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EPA Announces Audit Policy for New Owners

Environmental Law Update

August 11, 2008

Agency Provides Clear Methodology to Minimize Environmental Liability in Major Transactions
On August 1, 2008, the Environmental Protection Agency (EPA) announced its “Interim Approach to Applying the Audit Policy to New Owners.” The Interim Approach represents a major leap forward in EPA’s efforts to help purchasers and acquirers of businesses avoid environmental penalties to which they might otherwise succeed through a program of voluntary assessment, disclosure and corrective action. Inspired in significant part by a series of transaction-related audit agreements and disclosures pioneered by Bracewell & Giuliani partner Tim Wilkins that have already led to significant savings for firm clients, this new directive follows several years of negotiation and cooperation between EPA and Bracewell’s Environmental Strategies Group and offers important tools for managing pre-acquisition compliance concerns.

While the Interim Approach became effective immediately upon announcement, EPA is seeking public comment prior to finalizing the policy.  All comments must be received by October 30, 2008.

An Evolving Approach:  Encouraging Voluntary Disclosure and Compliance
For more than a decade, EPA has been moving toward a policy of encouraging businesses to identify, report and correct environmental liabilities on a voluntary basis.  The rationale for this approach is readily apparent: the business itself is generally in the best position to identify and correct environmental issues; self-policing reduces the manpower and resources required by the federal government to investigate and prosecute violations; and improved compliance has a direct, positive effect on both the environment and the quality of life in the communities in which these businesses operate.

In April 2000, this policy was codified by EPA in “Incentives for Self-Policing: Discovery, Disclosure, Correction and Prevention of Violations” (65 FR 19618), generally known as the “Audit Policy.”  The Audit Policy clarified the terms and incentives — including the waiver of penalties — used to encourage companies to voluntarily discover, disclose, correct, and prevent the recurrence of environmental violations.  Through September 2007, EPA had resolved violations involving over 3,500 entities and at nearly 10,000 facilities using the Audit Policy.

As written, however, the Audit Policy did not clearly explain how the program might be applied to parties contemplating the purchase of facilities or businesses with potential environmental violations.  Certainly, the risks associated with environmental problems have long been a point of concern for acquirers of existing businesses and facilities, and such risks are a key area of focus when conducting due diligence in transactions.  Since EPA’s Audit Policy focused specifically on existing owners, however, there were significant uncertainties as to whether and how the agency would credit audit disclosures made by acquirors of facilities who discovered environmental violations during transactional due diligence.

Bracewell Attorney Presses for Clarity in Audit Policy
In 2004, one of Bracewell's clients requested environmental partner Tim Wilkins' assistance with a merger of chemical manufacturing companies involving the acquisition of approximately one hundred U.S. facilities.  It soon became apparent that both the value of the deal and the opportunity to positively impact the environment could be enhanced if the new owners could obtain a “clean start” by finding, correcting, and obtaining penalty relief for existing violations at the target facilities. 

Wilkins began working with EPA immediately to adapt both the spirit and the letter of the Audit Policy to the circumstances facing potential new owners of manufacturing and industrial facilities.  In close cooperation with policy-development and administrative leadership at EPA, innovative agreements were developed for a transactional audit disclosure under the Audit Policy on terms that closely resemble the recently announced Interim Policy.  As a result of those disclosures, Bracewell's client successfully avoided material environmental penalties associated with the target company's pre-acquisition violations.  Wilkins and the firm’s Environmental Strategies Group have continued to pioneer this innovative approach on other transactions and anticipate that use of this tool will only become more common in the wake of EPA's publication of its Interim Approach.