XL Europe: Buyers and Sellers Beware - Simon White




Environmental issues are increasingly demanding the attention of finance professionals, especially during transactions involving the sale and purchase of share capital and/or assets such as land.

This is being driven by the fact that one of the parties is increasingly giving indemnities and financiers are demanding financial protection more frequently. It is not uncommon for these issues to arise at critical moments, threatening to derail the transaction.

Environmental liability can arise in a number of ways: a company being sold to another party may retain liability or a land sale could trigger the transfer of liability through the contract.

Parties to transactions are now equipping themselves to face this challenge in a number of different ways; for example, through pre-acquisition due diligence and by including contractual warranties and indemnities to clarify their respective liabilities.

At the same time, environmental impairment liability insurance has developed to respond to organisations’ needs to manage their liability exposures. It insures against legal liabilities that may arise in the future from known or unknown contaminants.

It is designed to respond to uncertainty about potential site clean-up obligations or third-party claims arising from historical or new pollution conditions.

REASONS TO INSURE

There are four main reasons driving the growing interest in insurance:

  • Due diligence only goes so far
  • Environmental indemnity is only as good as the security behind it
  • Things can change in the future
  • Different parties are likely to have different priorities

DUE DILIGENCE ONLY GOES SO FAR

Due diligence is often conducted under time pressures, reducing its scope. The historical records reviewed may be patchy and the sampling plan may miss contamination 'hot spots'.

ENVIRONMENTAL INDEMNITY IS ONLY AS GOOD AS THE SECURITY BEHIND IT

An insurance policy can enhance the credit rating of the indemnity and provide comfort to the parties involved. In some transactions, cash may be placed in an escrow account to satisfy the perceived credit risk.

This can tie up useful working capital that could otherwise be employed elsewhere to further business objectives. If the seller has to put funds aside, this means the real value of the deal will not be realised until some time in the future, negatively affecting the return on capital. In these instances, the payment of an upfront insurance premium, which may even attract tax relief, can be an attractive alternative to putting cash aside.

THINGS CAN CHANGE IN THE FUTURE

Although a site may not appear to have environmental issues, these can manifest themselves in the future. Environmental laws are evolving, and they may lower action thresholds for certain contaminants that exist on the site. Alternatively, previously unknown contamination could be discovered.

DIFFERENT PARTIES ARE LIKELY TO HAVE DIFFERENT PRIORITIES

The seller will want a 'clean' exit from the site or business, with no overhanging liability or the chance that liability could reopen in the future. The buyers, on the other hand, will want to protect their investment and ensure predictability of future cash flow. Insurance can be used to help meet the differing objectives.

Environmental issues are an increasingly a common feature of corporate transactions. While thorough due diligence, leading to more effective management of risk and allocation of liability, is key, the value of environmental insurance is proving to be a vital tool in the process. It provides all parties with the opportunity to mitigate the uncertainties inherent in the risky world of environmental liability.

Simon White is a senior environmental underwriter for XL Europe Ltd.