By Joachim Grittmann and Kristina Marx

A rise in costly post-acquisition environmental disputes has meant buyers are increasingly evaluating a target’s environmental compliance before completing a transaction. The sheer variety of regulations concerning environmental protection, coupled with the speed and frequency of regulatory change, means companies are forced to continuously adapt their activities to new circumstances and thresholds to avoid penalty.

In Germany, for example, a recent amendment to the German Law on Recycling and Waste (now the Recycling Act) and the implementation of the IED Directive has forced German companies to re-visit their environmental compliance. Under the amendment, producers are now obliged to reduce the overall effects of resource use and improve the efficiency of its use, in particular, through avoiding the generation of waste and through recycling. The IED Directive requires companies to adjust their operations to new emission thresholds and implement best available techniques to prevent and control industrial pollution.

As the goalposts of environmental compliance are consistently changing, acquirors need to assess the target’s liabilities across its entire supply chain to mitigate the potential for post-acquisition environmental disputes.

Managing Environmental Risk in M&A Transactions

Ultimately, the business activities, location, site history and environmental risk management strategy of a target will determine the extent to which environmental compliance will impact an M&A transaction. To avoid disputes, parties to an acquisition should seek to:

  • Determine the scope and implications of applicable environmental regulations: Diverse permission procedures result from different statutes and regulations. Parties to an M&A transaction therefore need to understand all permits to identify non-compliance. Amongst others, considerations include authorisations for operating an installation, use of groundwater and discharging water, handling and placing certain chemical substances on the market and interfering with nature.
  • Understand specific jurisdictional regulations in cross-border transactions: Although some basic principles under environmental law are alike in several jurisdictions, such as the “polluter pays-principle”, it is critical for the transaction that all specific risks in each relevant country are covered. For example, in Germany, the German Soil Protection Act not only holds the party who caused the contamination responsible for remediation, but also the former owner if the property was transferred after March 1, 1999. It is therefore crucial from a buyer’s perspective that any indemnity covers contamination on formerly owned sites of the target company or group.
  • Identify the existing and potential environmental liability risks related to the target: Owing to the high cost risks associated with environmental contamination or material non-compliance, an accurate analysis of environmental risks prior to signing is indispensable to buyers. It is common practice in M&A transaction to conduct Phase I Environmental Assessment Reports, which are carried out by an environmental consultant. During the course of due diligence, buyers should not only request such reports, but also conduct a critical review of the findings.
  • Negotiate a tailored environmental agreement that mitigates risks from a contractual perspective: It is important to agree a comprehensive environmental liability provision with limited references to specific jurisdictions. In particular, buyers should focus their attention on the list of definitions. Many M&A disputes primarily focus on the question of whether particular facts fall under the scope of such definitions. To cover all relevant regulations, contamination and substances, definitions such as “Environmental Laws”, “Environmental Liability”, “Environmental Contamination” or “Hazardous Substances” should be broad. Ultimately, the environmental liability regime could also include a sliding scale, balancing the particular risks for both parties by allocating liability over several years on a pro rata principle. The actual distribution will typically be subject to intense negotiations between the parties.

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