Companies that have recently acquired, or are planning to acquire, upstream oil and gas assets are beginning to take note of a recently proposed EPA program offering the possibility of penalty relief for Clean Air Act (CAA) violations.
For the past ten years, the EPA's 2008 Interim New Owner Audit Policy has encouraged new owners of oil and gas assets and others to voluntarily discover, disclose and correct environmental violations in exchange for partial liability relief (2008 Audit Policy). Although largely hailed as a success, the 2008 Audit Policy has several limitations which have arguably stunted its true potential – namely, a costly, protracted negotiation process and uncertain protections against post-acquisition noncompliance penalties.
This past May, in recognition of the numerous acquisitions occurring within the oil and gas sector and in an effort to provide "efficiencies and certainty" to this sector, the EPA published a draft template agreement titled "Oil and Natural Gas Exploration and Production Facilities New Owner Audit Program Agreement" (the New Audit Agreement). This proposed New Audit Agreement is meant to enhance – not replace – the 2008 Audit Policy and is geared specifically to CAA violations associated with upstream operations – eg, well sites, including associated tank battery vapor control systems. The new program presents penalty and transaction cost reductions beyond those provided by the 2008 Audit Policy and if adopted, should prove especially helpful to entities that have recently acquired, or are planning to acquire, upstream oil and gas assets, and, in particular, those with a history of CAA violations.
Under the proposed program, a new owner may utilize a standardized template agreement and to achieve penalty forgiveness and releases of liability from the EPA for self-disclosed and timely-remedied violations of the CAA. The EPA views this new program as a unique "opportunity for timely and cost-effective Clean Air Act compliance" for the upstream oil and gas sector, separate and apart from the 2008 Audit Policy.
The original 2008 Audit Policy provides a new owner with significant, but not total, liability relief. If the new owner enters into an audit agreement with EPA and meets the conditions of the EPA's April 11, 2000 policy on "Incentives for Self-Policing: Discovery, Disclosure, Correction and Prevention of Violations,"commonly referred to as the Audit Policy, the new owner receives the following liability relief:
- Total elimination of gravity-based civil penalties
- Partial elimination of economic benefit penalties, or only those associated with avoided operation and maintenance costs that pre-date the acquisition and
- No penalties associated with delayed capital expenditures or with unfair competitive advantage.
The protection scheme of the 2008 Audit Policy does not protect new owners from "economic benefits" of non-compliance penalties. In addition to this gap in protection, the 2008 Audit Policy does not have a pre-approved template agreement. Consequently, new owners looking to avail themselves of the protections of the self-audit policy must negotiate a bespoke contract with the EPA, with compliance and timing terms that are unique to the company and facility. This iteration process is often costly and time consuming.
By comparison, the New Audit Agreement offers certainty through clearly defined penalty mitigation and a standard template agreement that aims to reduce transaction costs, improve efficiencies, and help to define and eliminate liabilities that can bog down the acquisition process or complicate operations for new owners. Unlike the 2008 Audit Policy, this proposed program provides penalty relief for economic benefit gained through noncompliance post-acquisition. Although in practice post-acquisition economic benefit is rarely penalized, the time and cost to negotiate such penalties can be excessive. Indeed, in many cases, the transaction costs associated with arguing the final, de minimis economic benefit exceed the ultimate penalties imposed. By eliminating the need for an economic benefit analysis as part of the self-audit policy, the new proposed program should help streamline the audit process and provide needed certainty to acquiring companies.
The most significant component of the New Audit Agreement is the plug-and-play draft template agreement. This standardized agreement, which allows users a certain amount of personalization, will considerably reduce overall transaction costs associated with drafting and negotiating individual contracts with the EPA. Such costs – coupled with unknown outcomes – have obstructed the success of the 2008 Audit Policy. With a template agreement in place featuring terms pre-approved by the EPA concerning the audit and correction schedule, as well as compliance categories and other items, administrative cost savings are destined to be significant.
The New Audit Agreement also offers a potential solution to straddle liability issues – or violations by the previous owner which continue to exist after the facility has been acquired by a new owner – which, pre-Closing, can bog down negotiations between buyer and seller and post-Closing, give rise to challenging indemnity claims. The New Audit Agreement template offers an additional pathway for buyers and sellers to allocate responsibility for these matters. Since the acquirer can more efficiently and definitively obtain releases of liability by participating in the proposed program, parties could conceivably limit any agreed indemnity to the costs of remedying identified violations.
Additionally, the New Audit Agreement program offers a unique opportunity for financial buyers who seek to divest assets within several years of their acquisition. Specifically, the program provides newfound certainty around the financial implications of noncompliance with the CAA. By participating in the proposed program, qualified buyers who voluntarily disclose and remedy violations can obtain releases of liability from the EPA as well as full penalty forgiveness. The agreement is fully transferable to any subsequent owner of a participating facility, bringing with it all benefits and obligations originally secured by the initial acquirer. Thus, the risk profile of facilities that participate in this proposed program is significantly lower.
Release of the final draft of the proposed New Audit Agreement is projected for September or October. In the interim, the EPA has reported that it will entertain requests to participate in this new program. Companies that wish to participate may be able to do so while the draft remains in the public comment phase.
We anticipate opportunities to mitigate and adapt risk strategies in the near future and are actively monitoring developments to the proposed program. In the interim, we are available to work with you to determine if the New Audit Agreement Program is right for you or your contemplated transactions. Learn more about this development by contacting either of the authors.