Legal Intelligencer
(by Ben Clapp)
The risk transfer transaction structure is being increasingly employed in Pennsylvania and elsewhere as industrial site owners seek to clear long-tail environmental liabilities off their balance sheets. Commonly known as an environmental liability transfer, these transactions generally involve the purchaser acquiring the real property and other assets associated with an industrial facility and assuming responsibility for all environmental liabilities associated with that property, including site closure, demolition, and environmental remediation obligations. Often, the purchaser agrees to assume all such liabilities regardless of whether they arose prior to or after the purchaser’s acquisition of the facility. The purchaser also commonly provides a release of liability and indemnity to the seller. The costs associated with the purchaser assuming these obligations and liabilities are then deducted from the value of the assets being acquired to arrive at the transaction price. This price is frequently “upside-down,” with the seller paying the purchaser to acquire the property and assume its obligations.
While environmental liability transfers have been around for years, the transaction structure appears to have increased in popularity recently as power generators and other industrial companies are motivated to divest non-core assets and reduce environmental expenditures. In the power sector in particular, a shift away from coal-fired electricity generation has left power producers holding old coal plants that are closed or rapidly nearing closure, and ancillary assets such as coal ash landfills, all of which come with hefty environmental carrying costs. On the other hand, these properties are often well-suited for redevelopment, being industrially zoned, with access to electricity transmission lines and, often, shoreline infrastructure. Companies specializing in acquiring properties through environmental liability transfers believe that they can address environmental issues more efficiently and cost-effectively than the previous owners, leaving them well-positioned to profit by redeveloping the property and either selling or operating it once environmental obligations have been satisfied.
While relatively easy to conceptualize, environmental liability transfers can pose legal and technical challenges. Obviously, a seller will want to ensure that they are reducing their exposure to residual liability for a given site to the greatest extent possible. However, a seller generally cannot eliminate its exposure to statutory environmental liability arising from its past ownership or operation of a facility by simply contracting away that liability to a third party. For example, Section 107(e) of the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA” aka “Superfund”), makes clear that “[n]o indemnification, hold harmless, or similar agreement . . . shall be effective to transfer from the owner or operator of any . . . facility or from any person who may be liable for a release or threat of a release under [CERCLA], to any other person the liability imposed under [CERCLA].” 42 U.S.C. § 9607(e)(1). This provision does not bar contractual arrangements allocating CERCLA liability between private parties. See 42 U.S.C. § 9607(e)(2). It simply means that the government will continue to have a claim against a party liable under CERCLA regardless of whether that party may have contracted with a third party to assume that liability.
As long as the purchaser remains a viable party with the financial wherewithal to honor its contractual indemnification obligations, and those obligations are sufficiently robust to cover any environmental liability that may arise, the seller can feel comfortable that it is largely protected from residual environmental liabilities. To that end, a seller should employ a suite of contractual, legal and financial protections designed to insulate itself from environmental liabilities that were assumed by the purchaser. Contractual protections include drafting provisions relating to the buyer’s assumption of liabilities that are broad enough to ensure that the seller is not inadvertently retaining liabilities relating to pre-closing operations that were intended to be assumed by the buyer. The contract should also include an acknowledgement by the buyer that it is acquiring the property “As Is, Where Is, With All Faults” and a provision releasing the seller from any claims by the buyer arising from the environmental condition of the property and other liabilities assumed by the buyer. The seller should also seek an indemnity from the buyer, whereby the buyer agrees to indemnify and defend the seller for the assumed liabilities, including all claims arising under environmental laws. Other contractual provisions, such as covenants requiring the buyer to perform certain environmental obligations, and provisions conditioning closing on the satisfaction of certain events such as the transfer of material permits or obtaining key regulatory approvals may also be required depending on the circumstances of a given transaction. The seller may also be subject to consent orders or similar instruments obligating it to perform remediation or other environmental compliance activities at the subject property, in which case the parties may seek to engage with the applicable regulatory authorities to modify such instruments to replace the seller with the buyer as a party. Another key consideration is that financial assurance posted by the seller to secure its environmental obligations will need to be replaced by financial assurance posted by the buyer.
The buyer should feel comfortable taking on these obligations provided that they are confident that they are assuming only those liabilities that they are being compensated for assuming, and that the compensation they are receiving is sufficient to cover the costs of those obligations. Thus, from the buyer’s perspective, a careful review of the contract’s assumed liabilities is required, likely involving input from real estate, environmental and corporate counsel, among others. The contractual review should complement a robust due diligence process that provides for an accurate accounting of all demolition, remediation, restoration, closure and other activities that will be required at the property. This process also involves input from counsel, as well as various contractors and one or more environmental consulting and engineering firms. Buyers will also often seek to protect themselves from unknown environmental liabilities through the purchase of environmental insurance products.
For upside-down transactions, where the seller pays a sum to the buyer on or after the closing date, a final consideration for the parties is how the transaction price will be distributed to the buyer. The seller should take steps to ensure that the funds it pays are put to use for their intended purpose. If the funds are extinguished prior to the completion of work the buyer has agreed to perform, and the buyer becomes bankrupt, the seller runs the risk that some or all of the environmental liabilities it has attempted to contract away will revert to the seller. To avoid this scenario, the parties will often agree to have the transaction funds placed in an escrow account. An independent engineer is employed to track the progress of the work being performed by the buyer, as measured by the achievement of certain agreed upon milestones. Upon verification by the independent engineer that a certain milestone has been achieved, the escrow agent is instructed to release a predetermined amount of funds to the buyer. In this way, the seller is provided with a level of protection against the insolvency of the buyer, while the buyer is ensured of receiving the funds it needs to complete the work.
Environmental liability transfers can be complicated contractually, require technical expertise and are diligence-intensive exercises. However, when well-executed, an environmental liability transfer is a “win-win” for the buyer and the seller and can benefit the surrounding communities as well when an idle industrial property is put back into productive use.
Ben Clapp is a shareholder of Babst Calland. Mr. Clapp’s transactional work, which straddles the Firm’s Environmental and Corporate practice areas, consists of advising clients on the environmental components of complex deals, including identifying and analyzing significant environmental liability and compliance issues arising in connection with mergers and acquisitions, asset sales, project financings, and corporate restructurings, and working to resolve, manage, allocate or mitigate these environmental risks in the client’s best interest. Contact him at 202-853-3488 or bclapp@babstcalland.com.
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Reprinted with permission from the December 15, 2022 edition of The Legal Intelligencer© 2022 ALM Media Properties, LLC. All rights reserved.