How COVID-19 May Change Environmental M&A Due Diligence

By Michael Bittner
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Law360 (July 8, 2020, 3:49 PM EDT) --
Michael Bittner
Michael Bittner
The global coronavirus pandemic has brought into sharp focus a number of business processes and systems that will require diligent and focused attention as businesses reemerge into an altered landscape, and beyond.

Whether because of competing priorities, resource challenges or even complacency, many businesses have failed to routinely monitor and shore up crisis management plans, business continuity measures, workplace safety, supply chain logistics and other critical business processes.

Due diligence is one process that will surely be tightened up and enhanced post-pandemic. Acquisition targets will be scrutinized more closely in these areas than ever before.

A weakened global economy, changing business conditions, fear of an infection spike in the third quarter of 2020, and the pressing need to protect employees engaged in site assessments and follow-up work may reveal unexpected environmental, health and safety, or EHS, risks that will alter the practice of transactional due diligence.

No one can say for certain how environmental due diligence will change, but due diligence focus areas, future intended uses of properties and assets, the on-site assessment process and structure of closing conditions are likely to be impacted.

Legal counsel and their clients will be well served by preparing for these changes and positioning to navigate them effectively.

Due Diligence Focus Areas

EHS Compliance and Liabilities

The economic slowdown that accompanied the COVID-19 crisis has strained many businesses to the breaking point. To conserve cash, some companies have reduced headcount, idled plants or equipment, suspended ongoing environmental monitoring and compliance programs or negotiated complex pivots in their operations and products.

Some have also halted or reduced capital investments, infrastructure upgrades and critical maintenance activities required to protect facilities, employees and the environment. Post-pandemic due diligence investigations must go beyond traditional Phase I site assessments if they are to uncover potential EHS liabilities and risks associated with these operational changes.

Key related questions to address include:

  • Does the EHS function have sufficient staff to meet the company's regulatory requirements and other commitments?

  • Are EHS permits and procedures in place for all new or changing operations?

  • Is there a plan for safely getting idled equipment back online or shutting down additional operations?

  • How severe are potential EHS impacts associated with canceled or postponed infrastructure improvements, preventative maintenance and capital investment?

  • Were environmental reserves calculated using realistic assumptions, and are the reserves sufficient for likely future liabilities?

  • Are any contingent liabilities associated with contaminated sites likely to become more urgent if the primary responsible party seeks bankruptcy protection?

Coronavirus Response

Until an effective vaccine is available, investors must assess whether a company's past COVID-19 response was sufficient and sustained, whether plans are in place to manage the health impacts of future COVID-19 spikes or other pandemics, and whether the company can withstand additional business disruption.

Key related questions to address include:

  • Have adequate protective measures been put in place to protect employees and contractors?

  • Are future plans sufficient to protect the company in the event of a second peak of infections or a new pandemic?

  • How does the company assure employees and customers that they can work, shop, visit and buy safely?

  • Do the company's Occupational Safety and Health Administration safety statistics accurately report COVID-19 infections?

  • Are medical records and information related to employee testing, contact tracing and infections maintained and communicated in accordance with applicable legal requirements?

  • Does the company follow applicable guidance from public agencies such as the Centers for Disease Control and Prevention and the Occupational Safety and Health Administration?

Health and Safety Programs and Culture

Most environmental due diligence work scopes include only a cursory review of health and safety programs and culture. We can expect this to change in the future as investors look beyond COVID-19 response planning to an asset's ability to protect employees and customers in the face of changing business conditions.

Key related questions to address during due diligence include:

  • Does the company have a robust health and safety program supported by visible commitments from company and site leaders, appropriate resources and capable staff?

  • Have critical health and safety programs and procedures such as job hazard analyses kept pace with changing business conditions?

  • Has health and safety training continued or been cancelled? How will the company handle worker competence and training in the future if workshops and team training sessions aren't allowed?

  • Have social distancing changes in the workplace created additional hazards that have not been addressed?

  • Is capital investment required for safety equipment that accommodates changing workplace needs (e.g., installing lifting devices to replace manual team lifts)?

Business Continuity, Emergency Planning and Crisis Management

The pandemic has also brought the importance of emergency planning and crisis management into sharp focus. Preparedness and response plans must be updated to incorporate potential impacts to operations and staff including heightened awareness of EHS risks associated with business shocks and slowdowns.

Ideally, these plans and procedures would also be expanded to support the company's business continuity and supply chain resiliency programs more effectively.

Key related questions to address during due diligence include:

  • Have contingency plans been developed for all likely emergency scenarios? Are the plans accurate and complete, and are they periodically tested and improved?

  • Does the company have a robust process for business continuity planning, and is EHS included in the planning process?

  • Does the company have an ongoing program to ensure asset integrity, especially with respect to potential fires, explosions, runaway reactions, spills, leaks and releases?

  • Does the product stewardship program assure compliance with evolving product regulatory requirements and respond to events that threaten supply chain reliability?

  • Does the sustainability program adequately address stakeholder concerns and the effects of climate change?

Future Intended Uses of Property and Assets

The intended use of assets is likely to be of concern in the future given the financial difficulties experienced by many companies during the lockdown and the possibility that buyers may already have plans for facility closures, operational changes, divestitures or renovations.

These pressures will be accentuated by operational changes enacted during the pandemic, the need to apply social distancing guidelines to all work areas regardless of activity and the potential for onshoring of production facilities to reduce supply chain risk.

Evaluating assets based on historical operations may be insufficient for future operational planning. Thus, due diligence work scopes should also seek to answer the following questions:

  • Are there any regulatory triggers for site investigation or environmental remediation associated with site closure, lease termination or future sale of the business?

  • Have asset retirement obligations been accurately estimated for all sites?

  • Are asset retirement obligations sufficient to cover the costs of facility closure, decontamination, decommissioning and demolition?

  • Have hazardous building material surveys and environmental investigations been conducted to identify the presence of asbestos-containing materials, lead-based paint, polychlorinated biphenyls and contaminants such as chlorinated solvents and per- and polyfluoroalkyl substances that could require expensive remediation or abatement as part of facility renovation or closure?

  • Are proposed and approved capital investments sufficient to meet EHS regulatory requirements and control EHS liabilities and risks at each facility? Do they take into consideration the company's sustainability goals?

Changes in the On-Site Assessment Process

The on-site due diligence process is likely to change as law firms, consultants and companies seek to protect their employees from unnecessary coronavirus exposure. Possible changes include:

  • Increase the use of desktop reviews to prioritize asset portfolios and identify the highest-priority sites where in-person site assessments will be conducted.

  • Use remote reconnaissance technologies more frequently. For sites of large aerial extent, drones might be deployed for field surveys, while more detailed work can be conducted remotely using live-feed cameras embedded in smart pads and tablet computers or virtual reality glasses operated by site personnel or consultants.

  • Complete detailed travel risk assessments and project planning before on-site work is conducted. Consultants will likely be required to prepare safety plans and carefully coordinate with site contacts to ensure that site tours and document reviews can be completed using proper social distancing precautions.

  • Increase the size of due diligence teams to accommodate the additional areas of expertise required to address changing scope elements. Specialists in health and safety, process safety, asset integrity, product stewardship and hazardous building materials are likely additions to the environmental due diligence team of the future.

  • Address staffing challenges associated with accommodations provided to employees who are unable to travel or are uncomfortable with the perceived safety risks associated with a particular site visit. These accommodations could result in the use of more expensive senior staff, less experienced junior staff or employees from other offices who need more time and budget to travel to the site.

Closing Conditions

The changing face of EHS due diligence could also be reflected in modified closing conditions that must be negotiated by legal advisers representing buyers and sellers. The impacts of COVID-19 may result in the need for additional time to evaluate and document key closing conditions.

Representations and Warranties

Buyers and sellers may struggle to agree on the level of detail to be included in representations and warranties, including:

  • How to forecast and represent the operability of plants and equipment;

  • Liabilities associated with work-related employee illness or death caused by coronavirus exposure;

  • Status of EHS compliance during the pandemic; and

  • Sufficiency of environmental reserves and identification of potential litigation related to customers, suppliers and contractors who were adversely affected by the company's operations during the pandemic.

Material Adverse Conditions

Additional effort will likely be required to define the grounds and trigger points for terminating proposed purchase and sale agreements to accommodate the effects of future infections and changing business conditions that result in material impacts.

Insurance Agreements

More time will be required to negotiate an ever-expanding list of new and changing insurance conditions focused on exclusions for coronavirus infections, losses due to business disruption and representations and warranties indemnities.

Affected Sectors

Companies with a high-touch customer interface, including restaurants, bars, gyms, hotels, resorts, retail stores, office buildings, cruise lines, airlines, rental car companies and the enterprises that supply and support them, will likely be most impacted by the COVID-19 financial crisis.

Some of these businesses will bounce back quickly when travel restrictions are lifted. Others could continue to suffer, becoming targets for future operational changes, including acquisitions and divestitures. Sectors that were already struggling such as specialty chemicals, mining and processed foods, will need to negotiate changes in customer behavior, softening demand and erratic global supply chains or risk becoming financial casualties and takeover targets themselves.

Energy companies and oilfield services firms, which were affected by the sudden drop in oil demand and price, will likely struggle until rising demand depletes accumulated stockpiles of oil. All of these sectors could see strong deal activity as stronger companies and investors seek to eliminate competitors, capture sector cost synergies, diversify product lines or acquire bargains.

Among the likely winners from the pandemic are social media and e-commerce giants, which have seen continued growth in subscribers and revenue; data centers; transport and logistics providers that specialize in last-mile delivery; and manufacturers of high-tech products that facilitate low-touch customer interactions.

These companies, which have been buoyed by surplus cash, may actively seek strategic investments and bolt-on acquisitions.

Conclusion

Regardless of the focus or process changes that may lie ahead, the fundamental intent of environmental due diligence will remain intact: to identify, evaluate and report potential EHS liabilities and conditions that can adversely affect an investment.

Legal advisers must work with their clients in these uncertain times to prepare well-crafted due diligence strategies and work scopes that not only address changing business imperatives, but also protect the health and safety of the individuals engaged in evaluating the target assets.



Michael Bittner is a principal and the director of post-merger integration services at Ramboll Group A/S.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

For a reprint of this article, please contact reprints@law360.com.

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