Bernardo Freitas Thiago Riccio Marcela Assis June 29 2022 Environmental liability in M&A transactions – what are the risks? Freitas Ferraz Advogados | Corporate Finance/M&A - Brazil Bernardo Freitas, Thiago Riccio, Marcela Assis Corporate Finance/M&A IntroductionCivil environmental liabilityAdministrative environmental liabilityCriminal environmental liabilityAsset purchase transactionsShare purchase transactionsJoint venture transactionsEnvironmental liability cross referencingIntroductionIn Brazil, any company that harms the environment can be civilly, administratively and criminally liable for the same act (article 225, section 3 of the Constitution). Although the procedures to investigate each of these three forms of liability are independent, the consequences and penalties arising from them can overlap. This means a company can be simultaneously condemned to pay damages (civil liability), a fine (or suffer another type of administrative penalty, ie, administrative liability) and even to suspend its business (or suffer another criminal sanction, ie, criminal liability) if it harms the environment.Because of those risks, environmental liability has become a sensitive topic in M&A. Two questions arise from this subject:Is the buyer liable for all seller's acts – related to the target company or its asset, and carried out before the transaction – that could cause any harm to the environment?Do the buyer's environmental risks change depending on the type of transaction (asset purchase agreement, share purchase agreement or joint venture)?Civil environmental liabilityAccording to the Environmental Policy (article 14 of Federal Law No. 6.938/1981), the civil environmental liability is strict (meaning, it does not investigate whether the company had any part in causing the environmental damage). In fact, it depends solely on three elements:conduct – the act carried out by the agent (regardless of whether such act is compliant with the law);damage – any harm caused to the environment; anda causality relationship – a causality connection between the conduct and the damage.Therefore, if a company causes damage to the environment, it will be civilly liable regardless of whether it is guilty of breaching the law.The Supreme Court of Justice has escalated such provision by deciding in numerous cases that defences such as force majeure, acts of God and fault by third parties do not exclude a company's civil environmental liability. Besides that, the Court understands that the obligation to repair environmental damage is connected to the properties' ownership (precedent 623). In other words, if a company purchases a property from a seller that had illegally deforested environmentally protected areas, the buyer must repair the environmental damage caused by the previous owner.As a consequence of this kind of liability, the company must repair the damage:by recovering the damaged area;by paying damages; orthrough environmental compensation (that could include reforesting areas with similar flora or financing an environmentally sustainable project).Administrative environmental liabilityUnlike environmental civil liability, environmental administrative liability depends on fault (meaning, a company will only be liable if there's proof that it has been negligent or acted unlawfully to cause the environmental damage). This type of liability arises from non-compliance with regulations set out by environmental agencies.Once the administrative proceeding that investigates this liability is concluded, and the environmental agency does not rule in the company's favour, the company might receive a warning or be subject to the following penalties, according to the severity of the harm caused by its acts:fines;daily fines;suspension of selling or manufacturing products;partial or total suspension of activities; andrestrictive sanction of rights.Criminal environmental liabilityAs with administrative liability, Brazilian criminal environmental liability also depends on fault. Besides that, among other fundamental rights, article 5, XVIV of the Constitution provides that no criminal penalties can be transferred or inherited from one person to another. It is the fundamental right to the individuality of criminal penalties.Another important aspect regarding criminal environmental liability in Brazil is the fact that it applies both to individuals and companies (article 3 of Federal Law No. 9.605/1998). Therefore, a company's criminal liability can extend to those who knew about the crime but have not prevented it from happening when they could have (eg, directors, officers and auditors). However, since companies cannot be detained, they are subject to other penalties, such as:fines;partial or total suspension of activities;services to the community;prohibitions to execute contracts with the government; andtemporary bans on the activity.In the event of a financial penalty, the corporate entity may be disregarded to prosecute the shareholder's assets when the corporate veil represents an obstacle to the compensation of the damages caused.Asset purchase transactionsAn asset purchase transaction happens when a company directly acquires one or more assets from another company. Once the transaction is closed, the buyer does not become the seller's shareholder, and the seller remains the owner of all those assets the buyer has not purchased.On the one hand, since the administrative and criminal environmental liabilities depend on fault, in an asset purchase transaction, only the seller responds for the administrative infractions and crimes it had committed in connection to the purchased assets. On the other hand, the buyer might be liable for the environmental damages the seller has caused in connection with the ownership of the assets. In other words, the buyer inherits the civil liability along with the purchased asset.Share purchase transactionsThrough a share purchase transaction, a buyer acquires the shares of a target company from one or more of its shareholders. Once the transaction closes, the buyer indirectly inherits the rights and obligations of the target company. As the target company is a legal entity with its own rights and obligations, it remains liable for the environmental liabilities that exist before the transaction. As soon as the buyer becomes a target company's shareholder, it indirectly assumes not only its assets but those previous liabilities, including the environmental ones.Therefore, in a share purchase transaction, the target company remains administratively, criminally and civilly liable for its previous acts. The buyer will be indirectly affected by such liabilities as a shareholder of the target company (except in cases of piercing the corporate veil, in which cases the buyer becomes directly liable). It is important to highlight that, because of the fundamental right to the individuality of criminal and administrative penalties, the buyer cannot not be directly held liable for previous acts committed in non-compliance with environmental criminal law or environmental administrative law.Joint venture transactionsA joint venture transaction comprises a transaction in which two or more companies cooperate or associate for a common purpose, such as to develop an enterprise or a project. Joint ventures may have two structures:non-corporate joint ventures, in which two or more companies cooperate or associate by executing a contractual agreement (only a contractual arrangement is executed and there is no creation of a new legal entity arising from the joint venture); orcorporate joint ventures, in which two or more companies cooperate or associate by creating a new company – the new company will be responsible for developing the enterprise or the project (the "newco").In the former, the companies must directly perform their obligations accordingly to the contractual arrangement, while in the latter, each company must comply with the articles of association of the newco, which will be the agent responsible for directly carrying on the joint venture's activities and businesses.In a corporate joint venture, only the newco is civilly, administratively and criminally liable (except in cases of piercing the corporate veil, where the relevant shareholder may be held liable). On the other hand, in non-corporate joint ventures, each partner may be held directly liable for the environmental damages, as there is no company to limit their liability.Environmental liability cross reference The information in the below cross-reference table regarding liability succession is from the buyer's perspective. This table was created based on the majority understanding and precedents on the matter. Asset purchaseShare purchaseCorporate joint ventureNon-corporate joint ventureCivil responsibilityYesYesYesYesAdministrative responsibilityNoNoNoYesCriminal responsibilityNoNoNoYesFor further information on this topic please contact Bernardo Freitas, Thiago Riccio or Marcela Assis at Freitas Ferraz Advogados by telephone (+55 31 4141 0308) or email ([email protected], [email protected] or [email protected]). The Freitas Ferraz Advogados website can be accessed at www.freitasferraz.br.