As a continuation of this series on the Environmental Corporate Governance, it is important to consider the governance issues arising from mergers and acquisitions. Environmental, health, and safety due diligence is vital in acquisitions. A critical issue identified is the need to integrate the new employees and company or asset (plant, facility, etc.) into the EHS management system and integrity system of the acquiring company. Failure to do so may have significant consequences.
The first step is to ensure that the appropriate due diligence is conducted. This must be a message from the board and management on down to those involved in the acquisition. Due diligence now consists of three parts: (1) review of the company’s and its assets and facilities compliance with laws and regulations, (2) review of the environmental management system of the company, and (3) review of the policies, processes, and internal controls (where appropriate) for accounting for and disclosing environmental liabilities and asset retirement obligations.
Review of the target’s compliance with environmental laws and regulations and potential environmental liabilities is fairly standard. More and more consideration of the systems in place to ensure compliance and risk reduction is occurring. What is now becoming more clear is that the evaluation of the target’s environmental financial accounting and disclosure may be a critical issue for the acquiring entity.
The US Liquids case discussed in another post, shows that the acquisition of entities that not only have poor compliance histories, but also the failure to account for the risks and liabilities by the target and then the new owner can have significant consequences on the acquiring entity and its board of directors. The stock price fell and trading was stopped when a criminal investigation was announced of the facilities that had been acquired. The directors were sued and the insurance company successfully argued that the environmental exclusions in the director and officer insurance policies excluded the claims and no coverage was available for either defense costs or liability.
The details of these issues will be addressed in a future post, but areas like asset retirement obligations under the Financial Accounting Standards Board’s (FASB) Financial Accounting Standard (FAS) No. 143, Accounting for Asset Retirement Obligations, and its subsequent interpretation of this standard, Interpretation No. 47 (FIN 47), Accounting for Conditional Asset Retirement Obligations, have created opportunities, but also pitfalls for acquiring companies. Care should be given in evaluating the AROs as well as the more traditional reserves for claims and loss contingencies under Financial Accounting Standard No. 5, Accounting for Contingencies, or AICPA Statement of Position 96-1, Environmental Remediation Liabilities (“SOP 96 1”).
An interrelated issue with the review of policies, processes, and practices is the need to ensure that the target company understands how these three “Ps” compare with its own. Management, directors, and environmental VPs and managers must understand the importance of integrating the new employees and facilities immediately into the acquirer’s EHS management system and to ensure that no tolerance was provided for deviation. Some employees would not be able to survive the transition—they simply would refuse to comply with the new system and would quit or be terminated.
Immediate imposition of the new system and review of performance and deviations was seen as critical. Failure to do so immediately was viewed as likely to result in a very difficult process of trying to integrate the new people and facilities in the future.
Management and boards of directors should consider that the integration of new companies or assets through mergers or acquisitions requires a process-based approach. The compliance status and environmental liabilities is just one part of this process. Understanding the environmental management systems is critical, particularly after the Baker Panel Report regarding the explosion that killed and injured so many people a the BP refinery in Texas City, Texas. The third leg of due diligence is the review of environmental accounting and disclosure in financial statements and any reports filed with the SEC if the target is a public company.
The key point is understanding that the rigor of the related processes of the acquiring company must be compared with and harmonized with the target before and then after closing. Otherwise, the buyer may find not only existing conditions that lead to environmental liabilities after closing, but potentially practices that lead to lawsuits and enforcement actions and even financial restatements months or even years after the deal is done.