Environmental Risk Can Be M&A Hazards

Take nothing for granted or at face value, and asks lots of questions. These were the watchwords delivered at a seminar on environmental solutions for mergers and acquisitions recently sponsored by insurance broker Marsh in New York.

According to John L. Cusack, senior vice president for Marsh Environmental Solutions, statistics show that 70 percent of mergers and acquisitions fail.

Peter B. Walther, managing director of Marsh Private Equity and M&A Services, added that not only has the rate of M&A activity slowed since 2000, but also that the Enron scandal has made buyers and their financiers skittish about risk.

For a buyer who wants a successful merger or acquisition, one important element of the deal is to quantify the environmental liabilities, Mr. Cusack said. Contamination affects the value of a property and the reputation of a company, he stated. Moreover, the more certainty a buyer has about the risks and liabilities it is undertaking, the more favorable financing terms it will find.

Daniel R. Lavoie, senior vice president and environmental group leader in Marsh Inc.'s New York office, who served as panel moderator, discussed some of the many insurance options available for handling environmental issues in merger and acquisition transactions.

For unknown environmental risks, the most widely used policy is the pollution legal liability policy, which goes by several other names in the marketplace, he said. The policy provides first- and third-party protection for sudden and gradual releases from new and pre-existing contaminants.

Legal defense coverage is another important feature of the policy, given the rising legal costs in environmental litigation, Mr. Lavoie said.

Other coverages under a pollution legal liability policy can include first-party business interruption expense, diminution of value of the site, natural resource damage restoration costs, and liability coverage related to the governmental re-opening of a pollution case against a company, he stated.

The major benefit of the pollution liability policy is the rapid decision-making in the underwriting process as well as flexibility in scope and pricing, Mr. Lavoie said. Underwriters understand that every merger deal is unique, and they are willing to suggest creative solutions to suit the client and the particular transaction, he stated.

For known environmental issues, Mr. Lavoie said, remediation cost cap or stop loss insurance is a desirable option. He emphasized this point by noting that 65 percent of all environmental cleanups exceed budget by at least 10 percent.

A cost cap policy can be an acceptable alternative form of financial assurance to support indemnities and releases exchanged in a merger or acquisition, Mr. Lavoie said. It also can cover cost overruns related to the transportation and disposal of waste, the discovery of unknown and pre-existing contamination and natural resource damage restoration.

For Mr. Lavoie, the major benefit of a cost cap policy is that it transforms the uncertainty of environmental cleanup costs into a manageable, finite number.

But because the cost cap policy lacks a liability component, Mr. Lavoie said, Marsh often counsels its clients to merge the pollution liability policies with the cost cap policies to take care of both known and unknown risks.

Another available tool is secured creditor coverage, Mr. Lavoie stated. It protects lenders for loss arising from default of commercial real estate loans made on properties that have an environmental condition. The coverage also gives the lender third-party liability coverage for bodily injury, property damage and cleanup costs associated with a default, Mr. Lavoie said.

One benefit of secured creditor coverage is that it can be used in large securitizations to improve a company's credit rating, he noted. Having the coverage also establishes that funds are available for the payment of losses and facilitates the closing of transactions on property that is environmentally impaired, he said.

One of the newer solutions Mr. Lavoie described for managing environmental risk in M&As is “environmental liability cleansing.” This involves spinning off environmental liabilities into a special purpose vehicle “and then wrapping an environmental insurance program around that,” he said.

David T. Freeman, of counsel to the New York law firm Paul, Hastings, Janofsky & Walker, stressed the importance of “very thorough” due diligence by a buyer or the financier in a merger or acquisition.

The panelists suggested that good due diligence helps the acquiring company to construct a more accurate risk profile of the target company and to uncover hidden liabilities such as uninsured or underinsured risk exposures, insolvent insurers or coverage gaps.

Mr. Freeman outlined basic steps to effective due diligence and risk allocation in an M&A transaction, including:

Start early by reviewing existing data about the site such as permits, past or present enforcement actions and public records, inspecting the site, and testing the soil and/or groundwater.

Begin with the end in mind by developing a strategy for addressing and resolving environmental risks at an early stage of the negotiations. This would include defining who pays for cleanup and who controls the cleanup decision-making process, Mr. Freeman said.

Understand the concerns of environmental regulators.

Consider all possible solutions to save a deal, such as reducing the purchase price, cleanup cost-sharing, third-party acceptance of specific site cleanup responsibility and the buyer's offer of representations, warranties or indemnities.

As noted by Sengal M.G. Selassie, director of New York-based SG Capital Partners, LLC, who offered a “private equity perspective,” the buyer in a deal has enough risks and does not need surprise environmental risks as well.

“You can sleep better at night knowing that [the environmental risks] are being taken care of” through insurance and other means, he said.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, July 15, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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Environmental Risk Can Be M&A Hazards

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