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3 ways to reduce environmental risk in your transaction

Environmental risk is inherent in the purchase and sale of assets. Understand your environmental exposures and the impact they can have on your strategy.
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by Kimberly Mann , 

Senior Vice President, Environmental Practice

05/15/2023 · 3 minute read

Despite today’s difficult macroeconomic environment, merger and acquisition (M&A) activity remains an important component of companies’ plans for strategic growth. But transactions are under increased scrutiny, underscoring the need for both buyers and sellers — whether in the US or abroad — to understand and employ creative solutions to reduce their risks. These include identifying and addressing any environmental exposures that could impact the return on investment, and in some cases derail the transaction itself.

Many organizations — especially those in the chemical, oil and gas, and power generation industries as well as real estate investors and developers — have become more aware of potential environmental risks inherent in a property transaction. Existing property contamination or pollution conditions, for example, can result in significant environmental liabilities, which could require costly remediation and substantial monitoring expenses. Regulatory action for natural resource and biodiversity damage may lead to hefty fines and penalties. Organizations may also face third-party liability and mass tort claims, which often bring about significant legal defense expenses.

Mitigating environmental risks

Organizations can reduce their risks and increase the likelihood of a successful transaction by taking three steps:

1. Conduct thorough environmental due diligence

Carry out a comprehensive review of environmental risks as part of the transaction due diligence process. It is important to keep in mind that environmental risks can arise gradually; some liabilities may not be readily apparent. Consulting with environmental professionals early to help you identify and quantify the expected costs of both obvious and potential hazards is critical. This will allow you to begin to evaluate suitable solutions — such as contractual indemnifications, purchase price adjustment, escrow or holdbacks, regulatory programs, and insurance — early in the transaction process.

Buyers should

Have a clear understanding of environmental risks being assumed through their investment.

Sellers should

Ensure they are adequately transferring liability from the business/property being sold to avoid any unanticipated legacy risks.

 

2. Include clear indemnification clauses in the purchase agreement

Attracting financing during a difficult economic period with high interest rates can be challenging, especially when an investment has known or potential environmental contamination risks. Identifying contractual ways to transfer these risks can increase lender comfort and help you secure financing. When designing the transaction agreement, seek to create clarity regarding known or suspected environmental conditions, and which party will assume liability. This will allow both parties to devise the appropriate solution to address their potential liabilities. It is important to review any indemnification clauses with your legal counsel to help you understand the extent of your protection and your potential exposures.

Buyers should

Understand and maximize the use of regulatory and contractual protections from known or suspected environmental conditions.

Sellers should

Confirm their counterparty’s financial capability to perform on contractual indemnities.

3. Use specialty risk transfer solutions

Once you have a clear view of your organization’s potential liabilities and their impact on your balance sheet, work with your insurance broker or risk advisor to develop an insurance solution that is tailored to your risks and can help you mitigate identified environmental threats that could impact your property. Specialty environmental risk transfer products, such as pollution legal liability, excess of indemnity insurance, and environmental liability buyouts, can help reduce risks for both buyers and sellers.

Buyers can

Attract more competitive financing options by transferring environmental risks to the insurance marketplace and further distancing their investors from exposures.

Sellers should

Consider using environmental insurance solutions to satisfy buyers and potentially eliminate post-closing escrow obligations that could tie up valuable capital.

Whatever the size of the transaction and irrespective of the industry, buyers and sellers will likely face environmental risks. Careful due diligence, clear indemnification clauses, and a tailored environmental risk insurance program can help you address these challenges and successfully close a deal. 

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