FULLY Understanding Environmental Due Diligence: Mitigating Risks in M&A Transactions

Why Getting (Just) a Phase I ESA Is a Bad Idea for Your Business

In the fast-paced world of property investments, venture capitalism, & mergers and acquisitions (M&A), savvy companies understand the critical importance of due diligence, particularly when acquiring industrial facilities.

While Phase I Environmental Site Assessments (ESAs) are standard practice, they often fall short of providing a complete picture, focusing primarily on historical and current contamination issues (which are within the scope of a Phase I ESA) and missing deeper regulatory compliance and future opportunity aspects, all of which are outside of the Phase I ESA scope.

We often see companies put too much emphasis on the traditional view of a Phase I ESA (which is still absolutely critical in all transactions, and at each location) while neglecting other potential environmental concerns that are just as risky - and which could have easily been identified and remedied during the due diligence phase! This narrow focus can leave companies vulnerable to hidden liabilities and missed opportunities.

Our team of experts is here to help you navigate these complexities - if you're looking for the highest quality environmental due diligence, reach out to us here at RMA to get started.

So, what else should these companies be considering? Let's dive in!

Traditional View: Phase I Liability Contamination Issues

Phase I ESAs are typically the go-to for initial environmental due diligence. Conducted in accordance with ASTM standards, these assessments aim to identify potential environmental contamination resulting from historical and current practices and conditions, both on- and off-site.

They primarily focus on historical site uses and visible environmental concerns, brought about by releases of petroleum products or hazardous substances to the environment. However, this traditional view often overlooks nuanced regulatory compliance issues and operational deficiencies that could pose future risks, and which lie outside of the scope of a Phase I ESA. In fact, many Phase I practitioners may not even be qualified to fully evaluate these non-scope – but vitally important – environmental concerns.

Phase I assessments tend to (only) look for the “big ticket” contamination issues. Think of them as a surface-level check-up that identifies what are called “recognized environmental conditions” as defined by the Phase I standard, mostly related to releases to the environment of petroleum products or hazardous substances. While these are undeniably important, they don’t tell the whole story. Relying solely on Phase I can leave companies vulnerable to hidden liabilities that aren’t immediately apparent.

The Real Picture: Regulatory Compliance and Day-to-Day Operations

M&A transactions should go beyond Phase I assessments to address the full scope of environmental liabilities. Regulatory compliance issues, often neglected in standard due diligence since they are considered “non-scope” items, present a significant area of risk.

Many transactions fail to investigate operational compliance thoroughly, overlooking deficiencies in permits (such as NPDES permits), SPCC (Spill Prevention, Control, and Countermeasure) plans, RCRA hazardous waste handling and management requirements, and required environmental reporting, such as Toxic Release Inventory (TRI) reporting and Tier II Community-Right-to-Know reporting - and more! These day-to-day compliance issues can lead to unexpected fines and other penalties (which can be significant), and other legal actions post-acquisition.

For instance, a facility might have a squeaky clean Phase I report, but could be non-compliant with air quality permits, NPDES regulations, or hazardous waste management practices. Such non-compliances can result in substantial fines and operational disruptions, impacting the profitability and reputation of the acquired entity. A truly comprehensive due diligence process should go beyond the "big ticket items" and assess the operational aspects and compliance history of the facility.

Beyond Risk: Future Opportunities and Environmental Performance

Forward-thinking companies recognize that robust environmental performance is not just about risk mitigation but also about capitalizing on future opportunities. Facilities with strong sustainability practices and proactive environmental stewardship reduce regulatory risks and attract investors, customers, and partners who value sustainability in today’s marketplace. By enhancing these aspects, companies can unlock potential market advantages and cost savings, positioning themselves as leaders in environmental responsibility.

This perspective involves identifying and leveraging opportunities for improved environmental performance. Companies that excel in sustainability can enjoy reduced regulatory scrutiny, lower operating costs, and enhanced brand value. Customers, investors and stakeholders are increasingly looking at environmental performance as a key criterion for purchasing and investment decisions, making it a crucial factor for M&A success.

The Difference Between a Regular Phase I and a Complete Environmental Due Diligence Evaluation

A regular Phase I ESA focuses primarily on a narrow view of environmental concerns. It includes a standard treatment that is designed to identify present or past releases to the environment of petroleum products or hazardous substances in order to identify potential or existing environmental liabilities. However, Phase I ESAs do not typically delve into the operational aspects or regulatory compliance status of the facility, let alone an evaluation of readiness to pursue opportunities made available by a sound environmental management program.

In contrast, a complete environmental due diligence evaluation encompasses a broader scope. This thorough approach includes not only the components of a Phase I ESA but also a detailed review of regulatory compliance and operational practices. Think of it like a hybrid between a Phase I ESA and an environmental audit. It assesses whether the facility adheres to current environmental regulations and standards, including permits, reporting obligations, and day-to-day environmental management practices. Additionally, it evaluates opportunities for enhancing environmental performance and sustainability, looking beyond mere compliance to proactive stewardship and efficiency improvements.

A "FULL" Evaluation: Integrating Comprehensive Due Diligence

To address these challenges comprehensively, M&A firms should adopt a holistic approach to environmental due diligence. This involves expanding beyond traditional Phase I assessments to include thorough reviews of regulatory compliance, potential liabilities, and future sustainability opportunities.

When you partner with an experienced environmental consulting firm early in the M&A process, companies can uncover hidden risks, evaluate operational compliance, and strategize to enhance environmental performance post-acquisition.

Real-World Example: The Acquisition of XYZ Inc.

Consider the fictional acquisition of XYZ Inc., a company known for its innovative manufacturing processes. During the initial Phase I ESA, no significant contamination issues were found, and the acquisition proceeded without further environmental scrutiny. However, this proved to be a costly oversight.

Shortly after the acquisition, it was discovered that XYZ Inc. had several regulatory compliance issues that were not identified during the Phase I assessment. These included outdated documentation, expired permits, and significant issues with their annual reporting. The company had also failed to comply with local regulations, resulting in substantial fines.

Addressing these compliance issues required unexpected, significant investments. The acquiring company faced not only financial penalties but also legal actions from regulatory agencies. Additionally, the public disclosure of these issues damaged the company’s reputation, leading to a loss of investor confidence and customer trust.

The oversight in environmental due diligence didn’t stop there. The acquiring company missed opportunities to enhance XYZ’s environmental performance. The lack of investment in a sound environmental program and sustainability practices led to higher operating costs and missed opportunities for cost savings and market advantages. As a result, the acquisition, which initially seemed promising, turned into a financial and reputational burden.

The Bottom Line: A Phase I Alone is NOT Enough to Protect You from Environmental Liabilities!

In summary, while traditional Phase I ESAs focus on identifying major contamination issues, a more comprehensive approach to environmental due diligence should also consider regulatory compliance and future opportunities. By broadening the scope of your due diligence, you can uncover hidden liabilities, ensure compliance with all environmental regulations, and identify potential opportunities for sustainable growth.

Here at RMA, we pride ourselves on providing comprehensive environmental assessments that go beyond the basics. Our expert team is dedicated to helping you navigate the complexities of due diligence, ensuring that you make informed decisions and protect your investments.

Don't leave your M&A process to chance. Ensure your investments are protected and your business is positioned for success. Contact us today to learn how our expert team can support your due diligence efforts with tailored environmental assessments and strategic insights. Secure your future by making informed decisions now. Reach out to us and take the first step towards comprehensive environmental due diligence.