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“A Contracts Tool Kit for Negotiating Environmental Risk”

InsideCounsel By Marian C. LaLonde and Arthur A. Vogel, Jr.

Once you execute that letter of intent, reality sets in. It's time to roll up your sleeves and start drafting the document that will consummate the transaction and protect your legal interests. For some transactions, environmental risks and liabilities add a formidable wrinkle to the equation. Parties buying or selling companies or real estate must identify, understand, evaluate and allocate environmental risks and liabilities. Ultimately, with the right tools, it is possible to define, limit and allocate risk and liabilities in a manner acceptable to both parties.

Each transaction, of course, is unique, with a different set of problems and priorities. Risk tolerances and preferences can range widely, complicating the allocation of environmental risks and liabilities among the parties. Assuming you have investigated environmental conditions and regulatory compliance, a simple box of tools will help you draft a definitive purchase agreement.

The Hammer: Environmental Statutes

Much of what a purchase agreement covers focuses on the very foundation of environmental risks and liabilities: federal and state statutes, associated regulations and local (county, town and regional) environmental laws. For every transaction, you must consider the applicable regulations and reference them accordingly.

The Socket Wrench: Definitions

The key to finding middle ground is making sure everyone involved shares an understanding of the agreement’s provisions. Defined terms are essential to any contract, but even more so when specifying environmental risks and liabilities. Definitions may originate in federal and state regulations and, in some instances, choosing not to define a term could shape interpretation of the agreement.

Defined terms can range from the generic (such as "environmental laws," "permits" or "regulatory authorities") to the specific, which also correspond with highly detailed provisions of the transaction ("hazardous substances," "release"). Take particular care to craft definitions to make your agreement straightforward and easy to decipher.

The Cordless Drill and Bits: Representations and Warranties

The seller typically makes representations and warranties. These provisions require the seller to disclose material information about business operations and the condition of associated property. The buyer, in turn, can test these representations during the due diligence period before closing.

When negotiating representations and warranties, keep in mind that these are created from fact- and transaction-specific information about the facilities, properties and operations to be acquired. A seller may try to limit the scope of liability by including provisions relating to survival periods, materiality and knowledge qualifiers. To assist in the negotiations, disclosure schedules are commonly used for exceptions to the representations and warranties. This is often the most controversial part of the drafting process, but it can be critical, not only in light of penalties for breaching a representation and warranty, but also to establish a baseline between pre- and post-closing conditions and liabilities.

The Tape Measure: Covenants and Conditions Precedent

In most cases, the parties will execute a purchase agreement before closing. Pre-closing covenants and conditions will help ensure the buyer has protection against any adverse environmental discoveries or consequences that may arise before closing. Moreover, the parties may agree to conditions precedent before closing, such as the transfer of environmental permits. In the event of a breach of a closing covenant, the buyer may want a right of termination.

The Planer: Allocating Responsibility for Known (and Unknown) Conditions

The existence of a problem before closing may not scuttle the deal. Should contamination be found on a piece of real estate, for example, or should a piece of equipment be out of compliance with permit conditions, the parties can draft covenants designed to make clear who pays for—and who conducts—necessary remedial measures. These arrangements can even be made to govern circumstances unknown to either party before closing but that come to light afterward.

The Vice Grips: Indemnities and Releases

If environmental problems emerge before closing, price adjustments, escrows or cost sharing are obvious ways to resolve liabilities and obligations among the parties. An equally important component, however, is the negotiation of indemnities. Indemnities make clear which party is responsible for the specific environmental liability in issue. To reach middle ground, the parties can negotiate survival periods, caps and deductibles for the indemnity obligation. If the parties can’t reach consensus on indemnities, they may use a simple release and covenant not to sue. The release should prevent the releasing party from pursuing a claim against the released party, but will not necessarily protect the released party from statutory liability or third-party claims.

The Utility Knife: Financial Assurances and Environmental Insurance

Finally, insurance or financial assurances can capture environmental liabilities. The indemnitor or party obligated to cover the environmental liability can purchase a bond or other mechanism to protect the indemnitee in the event of a default by the indemnitor. Insurance can cover problems such as pollution and cleanup costs. It is critically important to research and fully understand the limitations and scope of insurance coverage when drafting such an agreement.

You can’t avoid environmental risks and liabilities, but the discussion above provides a box of tools for drafting transactional documents. How to best select your tools will depend on the unique structure of the transaction, the condition of underlying property and the parties involved. But with a variety of methods to choose from, you often can find middle ground.

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