Every business making an acquisition needs to have a complete picture of what they are getting for their money – including risk as well as opportunity. Environmental risk is one example of the former that has sometimes been overlooked in merger and acquisition (M&A) activity.
Buying a business exposes the acquirer to the target’s environmental liabilities. These need to be planned for carefully to avoid jeopardising the deal, with insurance potentially having a significant part to play.
In some cases, environmental risk will be visible. A target may come with a site where there is a known source of pollution, say.
However, it is also possible that environmental liabilities only emerge after deal completion – perhaps pollution on the site is only discovered some months later.
Either way, this risk needs to be addressed to the satisfaction of both parties. Sellers are understandably keen to pass on responsibility for pollution they have caused – wittingly or not – to the new owner so they can achieve a clean exit.
Buyers, on the other hand, are anxious not to be on the line for unexpected costs; they need to understand the potential environmental liabilities upfront so they can take a measured view about what to accept.
What pollution means
This issue is becoming ever more important in the M&A process as environmental issues rise up the agenda and regulators around the world take a tougher line. And the list of risks is a long one – examples of pollution include:
- Historic pollution – a site may be contaminated by work done in the past; any projects undertaken by a new owner could release this pollution.
- Soil pollution – this may be gradual and ongoing, occurring because of buried waste, poor storage of raw materials or leaking pipelines or tanks.
- Water pollution – this could emanate from both direct spills and run-off, with pollutants finding their way into groundwater or rivers.
- Air pollution – a one-off incident due to an accident is one risk, but acquirers also need to understand the carbon footprint of their targets.
- Odor – sites may cause bad smells that damage quality of life or even pose a health risk; this can lead to legal claims from those affected.
- Loss of biodiversity – where pollution damages plant life or the natural habitat of animal species, particularly in protected areas, companies may face prosecution or other types of legal action.
It’s not just the potential sources of environmental risk that acquirers need to understand. They also need to assess how pollution and contaminants might find a pathway to where they’ll cause harm – through soil or groundwater, for example.
They must also identify the “receptor” that will be harmed by the contamination – the fish in a river, say, or a local population.
The role of insurance
With so much at stake, Environmental Impairment Liability (EIL) insurance can help both buyers and sellers navigate their way through deal complexity in this area. EIL can cover both known and unknown future liabilities for pollution, capping off a potentially complicated risk.
That reassures buyers – and may enable them to improve their bid where they’re competing for an asset. It also helps sellers by ensuring they can make a clean exit, and by increasing the pool of potential bidders with those who might otherwise have been deterred by environmental risk.
Importantly, EIL policies can usually provide much higher limits and more extended coverage terms than the escrow arrangements that have often been used to manage risk in an M&A process.
EIL policies come in different shapes and sizes. But the goal is to fill the gaps in general liability and property insurance policies. The former may pay out for a sudden and accidental pollution incident, but neither type of policy typically covers cases of gradual pollution, statutory or first-party clean-up costs, biodiversity damage or loss mitigation.
Similarly, most warranty and indemnity policies have a blanket exclusion for all claims related to pollution.
By contrast, EIL can cover all environmental liabilities, whether or not they are passed on by contract, including both known and unknown historic pollution risks, and new pollution that arises after deal completion.
