Following on from the article in the previous edition of this newsletter, we consider the importance of carefully considering environmental concerns when carrying out due diligence on a business or property transaction.
The Environmental Framework
Across the UK at least 30 new pieces of environmental Unlike health and safety law, there is no primary piece of legislation governing environmental concerns in the UK as 'the environment' is so extensive in scope. Environmental legislation in the 1990s was largely concerned with controlling point-source pollution, for example discharges to water, land or air. Since then the focus has expanded to encompass producer responsibility obligations, liability for historic land contamination, regulated incentive schemes to encourage energy efficiency and market intervention to influence consumer decisions. Which environmental laws will be relevant to due diligence will largely depend on the nature of the target, whether a property or a business. For businesses, due diligence will also consider, current and historic activities and what properties are owned or occupied now or in the past.
In addition, under the devolution settlements for Scotland, Northern Ireland and Wales, policy responsibility for the environment resides with the devolved administrations. Organisations that operate in more than one UK jurisdiction need to be aware of the differences that are emerging between them.
legislation have come into force every year since 2006. There are many consultations each year on proposed legislation and policy. An awareness of future investment requirements necessitated by legislation, for example in respect of energy efficiency performance of rented non- domestic properties (see below) and the impact that environmental legislation may have on key supply chains or markets will enable a more accurate value to be placed on a target business.
The consequences of failing to undertake effective due diligence can include incurring criminal and civil liabilities, remediation costs and penalties and damage to reputation and brand values. Changes to the Sentencing Guidelines in England and Wales from 1 July 2014 mean that the larger an organisation is the greater may be the financial incentive to avoid criminal penalties.
As we noted in our previous article, the key concerns will be determined by the type of activities undertaken. We have listed some of the main areas to watch out for below.
Land Contamination - whether buying a company or a property, the maxim "caveat emptor" (buyer beware) should be borne in mind. The statutory framework for securing the remediation of land that is causing or is likely to cause unacceptable risks to human health or the environment affects only a very small proportion of properties. However, liability for historic contamination can be attributed to innocent purchasers who become knowing permitters of the presence of contaminative substances. There is no time limit on liability for causing or knowingly permitting the presence of contaminative substances where land is identified as contaminated under the Environmental Protection Act 1990 Part 2A, so liabilities may emerge many years after a property has been disposed of.
In fact, the Part 2A regime was designed to be a measure of last resort and the vast majority of contaminated land clean-ups take place within the planning system as land comes forward for redevelopment. The costs of remediation can be very considerable indeed. Other issues that may arise in connection with land that is in a contaminated state include civil liabilities for damage caused to third parties from migrating contaminants and other regulatory regimes concerned with environmental protection. The costs of business disruption and remediation to ensure that land is fit for the purpose the buyer intends should also inform the due diligence process.
Effective due diligence will enable a prospective purchaser to understand the condition of the land that is being bought and, in the case of companies, the properties that they have previously owned or occupied and may have potential liabilities in connection with. The allocation of liabilities and risks as between buyer and seller will usually be addressed in the transaction. It may be in the interests of either party to investigate the availability of insurance to further minimise exposure to risk.
Permits - It is important to check that the target business has the relevant environmental permits, as well as any other permits, consents or registrations that the business requires, including in respect of the activities it undertakes and the wastes it generates. Sometimes businesses can operate for some time without necessary permissions, e.g. trade effluent discharge consents, waste exemption registrations, particularly as the environmental permitting regime has changed since 2007. Careful attention should be paid to the wording of permits to check that the buyer will be able to comply with the requirements following completion. Permit compliance failures may indicate that the business cannot be viably operated within the limitations of the permit conditions, which goes to the heart of a transaction. Producer Responsibility – to reduce the generation of certain wastes, producer responsibility regimes place obligations on businesses across a supply chain, from manufacturer through distributor to retailer. For example, undertakings that handle more than 50 tonnes of packaging materials a year and have an annual turnover in excess of £2m have a Packaging Waste Obligation to achieve directly or through membership of a compliance scheme specified targets for the recycling of certain waste streams. Other producer responsibility schemes cover electronic and electrical equipment, batteries and cars. If a business has failed to appreciate the existence of a producer responsibility obligation it will have committed a criminal offence and the costs of securing compliance may be substantial.
Energy Efficiency – owners, occupiers, landlords and tenants of non-domestic properties should consider the potential for obligations under existing and emerging energy efficiency requirements. A target undertaking may be subject to the new Energy Saving Opportunities Scheme. For landlords in particular, the draft Minimum Energy Efficiency Standard Regulations that were the subject of recent public consultation envisage that all eligible properties in England and Wales will have to be improved to an E rating before being let to tenants under a new lease on or from 1 April 2018. Lease renewals from that date will be treated as a new lease. In addition, all non-domestic private properties will be required to comply with minimum energy efficiency standards by 1 April 2023. Effective due diligence will better enable a buyer to understand future investment requirements and an informed seller will be better placed to secure an acceptable allocation of responsibility in the transaction.
Climate Change – Many companies participate in regulated carbon reduction schemes, including Climate Change Agreements, the EU Emissions Trading Scheme and the Carbon Reduction Commitment. Information disclosed during due diligence should assist in determining the likely impact on the status of the buyer’s group under CRC or EU ETS of the addition of the target business. The Seller will need to determine what changes the disposal of the target business will have on its own status.
Environmental reporting – is the target company subject to any reporting requirements such as carbon emissions reporting and monitoring under the EU Emissions Trading Scheme, the CRC Energy Efficiency Scheme or the forthcoming non-financial reporting requirements for large companies? Will the acquisition of the target business change any reporting obligations?
Habitats and Species – if a property is used by European protected species or business activities are capable of impacting on protected habitats and species then buyers
need to ensure they are aware of the extensive legal protection that is afforded to such habitats and species and what steps they should take to ensure compliance and minimise the risks of business disruption. The presence of invasive species should also be looked into – if enacted, proposals in the draft Infrastructure Bill 2014 could require landowners in England and Wales to take action on invasive non-native species.
Documentation – what to look out for
As we noted in our previous article, it is vital to check that the due diligence documentation is up-to-date and that there is evidence of regular review. If issues have been identified – either in audits or reviews, or following an incident, then clarification should be sought as to whether an action plan has been put in place and if there are any follow-ups outstanding.
Many businesses that carry out processes or industrial activities will require an environmental permit, for example for carrying out a regulated activity, for waste treatment, recovery and disposal and for discharges of waste waters into the environment. It is important to check that the target business not only has the correct permits for its operation, but also that it is has been acting in compliance with the conditions imposed on permits. If a buyer purchases a business that has failed to comply with its environmental permits it could be taking on liability for criminal prosecution and significant fines.
Reports and searches
Buyers should consider obtaining environmental screening reports to check for any potential issues that may not be disclosed by the seller, principally the risk of onsite and offsite contamination. If concerns are raised about contamination on a site the buyer may wish to investigate further by instructing environmental consultants to carry out Phase 1 or 2 site investigations – the latter involving intrusive soil and groundwater sampling – so they have a better understanding of the extent of any future remediation required or exposure to liabilities.
Any recent accidents or incidents may lead to an investigation and potential enforcement action by the Environment Agency or local authority. Details of any actions or investigations against the target business should be requested, including communications from third parties, such as neighbours, who may have any complaints about the operations of a business as this could result in future regulatory enforcement.
What steps should you take to avoid any pitfalls?
- Heads of terms – consider environmental issues at heads of terms stage, in particular the apportionment of contaminated land liabilities. This will inform the extent of due diligence that is appropriate.
- Careful planning – make sure sufficient time has been set aside and that everyone involved is aware of any time/cost constraints.
- Don't take the information provided by the seller at face value – check that the documents provided tell the whole story, ask questions and spend time talking to the seller and management about the target business. Existence of an environmental management system indicates an intention to secure compliance and improve environmental performance but will not be a guarantee that all is as well as it may appear.
- Involve experts as soon as possible to ensure technical points are picked up and appropriate provision made in the sale documents, and to avoid delays if any issues are identified.
- Consider the potential for future environmental requirements to impact on the target business, the likely costs of ensuring compliance and the impact on the market of the target business.
Thoughtful due diligence plays a key role in the successful purchase of a company or an asset, by providing the buyer with the information to make an informed decision about whether or not to go ahead with the deal and at what price. Contractual protections such as warranties and indemnities are not a substitute for due diligence in terms of dealing with potential environmental risks. Although risk can never be totally eliminated, careful due diligence should ensure the buyer goes into the deal with its eyes open.