If you recently made an acquisition or may make one in the future, consider using the USEPA’s recently published “Interim Approach to Applying the Audit Policy to New Owners” (Interim Approach) to provide a “clean start” on potential environmental liabilities. Under the Interim Approach, when new owners discover, disclose and correct violations that began prior to the acquisition, the USEPA will grant penalty mitigation beyond the reductions allowed under the “Incentives for Self-Policing: Discovery, Disclosure, Correction and Prevention of Violations” (Audit Policy). USEPA established this Interim Approach because it:

recognizes that there are equitable and policy arguments that a new owner should not be penalized for the full economic benefit relating to violations that arose before a facility was under its control, if that new owner is willing to promptly address such violations and make changes to ensure that the facility stays in compliance in the future. (Emphasis added).

Under the Interim Approach, USEPA will consider an owner “new” and eligible for “new owner” treatment for nine months after the date of a closing. During that period, the “new owner” can choose to make disclosures in either one of the following two ways:

  •  By entering into an audit agreement that specifies the facilities to be audited, the scope of the audits, and the dates for completion of audits and disclosure of violations.
  •  By making individual disclosures, as violations are discovered, within 21 days of discovery, or within 45 days of the closing, whichever is longer.

In addition, EPA is taking a special approach for Clean Air Act violations. While under the Audit Policy any violation that is required to be reported is not eligible for penalty relief, under the Interim Approach, there is a limited exception for certain required reporting of air emissions. If the new owner either discloses the violation in writing or enters into an audit agreement with the USEPA before the new owner’s Title V Operating Permit first annual compliance certification is due, the new owner is eligible for the penalty mitigation benefits.

There are at least two benefits to entering into an audit agreement. The audit agreement:

  •  “stops the clock”’ with regard to the need to promptly report violations within 21 days of discovery as required in the Audit Policy. This extra time is especially helpful at a complex facility where numerous violations may need to be reported.
  •  “stops the penalty clock” with regard to “violations that involve required monitoring, sampling or auditing,” if the new owner enters into an audit agreement prior to the first instance when such monitoring, sampling, or auditing is required.

An audit agreement may be entered into through a formal bilateral agreement or by an exchange of letters that reflect a meeting of the minds and contain appropriate commitments. Although the new owner identifies the facilities and scope of the regulatory programs to be audited, the EPA is “reserving its right to negotiate about the scope, timing, and sequence of the audits and disclosures.” Thus, it is best to be prepared for a broad audit if you are considering entering into the audit agreement. Further, although the deadline to enter the audit agreement is nine months, the USEPA will consider extensions if the delay is caused by them. Therefore, the request to enter into the agreement should be made as soon as reasonably possible after an acquisition.

In this Interim Approach, the USEPA accepts the pre-closing due diligence as the Environmental Audit that would be the basis for the reporting of violations and obtaining penality relief under the Audit Policy. Therefore, no new audit expenses may have to be incurred to obtain the penality reduction benefits of this Interim Approach.

USEPA also will not scrutinize or consider indemnity agreements that new owners have with sellers, although where the circumstances and equities warrant, the USEPA reserves its right to pursue sellers for violations that are disclosed and corrected by new owners. Accordingly, buyers and sellers may wish to craft pre-closing agreements to address these contingencies.

We have one note of caution regarding the decision whether to use this Interim Approach. Because this is a USEPA policy, you must consider whether the state regulators may take a more aggressive view of the reported violations. Where the violations of regulations are enforced only by USEPA, there obviously is less concern.

In summary, under this Interim Approach, if violations are corrected within 60 days of discovery or some other agreed upon time, the USEPA will not seek penalties from a new owner: (a) for violations that occurred prior to the date of acquisition; and (b) for the economic benefit associated with (i) delayed capital expenditures; (ii) avoidance of operations and maintenance costs; and (iii) unfair competitive advantage that may have resulted due to the delayed compliance. This Interim Approach seems best suited to new owners who are confronted with the prospect of investing significant capital to correct violations that began prior to their ownership and may well persist into the future.

The USEPA decided to implement this Interim Approach on a trial basis commencing on August 1, 2008 and will accept comments on the Interim Approach until October 30, 2008.