Volume 18, Number 6
BUSINESS AND COMMERCIAL LAW
Minimizing Risks in Public Company Mergers and Acquisitions
By Judith A. Walkoff and Eric B. Rothenberg
The doctrine of corporate successor liability imposes the liabilities of a predecessor company on a successor entity when a corporation merges or consolidates with another company. In contrast, the general rule of successor liability in an asset purchase, where one entity acquires all or a portion of the assets of another entity, differs from the rules applicable to stock purchases, mergers, or consolidations in that the acquiring company is not responsible for the seller's liabilities.
With the boom in mergers and acquisitions involving publicly held corporations over the last decade, environmental lawyers are increasingly asked to conduct environmental due diligence on large corporations in very short time frames, using extremely limited information.
Environmental due diligence. A typical environmental due diligence review for the purchase of a nonpublic company, or the asset purchase of any company generally, includes the following activities:
- Review of environmental documents typically provided by the target company to identify on-site and off-site environmental liabilities, violations of environmental laws, and future regulatory requirements that could require significant expenditures in the near future.
- Searches of environmental databases relating to properties currently and formerly owned, leased, or operated by the target company as well as off-site disposal facilities.
- Use of an environmental consultant to perform a Phase I environmental assessment to identify areas of potential contamination at the facilities to be acquired and significant regulatory noncompliance.
- Conduct of Phase II soil, groundwater, surface, water, air, or asbestos testing at the facilities to be acquired, if warranted based on the Phase I findings.
- Review of historical acquisition and divestiture documents to identify retained or assumed environmental liabilities and indemnifications provided by or on behalf of the target company.
- Review of insurance policies and claims history to identify environmental liabilities and potential coverage for these liabilities.
- Review of lease agreements and environmental provisions of contracts to which the company is a party.
- Evaluation of new requirements under applicable categorical standards pertaining to air emissions, wastewater discharges, and hazardous waste management.
- Review of litigation files relating to any pending litigation, including toxic tort or diminution in property value suits.
- Review of self-audits.
Mergers and acquisitions involving public corporations present a unique set of challenges for conducting environmental due diligence for several reasons. There is typically a need to keep the proposed transaction confidential. There will be very limited access to individuals knowledgeable about the target company's environmental liabilities and compliance status. In addition, there is a substantially compressed time frame for conducting due diligence. Given the above challenges, what are an acquiror's options in this information vacuum?
Mechanisms for assessing a target company's liabilities. Securities and Exchange Commission (SEC) disclosures often are the most expedient way to obtain an overview of the target company's assessment of its material environmental liabilities.
Commercial online environmental databases are publicly available and can be accessed through a variety of commercial providers of environmental and legal research materials. Federal and state websites are useful to gather facility information, including whether the site is listed as a hazardous waste site. Searches should be conducted for currently and formerly owned, leased, or operated facilities; off-site disposal facilities to which waste was sent for treatment, storage, or disposal to identify potential Superfund sites where the target has been or may be named as a PRP; and any sites that are used by the target for toll manufacturing.
Requests for access to and copies of public documents can be made from federal regulatory authorities pursuant to the federal Freedom of Information Act. Relevant accessible information includes environmental permits; environmental compliance files; investigation and remediation reports that have been prepared by or submitted to regulators concerning releases of hazardous substances at properties currently and formerly owned, operated, and leased by the target; and information concerning off-site disposal facilities and Superfund sites. Newspapers, legal periodicals, and environmental, toxic tort, and insurance law publications are often useful sources of information regarding significant hazardous substance releases, penalties, lawsuits, and administrative and judicial enforcement proceedings and settlements.
A target company's website should be one of the first sources consulted for information. Of course, a company is easily able to determine the Internet service provider used by someone who searches the company's site. Depending on the sensitivity of the deal, you should consider using a noncompany Internet connection when conducting such a search.
The morning after. The scope of post-closing environmental due diligence should be similar to the scope of diligence typically conducted prior to closing a transaction. Additional actions include:
- Evaluating the reporting requirements of each relevant state.
- Conducting an environmental compliance audit to ensure that environmental permits are current, and have been transferred to the new entity; that the permits reflect current operations; and that each facility is in compliance with requirements of federal and state environmental statutes.
- Identifying and auditing off-site disposal facilities to which the company ships waste for treatment, storage, handling, or recycling for compliance with environmental laws, with a view toward minimizing future Superfund liabilities.
- Auditing toll manufacturing sites for compliance with environmental laws and tolling agreements to ensure that the agreements contain adequate protection against liabilities.
- Reviewing acquisition, divestiture, indemnification, escrow, and comparable agreements to identify areas of potential liability or noncompliance and whether any claims for indemnification can be asserted by the company for any matters identified during the pre-closing or post-closing diligence review.
- Reviewing insurance policies inherited in connection with the acquisition and identifying claims asserted for any pending environmental issues or potential liabilities identified in connection with the diligence review.
- Modifying the company's environmental compliance program to reflect the changes in the company resulting from the merger or acquisition and to include new facilities, operations, and personnel. A program should be developed and implemented shortly after a merger if an environmental compliance program does not exist. The program should be evaluated against the standards articulated in the Caremark decision to mitigate against shareholder claims.
There are a number of benefits to the proactive approach. Regulators are often sympathetic to the plight of the acquiring company and are willing to view the acquiring company as a new owner that was not responsible for the preexisting violation, as long as the "new owner" voluntarily discloses the violation and appears willing to correct the sins of the prior owner. The EPA will reduce penalties and will not add punitive fines to the standard penalties for companies that satisfy certain requirements.
One of the factors a court will consider in determining whether to hold a director personally liable for breaching his or her duty of care is whether the company developed and implemented an appropriate compliance program to detect violations of law. Implementation of an environmental compliance and auditing program could prevent directors from being held liable for breaching their duty of care.
Indemnifications from previous acquisitions or divestitures may provide coverage for identified matters. Identifying the issues earlier may allow the company to take advantage of an indemnification before it expires. Further, most insurance policies require claims to be made immediately upon the insured becoming aware of the underlying matter. Failing to follow through on an issue identified during preliminary due diligence could preclude coverage. Finally, it is particularly important to follow up on compliance and liability issues if a company intends to sell all or a portion of the company or its assets in the foreseeable future.
Judith A. Walkoff is a member and Eric B. Rothenberg is assistant manager of the environmental practice group in the New York office of Morgan, Lewis & Bockius LLP.
This article is an abridged and edited version of one that originally appeared on page 84 of Natural Resources & Environment, Fall 2000 (15:2).