Stock Deals vs Asset Deals
The scope of an EHS&S due diligence project needs to consider how the deal is structured. EHS&S risks, including environment, social, and governance (ESG) risks, can be connected with a corporate legal entity, but not necessarily connected with an existing asset. With that, additional risk exposures can occur on stock deals versus asset deals, particularly when the entire business is being acquired with no surviving legal entity(ies). Other factors can mitigate the risk exposure such as indemnifications in the purchase and sale agreement or representations and warranties (R&W) insurance provisions; however, risks must first be identified with appropriate consideration of what is being acquired so that appropriate mitigation can be built into the deal.
Formerly Owned Properties
An example of a risk that may not be connected with the existing assets of a target, but still represents an exposure risk to the corporate entity, is a formerly owned property. The potential for subsurface contamination left behind at a formerly owned property should be considered, particularly in the United States where joint and several liability allows for entities to be named as a responsible party for subsurface contamination they may have caused despite subsequently selling the property.
Case Study:
As part of a due diligence review, an industrial manufacturing client requested a Phase I Environmental Assessment (ESA) for a currently operating facility in Pennsylvania. It was established that the business had been operating for more than 30 years but had only been operating at the current location for two years. Through questioning with the facility management, it was determined that the business had previously operated approximately 10 miles away and had recently relocated to its current operating location (the current location being target of the Phase I ESA review). It was also determined through review of a commercially available data base for the current operating address, as normally reviewed during a Phase I ESA, that the business had been a responsible party at a federal superfund site in the state of Maryland that was a hazardous waste disposal facility. Chlorinated solvents were listed as the waste disposed of at the facility.
Putting the pieces together through further questioning of the operating management, it was apparent that the former operating facility had used chlorinated solvents for an extended period of time, though none had ever been used at the current operating facility. Although the responsible party situation associated with the hazardous waste disposal facility had been resolved through a de minimis settlement, there still remained the risk for subsurface contamination at the former operating location due to historical chlorinated solvent use. It was reported by the target management that the former operating facility had never been subject to a Phase I ESA or Phase II subsurface investigation.
In summary, should subsurface contamination (chlorinated solvents) be found in the future at the former operating facility, the possibility exists for the target to be named as a potential responsible party (PRP), despite no longer operating there. Although this risk became apparent through the Phase I ESA process via the eyes of a senior due diligence advisor, the risk was not required to be identified, nor reported as a “recognized environmental condition” in connection with the existing operating facility (i.e., the facility which was the target of the Phase I ESA scope). Therefore, an expanded scope, or in this case an astute advisor, was necessary to bring this sort of risk into view for the client.
Conclusion: Understand the Deal Structure and Potential Risk Exposures
In conclusion, understanding how a deal is structured prior to designing an EHS&S due diligence scope can set the stage for a more appropriate and thorough review of the potential risks. Risks associated with a former operating location are just one example of a risk that may not be captured through a simple Phase I ESA, requiring a broader scope to be considered in a stock deal situation.
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