Allocating Environmental Risks in the Transaction Agreement

Posted on 11-04-2019

By: Annemargaret Connolly and Thomas D. Goslin, Weil, Gotshal & Manges LLP

UPON COMPLETION OF THE ENVIRONMENTAL DUE DILIGENCE investigation, the buyer should have obtained a solid understanding of the environmental issues requiring attention after operations are acquired. Furthermore, the new information allows the purchaser to intelligently address environmental issues in deal negotiations. The primary way in which environmental information is used in deal negotiations is to enable the parties to allocate financial responsibility between one another and to make sound business decisions in the context of the overall transaction. This allocation may occur in several ways. For example, the parties may negotiate a different purchase price or may change the structure of the transaction. Alternatively, the seller may agree to pay for some, or all, of the costs of cleanup, or choose to indemnify the purchaser against future environmental liabilities. In some cases, the purchaser may concede to all of the seller’s terms because the risks or liabilities, when evaluated from a worst case perspective, would not be material to the bottom line of the overall transaction.

Environmental Representations and Warranties

Environmental representations and warranties can serve two purposes: first, they can help facilitate due diligence by requiring a seller to disclose what it knows about certain environmental matters; second, they can help to allocate liability for environmental matters between the buyer and seller. As with any transaction agreement, the representations and warranties concerning environmental matters will vary depending on the nature of the assets or business being acquired. That said, in today’s environment, nearly every purchase agreement will contain at least some environmental representations and warranties. These typically require the seller to represent that, except as might otherwise be disclosed to the buyer:

  • There is no contamination present at the properties being acquired.
  • The operations of the acquired company have not caused any contamination at any other property.
  • The assets or business are and have been in compliance with environmental laws.
  • There are no environmental proceedings pending or threatened concerning the assets or the business.

Tailoring Representations and Warranties

Environmental representations and warranties should be tailored to the business or assets at issue. For example, if the target is a corporate entity that has been built through a series of acquisitions, it may make sense to include a representation that the business did not assume, by contract or otherwise, any liabilities of any third parties. If the target has a long history of manufacturing, a buyer might request a representation that the business does not and has not manufactured products containing hazardous materials such as asbestos. If a buyer feels that it has not had an opportunity to conduct ample facility-level diligence, it may request a representation that certain features are not present on any acquired real property, including underground storage tanks, landfills, or wetlands. Buyers also often seek to have a seller represent that the seller has made available to the buyer all material environmental documentation so that the buyer can obtain some level of comfort that they are aware of all known environmental liabilities.

Qualifying Representations and Warranties

Depending on the nature of the assets or businesses that are the subject of the transaction, it may be necessary to include certain qualifications on the environmental representations and warranties, particularly with respect to materiality and knowledge. For example, a purchase agreement for a highly-regulated chemical business would likely contain language in the representations providing that the business is and has been in material compliance with all environmental laws or that the business has been in compliance except for any noncompliance that could not reasonably be expected to result in the company incurring material liabilities. Representations also may be qualified by knowledge. For example, the seller would represent that, to its knowledge, the assets are free of any contamination. Whether and when materiality and knowledge qualifications are appropriate for environmental representations and warranties will largely depend on the nature of the transaction and the parties’ tolerance for assuming or retaining risk and the strength of its bargaining position.

Indemnification

Depending on the outcome of environmental due diligence, the nature of the deal and the bargaining strength of the parties, certain transaction agreements may provide the buyer with indemnity in the event that the seller breaches an environmental representation or warranty.

Survival Period

A key consideration in such agreements is whether the environmental representations survive. In agreements where the representations survive, the buyer may be entitled to indemnification (often subject to deductibles and caps) if it turns out that a representation was not true and the buyer incurred a loss as a result of the breach before the termination of the survival period. Survival periods for environmental representations vary, much like they do for other types of representations: they can survive for a brief period of time or, in some rare instances, they can survive forever.

One variant on the survival concept seen in some agreements provides that the representation will survive until the expiration of the statute of limitations. This presents a unique issue in the environmental context because the statute of limitations under certain environmental laws does not begin to run until the environmental issue is discovered. A survival period tied to the statute of limitations arguably creates a situation where that representation would survive indefinitely. For example, if an agreement contains a representation that there is no contamination present at real property acquired by the buyer, and that representation survives until the expiration of the statute of limitations, then arguably the buyer could demonstrate a breach of the representation if, 20 years hence, contamination attributable to the seller is discovered at the property.

Indemnification for Environmental Matters

In addition to indemnification for breaches of environmental representations, it may be appropriate for the parties to agree to specific indemnification for environmental matters. These can take many forms and cover specific known issues, contingent liabilities, or both. Specific environmental indemnities can be particularly useful when due diligence has identified a known issue, but the magnitude of the liability cannot yet be calculated. In those circumstances, the parties may not be able to agree on a purchase price adjustment to account for the liability. Thus, the parties, may agree to a special environmental indemnification clause that will provide the buyer with some level of protection while allowing the transaction to close before the full extent of the liability is known.

Agreements containing indemnification for environmental matters may also contain certain environmental-specific limitations:

  • No-dig provisions. For example, the agreement may provide that the buyer will not be entitled to any indemnification to which it might otherwise be entitled if the loss incurred by the buyer arises because the buyer conducted environmental sampling during the indemnification period. Often referred to as a no-dig, these provisions prevent a buyer from voluntarily looking for issues and then seeking indemnification under the agreement. No-dig provisions are often subject to several exceptions, including to the extent sampling is required by law or demanded by a governmental entity.
  • No recovery if changes to site. Environmental indemnities may also be subject to restrictions that prevent recovery to the extent the buyer changes the use of a site after closing or ceases operations, both of which can change the legal requirements applicable to the site.
  • No recovery for cleanup beyond required levels. In addition, there may be specific indemnity limitations that prevent recovery for losses incurred to cleanup a site to a level greater than required by law, for instance, if the law allows for low levels of contaminants to remain in the ground, the indemnity will not cover losses to clean up contaminants that the law would allow to remain.

In short, environmental indemnification rights and obligations can vary significantly from transaction to transaction and are often dictated by the issues identified (or not identified) during the due diligence process.

Access Rights

While a significant portion of environmental due diligence will occur prior to signing a definitive agreement, in certain transactions environmental due diligence will continue to occur between signing and closing. To the extent that the buyer wants to continue environmental due diligence after signing the agreement, the buyer will need to ensure that it has the right to do so in the agreement. Most transaction agreements will include provisions granting a buyer certain access to the seller’s properties and records. These access provisions often include limitations that prevent a buyer from conducting invasive environmental sampling. To the extent that a buyer believes it may wish to perform such sampling, it should seek to include language in the access provision explicitly authorizing it to do so. Sellers are often reluctant to provide buyers with the right to conduct invasive sampling because, if the buyer identifies a significant issue, the contract may allow the buyer to terminate the deal, leaving the seller to deal with a new environmental liability. Conversely, buyers may wish to seek to include rights to conduct sampling in the access provisions where earlier diligence suggests that there may be a potentially significant issue at a property. Depending on the deal dynamics, the seller may have no choice but to agree.


Annemargaret Connolly is a partner based in the Washington, D.C. office of Weil, Gotshal & Manges LLP. She is the head of Weil’s Environmental Practice, a leader of Weil’s Climate Change Practice Group, and a member of the firm’s hydraulic fracturing task force. She advises clients on a wide range of global environmental compliance and liability issues, most notably in the context of mergers and acquisitions, real estate transfers, financing transactions, and infrastructure projects. She also works closely with the firm’s European and Asian offices on cross-border transactions, assisting in identifying and allocating environmental risks and educating foreign clients on potential issues raised by global environmental movements. She undertakes and oversees due diligence assessments, retains and works with consultants, engineers and other environmental professionals to quantify potential liabilities, and drafts and negotiates contract language to effectively allocate the risk of environmental liabilities between the parties. She also advises on disclosure issues in the preparation of financial statements and public securities filings and negotiates transaction-specific environmental insurance transactions. ThomasD. Goslinis counsel based in the Washington, D.C. office of Weil, Gotshal & Manges LLP. He focuses on a wide range of environmental, energy, and other regulatory concerns in the context of mergers and acquisitions, private equity investments, financing transactions, infrastructure projects, and corporate restructurings. He has extensive experience with environmental and regulatory liability and risk allocation issues, drafting and negotiating contract terms, managing due diligence, and administrative and judicial proceedings to obtain regulatory approvals necessary to close client transactions.Mr. Goslin has been involved with teams representing a wide range of clients in a variety of industries, particularly the renewable and traditional power generation, oil and gas, natural resources, infrastructure, and automotive industries. Mr. Goslin also assists clients in identifying business opportunities and risks arising from proposed changes to federal and state legislation and regulation, with respect to renewable energy development and greenhouse gas emissions.

To find this article in Lexis Practice Advisor, follow this research path:

RESEARCH PATH: Corporate and M&A > SpecialtyIssues in Mergers & Acquisitions > Environmental M&A > Practice Notes

Related Content

For a discussion of environmental due diligence, see

> ENVIRONMENTAL DUE DILIGENCE IN M&A TRANSACTIONS

RESEARCH PATH: Corporate and M&A > Specialty Issues in Mergers & Acquisitions > Environmental in M&A > Practice Notes

For a discussion of environmental concerns during and after closing, see

> CLOSING AND POST-CLOSING ENVIRONMENTAL LAW CONSIDERATIONS

RESEARCH PATH: Corporate and M&A > Specialty Issues in Mergers & Acquisitions > Environmental in M&A > Practice Notes

For a sample material adverse change definition clause, see

> MATERIAL ADVERSE CHANGE DEFINITION CLAUSE

RESEARCH PATH: Corporate and M&A > Acquisition Agreements > Asset Purchase Agreement > Clauses

For a discussion of knowledge qualifiers, see

> KNOWLEDGE QUALIFIERS IN REPRESENTATIONS

RESEARCH PATH: Corporate and M&A > M&A Provisions > Practice Notes

For a sample knowledge definition, see

> KNOWLEDGE DEFINITION CLAUSE

RESEARCH PATH: Corporate and M&A > Acquisition Agreements > Asset Purchase Agreement > Clauses

For items to consider when addressing environmental issues, see

> ENVIRONMENTAL PROVISIONS IN ACQUISITION AGREEMENTS CHECKLIST

RESEARCH PATH: Corporate and M&A > Specialty Issues in Mergers & Acquisitions > Environmental in M&A > Checklists