Environmental Risk in Corporate Transactions

The law in the UK relating to environment is complex. Individuals, companies, other bodies and organisations can be caught by the legislation as can their directors and officers. There are, broadly speaking, three bases on which a person may be liable in respect of environmental matters:

• Compliance – a person may be liable for acts or omissions in the course of running a business (i.e. operating without an environmental permit or causing water pollution).
• Clean-up – a person may be liable as a result of the presence of contamination on or under land in which that person has an interest. The contaminated land regime is retrospective, it covers contamination regardless of when it was caused. Owners and occupiers may be liable for clean up caused by previous uses of the site.
• Third parties – third parties can bring actions for damages and in some cases injunctions in relation to problems such as excessive noise, soil or groundwater pollution.

Environmental liability can have very serious and expensive consequences, taking the form of criminal liability resulting in fines and/or imprisonment; service of an enforcement notice by the relevant regulator, civil liability resulting in payment of damages; and clean-up under the contaminated land regime.

Frequently an environmental audit is undertaken by or on behalf of a company or buyer. Such investigations can include due diligence, site visits and property audits. However, such enquiries can be time consuming and expensive.

There is no standard answer to the question of who should bear environmental risk in a transaction. The buyer will say that it should be fully protected and why should it accept environmental risk in relation to matters which are outside its control and which have arisen prior to the date of the transaction? The seller will say that the proper approach is to consider what represents a fair allocation of environmental risk in the transaction. Whether or not liability arises may depend on future changes in law and practice. The seller’s view is these are beyond its knowledge or control and should be treated as future risks borne by the buyer.

The two main bases for liability are: causing or knowingly permitting an environmental problem; and ownership or occupation of site where an environmental problem exists. The structure of the corporate transaction is relevant to risk allocation. By way of general principle in a share purchase any environmental liabilities incurred by the target company before completion will remain with the company after completion. If a buyer buys only the assets of the company which operates the business, then it does not inherit all of the environmental liabilities associated with the business and the site.

The sale and purchase agreement is likely to contain a number of detailed warranties and indemnities plus mechanisms designed to limit the claims. Subject to negotiation, these limitations may be varied or added to take account of environmental matters in terms of cap on liability, time limits and percentage sharing liability.

Breach of warranty will give rise to a claim in damages if the warranty was untrue and the effect of the breach is to reduce the value of the company or business acquired. It is a general principle that where a specific problem has been identified and it has been agreed that risk should be borne by the seller, then an indemnity ("pound-for-pound" recovery in respect of costs and liabilities) is the way to achieve this. Unlike a warranty, there is no need for the buyer to establish that it has suffered loss which stemmed from the liability. The buyer may also seek a price reduction, if a serious problem is disclosed.

It is increasingly common for an environmental indemnity to be given by the seller, and even more difficult for the seller to justify refusing to give environmental warranties or indemnities as buyers and lenders continue to develop stringent policies regarding the assumption of environmental risk.

As a risk management tool the parties may consider obtaining environmental insurance cover, which protects against different environmental risks (i.e. land contamination or warranty and indemnity cover). Such policies have become increasingly obtainable in recent years, although the cost varies. Involving specialist insurance brokers as early as possible in the negotiations, could result in potential deal breaking points being addressed early. Although commercial reality is such that the need for insurance may not become apparent until the parties reach a deadlock in late stage negotiations.

Reconciling the position of the seller and the buyer in relation to risk allocation on environmental matters on a corporate transaction is likely to continue to result in some heated boardroom negotiations. The debate is only set to continue.