This article provides an overview of the importance and benefits of an environment and health and safety due diligence process when acquiring a corporate entity or its assets and highlights how the information gathered during the process can be utilised prior to and post-completion
In corporate transactions, the need for environment and health and safety (EHS) due diligence can be overlooked and its importance underestimated. This often stems from a lack of appreciation of the risks involved or a desire to control costs.
It is not often appreciated that clean-up costs for historic contaminated land can be one of the largest financial risks in any transaction, that many offences carry strict liability and can carry unlimited criminal fines.
This article provides an overview of the importance and benefits of an EHS due diligence process when acquiring a corporate entity or its assets and highlights how the information gathered during the process can be utilised prior to and post-completion.
The scope and importance of EHS due diligence
The scope of due diligence will largely be determined by the sector in which the target operates, as well as the size and the nature of the proposed acquisition (such as whether it is a share sale or an asset sale). Usually organisations within higher risk sectors, such as manufacturing, construction, energy/utilities and healthcare, threaten greater EHS liabilities, but inherently all businesses involve some level of EHS risk. Therefore, while some level of EHS due diligence is always advisable, the level and extent of the due diligence scope can be tailored for each transaction, depending on the potential risks involved.
Having an EHS lawyer on board from the outset of a due diligence process ensures that many areas of the target business can be scrutinised. Typical areas of analysis include:
- reviewing desktop environmental searches (which include contaminated land) and flooding searches;
- considering whether the target has the appropriate permits and licences in place to operate the business lawfully and reviewing whether statutory inspections have been carried out;
- detailing any historical, ongoing or anticipated EHS incidents which may attract regulatory enforcement action from the Environment Agency or Health and Safety Executive;
- highlighting any liabilities or risks arising from any fire risk assessments or asbestos reports of any properties included within the transaction;
- assessing the company’s general approach to EHS with a review of its internal policies and procedures for managing EHS risk and whether those are implemented, embedded and regularly reviewed; and
- assessing various other areas of EHS law such as modern slavery, legionella, food safety, COSHH and waste management, to name a few.
As you can see, EHS due diligence covers a broad spectrum of issues and will look carefully at the target’s compliance with EHS laws. Breaches of EHS laws can attract third party claims, as well as unlimited criminal fines and criminal prosecutions which cannot be indemnified or insured against. On a share sale, this is even more pertinent given that, post-completion, a buyer is essentially ‘stepping into the shoes’ of the seller and may inherit many EHS liabilities by virtue of the transaction. It is important that these risks are identified and managed at the earliest opportunity during the transaction timeline.
Benefits of EHS due diligence as a strong negotiating tool
A thorough due diligence report will provide an in-depth and holistic view of EHS liabilities of a target, providing buyers with visibility into the business and any current or historical operational risks. This can be an invaluable tool during the negotiation process. Depending on the results of the due diligence, a buyer has many potential options at its disposal:
- Leverage to negotiate a better and fairer price which better reflects EHS risks, site conditions and any remedial works that may need to be undertaken.
- Negotiate ownership of liabilities, for example allocating responsibility for the cost of remediation action and liabilities under the contaminated land regime. For the seller, depending on the nature of the transaction, it may give them an opportunity to offload such EHS liabilities that may have otherwise stayed with them post completion and giving them a ‘clean break’, so it is beneficial for both parties to discuss ways to address any identified problems.
- Request warranties or indemnities from the seller to protect it from any future liabilities which may arise from any risks identified.
- Require the seller to remedy specific issues pre-acquisition to bring the organisation into compliance (for example, carrying out remedial works, commissioning fire risk assessments or securing relevant environmental permits to run the business lawfully). The seller may prefer this rather than accepting a price chip as it may have its own consultants in mind where they are able to manage the costs.
- Purchase environmental insurance which may protect itself against potential risks.
- Walk away from the transaction - the buyer may feel that the EHS risks are so serious as to cause it to reconsider the potential investment altogether. The importance of EHS due diligence is that it allows the buyer to make informed decisions about its potential investment.
Post-completion
Inevitably, there may be some minor issues identified during the due diligence process, which are not considered serious enough to consider within the negotiation but still warrant rectification and/or active management by the buyer post-completion.
Where there are these outstanding issues, by entering into a purchase with awareness of any EHS problems that need to be rectified, a buyer will be able to hit the ground running post-completion by taking heed of the recommendations. For example, by carrying out appropriate due diligence, the buyer is more likely to be aware of the need to take actions such as notifying regulators of a change in ownership, reviewing EHS policies and procedures, transferring permits or reviewing the asbestos management plan in order to operate the business lawfully.
Early and thorough due diligence ensures that a prudent buyer can address any EHS issues and avoid potentially crippling liabilities and any associated adverse reputational risks. Although due diligence may not unearth every single risk in every single transaction, it provides an invaluable and useful platform from which to negotiate the deal and to address any outstanding issues post-completion.
For more information or advice, please contact a member of our environmental regulatory team.
The authors would like to thank Isabelle D’Arcy for her assistance with this article.
