American Bar Association Section of Environment, Energy, and Resources. Environmental Considerations in Business Transactions 1

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1 American Bar Association Section of Environment, Energy, and Resources Environmental Considerations in Business Transactions 1 Larry Nettles Vinson & Elkins LLP Houston, TX Abbi Cohen Dechert LLP Philadelphia, PA 43rd Spring Meeting Salt Lake City, UT March 20-22, 2014 ABSTRACT Buyers and Sellers have flexible legal tools at their disposal to structure a transaction and allocate liability. Buyers should investigate the target s environmental liabilities thoroughly and as early as possible seeking to maximize post-closing protections for environmental liabilities; Sellers should negotiate for terms in the purchase agreement limiting environmental representations, warranties, covenants and indemnities that will limit their exposure to postclosing liabilities. This paper describes some approaches Buyers and Sellers take when negotiating environmental liabilities in corporate transactions, moving chronologically from initial diligence to exit strategies. Introduction Although Sellers and Buyers have a common interest in closing a deal they frequently have opposite agendas regarding how to manage the environmental liabilities in the transaction. Sellers want to avoid future environmental liability associated with a company or asset that they will no longer directly or indirectly own or operate. Buyers do not want to become subject to any unanticipated environmental liabilities or to unwittingly assume any unquantified environmental obligations. There are many tools the parties can use to identify and then allocate a company or asset s environmental liabilities. Even relatively traditional approaches are quite flexible and can be adapted to almost any situation. First Steps A prospective Buyer should seek to understand and quantify potential environmental liabilities associated with a target property or business early in the transaction, before it makes a binding offer or issues a letter of intent. The Buyer typically begins its due diligence by examining Seller-provided reports and documents, and reviewing publicly available 1 These materials are intended for educational and informational purposes only and do not constitute legal advice. These materials represent the views of the authors and do not necessarily reflect the opinions or views of Vinson & Elkins LLP, Dechert LLP, any of their other attorneys, or their clients.

2 environmental databases. If the target entity is a public company or otherwise heavily regulated, the Buyer may also have easy access to public filings, disclosures, and promotional materials such as prospectuses. The Buyer should develop follow-up questions based on these disclosures, remembering that the Seller-supplied or database information may be outdated or incomplete. The Buyer s comfort level with identified and potential environmental issues will depend on its risk tolerance and goals; if the transaction still makes sense in light of the Buyer s preliminary due diligence, the parties should establish a schedule for a more fulsome environmental review. It is increasingly common in transactions involving sophisticated Sellers for the Seller to supply prospective Buyers with current Phase I environmental site assessments. Doing so can reduce a Seller s transaction costs, accelerate due diligence if there are multiple bidders, and help preserve confidentiality. If the Seller has supplied current Phase I environmental site assessments from a reputable consultant, a Seller may negatively view a Buyer s request to perform its own Phase I environmental site assessment. If there are no current Phase I environmental site assessments, the Buyer should anticipate undertaking such a review. If the transaction includes an operating business, not just the acquisition of real property, the Buyer may also want to commission a limited regulatory compliance review. While the deal s timing typically determines the diligence schedule, if the Buyer will need new or updated environmental site assessments the schedule should take into account the consultants availability and time to access the site. Depending on the known and/or potential environmental contamination issues identified during the Buyer s preliminary environmental review, its risk tolerance, and cost and timing constraints, the Buyer may also consider undertaking Phase II sampling and testing. In most transactions a Seller will resist a request to perform a Phase II investigation, and the parties will highly negotiate both the request and process. A Seller s resistance may be viewed as a matter of letting sleeping dogs lie. However, the Seller simply may not want to risk uncovering an issue that the Seller would not have been legally bound to investigate or remediate but for the Phase II without at least some assurance it has a deal. The parties will frequently work on deal structure and even the agreement while more extensive due diligence is completed. However, sometimes deal timing and other considerations result in less complete environmental due diligence than a Buyer would prefer, in which case the Buyer relies on the strength of the negotiated contract provisions, other risk mitigants (e.g., insurance) or on the value of the deal it struck on price. Deal Structure Choosing an appropriate deal structure is one way to allocate environmental liabilities. A basic choice is whether the transaction should be structured as an asset purchase, stock transfer, or some form of business combination. A Buyer might protect itself from environmental liability by structuring the transaction as an asset acquisition; it might also consider forming a subsidiary, limited liability company, or limited partnership to hold the property or business and thereby contain the environmental liabilities. Asset acquisitions are traditionally pro-buyer. Under most environmental cases addressing successor liability, the Buyer should not be responsible for the Seller s environmental liabilities unless the Buyer expressly or impliedly assumes the liability, the transaction is a de facto merger, the Buyer is a mere continuation of the Seller, or the transaction was entered into fraudulently. 2 Of course, if the Buyer is acquiring real property assets, the Buyer could still have owner/operator liability under the Superfund statute for releases 2 Gerard A. Caron, Structuring the Transaction to Allocate Environmental Liability, in ENVIRONMENTAL ASPECTS OF REAL ESTATE AND COMMERCIAL TRANSACTIONS 295, 313 (James B. Witkin ed., 3d ed. 2004) (citing Philadelphia Elec. Co. v. Hercules, Inc., 762 F.2d 303, (3d Cir.)) (acknowledging general rule of nonliability for transfer of assets). But see United States v. Mexico Feed & Seed Co., 980 F.2d 478, 488 (8 th Cir. 1992) (looking to the substance rather than the form of a purchase agreement). 2

3 of hazardous substances on the acquired real property assets unless it has an exemption from Superfund liability as a bona fide prospective purchaser, innocent landowner, contiguous landowner or another applicable defense. 3 Where a prior corporation merges into a successor corporation, the successor automatically assumes the prior corporation s liabilities. If the transaction is structured as a stock transfer, the Buyer will be concerned about environmental liabilities arising from the current and former businesses and real property, off-site disposal activities, and liabilities that were expressly assumed by the entity or as a matter of law through a merger or other combination. The Buyer should consider forming a corporate subsidiary to hold the acquired entity or entities unless or until it is comfortable with the acquired entity s associated environmental liabilities. Unless there is a basis for piercing the corporate veil or a parent corporation acts as an operator of a subsidiary s facility, the parent corporation should be insulated from the subsidiary s liability as an owner under the federal Superfund statute. 4 Similarly, a Limited Liability Corporation ( LLC ) also may be a helpful structure in limiting a Buyer s exposure to the environmental liabilities of the target because an LLC s members (owners), like shareholders of corporations, are not personally liable for its debts or obligations unless the member assumes them independently. 5 A Buyer might also form a Limited Partnership ( LP. ) Under traditional partnership law, limited partners are not responsible for the partnership s liabilities beyond the amount of capital they contributed. 6 The parties may combine these legal structures with mergers and acquisitions provisions such as earn outs, which condition future payment to the Seller on the Buyer s future earnings, or milestone payments, which condition future payments on the accomplishment of pre-determined goals. Finally, the parties should evaluate exit strategies when determining the deal structure. A private equity Buyer with a five or seven year investment horizon may be more comfortable if the deal includes a walk away risk transfer product. In certain circumstances, the Buyer may choose to lease an environmentally risky property instead of acquiring ownership. For example, a Buyer may want to purchase a small business that is operated on property with historical environmental contamination. The Buyer decides that it would like to relocate the business soon after closing. In this scenario, the Buyer could ask the Seller to transfer the business to a new entity that the Buyer will purchase, under an arrangement whereby the new entity leases the property from the Seller for an interim period of time until the new location for the business is acquired. Leasing the assets may protect the Buyer from contamination that occurred prior to the lease term, but it will not protect the lessee from liability as an operator or if the lessee contributes to existing contamination on the property. 7 Finally, a Buyer may prefer to structure the deal as a stock transfer if the entity to be acquired has valuable permits, intellectual property, or tax benefits. Asset transfers typically trigger permit transfer requirements while stock transfers may not, simplifying the deal. Terms of the Acquisition Agreement Once the parties settle on a deal structure, counsel should key the due diligence schedule to the deal s timing and begin to draft the purchase agreement. It is customary for the purchase agreement to contain representations and warranties addressing matters that are important to the Buyer. A representation and warranty is a snapshot in time pertaining to various factual issues 3 See 42 U.S.C. 9601(35)(A), 9607(q)(A), 9607(r)(1). 4 See United States v. Bestfoods, 524 U.S. 51 (1998). 5 Caron, supra note 2, at Id. 7 Id. at

4 such as past operations, conditions of properties, lawsuits, compliance, and remediation liabilities, and may look back in time to cover all or specified prior periods. One traditional contract approach to environmental liability would be for the Seller to provide limited representations and warranties backed by a limited indemnity. Although not common, the Seller might also disclaim all environmental representations and warranties while the Buyer assumes all of the risk. In an asset acquisition, the parties may draw a line in the sand distinguishing pre-closing liabilities to be retained by Seller from post-closing liabilities to be assumed by Buyer. There are many different types of representations and warranties, covenants, and indemnities that a Buyer or Seller can use to allocate environmental liabilities. Reps and Warranties Knowledge Modifier An acquisition agreement may include a provision that broadens or narrows the scope of its representations and warranties depending on the Seller s knowledge. The Seller would want to narrow the definition of its knowledge as much as possible; for example, by defining knowledge to include only the actual knowledge of certain specified individuals. In contrast, the Buyer could define knowledge broadly, including constructive knowledge upon due inquiry and information known to the Seller s representatives, such as environmental consultants. Constructive knowledge generally would include knowledge that a Seller using reasonable care should have, while due inquiry would require a higher standard of inquiry into the Seller s environmental liabilities. A Buyer likely will want knowledge to include due inquiry especially if the Seller is a large company with many properties and employees, or where the Seller s representations and warranties relate to the operations of predecessors or third parties. Materiality Modifiers and Scrapes Sellers may prefer to narrow the scope of their representations and warranties using a materiality standard, especially in complex transactions involving multiple assets. From the Seller s perspective, scheduling every exception to broad, complicated environmental representations and warranties can be unduly burdensome. Because a materiality standard can create ambiguity about whether or not something is material, Sellers may prefer language that defines materiality as a material adverse effect or uses a specified dollar amount as the frame of reference. Under the latter approach, Seller would not need to disclose exceptions to its representations and warranties unless those exceptions exceed a certain dollar value, either individually or in the aggregate. Buyers, in contrast, likely would prefer flat warranties, such as Seller is in compliance with all Environmental Laws or that there are no hazardous substances adversely affecting a property. A materiality scrape is a provision that eliminates materiality qualifiers from one or more sections of the purchase agreement for purposes of determining whether or not a breach of those sections has occurred. 8 For example, a materiality scrape may remove the materiality standard for determining whether closing conditions have been satisfied, but retain it for determining whether a breach of a representation has occurred or the damages arising from a breach that is subject to indemnity. Buyers favor materiality scrapes because they eliminate the possibility of double materiality protecting the Seller, i.e., if a purchase agreement includes a bucket or basket that protects the Seller from indemnifying claims below a certain amount and there are materiality terms throughout the representations and warranties, then there would be 8 Daniel Avery and Daniel H. Weintraub, Trends in M&A Provisions: The Materiality Scrape, 5 BLOOMBERG LAW REPORTS MERGERS AND ACQUISITIONS (2011). 4

5 two materiality filters protecting the Seller. The materiality scrape prevents this by removing one level of materiality protection. Disclosures A purchase agreement typically will include exceptions to a Seller s environmental representations and warranties for which the Buyer will not be entitled to a breach of representation indemnity. Buyers and Seller tightly negotiate the scope of such disclosures. Sellers prefer the broadest possible disclosures; Buyers prefer narrow, responsive disclosures. For example, the Seller may seek to incorporate by reference all environmental reports disclosed in the transaction. The Buyers will likely resist disclosure of the contents of reports that address speculative or contingent environmental issues. One compromise is to allow disclosure of specific issues identified as recognized environmental conditions or that are otherwise identified with specificity in the executive summary or conclusions section of the report. Survival Dates The duration of the Seller s representations and warnings is often a key provision in a purchase agreement because certain environmental liabilities, such as contamination-related liabilities, can surface, or the Buyers discover them, many years after the closing of the transaction. Consequently, a Seller generally seeks to negotiate shorter survival dates, such as one to two years; a Buyer will seek to negotiate longer survival dates, such as five years, the length of the statute of limitations, or no time limit at all. Many agreements use a five year term as a compromise because many federal environmental laws have a five year statute of limitations. If a Seller is able to include shorter survival dates in a purchase agreement, the Buyer may be incentivized to investigate a site s environmental conditions more quickly in order to have recourse against the Seller. Compliance with Environmental Laws and Permits A Buyer will expect a Seller to provide representations and warranties relating to violations of environmental, health, and safety laws and regulations, such as possessing permits and approvals. The parties will typically negotiate the time frame to which many of the environmental representations and warranties apply. Sellers will seek to represent that they are in compliance with environmental laws and permits at closing only; Buyers, in contrast, prefer the Seller to represent its compliance with environmental laws and permits for lengthy periods before closing and to provide forward-looking assurances regarding the property s ability to comply after closing. On-Site Hazardous Substance Issues Representations and warranties regarding on-site hazardous substance issues typically include the generation, storage, treatment, handling, disposal and release of or exposure to hazardous substances. Buyers should also consider including the existence of any underground storage tanks, underground pipelines, or other subsurface sources of environmental risk. These hazardous substance representations are especially important when a transaction involves mature industrial sites with long histories or varied uses. Sellers prefer representations that are limited to their conduct or have knowledge qualifiers for releases of hazardous substances. Many Sellers will want to avoid warranting the liability or practices of prior owners, especially if the Seller has limited information about its predecessors activities. Buyers, in contrast, may inherit substantial environmental liabilities from the Seller s predecessors and would want to be informed about them. Most Sellers are unlikely to make a flat representation that there have been no releases of hazardous substances, preferring a qualified representation that they have had no releases in violation of environmental laws or releases that require investigation or remediation pursuant to environmental laws. Off-Site Disposal Issues 5

6 The purchase agreement may include representations and warranties regarding the storage, treatment, and disposal of hazardous materials off the site or sites being acquired or, in a stock deal or where there is concern about successor liability, formerly owned or operated sites. This clause allows Buyers to assess the risk of off-site Superfund-like liabilities when the target entity may have engaged in hazardous materials activities. Sellers will typically seek to narrow these provisions or exclude them altogether. For third party sites, the Seller may simply include a knowledge-qualified representation that states hazardous substances were not sent to any sites that are currently the subject of environmental response actions. Third Party Litigation If the transaction involves the acquisition of an entity, any pending litigation will transfer with the entity to the new owner. Any unasserted claims (based on pre-closing conduct of the entity) are also likely to transfer. In an asset acquisition, some of the assets could be the subject of litigation that could terminate or delay the transaction. Sellers often seek to limit their representations and warranties regarding litigation to pending litigation and written notices of threatened litigation. Buyers, on the other hand, seek to include verbal notices of threatened litigation, as well as language stating that the Seller has no reason to know of potential litigation. Sellers will seek to avoid this heightened duty of inquiry. Interim Covenants Permit Transfer and Reissuances An acquisition agreement may include covenants that describe requirements the Seller must meet before closing. Interim covenants are an effective way to give the Buyer certainty and move a transaction forward. The transfer or reissuance of environmental permits can be a crucial interim covenant because failure to comply with permitting transfer requirements can substantially delay a transaction, generate significant legal liability, and threaten post-closing operations. A Buyer may require the Seller: to ensure that all environmental permits are current and in good standing until closing; in an asset acquisition, to transfer all, or any material permits to the Buyer; to provide any documentation or information the Buyer would need to maintain the permit after closing; or, in order to allow for post-closing operations pending transfer, agree that the parties will become co-permittees prior to closing. A pro-seller environmental permit representation might state that the Seller possesses material permits required for operations as presently conducted. A pro-buyer representation might state that the Seller holds all necessary permits for the lawful operation of the company and that there are no capital expenditures needed to maintain compliance with permits. Environmental Transaction or Transfer Act Filings Transaction-triggered or transfer environmental laws may subject a transaction to regulatory approval as a condition to closing or even a government-monitored environmental audit and cleanup. The Seller may covenant to make any required filing and obtain regulatory approval or to begin or complete such an audit before closing, depending on the requirements of the applicable state statute. New Jersey s Industrial Site Recovery Act 9 ( ISRA ), the leading state statute of this kind, requires a Seller to obtain a regulatory sign off before transferring certain industrial sites to a Buyer. For covered properties, the Seller must commence an administrative review process within five days of a triggering event; the initial filing must contain basic information about the applicant, the basis for triggering the statute, the nature of the proposed transaction, and the authorized agent working with the state agency. The Seller must then complete a preliminary environmental assessment that identifies areas of concern; collect 9 N.J. ADMIN. CODE tit. 7, 26B

7 data, including environmental sampling; delineate any environmental concerns; and resolve the contamination. The transaction may not be completed until the applicant has completed the required work and received the state s or a licensed site remediation professional s sign-off. Alternatively, the Seller may submit a remediation certification to the state in order to allow the transaction to proceed without first remediating the site. This approach allows the parties to close the deal more quickly, without waiting to complete the remediation process. The remediation certification identifies who will be responsible for post-closing remediation and provides that the remediating party will post a remediation funding source equal to the remediation s estimated cost, such as a bond or environmental insurance policy or a self-guarantee. The Connecticut Transfer Act 10 requires that the transferor of an establishment certify to the transferee regarding the environmental condition of the property, using one of several different forms depending on the site status, and file that certification with the state. If the establishment has had releases of hazardous materials that have not been fully remediated to state standards or the condition of the property is unknown, the certifying party (which can be the transferor or transferee) must agree to investigate and remediate the property in accordance with prevailing remediation standards. The statute defines an establishment, to include, among other properties, those generating more than 100 kilograms of hazardous waste per month in any month since November 19, 1980, and, with certain exceptions, applies to transactions through which an establishment undergoes a change in ownership. Indemnities and Post-Closing Covenants Environmental indemnities should be a central negotiating point. One typical structure for environmental indemnities links them to the Seller s representations and warranties, using the breach of the representations and warranties to delineate the Seller s responsibilities to the Buyer. A deductible or cap limit often accompanies the indemnity structure, whereby the indemnitor must only cover certain claims after the indemnitee incurs a specified amount of liabilities. This is sometimes called a bucket or basket the indemnitee must fill. The indemnitor s contributions may also be limited, or capped, to a dollar amount or expire after a certain date. Indemnity that is unlimited in time or amount likely would make an indemnitor uncomfortable, especially if it has limited knowledge about its predecessors operations. The parties also may agree to stand-alone indemnities that cover certain specific liabilities, such as compliance, remediation, or lawsuits. Stand-alone indemnities may be keyed to the purchase agreement s disclosure schedule. A Seller will be more comfortable with stand-alone indemnities if they are limited to known liabilities or certain kinds of claims. In contrast, a Buyer may prefer to seek indemnities for unknown liabilities not listed in the disclosure schedule. Indemnity Limits and Procedures Protecting the Seller Control of Dealings with Regulators and Third-Parties Because the indemnitor will always be more careful with its own money than the indemnitee, a Seller will seek to limit any post-closing indemnities. One way a Seller might do that is to include a provision that gives the Seller control of dealings with regulators and third parties involved in any indemnity claim asserted by the Buyer. For example, the Seller may want to take the lead at meetings, reserve the ability to make submissions to regulators, or prohibit the Buyer from engaging in dialogue without the Seller s prior approval. Such a provision would allow the Seller to control the regulatory and compliance process, minimizing its liability. Indemnify Legal Requirements Only, No Gold-Plating 10 CONN. GEN. STAT. ANN. 22a-134 to -134e. 7

8 To control its post-closing liability, a Seller may seek to limit its indemnification obligations to legally required environmental audits, remediation, and pollution controls. Few Sellers would be receptive to an indemnity for a voluntary cleanup triggered by a release of hazardous substances that is not legally required to be cleaned up. Many Sellers will also seek assurance that the Buyer cannot use such an indemnity to remediate a site beyond minimum legal requirements inconsistent with the current site use or for an administrative process that would create protracted, unnecessary, or unpredictable expenses. A purchase agreement may require the Seller to perform certain work on the property before the deal closes. Such a provision is appropriate if the Seller can complete the work in a reasonable period of time, but can lead to disagreement if the work cannot be finished before closing. If the Seller cannot complete the work quickly enough, the parties should consider a side agreement describing the Seller s postclosing duties and rights. A side agreement could be used to ensure the Seller s continued access to the site and identify the remediation standards it must attain. By agreeing to remediation standards consistent with the existing site use and that allow for institutional or engineering controls the Seller is seeking some assurances that it would not pay for a gold-plated cleanup that remediates the site beyond legal requirements. The Seller may seek to include a provision stating that the indemnity only extends to legal requirements, and that the indemnitee must agree to the lowest cost remedy that complies with environmental laws. The Buyer may seek to include provisions allowing it to review and approve the Seller s plans to complete the work. Anti-Dog Kicking A Seller may limit its indemnities by prohibiting the Buyer from approaching authorities unless a violation of law or endangerment is detected. In the absence of such a clause, the Buyer might invite a governmental entity to order it to take a certain action that the Buyer wants to perform at the Seller s expense, so that it can perfect an indemnity claim against the Seller. This anti-dog kicking provision prevents the Buyer from finding claims or releases associated with the Seller s operations unless required by law or that pose a potential environmental safety or public health hazard. No Hole-Poking A no hole-poking or no hunt provision prevents the Buyer from randomly or voluntarily testing the site, although it typically does not prohibit investigations needed to comply with laws or government requirements. There can also be exceptions for sampling necessary to develop the property, respond to third party claims or respond to environmental releases. Without such a provision, a Buyer may test or sample the site in a way designed solely to recover under the indemnity. No hole-poking provisions are most often sought when the Seller has provided an indemnity for a limited period of time, which could incentivize the Buyer to investigate the site. The Seller would argue that the Buyer should not be allowed to accelerate or cause liabilities that would otherwise fall outside the indemnities survival dates. No Indemnity for Developing Property for Another Use or the Sale or Transfer of the Property To control its post-closing liability, the Seller may want to limit its indemnity of the Buyer by excluding the costs arising from the site s sale, transfer, or development for another use. These provisions are not easy to get. However, a Seller would argue that such choices are up to the Buyer s business judgment and should have been factored into the purchase price. Acceptance of Deed Restrictions 8

9 The parties may agree to deed restrictions, which are restrictive covenants, easements, or servitudes that limit the use or conveyance of land. 11 These limits might include restrictions on the non-industrial use of the property, subsurface excavation, groundwater uses, the type or placement of wells, or access to certain portions of the property. Deed restrictions can reduce remediation costs, and the parties should consider an explicit agreement to adopt them or cooperate when implementing them. Indemnities Are the Exclusive Remedy A Seller may want to provide that the indemnities in the purchase agreement are the Buyer s exclusive remedy, and accompany that provision with a broad, comprehensive release. This narrows and simplifies the Seller s liability to what the parties negotiated in the purchase agreement. Otherwise, the Buyer may be able to assert claims against the Seller pursuant to environmental laws that authorize various forms of cleanup cost recovery. A Seller may also seek to require the Buyer to exhaust any prior indemnities and/or environmental insurance before the Seller will cover a liability. Consequences of Buyer s Breach, Exacerbation, New Releases, or Violations A Seller may want to include a provision in the purchase agreement stating that if the Buyer violates a condition of the indemnity, exacerbates environmental issues, or is responsible for new releases of hazardous substances, the Buyer loses the indemnification for that particular claim. Similarly, the Seller may seek to provide that the indemnitor will not cover increases in costs that a breach causes. This language protects the indemnitor from liabilities it did not create and the indemnitee s potential site mismanagement. Arbitration The parties may provide that arbitration will resolve any disputes regarding an indemnity s application. Arbitration of a complex environmental matter before an experienced environmental professional may be much quicker, cheaper, and able to produce a more reasonable result than litigation in the court system. The arbitration clause should include the arbitrators qualifications, time limits on the proceedings or decision, and what the standard of decision should be. When choosing the standard of decision, the indemnitor should require the arbitrator to select the lowest cost means to remediate the site or restore compliance. A loserpays cost-shifting provision could benefit the indemnitor by discouraging opportunistic claims. Indemnified Third-Party Claims A Seller indemnity of the Buyer may be limited to third party claims regarding the property. The agreement should identify which party will handle an indemnified claim s defense, how settlement decisions will be made, the process that occurs if the indemnitor does not accept responsibility for the claim, and how the indemnitor will receive notice of the claim. The indemnitee should provide timely notice to the indemnitor of any claim for which it will seek indemnification; the indemnitor often expects an opportunity to control or participate in the claim s defense. Alternative Solutions Escrows and Hold Backs An alternative way to allocate environmental liabilities is a cost-sharing provision that requires the parties to contribute a percentage or dollar amount towards any future liabilities. By giving each of the parties some skin in the game, each party has an incentive to work efficiently 11 See Amy L. Edwards, An Overview of Institutional Controls, in ENVIRONMENTAL ASPECTS OF REAL ESTATE AND COMMERCIAL TRANSACTIONS, supra note 1, at 345,

10 and cost-effectively. The parties may implement that approach through an escrow account that would be applied to any future environmental liabilities; that account may include a hold-back, which earmarks some of the Seller s sale proceeds for environmental costs. Environmental Insurance Environmental insurance may be a heavily negotiated issue, especially when it supplements a Seller s limited indemnity or a conservative lender doubts the Seller s financial health. The parties counsel should scrutinize legal defense provisions and definitions. Off-therack, standardized policies will frequently contain troublesome exclusions from coverage. Counsel should negotiate, but, understand that deviations from the standard form will increase premiums. In general, if liability arises from an insured risk, the insurance policy will cover the liability subject to a deductible; may impose a co-participation percentage, such as 90/10 or 80/20, or maintenance charges; set forth policy limits; and include numerous other terms and conditions. Environmental insurance may allow the Seller to walk away from liability, clarify environmental disclosures, improve access to credit, and insulate lenders from a borrower s default. An insurance company may also limit the Buyer s right to recover under a certain policy or establish exceptions to coverage for known or unforeseen liabilities. There are two basic types of environmental insurance: Pollution Legal Liability ( PLL ) or Cleanup Cost Cap ( CCC ). A PLL policy covers legal liability coverage for cleanup, bodily injury, property damage, and defense of pollution conditions. PLL policies may range from $1 million to $150 million. A CCC policy typically covers cost overruns for cleanup of known conditions, new conditions discovered during cleanup, and offsite pollution conditions emanating from covered locations. It typically includes amounts exceeding a self-insured retention ( SIR ), which means expected remediation costs plus a buffer of 30% or more. Buyers may further protect themselves from environmental liability by requiring the environmental consultants who conduct due diligence to purchase errors and omissions ( E&O ) and pollution insurance. 12 An E&O policy protects consultants from claims made against them if they negligently fail to detect unknown pollution during their site investigation. Similarly, pollution policies protect cleanup contractors from inadequate remediation or releases the contractors negligently cause; thus, both types of policies will not pay out if the consultants are found to have met their professional obligations, and the timing of the insurer s payments may not meet the Buyer s needs. The parties may supplement or replace the Sellers indemnities with representations and warranties insurance. A Buyer-side representations and warranties insurance policy provides for an insurer s direct payment to the Buyer to cover costs arising from the Seller s breaches. The parties may use a Buyer-side policy to supplement the Seller s indemnities or as the Buyer s only recourse. Under a Seller-side policy, in contrast, an insurer indemnifies the Seller for payments the Seller must make to the Buyer for breaches of the representations and warranties. It usually backstops the Seller s liability and can be used when the Seller provides a limited indemnity to the Buyer and establishes an escrow account to fund that indemnity. Exit Strategy and Risk Transfer Products The parties may agree that an environmental contracting company will contractually assume cleanup responsibilities and indemnify the owner for any future costs or claims associated with a remediation issue at one or more specific sites. This approach is used as an exit strategy or 12 See Peter Breitstone et al., Business Transactions Involving Contaminated Property and Environmental Insurance, in ENVIRONMENTAL ASPECTS OF REAL ESTATE AND COMMERCIAL TRANSACTIONS, supra note 1, at 503,

11 risk transfer product, and only works if the site s environmental problems are known and well defined, regulatory approval is either not needed or is easily obtained, the project s schedule is realistic and allows for delays, and the environmental contracting company is financially capable of performing. For example, the parties might use a risk transfer product if they were closing a facility and wanted to minimize their cleanup obligations and improve their closure compliance; a company could also use it to manage its legacy site portfolio. An environmental contracting company can offer cost certainty, relief from future liabilities, experienced project management; and improved tax and accounting treatment. Covenants to Share in Post-Closing Regulatory Uncertainty Post-closing regulatory uncertainty may await the parties even if they carefully negotiate and allocate their liabilities. Site remediation may cost more than anticipated, regulators may find residual contamination that needs additional cleanup, or they may discover new contaminants during remediation. There also could be anticipated changes in law with uncertainty as to the effect on post closing operations. The parties may covenant to share this liability through a participation percentage, a cap or basket approach like that used for indemnities, or, for site remediation risk, environmental insurance. For example, an environmental insurance policy may be written to cover remediation cost overruns after the parties exhaust the expected remediation costs and the SIR. Alternatively, PLL policies may protect the parties from the costs of remediating newly discovered contaminants. Audit-Privilege Laws, Voluntary Cleanup Programs, and State Funded Cleanups Other regulatory programs that may play a role in a deal include federal and state auditprivilege laws, voluntary cleanup programs with covenants not-to-sue, and state funded cleanups. Some state statutes, for example the Texas Environmental, Health and Safety Audit Privilege Act, provide owners, operators, or purchasers with limited immunity from penalties for violations they identify and disclose following an environmental audit. 13 Without this protection, the parties might elect to conduct a more limited environmental audit in order to give a state regulatory agency less ammunition in an enforcement action. The parties may agree that these privileged environmental audits would be exempt from anti-dog kicking provisions, allowing the Buyer to approach authorities without a violation of law or endangerment. States may also offer voluntary cleanup programs. 14 Typically, these programs release liability or offer a covenant not to sue against owners or operators of a site if they supply a plan to remediate the site, agree to pay for and complete the necessary remediation, and the site is not subject to enforcement actions or permits. Similarly, a state may fund a cleanup itself. Approximately 40 states have established Underground Storage Tank ( UST ) cleanup funds that are distributed to private parties to pay for UST remediation work. 15 Conclusion Buyers and Sellers have competing agendas regarding a deal s environmental liabilities, but the legal tools available to resolve any disagreements are flexible and durable. The circumstances of every transaction are unique, and counsel should think critically about how to accomplish their client s goals. Counsel should combine and calibrate a deal s representations and warranties, covenants, indemnities, and alternative solutions to allocate risk effectively and help to close a deal. 13 See TEX. REV. CIV. STAT. ANN. art. 4447cc, 5, See Voluntary Cleanup Program, TEX. COMM N ON ENVTL. QUALITY, (last visited Jan. 30, 2014). 15 Karen J. Nardi, Underground Storage Tanks, in ENVIRONMENTAL LAW HANDBOOK 197, 238 (Thomas F.P. Sullivan ed., 20th ed. 2009). 11