Of all the potential banana skins that await a private equity firm once it has acquired a target company, finding it has inherited contaminated land as part of the deal is surely one of the most slippery. After all, the investor in question may have done nothing wrong – and yet still find itself identified as a guilty party and facing meaty financial penalties to rectify the damage.
That certainly now appears to be the case in the UK following the landmark court decision reached in Circular Facilities (London) Ltd v Sevenoaks District Council earlier this year, in which a property developer was served with a remediation notice requiring it to clean up land that had been polluted by a previous owner – a state of affairs the developer knew nothing of when the acquisition of the land was made.
The conclusion drawn by London-based law firm Lovells in a newsletter article reflecting on the case sends a warning: ?It is not inconceivable that in certain circumstances property owned or occupied by a [private equity] portfolio company could be classified as contaminated land and portfolio companies have liability even though they had no direct responsibility for the contamination.?
The situation is no less precarious in the rest of Europe, where countries have many ?different liability patterns, according to Edward Keeble, a partner at the London office of international law firm Slaughter and May. He says that in a large deal, where the target company has operations in, say, six different European countries, the best advice to the acquirer may be to assume an overall reasonable worst case in terms of potential liability and adopt the ?highest common denominator (i.e., make allowance in your budget for being subject to the more onerous of the six regimes) because ?you can't always afford to hire six different legal teams and analyse all of the differences? .
What is more, the future harmonisation of European laws in this area is not likely to bring any respite. On April 30,2007, the pan-European Environmental Liability Directive will be transposed into the domestic law of member states. According to the Lovells article, it will ?impose strict prospective liability for rectifying contaminated land and water.?
NOT THAT INNOCENT
In the US, the situation is somewhat different. On the face of it, greater protection is afforded would-be investors through the use of the ASTM (American Society of Testing and Materials) Phase I standard. ASTM requires various investigations to be carried out including the review of a variety of government and regulatory databases; direct enquiries of the regulators; interviews with current site personnel; and an overview of adjoining property. Completion of these investigations gives the buyer so-called ?innocent purchaser status and provides a bulwark against future claims.
However, US regulators are currently drawing up more stringent standards to be finalized either later this year or in 2006. The standards, known as the AAI (All Appropriate Inquiry) protocol, will require interviews not only with current operators of facilities but past owners, occupants and employees; a review of government records for both the subject property and adjoining properties; and identification of engineering controls applicable to the property and within a 0.5 mile radius of the property.
The exacting nature of the new standards may mean that private equity firms are unable to attain them. Says Emma Farthing, a principal at environmental consultancy ENVIRON: ?AAI will make much greater demands in terms of the time required and the depth of the information, and you won't meet those demands within the time-frames or confidentialities of the due diligence process. Enquiries of authorities, neighbours or former employees as required under AAI would just not be possible within the constraints of a typical private equity deal.?
So what practical problems arise from the increasingly stringent demands of environmental best practice? According to Edward Keeble, there is the ever-present potential for different views of risk as between a private equity bidder and its debt financiers. ?Private equity firms often have a robust approach toward risk, he says. ?They might be willing to take a risk on a potential liability so long as they can put a num, bto it, but they may have to get their funders to a higher level of com-fort. This can be a major stumbling block to the completion of deals.?
Louise Moore, a partner in the environmental, health and safety practice at Lovells, says that private equity firms should focus on ensuring they know exactly what the liability is, undertaking appropriate due diligence and factoring any potential liabilities into the pricing of a transaction. ?Proper forensic testing can be the difference between the success and failure of a venture, she says.
A further consideration for private equity firms is whether to take outan insurance policy. In a European context, for example, this would take the form of a property transfer policy, which is offered by a number of major insurance groups. The policy could be framed to cover an unforeseen liability, or alternatively to cover greater liability than that originally envisaged (for example, where an anticipated liability of £1 million ends up being £5 million).
Not that private equity firms are insensitive to cost, of course. Says one leading London-based lawyer:? I tend to waste a lot of brokers' time because these policies are expensive, meaning they tend to be looked at but not ultimately bought. However, given the direction in which the regulatory wind appears to be blowing, one might find more private equity firms digging just a little deeper into their pockets.