Preparing for Negotiations: The Environmental Lawyer s Checklist In Oil and Gas Transactions Presented by Jim Morriss Thompson & Knight LLP james.morriss@tklaw.com
The Process Drives the Checklist Confidentiality Agreement Letter of Intent or Bid Asset Purchase Agreement/Stock Purchase Agreement Due Diligence and Defect Process Closing Post Closing Corrective Measures Ongoing Compliance 1
Checklist? The Process Deal Terms Diligence Corrective Measures Compliance The Entry Point One never knows Not just one checklist- rather several sets of considerations 2
Preliminary Steps Confidentiality Agreements Letters of Intent Bids and the Ultimate Deal 3
Environmental Lawyer s Role Seller: Limit the seller s continued liability for environmental conditions or for compliance with environmental laws Buyer: Identify environmental conditions and violations of environmental law that could give rise to liability and limit the liability assumed by the Buyer 4
Nature of the Deal General Guidance Merger or Stock Purchase Buyer will succeed to the liabilities of the acquired entity or have exposure to such liabilities to the extent of the stock ownership Asset Purchase Liability flows from the buyer s ownership and operation of the asset Environmental conditions Compliance 5
Types of Liability Liability for conditions on the property Liability for offsite conditions caused by the onsite operations Liability for offsite shipments (CERCLA or Superfund liability) Liability for violations of permits and laws governing operations (examples: air, water, solid waste) Third party claims Contractual obligations 6
Buyer s Alternatives Don t close Remove specific properties Condition closing on correction Obtain concession on price Accept with escrow Indemnity? Probably not if deal relies upon a defect process 7
Seller s Alternatives Fix it Deny the problem exists or contest the cost of the solution in the defect process Adjust price Exclude asset 8
Check List of Deal Terms Definitions Representations and Warranties Access Defect Process Confidentiality Indemnity 9 Acknowledgement of Conditions
Definitions Hazardous Substances or Hazardous Materials Environmental Defect Environmental Laws Laws Knowledge of Seller Permits Retained and Assumed Liabilities 10
Role of Reps, Warranties, and Disclosures Complement due diligence Identify material issues that may give rise to liability and affect the deal Allow issues to be addressed in the deal Defect Process Specific provision addressing the issue and allocating responsibility Indemnity? Increasingly limited in scope and effect in the light of the defect process 11
Representations and Warranties No pending or threatened lawsuits No pending or threatened NOVs No administrative or civil actions Compliance Permits No written or oral notice of violations or claims Hazardous substances Specific substances No liens No contract obligations or assumed liabilities 12
Issues in Reps and Warranties Conflict between the general and the specific environmental provisions Knowledge of the seller Except as Scheduled Time Frame is in compliance and has been in compliance with all environmental laws Permits obtained and in full force and effect Materiality 13
Access Access to documents and property Timing and scope Operated and nonoperated assets Government agencies and files Phase I, phase II, and other Splitting Samples Health and safety protocols Indemnity for damages Discoveries and disclosure Costs 14
The Defect Process What is it? Origin create a more predictable path to closing Standard approach in oil and gas transactions Level of detail: description, valuation, basis of complaint Scope is critical - both site conditions and compliance should be addressed Timing Decisions and Consequences 15
The Defect Process The Defect Process often trumps representations and indemnity provisions Thresholds are critical for a buyer s protection Site vs. issue threshold Aggregate threshold Often combined with title defects Setting thresholds: Remember that today s buyer is tomorrow s owner/operator 16
Confidentiality Confidentiality of the deal Confidentiality of the findings in due diligence Disclosure to the Seller of Buyer s findings Attorney-client privilege State audit privilege acts IMPORTANT: Privilege does not relieve a party of obligation to report a condition if report is otherwise required upon the discovery of contamination 17
Indemnity The defect process has limited both the scope and availability of indemnities to address environmental issues in oil and gas transactions. Still used to address representations and warranties and retained liabilities and specific items emerging from the defect process. Duration the problem with the applicable statute of limitations 18
Acknowledgement of Conditions NORM Asbestos Other substances Acknowledgement vs. Waiver 19
Environmental Due Diligence Why due diligence? To Understand and Manage Risk and Avoid or Limit Liability 20
Benefits of Due Diligence Risk Avoidance Remove well sites and facilities that present unacceptable risks of liability due to contamination or significant compliance issues Risk Management Remediate conditions or bring operations into compliance before closing Address known conditions and risk of unknown conditions in deal terms (price adjustments and post closing obligations) Use regulatory programs and defenses to address conditions and avoid liability 21
Sources of Environmental Liability Environmental Conditions Activities Potential Contaminants / Structures Asbestos Lead Paint Contaminated Soil / Groundwater PCBs Indoor Air Pollution Vapor Intrusion Tanks Specially Protected Features Endangered Species Historic Sites Wetlands Floodplains Sole Source Aquifer Protected Watershed Air Emissions Water Discharges Waste Management Hazardous Materials Handling Conduct of Business Activities 22
Liability Conditions on Property Liability: Strict liability for contamination on or emanating from property CERCLA, RCRA and similar state laws Current owner or operator status liability Past owner or operator at the time of disposal or release One who arranges for the disposal 23
Liability Compliance Issues Factors that affect responsibility for compliance: Owner/Operator Presumption of continuing violation Nature of the deal 24
Due Diligence Basic Concepts Due Diligence One size doesn t fit all. Factors influencing the scope of diligence Familiarity with properties, past operations, and the conditions involved Level of site development and nature of operations Time and cost considerations Buyer s tolerance for risk and dependence on third parties (lenders) Seller s continued existence and viability Representations and warranties Disclosures Defect process 25
Key Environmental Issues in Due Diligence Onsite conditions and releases (Phase I and II) Compliance Permits and licenses Potential liability for offsite conditions Records Communications with regulatory agencies Environmental management system History of prior ownership or operators Insurance coverage 26
On-Site Conditions (When All Appropriate Inquiry is not appropriate) Phase I A term commonly misunderstood and misused in oil and gas transactions Identifies potential presence of environmental contamination based only upon records of prior use, reported incidents, neighboring uses, visual observations, and inquiries Does not involve testing or quantification of risks Does not address all site conditions or compliance Does not work with many distinct locations - well sites Does not assess compliance 27
Compliance Permit conditions and requirements Sampling and monitoring Recordkeeping & Reporting Certification Practices and procedures Applicable regulatory standards Audit program and reports Orders, citations, NOVs and NOEs Threatened actions Compliance agreements, schedules, consent orders Fines or penalties Environmental Management System Environmental studies 28
Approach for Post-Closing Cleanup Continued access investigation, monitoring, operation, and maintenance Deed and use restrictions Commercial/industrial (no residential) Restricted use of groundwater Restrictions on excavation Ability to employ a risk based closure (least cost alternative) Obligations regarding regulatory programs Cost cap insurance Importance of a baseline Antimining provisions 29
Using Regulatory Programs to Limit Risk After Closing Federal and state audit programs afford the buyer as a new owner an opportunity to limit exposure to compliance issues after closing Environmental diligence is similar to environmental auditing Goal: Identify and manage risk Method: Inspection of property, operations, and records 30
Why Transition from Diligence to Environmental Auditing? Environmental issues can be a significant source of liability A primary function of corporate leadership is management and avoidance of risk Important to understand the sources of liability and techniques or tools available to control or avoid it Auditing is a key ingredient in informed decision making and risk avoidance and a key component of environmental management 31
Audit Myths or Valid Concerns What I don t know can t hurt me. If I discover something I will have to do something about it and that will cost big bucks. I will be worse off if I document it. If I am sued, the plaintiffs will have a field day with my audit report. 32
Environmental Protection Agency Long history of incentives based upon enforcement discretion from 1986 Incentives for Self-Policing: Discovery, Disclosure, Correction and Prevention of Violations (2000) Interim Approach to Applying the Audit Policy to New Owners (2008) 33
EPA s New Owner Policy Addresses discoveries by a prospective purchaser made in the course of due diligence and disclosed following closing Provides enhanced incentives for a new owner conducting an audit following closing Eligibility and Conditions Potential for an audit agreement for lengthy multifacility audits 34
Texas Environmental, Health, and Safety Audit Privilege Act Passed in 1995, amended in 1997 Provides incentives to conduct voluntary audits and implement corrective action Requires advance notice of audit performed by owner/operator 35
Incentives Established by Act Limited evidentiary privilege Immunity from state administrative and civil penalties for violations disclosed as a result of the audit Structure for planning and implementing necessary corrective measures 36
New Owner Issue Under Texas Law (prior to September 1, 2013) Texas Environmental, Health, and Safety Audit Privilege Act, while an excellent statute, only applied to current owners and operators The requirement of advance notice of audit prevented a prospective purchaser who discovered a violation during due diligence and became the owner from being eligible for immunity from civil and administrative penalties under the Act This inconsistency with EPA s approach led to a voluntary disclosure conundrum Solution: Amend the Act to mirror EPA s New Owner Policy 37
SB 1300 Recognizes due diligence conducted prior to an acquisition as an audit Eliminates the need for a Notice of Audit to be filed in advance if the audit is commenced as due diligence Allows a new owner to obtain immunity for violations discovered during due diligence and disclosed to the regulatory agency within 45 days after closing Allows a new owner to continue an audit commenced prior to closing and obtain immunity for violations discovered during the on-going audit 38
First Questions in Building Checklists Nature of deal and timing Access for due diligence (property, records, data room) Any specific environmental conditions or issues already identified Client s sophistication and technical support: in-house/consultant Availability of draft APA or merger agreement and origin of document (seller s draft or buyer s draft) Client s risk tolerance 39
Managing Expectations Clear, open, and frequent communication Develop a time line for due diligence showing the contingencies and critical path Explain what you don t know and when you will know it Explain what you can t know and why Impact on the defect process Remember It s the client s call. 40
41 Questions?