Reverse Due Diligence, Part II Environmental Liabilities By Miriam V. Gold Last quarter as we started the reverse due diligence process, we looked at the need to understand the seller’s motivation for divesting the business and the condition of the assets of the business. In this article, we will talk about the environmental liabilities typically associated with the sale of a chemical business. You can think of liabilities in several different ways: (a) known versus unknown; (b) historic versus continuing; or (c) quantifiable versus unquantifiable. As the seller, especially of a small wholly contained business, you want to dispose of all of the liabilities. After all, you will likely have neither the apparatus nor the desire to manage liabilities after Environmental due diligence in the disposition of a chemical business can fill an entire book. This article will explore the process of thinking about how to conduct seller side due diligence and the types of issues likely to occur. We will not go through all of the laws that will impact the conduct of diligence. The formal due diligence team will do that, assisted by many environmental due diligence check lists. Developing a conceptual framework of environmental due diligence that is meaningful to company management is probably a more helpful way to consider diligence. You need to look at the process as part of the business operations instead of as detached from those operations. How do the operations of the business create potential environmental impacts? If the business has an environmental management system, the due diligence activities might follow that outline. If you are not already at the pre-sale stage, you might want to consider integrating your environmental compliance obligations into your business process systems.
Not all chemical business transactions are the same. The scope of due diligence will depend on a host of factors, some of which might vary depending on the nature of the buyer. Analyzing the activities of the business from an environmental perspective will be helpful in negotiating with the buyer the environmental due diligence checklist it will likely present. Often, buyers pull out lengthy form checklists asking for everything including the kitchen sink, to avoid having to do the work to pare the form checklist down to meaningful proportions. Buyers, not knowing as much about the business as the seller, don’t want to take the chance of missing anything. Preparation in this area will be helpful in getting your potential buyers to tailor their inquiries to the transaction at hand. This will be of great assistance to both the buyer and the seller, to minimize costs and disruptions to the operations and to facilitate the speed of the transaction. Be prepared to educate your likely buyers. What is the nature of the business? Does it distribute chemical products manufactured by others, or does it manufacture its own products? Are the products manufactured formulations or the results of syntheses? How many facilities are involved in the transactions? What is the nature of each of those facilities? Manufacturing sites? Labs? Warehouses? Offices? How about waste disposal sites? Are any products toll manufactured for you by third parties? Different sites are reviewed differently. In what jurisdictions are your facilities located? Are there any particular state or local requirements that will impact the deal? What will the value of the transaction be to the buyer – the smaller the transaction value in the scheme of things, the more likely the buyer will be to accept a greater level of uncertainty. How knowledgeable is the buyer about the chemical industry? The more knowledgeable the buyer, the more comfortable the buyer will be taking responsibility for the types of risks inherent in such deals since it likely has the internal capability to deal with those risks. Is the buyer public or private? A public buyer will have to consider materiality thresholds for SEC-related disclosures after the deal closes. What is the history of the seller and its facilities? Has the seller sold off other facilities or business lines, and in so doing, what obligations did the seller retain or assume? A review of prior transaction closing documents would be appropriate.
After you have classified the activities of the operations, you might next want to look at all of the input and outputs of those activities. For example, for each product sold, you should trace back up the chain all of the materials that are connected to the manufacture of that product, whether intentionally or as the result of a reaction. In essence, you are creating a mass balance chart, looking at raw materials that are used and any byproducts, intermediates, wastes or emissions created in the development of the final end product. Is every raw material, isolated intermediate and final product allowed to be manufactured and sold in the country of manufacture or sale? Are all emissions that need to be permitted (to the air, water or land) properly permitted? How is the waste disposed of? Do you have properly documented copies of all hazardous waste manifests? Do you have underground storage tanks? You will need to assemble documentation demonstrating that you have all of the required permits and other governmental approvals needed to operate the business as you have been operating it. Careful consideration should be given before starting this process to how deep and how broad it should be.
While not part of the due diligence process, there is always the possibility that you might become aware of some noncompliance with law as you go through this process. You should give some thought at the outset as to how you might handle such a discovery. The Environmental Protection Agency (“EPA”) has published policies allowing companies that self report violations of law to mitigate gravity based penalties, in some cases up to one hundred percent. To be eligible for mitigation, you need to ensure that your diligence is set up to meet the requirements of the various EPA policies, all of which require disclosures to be made within a specific (and short) timeframe. Remember also that while some disclosures are voluntary and are rewarded with penalty mitigation, other disclosures, such as under certain permits, are mandatory and the failure to disclose is itself another noncompliance. Given the pressures of the transaction, waiting for a problem to surface during the process is not the best approach. Balancing the timetable for closing the transaction with the timetable for resolving any noncompliances is not easy. As an aside, buyers will want to see as part of diligence copies of any prior audit reports and self disclosures.
If the buyer will want to change the manner in which the business is conducted, whether and how that can be done should be left to the buyer. Remember that expansions may require new permitting and that changes in regulations from when the initial plant was built may make such permitting difficult. If your products are marketed solely domestically for domestic use, remember that chemical products sold for use in other countries need to meet the chemical regulation requirements of those other countries. Do not assume that if a product is allowed to be sold in the
The work you do upfront preparing for the sale of your business will no doubt help you facilitate the transaction and obtain the most attractive after tax net profit. Good luck!
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you are out of the business. The buyer, on the other hand, wants to limit the liabilities for which it will be responsible and to quantify every liability it will assume so that it can factor the cost into the purchase price. It also wants to be assured that the business is currently in full compliance with the law, so it doesn’t buy a business that might expose it to criminal and civil penalties or burden it with additional costs to come into compliance.