We often say here at Benchmark that signing an LOI is the 10% mark of a transaction. While it’s difficult to support that quantitatively, it’s certainly anecdotally true. Due diligence is an arduous part of the closing process that will either substantiate the terms outlined in the LOI, call for different terms, or reveal such material differences that the deal craters altogether. Financial, operational, and sales diligence are all givens, but one component that isn’t always conducted is environmental due diligence. While the former three, as examples, are customary and a part of every transaction, environmental is not always a necessity. If the business is purely a service business, it is increasingly unlikely that a purchaser will seek to conduct environmental due diligence.
However, there are many reasons a purchaser may decide to conduct environmental due diligence. Perhaps, real estate is included in the deal, or maybe the target entity is a manufacturing business that uses various chemicals in the production of a product. Ultimately, the purchaser is seeking to become aware of any pre-close conditions and limit any post close liability. This is a necessary step in the process as finding and assessing potential issues affecting the facilities is imperative to the facility’s overall health and safety for its future employees and customers. The environmental due diligence audit ensures future regulatory compliance and reduces potential issues as well as future energy and waste costs associated with the property.
Traditionally, purchasers have sought to go straight to a Phase 1 ESA (Environmental Site Assessment) which we will discuss further below in this article. However, environmental due diligence can be very costly and time intensive. Many environmental consulting firms now offer an Environmental Desktop Report. This is the most cost-effective tool for evaluating the risk of future property, as it is done without a visit from the environmental consultant on-site to the property. This assessment is limited and is used as an initial screen of the property to understand the potential environmental liabilities better. Different types of environmental desktop reports consist of Historical Records and Database Review, Records Search with Risk Assessment, Environmental Historical Reports, and Environmental Database Reviews. If any documented contamination has been identified from the past and the purchaser feels more comfortable with further inspection of the property’s existing state, the process expands to the previously referenced on-site Phase I ESA. Many times, the Desktop Report is packaged with the Phase I process to streamline. The Phase I ESA includes a site visit by the Environmental Professional to document the potentially hazardous materials that could exist. Phase I ESA uses historical resources such as local, state, and federal records to identify any past uses and occupants of the property. Additionally, the purchasing party will conduct interviews with tenants, government officials, as well as nearby businesses. Once all research is complete, the group will prepare a records review to determine if the next steps may be applicable.
If contamination is detected, the viable next step is a Phase II ESA. Phase II ESA is essentially a field investigation that evaluates the impact the hazardous waste had on the property. Phase II ESA includes Soil Sampling, Groundwater/Surface Water Sampling, Geophysical Testing for Tanks, Drums & Waste Materials, among other tests. The most frequent substances tested are petroleum hydrocarbons, heavy metals, pesticides, solvents, mold, and asbestos. After proper testing and concise reporting, a Phase III ESA may be completed to remediate any contamination based on recommendations made during Phase II. Phase III ESA includes identifying the extent of contamination, determining the amount of material that was impacted by said contaminants, and assessing options available for all parties involved.
Regardless of the findings, it is very rare that a buyer walks away after conducting and concluding environmental due diligence. If it makes it past the Phase II ESA, evidently there will be some remediation. In the very off chance that the contamination is beyond safe and capable remediation, Phase IV ESA will be conducted. Phase IV ESA is quarantine and closure of the site. Think of Chernobyl. It’s not an often occurrence, and one we haven’t seen here at Benchmark. All in all, it’s helpful to understand this part of diligence, its importance, and level of detail associated with it. Buyers and sellers alike should be as informed as possible, heading into the due diligence.
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