Optimal transaction structure and environmental risk
Selection of the structure for transactions typically depends on business conditions and tax considerations, but findings made in environmental due diligence are also beginning to play a greater role.
Development of the structure for a planned transaction requires the involvement of legal, tax and financial advisers to identify the optimal model for all of the parties. One element that should be considered when selecting the transaction model is the allocation of risks of liability under environmental laws.
Under different transaction variants, legal succession with respect to rights and obligations connected with environmental protection differs, and often the acquirer of real estate, an industrial installation or a company conducting industrial operations assumes the seller’s liability for environmental violations. Moreover, depending on the type of transaction, the rules for passage of rights and obligations under permits for operation of an installation or conduct of a specific type of business will differ. The situation is further complicated by the fact that sometimes the transaction structure that is desirable for business or tax considerations is unacceptable from the environmental point of view because it requires the investor to assume significant environmental liabilities. In such case, it is necessary to apply additional legal solutions to properly secure the interests of the investor. Sometimes this will require abandonment of the previously agreed transaction model.
When developing the transaction structure, it should be borne in mind that environmental considerations may exert a positive impact on the structure (assuring the acquisition of entitlements) as well as a negative impact (bearing risks of assuming liabilities).
In the case of a transaction involving an entity conducting operations requiring an integrated permit, industry permit, or other decisions connected with the environmental impact of the operations, the more beneficial model may prove to be one involving a merger of companies (because of the automatic entry into the legal situation of the target) or acquisition of shares. In the case of shares, the holder of the administrative decisions will not change. In such transactions it is generally not necessary for the investor to obtain new permits or to conduct procedures connected with transfer of rights and obligations under the existing permits.
The public-law nature of permits means that they are controlled by the public administrative authority. The parties therefore cannot cause the rights under the permits to pass from one party to another through the provisions of their own agreement. In the case of transactions involving an enterprise or specific assets, it is therefore necessary to conduct a procedure for transfer of the rights and obligations under the existing permits or to obtain new permits.
The selection of a specific transaction structure may also be influenced by the acquirer’s efforts to limit the liability of the target. A frequently asked question is whether a material risk identified in due diligence can be eliminated through a change in the structure of the planned transaction (e.g. by acquisition of specific assets instead of shares in the company) or through remedial measures undertaken by the seller. In the case of remedial measures, this is probably very difficult if not impossible, particularly if the time frame for the transaction is short. If the investor acquires shares in the target, it must realise that the company it has taken control of will continue to be liable for events that occurred prior to the transaction. Acquiring only selected assets may allow the liability to be left behind with the seller.
In some cases, an audit by environmental consultants or environmental legal due diligence may reveal a particular risk connected with specific assets, such as contamination of one site, the presence of a closed waste dump, or the like. A large risk of potential liability or costs for remedial measures or reclamation has a major impact on the financial terms of the transactions, resulting in the investor’s demand for a reduction in price. But the buyer and seller often differ in their evaluation of the risk arising out of such circumstances. In such situations it may prove more beneficial to carry out a transaction including or excluding specific assets.
In the case of operations carrying a specific risk of liability under environmental law (e.g. the potential for an ecological disaster), the parties may decide on a transaction structure assuring that the assets connected with those operations are spun off into a separate entity, maintaining the construction of a limited-liability company or joint-stock company, thus limiting the risk of the shareholder’s liability for the operations of the company.
Factors favouring a share deal
Performance of environmental testing, including assessment of contamination of soil and water within the real estate to be acquired, and a risk assessment based on the test results, enable the parties to develop a transaction structure which is a compromise reconciling the interests of the buyer and the seller. Structuring the transaction on the basis of a share deal model will be favourable for the buyer if:
- The target company conducts operations requiring numerous environmental permits, and the permits have been obtained and are valid and adequate for the company’s operations. In that case, the buyer will avoid the need to conduct administrative procedures for transfer of the rights and obligations under the permits, or to obtain new permits if the permits cannot be transferred.
- The subject of the transaction is a special-purpose vehicle created to carry out a development, and the SPV has obtained a decision on environmental conditions, zoning decision, building permit, and the like.
- The seller will be in favour of a transaction involving shares in a limited-liability company or joint-stock company because acquisition of all of the shares will transfer full control of the company. Under this type of acquisition, the buyer will step into the company’s existing legal situation along with all obligations arising out of environmental violations, environmental harm and so on. Thus the seller will free itself of such liabilities.
Factors favouring an asset deal
A transaction involving selected assets will be a desirable model in cases where:
- A risk of financial liability (e.g. for administrative penalties or increased fees) is identified in due diligence. In such cases, acquisition of assets will generally not result in automatic assumption of the financial exposure.
- Certain assets are connected with a risk of liability for environmental harm. If certain real estate is contaminated and requires remedial measures or reclamation, the possibility of excluding the property from the transaction may be considered.
- The subject of the transaction does not involve significant permits or administrative decisions, or they can easily be transferred to the investor.
Dominik Wałkowski, Mergers & Acquisitions Practice, Wardyński & Partners
See also D. Wałkowski, “Selection of Transaction Structure,” in D. Wałkowski & I. Zielińska-Barłożek (eds.), Environmental Law in M&A and Real Estate Transactions (Warsaw 2014), pp. 281 and following.