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“Avoiding the Big Surprise: Evaluating Regulatory Compliance Prior to Closing”

InsideCounsel By Peter A. Tomasi

Below is an excerpt:

In most transactions, buyers look to a Phase I/II Environmental Site Assessment (ESA) as the standard way to evaluate the condition of assets, especially real property. While this is a critical starting point, it is only that. Phase I/II ESAs look for evidence of contaminated soil and groundwater—i.e., the “dirty dirt” that state and federal authorities want cleaned up. But the Phase I/II process does not evaluate whether a business is operated in compliance with environmental laws in general. Evaluating regulatory compliance in the thick of a deal can be an art unto itself. Doing it well requires a critical look at the sophistication and risk maturity of the target company, as well as a deep dive into data demonstrating compliance with applicable regulatory standards.

Whether and how to evaluate environmental compliance depends first on the type of deal and the operations of the company to be acquired. In the purchase of a large public company, there may be a large materiality threshold and/or indemnity provisions covering all but the smallest compliance concerns. The purchase of a small business, on the other hand, may not be structured in the same way. Likewise, a service company operating in leased office space most likely has limited compliance concerns, while the contrary is true for a heavy manufacturing operation. Other factors include the “risk maturity” of the acquisition target from an environmental prospective: Is the target company a longstanding operation or a relatively new endeavor? Has the company seen significant growth leading up to the proposed sale? Is the target part of a larger company with a longstanding environmental compliance team, or is it a stand-alone family business? All of these factors can play a role in the approach taken to evaluate compliance with applicable environmental regulations.