Environmental risk and liability have been established as concepts for much longer in the US than in the European Union, emerging more than 20 years ago in North America, and are still a more integral part of the deal process there. But Europe has been catching up and has developed a more holistic and flexible approach to regulation than the US’s more tick-box approach.
A key difference between the way environmental due diligence is carried out in the two geographical areas is the legal background. The methodology in the US has remained fundamentally unchanged since the Hazardous and Solid Waste Amendments legislation of 1984 established an ‘innocent purchase provision’ and potential relief if purchasers conducted inquires meeting certain standards, says John Fillo, director of PricewaterhouseCoopers’ EDD practice in the US. There is a laid-down framework, of which the most common part is carrying out a ‘phase one’ assessment. This legislation dates back to 1993 and is essentially the first basis of defence for an acquirer. “If the acquirer has made all the right enquiries related to the phase one it can be difficult in law to be held responsible for anything that has gone on before at the site,” says Marcel Steward, co-director at Aon Environmental Consulting.
The way a phase one assessment should be carried out is laid down in the ASTM (American Society of Testing and Materials) standard E-1527, which is in the process of being replaced by an updated framework, known as ‘all appropriate inquiries’. It is basically an assessment to find out if there are any environmental liabilities related to a site or property. It may be followed up by a more comprehensive phase two assessment.
Much of the work on a phase one is checking information on the site from various databases and registers. If none of those sources suggests a problem the acquirer enjoys some degree of protection.
“The US approach is prescriptive, while in Europe and elsewhere in the world the approach is more risk-based,” says Steward. For example, he says, in the UK there must be evidence of contamination at the site, a potential target for that contamination and a possible pathway between the two. “In the UK case it would be much more about someone’s professional judgement than a codified law,” says Steward.
John Fillo of PwC says the way regulators and industry deal with each other can be very different in the two markets: “There is typically less flexibility in meeting hard and fast limits or requirements in the US, whereas when working within European regulatory regimes we tend to see more flexibility.”
He adds that US regulations are more ‘command and control’, with prescriptive requirements around compliance limits, as well as data collection, record keeping, and reporting to regulators: “US regulations often include onerous enforcement requirements, including fines and penalties, and the ability for citizens to bring suit if agencies exercise too much discretion in enforcement.”
He notes that non-compliance with regulatory requirements, even matters as simple as failure to report excess emissions on a timely basis, can risk fines.
Often US companies and funds making acquisitions in Europe tell their environmental consultants they want a phase one assessment, says John Simonson, global head of M&A at consultants ERM. “I’ll ask them if that’s what they really want because although a phase one may protect you from contaminated land liabilities it’s prescriptive and will not explore some of the more difficult issues on what may be going on above ground, such as air emissions or process safety.”
David George, director of transaction services in Europe at consultants URS, agrees that it can be complicated trying to do a US-style EDD exercise in Europe. One of the main differences between the two markets, he says, is the availability of information. “In the US there are lots of databases and public sources of information that are available at the click of a mouse,” he says: “Whereas in Europe commercial sources are limited and the local authority information is often limited, subject to confidentiality or not available in the short timescales often associated with due diligence exercises.”
In Europe the UK is probably the most developed when it comes to the amount of information available from commercial organisations, he says, but in general Europe is far behind the US in this area. “In the US probably 75% to 80% of the information you need for an EDD assessment comes from public sources,” he says, adding that in the US freedom of information legislation means that information is more readily available and the legislation more rigorously applied than in most of Europe.
The lack of such easily accessible data in Europe means that there is more emphasis on going to sites and carrying out physical inspections and asking questions. Excepting certain parts of Europe, such as Holland and Belgium, there is generally a less hands-on approach by regulators than in the US, says George: “The pressure on companies to clean up is done more through the land re-development route than through strict enforcement of land and ground water regulations. For example, the contamination of soil in general, but not contamination of ground water, is not generally a criminal offence in much of Europe.”
This difference of approach means that companies in Europe can manage their liabilities over a longer time frame, he adds: “If you find a problem you don’t necessarily need to report it – that will depend on the country. In the US, you must disclose it quickly and clean it up otherwise you’ll be formally warned and possibly prosecuted by the regulator.”
The contrasting ways that EDD has developed in the two markets means that private equity houses, which tend to have absorbed the US attitude on EDD, can misunderstand how things differ in Europe. The private equity house will assemble a team of advisers, including solicitor, accountant and environmental consultant, says Marcel Steward of Aon. “They will want to know what the environmental risk is but often do not appreciate that the information they will get back is not as quantified or defined as they may imagine.”
The problem is, he says, that acquirers want to know their financial exposure and when the environmental consultant says it will cost, say, £250,000 to remediate a piece of land they think that that is the extent of the liability and they can simply ask for £250,000 off the purchase price. “But EDD reports are caveated and can’t cover all the potential risks, such as neighbouring land having been affected,” says Steward, adding that private equity houses in particular are used to seeing everything in quantified financial terms.
Another significant difference between the two markets when it comes to environmental regulation is the threat of legal action. Paul O’Connor, manager at PwC’s sustainable business solutions team, says that among US players there is a perception that the risk of legal action, as a result of environmental liability issues surfacing during a transaction, is higher compared with European companies who may be more comfortable resolving liability issues without legal recourse.
Marcel Steward of Aon agrees: “Legislation in Europe evolved in a different and less litigious way.” He adds that in Europe EDD is often seen as optional, particularly in the early stages of an auction when private equity players do not want to take on too many due diligence costs when they are not confident of getting to the final stages. In the US, by contrast, potential acquirers will often ask for a phase one study from the beginning. But Steward argues that in Europe things are changing and EDD being taken more seriously from an early stage, due to the evolution of legislation such as the new European directive on environmental liability that is being introduced. “Historically, in the US there’s been an awareness that in law when you buy a property you take on the liability, but in Europe there’s been a sometimes mistaken belief that the main legal principle is the polluter pays,” says Steward.
One of the implications of the litigiousness of US society is that most of the EDD work done by consultants is carried out via the client’s lawyers. In Europe EDD suppliers are far more likely to be meeting with the client directly and feeding into the process at a higher level.
David George of URS says that because of the attorney-client privilege rules in the US, which afford clients some protection from future law suits, environmental consultants generally do their work with instructions from the lawyers. “In Europe, we get more involved at the contract level, including the sale and purchase agreement, whereas in the US all that is handled by the lawyers,” he says. John Simonson of ERM echoes this, noting that in the US there is more of an “all or nothing” approach on the EDD, whereas in Europe the more flexible and less prescriptive approach means the consultant is more involved at an earlier stage in advising on what level of EDD might need to be done and then will carry out progressively more comprehensive EDD the closer the client gets to acquiring the asset.
The environmental aspects of an acquisition are more broadly tackled in Europe, argues Marie-Helen Lemarre, manager of operations at the Montreal office of consultants AMEC. She says that in the US EDD is viewed as a liability-related cost, risk management and a legal check: “It is essentially a tick-box commodity exercise as part of the legal requirements of a transaction and does not in itself become embedded into business planning.”
She adds that this is a shame, as in other geographies the process is more holistic and involves all parties advising on a transaction, which can both help identify liabilities and find business solutions post-transaction. “Further, the approach which is more of a legal check does not really incorporate the softer but equally important issues of corporate image and social responsibility,” she says.
In Europe, says Lemarre, the consultants involved in EDD are mainly sourced from an engineering background. Those in North America tend to be specialist in environment only. She adds: “There is more reliance in North America on the attorneys and less on the consultant opinion. The European perspective relies heavily on the technical detail of the consultant distilled into laypersons’ English, which can be used by management in their decision making. Essentially, the investor often finds the European approach a more useful document.”
One issue that needs to be highlighted is that within Europe and the US there may be variations of approach, depending on the particular state or country. Clearly, if one is looking at Europe in a broad way and beyond the EU’s borders one will find distinct differences.
John Fillo of PwC says that EDD probably has a higher profile and is more formalised in the US due to factors such as Superfund, which is the federal programme to clean up uncontrolled hazardous waste sites, and other associated legal protections associated with performing EDD. In addition to these there are various state-specific requirements, such as the New Jersey Industrial Site Recovery Act, which drive the need for assessment and remediation of contaminated sites.
He says: “In the US there can be localities within which regulatory requirements are more stringent than those enacted at federal level, with California and New Jersey being most prominent, and others states like New York and Massachusetts not being far behind.”
There are some innovations from the US that have now become commonplace in Europe, such as the combination of environmental and technical due diligence on property deals. In Europe there continues to be a huge interest in real estate assets, particularly in Central and Eastern Europe. “All kinds of properties are being bought, both residential and commercial,” says ERM’s John Simonson. A key part of the due diligence often conducted on these acquisitions is technical due diligence, which means how to bring the property portfolio up to a good enough condition so that it can be sold on profitably. Combining this kind of due diligence with the more traditional environmental due diligence looking at contaminated land and other issues has been common for decades in the US, says Simonson: “But it’s a trend that has only recently arrived in Europe because a few years ago all the technical due diligence was done by civil engineers but now environmental consultants have moved into that market offering to combine it with the EDD.”
But one trend that has emerged in Europe and not been successfully exported across the Atlantic is the popularity of vendor due diligence, says Simonson. In Europe vendor due diligence, including EDD, has become the norm in auctions, he says. “It has become popular because it’s handy to have when you go into an auction data room as a potential buyer but it’s far less common in the US.” In North America potential purchasers are reluctant to use vendor due diligence and prefer to carry out their own assessments. Simonson attributes this suspicion partly to the decline in trust following the financial irregularities at companies like Enron. “But in Europe if there is vendor due diligence you have to use it,” says Simonson: “And so when we’re working with a US client acquiring a European-owned asset we have to explain to them that this is the way it’s done in Europe and they can’t just go off and do their own EDD as and when they want.”
According to John Fillo of PwC the types of requirements in both the US and Europe are not fundamentally different. “On one hand, the EU is catching up on many of the US regulations and legislation that has been in place for over 20 years.” At the same time, he says, the EU has surpassed the US in some areas, such as the Integrated Pollution Prevention and Control (IPPC) Directive, which brings in measures to reduce or prevent emissions to air, sea or land. Fillo cites other innovative EU legislation aimed at tackling environmental risks and liabilities. These include the REACH (Registration, Evaluation and Authorisation of Chemicals) Directive, which covers the production and use of chemicals, the Waste Electrical and Electronic Equipment (WEEE) Directive, which covers the disposal of electrical and electronic goods, and the complementary RoHS regulations, which restrict the use of hazardous substances in electrical and electronic equipment.
Despite the differences between the two markets, there are many similarities, says Ben Sawford of AMEC. He argues that beyond the stereotypes the difference may not be as great as generally perceived.
But he stresses that it is market pressures, as much as regulatory enforcement, that will determine the importance of environmental issues for companies in the future.
“It is becoming clear that the real driver for investors in the consideration of environmental and social impacts is public opinion and market forces,” he says. “Indeed, this force does appear to be stronger, at least for the moment, in Europe where there seems to be a more acute collective awareness of the value of the environment.”
Mark Thompson, director of sustainable business solutions at PwC Moscow, says that environmental legislation and enforcement agencies in Russia are in a state of flux and no real clarity is expected for the next 12 months or so. After this time it should be easier to know who the competent authority is likely to be in any given case, he says: “Currently, there is a lot of confusion over whether city or federal bodies take precedence.”
Thompson adds that other issues in Russia include what he calls “paper only compliance” and “deep pocket syndrome”. He says: “An example of the former is a manufacturing plant we investigated 12 months ago, where all the papers and permits were in order, despite the fact that production was in fact four times the permitted capacity of the plant. Subsequent discussions with the deal management team at the target revealed that the target had an ‘arrangement’ with the local regulator, the exact nature of which we never got to.”
He adds that in deep pocket syndrome the regulator suddenly becomes emboldened by the arrival of a new foreign owner and seeks to enforce conditions that were previously ignored.
During the 20th century, Russia’s economic crisis limited the rate of environmental destruction. However, the transition during the last five years to improved economic conditions has been characterised by the extensive growth of industrial production, accompanied by an increased impact on the environment resulting from both extensive use of natural resources and environmental pollution due to implementation of old technologies.
With the added pollution caused by Russia’s economic recovery and the manipulation of the current regulation by enforcement officers and polluting companies, it is unclear how Russia will ever improve its environmental record but even within the EU itself, while the overarching framework on environmental regulation is standardised, there are still significant differences in implementation. Tony Iles, an associate at consultants Atkins, points out that different member states have varying track records on the speed and effectiveness in which European directives are put into practice. He says: “There are big differences between some countries in southern and northern Europe. The anti-pollution IPPC Directive, for example, is supposed to be implemented in 2007 and the UK has already started preparing for it but some countries seem to be doing nothing and will probably only get going a month before it’s due to be implemented.”
Ben Sawford, European director at AMEC, says: “Europe obviously has a greater degree of variation between member states than exists in the US. However, the role of the EU and continuing ascension of countries to the EU is standardising the practice in Europe.”
Despite the more relaxed attitude in parts of the EU, Tony Iles argues that there has been a major shift of awareness in Europe in the past decade: “In the past I’d get a phone call on Monday asking if we could an EDD study by the Friday, but now people are much more aware of the importance of environmental issues.