Columnists

Regulatory Developments

Michael C. Ford Attorney

Polsinelli Shughart, PC

EPA Extends Audit Policy to New Owners

Oct/Nov 2008

The author would like to thank his colleague at Bryan Cave, Maribeth Klein, for her insight and analysis in drafting this article.

EPA recently extended the scope of its Audit Policy (Incentives for Self-Policing Discovery, Disclosure, Correction and Prevention of Violations) on an interim basis ("Interim Approach") effective August 1, 2008.1  The Interim Approach offers incentives to new owners to disclose violations pursuant to EPA’s Audit Policy, which has been in effect and available to facility owners/operators in its current form since May 11, 2000.2  Facility sellers and buyers should beware, however, that the Interim Approach may lead to increased scrutiny for newly acquired facilities that opt not to self-disclose pursuant to the Interim Approach, and increased non-compliance liability exposure for sellers.

To qualify as a "new owner" under the Audit Policy, a new owner must certify that 1) prior to the transaction, the new owner was not responsible for environmental compliance at the facility which is the subject of the disclosure, did not cause the violations being disclosed and could not have prevented their occurrence; 2) the violation which is the subject of the disclosure originated with the prior owner; and 3) prior to the transaction, neither the buyer nor the seller had the largest ownership share of the other entity (determined by shares of stock or shares of stocks with voting rights) nor a common corporate parent.3  The Interim Approach applies only to new owners who did not control operations at the facility before the transaction and only to violations that the new owner did not initiate.

Under the Interim Approach, EPA will not assess economic benefit or gravity-based penalties against new owners for the period before the date of the acquisition. EPA also will not assess economic benefit penalties associated with delayed capital expenditures or with unfair competitive advantage if the violations are corrected in accordance with the Audit Policy (within 60 days of discovery or another reasonable timeframe to which EPA has agreed). EPA also will not recommend criminal prosecution of the disclosing entity.4 

Under the Audit Policy, a disclosed violation must have been identified voluntarily and not through a legally mandated monitoring, sampling, or audit procedure to be eligible for penalty reductions. The Interim Approach expands the definition of voluntary discovery to include all disclosures discovered before the first required instances of monitoring, sampling, or auditing for the new owner, thus allowing new owners a one-time "catch up" period to disclose violations found through activities that are already required.5 

 

 

Under the Audit Policy, disclosures must be made in writing within 21 days of discovery. Under the Interim Approach, new owners will have 45 days after closing to disclose violations discovered pre-closing. For violations discovered after closing, new owners must disclose violations within 21 days after discovery or 45 days after closing, whichever is longer.6 

 

 

Under the Audit Policy, violations resulting in serious actual harm or imminent and substantial endangerment to human health or the environment are not eligible for Audit Policy consideration. Under the Interim Approach, EPA will not exclude such violations as long as the violation that gave rise to serious actual harm or imminent and substantial endangerment began before the new owner acquired the facility and did not result in a fatality, community evacuation or other seriously injurious or catastrophic event.7 

 

The Interim Approach, however, also raises significant liability concerns for the parties to the transaction, particularly the non-disclosers. EPA plans to track the number of recently acquired facilities whose new owners choose not to make "new owner" disclosures under the Interim Approach and cross-reference the newly acquired facilities with existing enforcement data.8  EPA asserts that by tracking self-disclosing and non-self disclosing newly acquired facilities, EPA can assess whether the Interim Approach motivates owners to come forward to the EPA.9  EPA suggests that it will monitor ongoing mergers and acquisitions pertaining to facilities that are subject to significant environmental regulatory obligations or facilities in certain sectors. By doing so, EPA hopes the tracking will yield the added benefit of identifying enforcement issues EPA may be "missing" in the effort to promote disclosures and compliance.10 

EPA may also identify newly acquired non-disclosing facilities as "facilities of interest" where the available enforcement data indicates that there may be compliance concerns or gaps in EPA’s understanding of the facilities’ compliance status. "While such facilities may potentially be ripe or appropriate for inspection or enforcement attention, EPA has not established any new enforcement priority focused on [merger and acquisition] transactions or recently acquired facilities."11  The tracking, however, could impact EPA’s enforcement planning, and EPA expects that its tracking plan will further encourage new owners to self-audit and disclose.12 

EPA also clearly reserved its right to pursue sellers. "A seller that did not discover, disclose and correct violations when it operated a facility should not be a beneficiary under the Audit Policy, simply because the facility’s new owner decides to undertake such actions."13  Proponents of relief or incentives for sellers argue that the Interim Approach will chill mergers and acquisitions by substantially increasing transaction costs for the seller. Sellers might also prohibit buyers from disclosing violations by requiring non-disclosure clauses, or requiring indemnification for penalties assessed against the seller as a result of the buyer’s voluntary disclosure. EPA rejected such claims, however, citing numerous comments indicating that environmental compliance liabilities (as opposed to environmental cleanup liabilities) are generally not the driving force in mergers and acquisitions. In addition, EPA questioned whether "no tell" clauses in transaction or indemnity agreements would be voidable as contrary to public interest.14 

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Revised: 05 May 2010 13:10:31 -0400