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Environmental issues

Issues under environmental law in an M&A transaction should be identified separately for transactions in which there is a change of shareholder (share deals) and for transactions involving an enterprise, an organised part of an enterprise, or other assets (asset deals). The risks should then be appropriately addressed in the transaction structure and documentation.

Identification of risks related to environmental impact of operations

In many situations, an expert understanding of the complex issues of environmental law and skill at identifying risks and drawing the proper conclusions on the basis of a thorough analysis of the operations of the target and the findings of an environmental audit are a condition for carrying out the transaction properly.

The risk arising from non-compliance with environmental requirements is important not only in the context of transactions involving major industrial facilities, or companies operating in the chemicals, mining or transport sector—in other words, entities with significant environmental impact. In such cases, irregularities may occur more often and entail serious consequences, but the risk of environmental impact of the target’s operations also arises in other transactions, particularly when real estate is involved.

Attention must also be paid to essential environmental issues in many transactions involving corporate merger, division or conversion, and in transactions involving an enterprise (or organised part of an enterprise), real estate, or shares.

The importance of detailed environmental due diligence is increasing, as is visible in three aspects.

First, for several years there has been a visible trend toward expanding the list of environmental requirements imposed on businesses. This has been accompanied by imposition of more rigorous liability standards. Examples include implementation into Polish law of the Environmental Liability Directive (2004/35/EC) and the Environmental Crime Directive (2008/99/EC). The Environmental Liability Directive imposes costly obligations to prevent and remedy harm to the environment, and the Environmental Crime Directive requires EU member states to punish perpetrators of environmental crimes. The trend toward expansion and stiffening of environmental laws is expected to continue in the upcoming years.

Second, apart from criminal environmental liability and liability with respect to remediation of environmental harm, businesses may also face administrative sanctions in the form of increased fees and fines. Significantly, these administrative sanctions are imposed on the basis of strict liability, without regard to fault on the part of the persons conducting the business. In order to impose administrative sanctions, it is sufficient to prove a violation of the regulations, and as a result these are the sanctions most commonly imposed on businesses. And in many instances there is no fixed upper limit for increased fees or fines, because the amount often depends on the duration of the violation and the type of substances released to the environment.

Third, Poland’s history, the legacy of the former communist system, and a continuing low ecological awareness have resulted in widespread neglect of environmental compliance, which even many years later may present a material risk for acquirers of businesses or brownfield sites.

Evaluation of the environmental risk associated with a planned transaction is thus extremely difficult. The lack of a highly developed legal culture in the area of environmental compliance significantly hinders contract negotiations. This awareness is rapidly growing, however, among parties to transactions and environmental enforcement authorities. This means that even if the enforcement authorities are not in a position now to identify a given violation, they may be in the near future.

In short, the importance of environmental legal issues in transactions is often underestimated. At the same time, these issues are fundamentally important to many foreign investors. This can cause a disconnect in risk assessment and difficulties in negotiations. But when environmental risks are identified at an early stage, this knowledge can be used as an argument in negotiations and in properly framing the transaction structure and documentation. This also helps avoid incurring additional, often significant, costs after the closing, or a claim by the acquirer that certain aspects of the transaction were not disclosed thoroughly enough.

Share deals

In share transactions, it is important to identify risks arising out of violation of environmental regulations because it enables an assessment of the potential sanctions that could be imposed on the entity or its managers for environment violations. Violations could result in imposition of financial sanctions, and in the case of environmental harm, a duty to remediate (restore the prior state), and in extreme cases the environmental compliance authorities may also issue a decision to shut down the operations of the business.

All of this will typically translate into major expenditures, impacting the financial condition of the acquired company. Failure to identify environmental compliance issues and address them in the transaction documents may result in the real value of the company whose shares are acquired being much less than the price established (or already paid) for the shares.

This issue may be depicted using the examples of risks arising out of improper waste management and risks arising out of failure to obtain required permits.

Improper waste management

The statutory model for waste management rules is complex, not very transparent, and subject to frequent changes. A business must comply with a large number of regulations spread across many different legal acts. This creates a risk of irregularities resulting in liability for improper waste management.

The most obvious examples would include situations in which a company conducts operations without a required permit or in violation of the terms of its permit. This may result in financial liability and in certain instances may also lead the environmental authorities to issue an order to shut down operations.

Another example of the risks connected with improper waste management has to do with the classification of substances or items. Businesses that produce or store certain substances or items often are unaware that they are classified as wastes. Doubts surrounding the definition of wastes increase the uncertainty in this area.

A final example of irregularities that may have major financial ramifications is neglect of requirements imposed on entities dealing in electrical and electronic equipment. The regulations lay down requirements that such equipment must meet before being introduced onto the market, as well as rules for handling such equipment when it becomes waste. Businesses operating in this area are often not in a position to properly assess which regulations apply to them or how they should comply with them. If they do not do so properly, they may face fines that go as high as PLN 500,000, depending on the degree of fault.

Failure to obtain required permits

Exploitation of the environment by business entities is regulated. This means that a business must often obtain permits specified by environmental laws or submit notifications to administrative authorities. Entities whose operations have significant impact on the environment are required to obtain an integrated permit.

Fines and increased fees will be imposed on businesses operating without obtaining a required permit or with a permit that is no longer valid. A permit may cease to be valid not only because the period for which it was granted has expired, but also for many other reasons. For example, a permit may expire as a result of failure to conduct operations for a certain period. A permit may be withdrawn in certain circumstances because of environmental violations, or invalidated because of gross errors in issuance of the permit. The latter risk is often overlooked, but practice provides numerous examples of decisions that were issued in violation of applicable law, for example by the wrong authority, without the proper wording, or contrary to statutory requirements.

Oftentimes an operator holding valid environmental permits will still face financial liability, particularly for failure to comply with the terms of the permits—for example by releasing substances different from those specified in a permit or in excessive quantities. A business may also face financial sanctions if, for example, it operates on the basis of a permit to discharge gas or particles into the atmosphere when under the environmental regulations it should obtain an integrated permit instead, or when it holds an integrated permit but it is no longer valid (e.g. as a result of improper assignment of the permit during an earlier transaction involving the installation for which the permit was issued).

If it is found in an inspection that the conditions set forth in a permit are being or have been exceeded, financial sanctions should be expected, and the amount of the sanctions will generally depend on the quantities of substances unlawfully released into the environment and the duration of the violation. In the worst case, the company may face withdrawal of the permit or shutting down of operations, which in practice may put the company out of business.

Asset deals

Asset deals present some of the most complex legal issues, particularly when they involve transfer of an enterprise. Some of the risks described in the section involving share deals should also be addressed in the transaction documents for an asset deal.

Asset deals require a particularly cautious approach, however, because it is necessary to reflect additional conditions that are specific to transactions of this type and which may have very serious consequences for the acquirer of the enterprise or specific assets if the risks are not identified.

An excellent example of the risks arising out of non-compliance with environmental regulations in asset deals is the issue of failure to make a proper assignment of rights and obligations under the administrative decisions under which the operations are conducted using the transferred assets. It should be borne in mind that under the administrative law governing issuance of environmental permits, the administrative authority controls the permit. Without the appropriate legal basis, the parties to the transaction may not decide by contract that the rights and obligations under the particular permit will pass to the acquirer of specific assets. Such provisions will not be effective, and the acquirer of the plant or installation will not become the holder of the permits for the facility in question.

It is somewhat simpler in the case of transactions involving transfer of an enterprise. The general rule is that the sale of an enterprise results in the acquirer’s obtaining title to the assets that are part of the enterprise. There are numerous restrictions on transfer, however. With respect to rights and obligations under administrative decisions, such as decisions on environmental conditions, the regulations allow for only a limited ability for assignment to the acquirer of the enterprise. This means that administrative succession is the exception and requires an express legal basis.

Environmental harm

Regardless of whether the deal is for shares or assets, if it involves real estate one of the fundamental risks is environmental harm—such as soil contamination.

Analysis of this risk typically requires cooperation between lawyers and environmental consultants, as well as particular caution. This is especially important with respect to harm to the earth’s surface, i.e. contamination, as real estate is very often included in a transaction. But the risk is also material in the case of harm to water, protected species, or natural habitats.

Generally environmental harm is understood to mean any negative, measurable change in the condition or function of natural elements, compared to the prior condition, caused directly or indirectly by an entity exploiting the environment. This definition is narrowed down with respect to the specific natural element affected by the harm. For example, with respect to soil, it is accepted that there is harm when soil quality standards defined by regulation have been exceeded.

If harm occurs, then by operation of law the duty arises to remedy the harm. With respect to the surface of the earth, this means that if there is soil contamination, it is necessary to conduct reclamation. The costs of reclamation may be significant. In certain circumstances the environmental authorities may conduct remediation, whose costs can be great.

The entity required to conduct remedial measures is generally the entity exploiting the environment which caused the harm. With respect to certain types of harm to the surface of the earth, liability will be imposed on the owner of the real estate, regardless of whether or not the owner was the perpetrator of the harm. An acquirer of real estate may thus also acquire an obligation to conduct remediation, and often it might not be feasible to obtain reimbursement for reclamation costs from the person who caused the contamination. The owner of real estate may also be jointly and severally liable with the perpetrator for conducting remediation or covering remediation costs, if the owner knew of or consented to the contamination. Failure to conduct remediation may also entail criminal liability on the part of the persons required to conduct it (e.g. members of corporate management boards).

Due to the specific nature of environmental law, each transaction requires an individual approach in the analysis and assessment of the transaction’s environmental risk as well as the proposed preventive measures to minimise the risk for the potential investor. In any event, it will be essential to address such risks in the transaction documents.