Newsletters

The Real Deal - Spring 2022

Date: March 29, 2022

Minimizing Environmental Liabilities Post-Mergers and Acquisitions

By: Stephen E. Luttrell, Partner, Whiteford, Taylor & Preston LLP and Chris Alviggi, NFP - Environmental Practice Group Leader

Mergers and acquisitions contain representation and warranty clauses that tie directly to the knowledge of the seller and purchaser parties. In most transactions, the seller’s representations and warranties are heavily negotiated between the parties, as they are a principal mechanism by which the purchaser transfers some of its risks in the transaction from itself to the seller. In this way, the seller provides the buyer with specific assurance regarding the contemplated deal, including material items like ownership of the shares (or assets) being sold, historical payment of taxes, the accuracy of financial statements and efficacy of intellectual property. These representations also include environmental representations, which are qualified by disclosing known environmental items or sometimes given subject to the seller’s knowledge. Depending on the nature of the target company business, the unknown or latent consequences of actual or perceived environmental risks can present a significant transaction hurdle.
 
Phase 1 Reports Show the Risks
In most transactions, the purchaser commissions Phase 1 environmental reports for all sites contemplated in the transaction. Phase 1 reports are completed by licensed environmental engineers and include visual site inspections, database searches for fines, penalties, or notice of violations, and open public records act requests to municipal, county or state representatives. These reports provide the purchaser with a baseline of the environmental conditions of the contemplated sites and help the purchaser frame the environmental risks.

Depending on the results of Phase 1, subsurface investigations may be required to determine the type, breadth and scope of contamination. Ideally, environmental assessments will be conducted on all sites where an insurable interest exists, which includes (or should include) all owned, leased, rented and divested sites. However, circumstances may arise when an environmental condition presents itself, and the purchaser is unable to conduct sufficient investigations to adequately assess the risk, particularly its magnitude and potential costs. In that case, the purchaser is covered solely by the seller’s representations and warranties, which may be of limited value due to survival provisions, liability caps, disclosure or the financial strength of the seller.
 
Advantages of Representation and Warranty Insurance (RWI)
Many times, purchasers explore representation and warranty insurance (RWI), which offers great flexibility on survival (term), limit of liability and high-quality credit ratings for the insurers providing coverage. Additionally, RWI policies effectively replace seller indemnity for all representations and warranties so that in the event of a misrepresentation (breach) by the seller, the buyer can go directly against the RWI policy to be made whole for any diminution of value of the purchased company or asset resulting from the breach. This mitigates the risks of an unknown or unquantified environmental condition and may be particularly useful in securing financing for transactions involving sites with known or suspected legacy environmental risks.
 
RWI policies are almost always effective at the signing of the transaction (to protect against breaches of signing representations) and stay in place to cover closing representations, with a policy term of up to six years post-closing. These policies have an aggregate limit of insurance for all claims made, including environmental, though they can be structured to include a separate aggregate limit or sub-limit devoted to environmental breach claims.

If previously unidentified contamination is encountered post-close, RWI provides the purchaser with the monetary costs for implementing equitable relief if remediation becomes necessary or tort liability results, or other direct or third-party damages in the event of a covered claim. However, should an environmental condition trigger an RWI claim, purchasers are left to their own devices to formulate remediation plans, engage appropriate environmental and legal professionals, and engage regulators —which will proffer remediation benchmarks. Additionally, the purchaser will have to approve the use to achieve closure and issue formal closure documentation.
 
The Limits of RWI Policies
What are the main limitations of RWI policies? It’s important to note that RWI will be qualified by (and loss excluded) for items disclosed by the seller or that are in the actual knowledge of the buyer’s deal team, whether through Phase 1 reporting or otherwise.

The other potential limitation of RWI for environmental representation breaches regards the scope of the representations themselves. Environmental representations in purchase agreement generally contain three limbs:
  1. All the necessary permits are in place and current to operate the target business
  2. The target business has been compliant with environmental laws (usually limited by a “look back” period of several years)
  3. There is no soil or groundwater contamination at owned or leased premises
The first two limbs are generally insurable in an RWI policy. However, the third may not be for certain industries (heavy manufacturing, chemical, oil and gas) or sites with such historical usage, or where Phase 1 or other buyer diligence or disclosure has revealed environmental contamination. For such instances, specific environmental insurance coverage (such as PLL) is necessary to supplement RWI to protect against breaches of environmental representations and any disclosed issues (as discussed below).
 

Environmental Insurance Policies = Pollution Legal Liability

Environmental insurance policies, more commonly referred to as pollution legal liability (PLL), complement pollution coverage (to the extent provided) in RWI policies.

PLL provides coverage for:
  • Post-close discovery of previously unidentified contamination, either on-site or off-site
  • Post-close changes in remediation standards mandating purchasers to reopen/remediate previously closed cases
  • Loss of income due to corrective actions taken to remediate contamination
  • Third-party bodily injury arising from known and unknown contamination including:
    • Former employees of the seller who are not part of the transaction
    • Off-site exposure to neighbors or adjacent property owners
    • Toxic or occupational exposure to former employees of the named insured, including 1099 employees or other invited guests
  • Third-party property damages arising from pre-close or post-close contamination events include:
    • Damages to the environment
    • Losses resulting from societal trends such as economic justice
    • Third-party diminution in value (market perception of value and resulting spread)
  • Legal defense expenses arising from actual or alleged environmental releases
 
Furthermore, PLL policies provide enhancements designed to:
  • Indemnify and defend commercial debt for costs arising from environmental misrepresentations, discovery or releases
  • Provide insureds discretion on panel counsel
  • Provide discretion on choice of law and venue
 
The environmental insurance underwriting community takes different approaches to credit the potential availability of pollution coverage under an underlying RWI policy. In this scenario, underwriters will structure PLL policies as excess and difference in conditions (DIC) coverage over primary RWI policies. Some advantages to this approach include:
  • Complementing a 6-year RWI policy term with a 10-year PLL term
  • Abdicating responsibility for remediation and legal defense to a third-party insurer
  • Potential assignment of PLL
     
As noted above, insurance can play an integral part in mergers and acquisitions and, when done properly, hedges against post-close discovery of pre-close unknown events. Clearly, the design and placement of RWI and PLL policies are complicated undertakings. When deal teams (counsel/client and brokers regardless of discipline) work together, clients benefit from a fully leveraged insurance program. 

About Whiteford

Since 1933, clients have come to Whiteford, Taylor & Preston for trusted representation and guidance on issues critical to achieving their business goals. With over 180 attorneys, we provide a comprehensive range of sophisticated, cost-effective business law and litigation services. Our clients range from innovative start-ups to middle market companies to Fortune 100 enterprises. With a growing Mid-Atlantic footprint that includes seventeen offices in Delaware, D.C., Kentucky, Maryland, New York, Pennsylvania and Virginia, we serve clients regionally, nationally and globally.  
 

About NFP

Thanks to steadfast senior-level relationships with expert environmental insurance companies and our knowledge of international and domestic insurance and reinsurance environmental markets, NFP is able to devise strategies that leverage the marketplace for your benefit. Our understanding of all kinds of commercial insurance allows us to provide top-flight coverage maximizing environmental insurance recoveries for you if and when a loss occurs. Wherever you’re at in development, our experts can help you through the environmental insurance process and structure appropriate pollution liability coverage.

Introducing New Attorneys at Whiteford

We are pleased to introduce several new attorneys to our Real Estate Practice Group.


Derek J. Baumgardner
Counsel 
Baltimore Office
Focuses his practice on land use and zoning, environmental, regulatory and energy law matters.


Andrew J. Gerlowski
Associate
Columbia Office
Focuses his practice on commercial leasing, real estate finance, real property and franchise agreements, real estate development contracts, and mergers and acquisitions.


Aleia K. Plenty
Associate
Baltimore Office
Focuses her practice on real estate transactions including acquisition, development, financing, leasing and disposition of property.
The information contained here is not intended to provide legal advice or opinion and should not be acted upon without consulting an attorney. Counsel should not be selected based on advertising materials, and we recommend that you conduct further investigation when seeking legal representation.