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The environment and M&A transactions
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When acquiring a business, how much attention is paid to the environmental risks?

Tony Lennon, European Manager - Chubb Environmental Solutions, highlights why careful consideration should be given to environmental risk allocation when negotiating a transaction :

Buyers often rely upon warranties in the share purchase agreement (SPA) to protect them against the onerous consequences of pollution, but how much protection do they really get?

Warranties are often limited to the sellers’ awareness and may not provide adequate protection against liabilities at former sites, historic activities or previous management’s knowledge.  Warranties are also one step removed from the direct action which the buyer may face from third party claimants.  In addition, warranties may not provide recourse for indirect or consequential loss such as business interruption.  Warranties, by their nature, are historic in their view and do not provide protection against on-going pollution.  Limitations in an SPA typically restrict the buyer’s ability to claim, including through relatively short time limits, caps on quantum, and exclusions relating to changes in legislation.  If a company has polluted over a period of time and continues to pollute into its new ownership, there may be an allocation of loss between the warranties and the new owner’s acts.  The new owner may be liable for all contamination (including historic) where the previous owner no longer exists.  If the sellers spend their proceeds or use them to repay debts, the new owner may face liability with little prospect of recovery from the actual polluter.  The buyer may be uncertain about the sellers’ future credit worthiness.

Uncertainty relating to potential environmental risks may result in the sellers and the buyer having different expectations over the price that should be paid for a business.

If the new owner is faced with litigation and damages for environmental contamination, it must fund these losses and then go on to prove that those losses are covered by the warranties in the SPA and recover such losses from the warrantors.  Warranties and indemnities are obviously only as good as the financial covenant of the seller.

If the original polluter no longer exists and no recovery can be made via the warranties in a sale and purchase agreement, what other protection can the new owner rely upon?  General liability (GL) policies offer some protection from third party damages (not own site clean-up) but only for “sudden and accidental” pollution.  The new owner’s GL policy is unlikely to cover historic contamination for the period when the sites were under third party ownership, and the buyer may not have access to the seller’s historic insurance.  The buyer can carry out environmental surveys but these are not conclusive (phase-one reports are desk-based and phase-two reports may involve sampling but will not cover an entire site) and come with no guarantee.  Consultants’ reports are often limited in scope and buyers may enjoy limited access to the sellers’ sites prior to acquisition.  A consultant’s report may have been prepared for the sellers, not the buyer.

Chubb can offer flexible insurance solutions which can offer businesses comprehensive protection.  Our products can be arranged to offer cover for the following areas:

  • historic contamination (regardless of who the polluter was);
  • on-going/future contamination (during the policy period);
  • business interruption as a result of pollution;
  • legal expenses and damages arising from the pollution; and
  • loss covered by warranties and indemnities.

Cover can be provided on an annual basis or for a long-period policy of up to a maximum of ten years.  Cover does not exclude losses which result from changes in legislation.

When a buyer is purchasing a company or premises (including from a liquidator), it is worth considering whether the seller is providing adequate environmental protection or whether insurance can be arranged to offer the best protection.

Buyer’s insurance policies can offer additional benefits such as:

  • noting a lender’s interest on a policy where the acquisition is being financed;
  • naming the company as the insured, allowing the policy to benefit a future owner if the business or property is sold;
  • removing any buyer concerns over the credit worthiness of the sellers or warrantors;
  • greater comfort than that which might be afforded from surveys with limited scope or limited site access and investigation; and
  • removing environmental concerns which may affect the price which a buyer is willing to pay for a business.

In summary:

  • Environmental warranties are often limited to warrantors awareness
  • Warranties are typically limited to relatively short time periods and capped in quantum
  • Warrantors’ financial covenants may be weak compared to a well-capitalised insurer
  • Buying insurance now can be beneficial if you try to sell the business or property in the future
  • Insurance can often provide broader protection than that afforded by warranties, for example: Business interruption/consequential loss cover
  • If a site is contaminated over a significant period of time by several owners, the new owner may only be able to make a partial recovery under warranties or they may end up paying for 100% of the liability and legal costs
  • A lender’s interest can be noted on a policy
  • Surveys are limited in their scope and provide no guarantee that a site has no contamination
  • GL insurance covers only sudden and accidental pollution for third party damages (not damage to property owned of occupied by the Insured)
  • Insurance can protect against historic and ongoing exposures