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M&A Roundtable: Environmental Risk in M&A Transactions

By Alliant Specialty

Jonathan Gilbert, Bill Nellen and Larry Shapiro, Alliant discuss environmental risk in M&A transactions and the steps buyers can take to offset and/or mitigate risk.

Intro (00:01):
You're listening to the Alliant M&A round table providing insights and expertise on the unique risk management needs associated with private equity firms. Here is your host, Jonathan Gilbert.

Jonathan Gilbert (00:21):
Well, thank you all very much for joining we're very excited here at Alliant to bring another M&A series podcast. And with me here today is Bill Nellen, Larry Shapiro and myself, Jonathan Gilbert. I co-lead the M&A practice for Alliant. We're a team of nearly 50 people nationally and growing and working with private equity firms nationally. And last year we worked on over 200 deals and collectively as a team, we've worked on over 10,000 transactions. So, there's not much we have not seen in the world of M&A, and risks and things, that said we always continue to be surprised, but we bring a lot of knowledge and experience to our clients given a situation may not be identical to what we saw before, but we can pull from the experience we had previously and use similar avenues or similar solutions to again, solve the problems to allow our clients, to get the deals done and allow Bill Nellen and, and Larry Shapiro here to introduce themselves in a second. What we're here to talk about is inviting environmental risk in M&A transactions and how a buyer should look at the risk when they're evaluating the company and the assumed liabilities from an environmental standpoint, and then two, how insurance and various forms can be a strategic tool to use to offset or mitigate or eliminate issues with known or unknown environmental conditions related to a target company or industry. But that is my long-winded intro. So, why don't I turn it to Bill for an introduction of himself?

Bill Nellen (01:54):
Good to talk with everybody. Thanks for tuning in today. We're here today to talk about hybridization between environmental risk, environmental insurance solutions and our Alliant M&A practice. And I represent our Alliant environmental group. I lead the practice, but in essence, we represent across the country, various exposures, various verticals, and work with the rest of our colleagues across the country, relative to M&A exposure, redevelopment exposure, and frankly just general real estate transactions. So, in this context, we'd like to bifurcate this discussion into two parts and relative to the M&A focus when doing due diligence. Alliant’s M&A group will function as a consultant, another tool in your toolbox relative to your environmental consultants, your accountancy, your legal advisors. We will be another piece of that both on the environmental risk and on the insurance more generally.

Bill Nellen (02:57):
And then the second piece will be relative to solutions and how we can both put together environmental solutions, risk transfer solutions, as well as reps and warranties solutions or both at the same time, kind of working with each other in synergy to make sure that you get the broadest coverage and the best protection for your enterprise, both on a legacy basis, and going forward to both in the private equity sense to be a good steward and a good fiduciary for your investors and your partners, not exposing the funds to enterprise risk associated with something that's uncertain, not probable, not expected, and could be catastrophic to a business. We, as a practice at Alliant, have worked on several billion dollars’ worth of transaction values in the last two to three years, and that results in 200 plus placements a year across our group, and a lot of those deal with transactional risk. John, can you focus just generally on telling us a little bit about the M&A practice as it relates to due diligence and insurance due diligence and how what you do also interfaces with the environmental risk and the things that your clients will bring to the table relative to what they've done on a transactional environmental deal analysis.

Jonathan Gilbert (04:27):
Yeah, thanks Bill. I'd be happy to, you know, a big part of our job when we're advising clients on risk and risk associated with transaction, is to identify the assumed liabilities and where is the offsetting asset indemnity or otherwise to protect that buyer for that assume liability and environmental is always a tricky one because again, as I mentioned before, we're working on limited time, limited information. And so, what we'll often do is review the environmental documents that are available in the data room, or that are being completed by the buyer's third-party advisors, which will often be phase one reports, a phase two report, if it's a subsurface investigation or other documents that may be available. And what we're trying to identify is what is a known risk. What's known to be in the ground, that's contaminated what may be in the ground, and then what operational risk does the target or company, or the seller have that we need to be cognizant of in intertwined into the insurance program on a go-forward basis, whether that's through a long-term pollution, legal liability policy or otherwise.

So, as we look to assess the first part is what is the operations of the business currently, and what has the site done historically, whether under the current ownership of the target or prior ownership of the target. And certainly, if the facilities owned or leased can help mitigate some liability. Although we have seen leases where any legacy environmental matters have been pushed to the lease, the company, as opposed to the lessor which is odd, but we have seen that and they have certainly crafted insurance solutions around that type of risk, too. But to get back to your question, generally, what we look to identify is, again, just what could be out there from an environmental standpoint, what do we know that's in the ground from a contaminate standpoint and what could be in the ground based on the company's operations or neighboring buildings that may generate hazardous waste that migrates down to our facility or the targets facility.

And so, you know, that that's sort of step one. And then step two, as I mentioned, is, what is the offsetting asset indemnity or otherwise that protects the buyer. If there is an unforeseen liability related to environmental condition known or unknown at the time signing. And there's a couple different areas to look at one is certainly the purchase and sale agreement, and oftentimes there'll be representations that are made by the seller that are related to environmental, certainly environmental compliance. They have the right permits. They have complied with their regulations on the activities, whether it's waste treatment or otherwise. We also want to see what is this seller saying. Here's what we know is in the ground and everything else we're not aware of any potential issues. And that sort of second piece is the one that's always the concerning piece.

You know, if they're not aware of something, and it could be a knowledge qualified, meaning the statement is only supported based on what the seller knows or doesn't know, or it could be what we say, a flat rep where the seller representation and it's based on what the seller doesn't know which helps the buyer, certainly from a protection standpoint. And traditionally that representation would be insured. Under most of the transaction we work on under a rep & warranty insurance policy. However, the rep & warranty insurance policy will be only be as broad as the protection given in the representation. And the reason I bring that up is that oftentimes you'll see something in the effect of accept as disclosed on schedule X, Y, and Z.

We know of no environmental matters, well then schedule X, Y, and Z includes a list of a myriad of things, as well as reference to a variety of environmental reports that have been done historically. And those reports are often going to identify contaminants that are known to be in the ground. And if there are known contaminants in the ground, then it's likely going to be difficult for the buyer to say, there's a breach of the rep. If it's a disclosed known matter, like it would not qualify as a breach. And that's where we oftentimes will see the buyer have a need for a separate insurance policy to augment what's available in the rep & warranty insurance policy, and really fill the holes that would exist from an environmental risk standpoint for that those particular items that are known or likely to be in the ground. And that's where really Bill and I will collaborate very closely, Bill being by far the environmental expert, more than I, by any means, but nonetheless, that's where we'll look to arrange for a traditional environmental insurance policy, with again, some creative solutions in there as well to solve the problem for the client, but Bill, why don't I ask you, as we work together in a number of these, you know, how do you see the pollution policy fitting together with what we're doing otherwise and what kind of characterize, does that seem appropriate? How would you sort of expand on that?

Bill Nellen (09:46):
Ultimately I think you brought up some good points and we can kind of pivot on that, that we are participating with sometimes some limited data and certainly a limited timeframe, and we have to work with what we have. We're not actually going out and visiting the sites. We don't have the purview to do sampling. So, sometimes it could be as simple as environmental data reports, as opposed to phase full phase ones and full kind of all appropriate inquiry. So ultimately, and there may not be an environmental policy in place by the target, we will look to the data that exists, whether it be old phase ones data reports, Google earth shots, and make a submission to the insurance market with our advice and representing all the knowledge that our insured or our client knows and kind of craft the best solution, because there are other mitigating factors out there. There are purchase price offsets.

There are escrows, there are sites that might be held out of the deal because of known conditions. There may be existing insurance. There may be to your point, there may be contractual indemnities, and all of those kind of have various risks and associated things that you need to kick the tires of those, because there could be a counterparty credit risk relative to an indemnity. That's either a privately held LLC or a historic company indemnified the last owner operator, which may be a fortune 500 company that could have fallen on hard times. So, all those things are taken into consideration as well as whether or not we at Alliant and our team, including Larry Shapiro, is involved in the reps and warranties placement part. And maybe Larry can talk a little bit about reps and warranties insurance as it relates to the environmental more generally.

Larry Shapiro (11:48):
Happy to be speaking with everybody on another podcast. This has been a great way to get some information I think out, a little bit more broadly than we could customarily do. And I think it's just terrific to be able to have conversations with colleagues over issues that are clearly relevant to our clients. So, I joined Alliant, within the last year. And my role here is to head up our representations and warranties insurance team and do so obviously in concert with John and Bill and a variety of our other colleagues. So again, happy to be here and happy to be part of the conversation today.

Bill Nellen (12:24):
Hey, Larry, as I framed this conversation around the M&A consultancy due diligence process that we do initially, relative to the environmental documents and insurance representations that the insureds make on the target, also wanted to kind of lead into and have this solution based and talk a little bit more about how reps and warranties insurance and pollution legal liability insurance can be used in concert with each other. Think the audience could probably benefit from a little bit of a description of what reps and warranties insurance is intended to do, and then kind of segue into how pollution liability insurance might help alleviate some of the underwriter’s concerns add to protection so that they can provide broader coverage or be kind 0of a third solution.

Larry Shapiro (13:17):
Why don't we start at a higher level, and then we can kind of narrow it down and talk about the application to environmental exposures. But as a general matter representations and warranties insurance is tended to either supplement or replace what would be traditional seller indemnity connection with an acquisition of a target. Customarily sellers will give representations and buyers will rely upon those representations in deciding to proceed ahead with a proposed acquisition. So, what the representations and warranties insurance does is it essentially picks up the risk that there would be unknown breaches of the reps that they're being given by a seller, and that they're relying on connection with their acquisition. So, if we take that as a construct and then apply it to environmental exposures, what you'll see customarily is that buyers will receive a full suite of representations from sellers covering financial statements, covering fundamental type representations about a seller’ss ownership of the target and their authority to sell. But it'll also cover off, you know, specific exposures, whether they're regulatory exposures, employment related exposures or as we're talking about here, environmental exposures, oftentimes our clients are going to, depending on the industry of the target that they're acquiring, they could get some fairly robust representations regarding the environmental risk exposure at a target. And you would apply representations of warranties insurance to cover the unknown risk that any of the reps that they're getting have been breached.

Bill Nellen (14:46):
Yeah, that's a great construct. I would imagine people take into account, like you said, whether or not there's indemnities available kind of contractual relief, and you brought up a good point. I mean, I think I've tried to extol this elsewhere, but is that compliance is only half of the puzzle relative to environmental risks. So, you might be compliant and you might make representations that you have done everything that the regulators have required you to, but this is different. This is something that could be ultimately have a financial risk to your business, to your shareholders, to the overall transaction. And so, you know, one piece of that obviously is compliance and doing the right thing. The other part is environmental is one of those black Swan kind of things. And if you don't know about it, you can't just bury your head in the sand and say, hear no evil, speak no evil. And so it kind of takes it out of the realm, like some other risks, but we don't have time to go through those today, but that take it out of this kind of contractual construct. And it might need additional due diligence or might need an insurance solution that's separate. And maybe we can talk a little bit about how we've used pollution insurance to help reps and warranties insurers and clients get comfortable with deals.

Larry Shapiro (16:07):
Sure. Yeah, it’s a great topic. I think along the lines of what you said about burying your head in the sand and, you know, a buyer's deployment of adequate due diligence. I think representation to warranties insurance, an underwriter is going to be primarily focused on avoiding a situation where a buyer is burying their head in the sand and just relying upon statements that a seller tells them. So, they are going to look to due diligence that the buyers can deducted to help bridge that gap there and get comfortable standing behind the representations that a seller is giving. And when you take a look at representations and warranties insurance on the one hand as one form of contractual risk transfer for environmental exposure and say pollution, legal liability coverage on the other, what we've seen is that the two tend to be complimentary approaches in putting a box around environmental risk.

And in fact, I think may rely upon at least some of the same base information in order to understand how bests to underwrite those risks at least on the transactional side, underwriters are reluctant to cover a naked rep for lack of a better term. And they are going to need to see that a buyer's conducted adequate due diligence to prove out a seller's ability to give the reps that they're getting. And they also have very little intention to being primary with respect to environmental risk. I think representation of the warranty insurers see environmental, I don't want to state it so affirmatively to that they look at it in a binary fashion. But I think there are generally two buckets of environmental risks from a transactional insurance underwriter's perspective. One would be more or less, core environmental exposures, and the other would be from a regulatory perspective, permitting a compliance. And I think each could have a direct effect and create a potential for loss to a buyer acquiring a particular target. Our intent with the representations of warranties insurance is to make sure that the policy that we put in place would be responding to both, but that's going to be predicated on a buyer doing adequate diligence and oftentimes the target having adequate underlying environmental insurance in place.

Bill Nellen (18:19):
Yeah. I mean, I think one of the coolest parts is what I do and what you do for clients is the kind of creativity aspect of it. And the tougher the risk, the more of the challenge is really exciting and kind of drives us as deal junkies. Ultimately, I look at those and maybe people who are listening to this, like relate, like I do a more of an experiential learner, but some of the case studies recently, you know, these deals can be several billion dollars. Like we did a deal recently, which was a multi-billion dollar agricultural industry deal all the way down to a 10 million deal that we did transaction value relative to a products liability type thing. So the exposures can be from, ghost sites that the target has very limited knowledge of, or that knowledge may lie 20 years ago in operating sites that people don't have much understanding of what happened there all the way to things that people are using in their homes that may cause pollution conditions for which the new buyer doesn't want to take responsibility for, because they just have very limited knowledge of. Another one is kind of emerging contaminants.

People have heard of PFOA, PFAS, these kinds of recalcitrant chemicals that exist forever in bioaccumulate, and there's a lot of fear and emotion around environmental risk and companies that are operating as financial sponsors to deals and supporting high net worth individual or institutional investors do not want to get in the game of predicting what can be the next horrible thing on the horizon relative to environmental. And so, we represented a construction target that made equipment that didn't want to be responsible for a ranger or generator liability for these kind of next gen contaminants that may exist in disposal site liability. And those are things that reps and warranties underwriters don't have a fear of in a realistic sense, and to kind of ring fence those. It makes sense to put those in a coverage position where you're getting an affirmative standalone pollution liability product.

Larry Shapiro (20:48):
Bill to kind of compliment what you just said. There's a pragmatic way of looking at it, too. Representations and warranties insurance, as you know, it's been pretty active over the last number of years, and we at least explore insurance solutions across a variety of different industry classes. And so, what emerges is we have highly capable and highly skilled underwriters. Many of whom are former corporate lawyers with a deep set of knowledge, but generalists when you take a look at it from an industry perspective. And one of the things that they want to make sure is that they're not necessarily missing a particular risk, or they're not thinking about manner that somebody who is finally tuned to environmental exposures might look so representations and warranties insurance are in many instances, the underwriters are in many instances willing to defer to the more finely tuned focus of an environmental underwriter who has specific expertise in that area. So, to the extent that you've got an underlying environmental coverage and that coverage focuses on particular areas, those underwriters may just be better suited for assessing that risk than the more generalist reps and warranties insurance underwriters.

Bill Nellen (22:00):
Yeah. I mean, how can you be an expert on gap accounting, HIPA, surplus, superfund site liability, everything EPLI related other than if you're Larry Shapiro.

Larry Shapiro (22:12):
And I think I can hear the laughter of everybody. I think pragmatically insurers will hire counsel that will help them and counsel will have specialists assist, but at the very end of the day, there's probably a more appropriate home for that risk. And that home is at least in this instance dedicated standalone environmental coverage.

Jonathan Gilbert (22:40):
Guys that was great. I think we had a great lively discussion here today. I hope everyone on the line appreciated the time and look forward to seeing you again on our next podcast. For more information visit Thank you and have a good day.


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