediation that may be required, as well as the cost of bringing the property into compliance. The company should decide how much it is willing to invest to mitigate the environmental risks and how much risk it is willing to retain on an operating basis. These thresholds may also be dependent on requirements set by the lenders involved with financing the project.
Seek carve outs with the sellers. Where potential environmental liabilities exist, companies should seek to negotiate with the sellers to include indemnities or liability transfers where necessary or appropriate. While this is common in the US, it may be less so internationally. The buyer will want to assess the enforceability of such contractual provisions in the specific country.
Obtain the appropriate engineering and consulting expertise to mitigate operating exposures. Companies starting up similar operations in a new country can use their past experience to guide them as to the permits and approvals that will be needed going forward. It is important to note that the experience may differ significantly for similar operations in different countries, even in the same region.
Transfer the environmental risks with a company that has international expertise. Environmental insurance purchased upon conclusion of the acquisition should provide coverage for the full range of first- and third-party exposures likely to arise from the operation. The coverage should be adaptable and provide protection for changing regulations. It should be legally enforceable in the local country or a chosen jurisdiction and the coverage should be consistent with the actual exposures raised by local law.
Businesses seeking growth opportunities today often must consider starting or acquiring operations in other countries. To avoid potentially expensive and unanticipated liabilities, companies should put environmental concerns on an equal footing with more traditional financial and legal implications in the due diligence process. By thoroughly evaluating the environmental exposures in a transaction, companies can be more confident that an acquisition will provide opportunities for growth, rather than unanticipated liabilities.
Steve Piatkowski is vice president of ACE Environmental Risk.
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