The allocation of risks arising from contaminated sites, irrespective of their location worldwide, is a frequent point of discussion in M&A transactions in the chemical industry. The economic risk is high (examination, decontamination, business interruption, liability to third parties). At the same time, the parties must often negotiate on the basis of assumptions (type and scale of the contamination, possibility that the duty to examine and decontaminate will be updated, actual costs). One possible solution is special environmental insurance that provides full or partial cover for risks arising from contaminated sites.

Typical negotiated solutions in M&A transactions

Depending on negotiating power, conventional negotiated solutions for contaminated sites range from full allocation of the risk to the buyer or a price discount, through to a warranty or indemnity issued by the seller. The seller should in any case consider strict statutory liability risks that can arise as a result of insufficiently disclosing environmental risks to the buyer.

Conventional W&I insurance does not cover risks arising from contaminated sites

Nowadays, warranty and indemnity policies (W&I policies) are used on a regular basis in M&A transactions involving strategic investors, including in the chemical industry. However, a conventional W&I policy is usually limited to ongoing environmental compliance and therefore does not generally cover risks arising from contaminated sites.

In individual cases, a seller’s warranty that, to the seller’s knowledge, there are no contaminated sites (apart from those disclosed) can be insured under a conventional W&I policy. A prerequisite for this is a “phase 1” environmental due diligence report without any negative findings. Thus, contaminated sites that are not known to the seller are uninsurable.

Special environmental insurance

In contrast, special environmental insurance can cover unknown and, in some cases, known risks arising from contaminated sites. Once viewed as expensive and difficult to obtain, this type of insurance has evolved to become a useful tool to manage the risks associated with contaminated land in M&A transactions. The policy can operate either independently of the company purchase agreement, or linked to specific environmental warranties or indemnities, and are often structured as follows:

• Unknown (and, in some cases, known) contaminated sites are insurable; with the insurability of known contaminated sites depending on the extent and nature of the contamination as well as on whether specific claims have already been asserted.
• When implemented independently of the purchase agreement, the insurance covers costs and damage incurred by the target company, including the cost of examinations and decontamination, environmental damage, damage incurred by third parties (including personal injury), for which the target company is liable, as well as consultant fees; cover can additionally be extended to include interruption to the policyholder's business as well as fines and penalty payments incurred by the target company.
• In some cases it can be beneficial to link the insurance policy directly to the company purchase agreement. For example, where a specific environmental indemnity has been negotiated for unknown or even known contamination. In such cases, the policy operates similarly to a traditional W&I policy and can even disregard a nominal liability cap provided by a seller under a specific environmental covenant.
• The duration of the policy is generally 10 years from when the transaction is closed. It can optionally be extended to include new environmental contamination that was not caused until after the transaction was closed.

If the contamination is discovered due to voluntary examinations, business expansion, underground building work, or a shutdown of business, the cover usually does not apply. This is also in line with typical restrictions on use in the company purchase agreement.

A prerequisite for insurability is usually a "phase 1" environmental due diligence report. A "phase 2" report is required in the case of a significant history of industrial usage. The level of the premium will vary widely depending on the amount of cover and the deductible, as well as the risk profile and the quality of information.

The highly specific circumstances of each case (risk profile, information base) mean that individual negotiations with the insurers and the careful interlinking of the policy with the provisions in the company purchase agreement are particularly important.

With thanks to Glenn O’Halloran, Head of Environmental Risk, Howden M&A, for his contributions to this article.

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