“Out of Sight, Out of Mind: What Don’t You Know and When Should You Find Out?”
Inside Counsel 09/02/15 By Lauren R. Harpke and George J. Marek
When you are preparing to sell property — or your business — a variety of issues should be considered in advance to make for a smoother and more reasoned sale. The environmental condition of your real property, for example, and the status of your company’s compliance with environmental laws, should be considered early in your advance planning. With proper planning, environmental issues need not be a sticking point in the transaction.
How can a seller take stock of environmental issues before the sale of a business? Should you look at the issues first, or do you wait for the buyer to do so? When selling your property or business, it often behooves you to understand environmental issues in advance. At the very least, you should consider the consequences of leaving due diligence to the buyer alone, thereby risking “surprise” environmental issues during the ensuing due diligence.
It is helpful for a seller to put itself in the shoes of a buyer when considering environmental issues. While not every environmental question needs a 100 percent answer, a buyer will likely have several questions that it (or its lender) will want answered. A seller who has answers at the outset can reduce the risk of surprise and delay during due diligence. The seller may derive other benefits as well. Advance insight on environmental issues (if any) may facilitate negotiations regarding the terms and price of sale.
As a threshold question, buyers often ask whether real property is contaminated, and whether future development costs or issues need to be considered relating to environmental conditions. Real property can be, and often is, contaminated from current or previous uses and operations, which may include the historic use of solvents, paints, and petroleum; on-site waste disposal (whether regulated or illicit); leaking underground or above-ground storage tanks; and PCBs in electrical transformers. Other site conditions can impact the cost of ongoing operations or future development, including the presence of asbestos-containing materials, lead-based paint, wetlands, radon in indoor air, and vapor intrusion from contaminated soil or groundwater, to name a few.
A company with in-house personnel focused on regulatory (environmental) compliance may have a good handle on these issues in real time. If so, it will be important for the “deal people” representing the seller to be aware of this information in advance. In addition, various types of environmental assessments can be used to get information regarding the risks identified above. One tool is the Phase I Environmental Site Assessment, which is a standard, widely used screening device in purchase and sale transactions. The current industry standard is ASTM Practice E1527-13. A Phase I ESA is by no means all-encompassing. It identifies only certain potential environmental risks, referred to as “Recognized Environmental Conditions” or “RECs.” The lack of RECs in a Phase I ESA does not guarantee that a site is clean or that all potential environmental problems have been identified. Also, a Phase I ESA does not consider the regulatory compliance of operations at the property. It is, however, the industry standard for initial assessments, and it includes a component that searches public databases for information relevant to the property in question. If a buyer is going to find out about publicly available information anyway, the seller should consider whether or not it's better to know what’s in the public domain before the buyer finds out (if the seller doesn’t know already).
Another major question that a buyer (and thus a seller) wants answered is whether the company has been and is currently operating in compliance with environmental laws. Does the company: (1) properly dispose of (or recycle) its wastes; (2) have all necessary permits for current and anticipated future operations (e.g., air, water); (3) comply with applicable safety and health regulations; and (4) keep records and file necessary reports with applicable governmental agencies? An environmental compliance audit, which is separate from the Phase I ESA, is one diligence tool that can be used to gather information of this sort.
Finally, in the sale of a business, a buyer will want to know whether there are current or potential legal liabilities and costs relating to off-site contamination, like contamination originating on neighboring parcels or liability for off-site contamination tied to wastes generated at the facility in question. The legal and financial exposures associated with liability under CERCLA, the federal Superfund law, are well known—if still often misunderstood. CERCLA's strict, joint, and several liability framework casts a wide net, encompassing those who "arranged for disposal" of hazardous substances, even if that disposal was legal at the time. A seller will want to have a good handle on potential off-site risks, either through in-house knowledge or through a separate assessment focusing on these issues, as this information may be key to accurate representations and warranties by the seller.
Buyers and sellers come to the table with different goals, to be sure. In terms of possible environmental risks, however, the two sides share a number of common goals. To the extent possible, in order to properly manage and negotiate the transaction, both seller and buyer will want to: (1) evaluate known environmental risks, (2) identify previously unknown risks, and (3) reasonably estimate the costs of those risks. In considering environmental risks, forewarned is truly forearmed. From the perspective of a seller, information gained from pre-transaction environmental due diligence allows the seller to manage its risks without jeopardizing the deal at the outset. From the perspective of the buyer, it needs to understand these issues to know exactly what it is buying and how to negotiate fair terms—including price—for the assets to be acquired.
Should a seller engage in physical testing prior to sale? Some considerations relevant to this topic will be addressed in the next article in this series.