Every business making an acquisition needs to have a complete picture of what they are getting for their money – including risk as well as opportunity. Environmental risk is one example of the former that has sometimes been overlooked in merger and acquisition (M&A) activity.
Buying a business exposes the acquirer to the target’s environmental liabilities. These need to be planned for carefully to avoid jeopardising the deal, with insurance potentially having a significant part to play.
In some cases, environmental risk will be visible. A target may come with a site where there is a known source of pollution, say.
However, it is also possible that environmental liabilities only emerge after deal completion – perhaps pollution on the site is only discovered some months later.
Either way, this risk needs to be addressed to the satisfaction of both parties. Sellers are understandably keen to pass on responsibility for pollution they have caused – wittingly or not – to the new owner so they can achieve a clean exit.
Buyers, on the other hand, are anxious not to be on the line for unexpected costs; they need to understand the potential environmental liabilities upfront so they can take a measured view about what to accept.
This issue is becoming ever more important in the M&A process as environmental issues rise up the agenda and regulators around the world take a tougher line. And the list of risks is a long one – examples of pollution include:
It’s not just the potential sources of environmental risk that acquirers need to understand. They also need to assess how pollution and contaminants might find a pathway to where they’ll cause harm – through soil or groundwater, for example.
They must also identify the “receptor” that will be harmed by the contamination – the fish in a river, say, or a local population.
With so much at stake, Environmental Impairment Liability (EIL) insurance can help both buyers and sellers navigate their way through deal complexity in this area. EIL can cover both known and unknown future liabilities for pollution, capping off a potentially complicated risk.
That reassures buyers – and may enable them to improve their bid where they’re competing for an asset. It also helps sellers by ensuring they can make a clean exit, and by increasing the pool of potential bidders with those who might otherwise have been deterred by environmental risk.
Importantly, EIL policies can usually provide much higher limits and more extended coverage terms than the escrow arrangements that have often been used to manage risk in an M&A process.
EIL policies come in different shapes and sizes. But the goal is to fill the gaps in general liability and property insurance policies. The former may pay out for a sudden and accidental pollution incident, but neither type of policy typically covers cases of gradual pollution, statutory or first-party clean-up costs, biodiversity damage or loss mitigation.
Similarly, most warranty and indemnity policies have a blanket exclusion for all claims related to pollution.
By contrast, EIL can cover all environmental liabilities, whether or not they are passed on by contract, including both known and unknown historic pollution risks, and new pollution that arises after deal completion.
“EIL can cover all environmental liabilities, whether or not they are passed on by contract, including both known and unknown historic pollution risks, and new pollution that arises after deal completion.”
Steven Torresan | Head of M&A, Asia Pacific and Africa, FINEX
Cover can also be extended to environmental risks from activities such as transportation.
Broadly, first and third-party costs covered by EIL include: liability to third parties for environmental damage and bodily injury; damage from sudden pollution and from accidental and gradual pollution; first-party clean-up costs, on-site and in the surrounding area; statutory clean-up costs if an environmental agency carries out work and demands payment; legal defence costs if the policyholder is prosecuted; and director and officer liabilities for environmental breaches.
In addition, environmental insurance can also help with prevention and recovery. It can cover the costs of pre-incident loss mitigation to prevent an immediate risk of damage caused by pollution.
It can pay for site investigations to assess the extent of pollution and potential mediation measures. If there is an incident, policyholders can claim for crisis management support.
Afterwards, costs such as long-term ground water monitoring and biodiversity restoration are also covered. Business interruption costs are also included.
Policyholders can usually purchase cover for ongoing operations after the transaction completes. And they can insure the entire target business or individual sites or operations.
The good news is that the cost of EIL is coming down as more insurers enter the market. And while insurers do require detailed information to arrange cover, much of the data will already have been gathered for the purposes of other insurance, planning processes or the growing environmental compliance requirements many organisations face.
Equally, environmental due diligence is becoming an increasingly important part of the M&A process. Buyers are determined to identify and quantify environmental risk, requiring both parties to assemble the kind of detailed information that insurers need in order to offer EIL.
The bottom line is that environmental risk is now a key consideration in a wide range of M&A transactions. Failing to get to grips with that risk can put deals at risk or undermine the outcome of the transaction for buyer or seller – or both.
For that reason, it’s crucial that dealmakers now step up their efforts to identify such risk – and to take mitigating action where necessary.
For smarter ways to managing environmental risks, please get in touch with our specialists.
