Many manufacturers and industrial operators carry environmental insurance. During due diligence, purchasers should evaluate existing insurance policy coverage, voluntary investigation exclusions, policy coverage dates, and the implications that performing due diligence can have with respect to policy coverage. Some insurance policies include what is known as a “voluntary investigation exclusion”, which can greatly complicate the process. This is because such exclusions may consider the performance of soil and groundwater investigations to be 'a voluntary act', and therefore a buyer who conducts such subsurface investigations may:

1. Trip a policy exclusion if a release of hazardous substances or petroleum is identified;
2. Be prevented from testing soil and groundwater entirely and reply on a policy renewal or new policy (with the same exclusion) to address the unknown; or
3. Kill the deal.

Considering the Scope of Your Due Diligence

In such cases, the purchaser will need to very carefully consider the scope of the environmental investigation required. Of course, lending on or purchasing an asset without conducting thorough due diligence always exposes lenders and buyers to significant risk of losses or liabilities. Purchasers need to consider the specific circumstances of the deal and their own risk profile to determine if they should conduct subsurface testing.

To resolve the issue of voluntary exclusions, a deal can include indemnification agreements, escrows, negotiations with the lender, or other insurance products to mitigate risk. For example, during one of our recent private equity projects, we were able to help the client work around this issue by restructuring the deal so that the seller retained liability for known conditions. Partner then completed a detailed site characterization to identify and delineate all recognized environmental conditions. When it comes to environmental issues, it pays to fully understand all risks instead of managing unknown conditions with insurance.

In order to help purchasers become comfortable taking on potential environmental liabilities associated with an acquisition, attorneys working on the deal should have a good understanding of environmental issues in the state. Advice from specialized environmental attorneys in the state where the acquisition will occur should be sought as needed. Local expertise is often the key to successfully navigating states' increasingly complex environmental regulations.

Environmental Compliance Issues

Asset purchases may not contain a real estate component, and liability is often limited to the future environmental compliance of the business operation. Environmental compliance on properties where hazardous materials are used (i.e. ensuring that a manufacturer is in compliance with State and Federal environmental regulations) is often overlooked. However, future environmental compliance is the line item that carries forward and can become an unaddressed issue for the new business owner. Purchasers should ensure that all aspects of the company's operations are in compliance before closing the deal. This can be accomplished by conducting an environmental compliance audit of the business systems, procedures and policies.

Once the deal has closed, ongoing review will ensure the business continues to operate in accordance with all applicable laws and regulations. An experienced consultant can evaluate compliance during a due diligence assessment to identify deficiencies and set a framework for future compliance obligations for the new owner.

For transactions that involve a real estate component, it is critical that the scale of due diligence is adequate to identify potential liabilities. Most of the time, purchasers will conduct some level of soil and groundwater investigation, but there may be a temptation to limit these studies to keep costs to a minimum. However, this approach can be penny wise and pound foolish: the cost of remediation or correcting compliance deficiencies or liability associated with issues discovered after closing a deal is many times the cost of due diligence!

As mergers and acquisitions continue, and as environmental regulations become more complex, environmental due diligence and compliance are becoming essential components of most deals. Don't get caught with a hidden liability! Investing in thorough pre-purchase due diligence will save you big in the long term.