Contractual agreements would include items such as indemnity agreements and liabilities as a Superfund PRP. Non-contractual contingencies will only need to be recognized if it is "more likely than not," as of the acquisition date, i.e., there is a 51% or greater likelihood of a liability.
Uncertainty as to the occurrence and amount of a liability will no longer be a valid reason to defer accounting recognition of contingent environmental liabilities in M&A deals. FAS 157 allows for the use of statistical probability analysis to determine the "expected fair value" measurement for contingent liabilities. Looking further to the future, it is likely that FAS 5 will be revised as well to incorporate fair value measurements of existing contingent liabilities.
The end result will be a significant increase in the number of contingent environmental liabilities that will need to be recognized in corporate accounting statements.
New Challenges for Buyers Sellers and Environmental Experts
The most obvious implication of the new accounting pronouncements is for buyers who must now recognize contingent liabilities on their books as of the transaction date. This will necessitate more careful due diligence concerning the environmental liabilities that will be assumed. Sellers also need to be cognizant of the new rules. Before proceeding with any transaction, sellers should get a good handle on the fair value assessment of their environmental liabilities to aid in negotiations and to avoid being surprised by issues that could derail the deal.
The new rules will also significantly alter the extent and complexity of due diligence services that environmental experts will need to provide. In addition to the traditional service of identifying recognized environmental conditions (RECs) there are myriad additional services that environmental experts may need to provide for their clients. Environmental experts may need to evaluate and answer any number of the following questions on any given deal:
•For each REC, or for the property in general, what is the likelihood that an environmental investigation or remediation will be necessary?
•What remediation technologies are potentially applicable to the contaminants?
•What will the regulators likely approve? Is there a possibility that fines or penalties could be levied by regulators?
•What is the range of potential outcomes? What are the estimated costs for each potential outcome? And what is the probability of each outcome occurring?
•What is the statistical "expected value" for the liability?
•Is there a possibility of natural resource damages (NRD) being assessed?
•Are there potential third party liabilities? (e.g. off-site impacts or toxic torts)
•For all identified liabilities, are they "more likely than not" to occur?
A combination of experience and judgment are necessary to evaluate all of these complex issues. Most engineers and consultants are capable of generating cost estimates for a single remediation scope of work. It takes an extra measure of judgment and experience to develop multiple outcome scenarios, provide cost estimates and assign probabilities for each outcome, particularly in situations where the results may come under the audit scrutiny of valuation experts.
In order to provide the lowest possible defensible estimate of environmental liabilities, experts will need to have a variety of capabilities in their tool box, including the ability to implement Triad investigation approaches where it is necessary to quickly evaluate the extent and magnitude of contamination in order to provide fair value cost estimates within the allowable due diligence time frame; expertise in the use of new and innovative remediation technologies which can reduce environmental remediation costs; command of statistical approaches and the latest cost modeling tools; experience in the procurement of government grants, insurance products and insurance recovery which can be used to off-set environmental liabilities; and the ability to conduct up-front negotiations with regulators to obtain acceptance in concept of a proposed remedial approach.
The views expressed here are those of the authors and not of Real Estate Media or its publications.
Edward Sullivan is senior project manager and David Robinson is VP-remedial services for The Whitman Cos., the East Brunswick, NJ-based environmental engineering and management firm. They can be reached at [email protected] and [email protected] respectively.