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Deal or No Deal:Recent Developments Impacting Environmental

Due Diligence in M&A Transactions

September 12, 2006

Presented by Holland & Knight LLPand the ACCA EH&S and Corporate

& Securities Committees

Association of Corporate Counselwww.acca.com

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Panel

Vincent Gonzales, Senior Environmental Counsel,Sempra Energy, Moderator

Amy L. Edwards, Co-Chair of National EnvironmentalTeam, Holland & Knight LLP

Brian Heim, Senior Counsel, Environmental Health &Safety, International Paper

Jennifer Hernandez, Co-Chair of NationalEnvironmental Team, Holland & Knight LLP

Rose Murphy, Vice President & Associate GeneralCounsel, Masonite Corporation

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I. Overview

Importance of Environmental Issues in the Transaction

1. Environmental issues are frequently material. Identifying transactional solutions for these issues is critical to deal success.

2. The rules continue to evolve:

Environmental disclosure obligations are heightened in the wake of Sarbanes Oxley, FIN 47, and SEC enforcement action against Ashland

Brownfields Amendments and Final “AAI” Rule

U.S. Supreme Court’s decision in Cooper v. Aviall is also impacting liability allocation negotiations

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II. Purpose and Scope of EnvironmentalDue Diligence

Identify material environmental conditions, risks andconstraints:

1. Legacy liabilities

2. Operational/ongoing liabilities or non-compliance

3. Facility expansion/modification mandates and constraints

- Mandated modifications of operational practices

- Facility-based environmental factors (contamination,wetlands, endangered species) affecting expansion orconstruction opportunities

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Satisfy environmental disclosure obligations

Satisfy fiduciary duties to shareholders

Identify transactional and regulatory tools to resolveenvironmental issues

II. Purpose and Scope of EnvironmentalDue Diligence (cont.)

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A. Preliminary Considerations That MayAffect the Scope of the EnvironmentalDue Diligence Process

1. Asset Purchase

Purchaser can typically shield itself from Seller’s liabilities.

Exceptions: – de facto merger or consolidation – “product line” or “continuation of the enterprise” – express assumption of environmental liabilities – fraudulent transfer

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2. Stock Purchase

Purchaser steps into the Seller’s shoes, and acquiresany liabilities that Seller may have.

3. Real Estate Purchase

Purchaser should conduct environmental due diligence in accordance with E 1527-05 and EPA’s final AAI Rule in order to qualify for one of the Landowner Liability Protections

A. Preliminary Considerations That MayAffect the Scope of the EnvironmentalDue Diligence Process (cont.)

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4. Confidentiality Issues

Seller may not want its employees, neighbors, tenantsor regulatory agencies to know that the company isbeing acquired

Need for confidentiality agreement with Purchaser

A. Preliminary Considerations That MayAffect the Scope of the EnvironmentalDue Diligence Process (cont.)

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5. Disclosure Issues

• SEC reporting/disclosure issues• Release reporting requirements• State transfer law issues

– e.g., NJ Industrial Site Recovery Act(ISRA); CT Transfer Act

• Regulatory process implications• Employee right to know issues

A. Preliminary Considerations That MayAffect the Scope of the EnvironmentalDue Diligence Process (cont.)

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B. The Environmental Due Diligence Process

1. Assembling the Environmental Team

EHS Director; Counsel; Business Person; PlantManager(s); Outside Consultant; Liaison to TransactionNegotiation Team

2. Identifying/Compiling Environmental Documents– Just reports that the Company has commissioned?– All documents in its files?– How far back in time?– Ways to make this information available to Purchaser

Central repository Hard copies Secure website CD

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3. Identifying Individuals with Knowledge Relevant tothe Company’s Representations and Warranties

– Senior officials only?– EHS Director?– Plant personnel?_ Former personnel?– Others?

4. Assets to be Assessed- All operating facilities (opt in/out choice?)- Formerly owned facilities?- All disposal facilities used by the company?

B. The Environmental Due Diligence Process (cont.)

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5. Intrusive Sampling– Purchasers will want right to conduct sampling in

order to quantify risks and costs, and understand/satisfy “continuing obligations” under Brownfields Amendments of 2002

– 60-90 days time frame for sampling is typical6. Regulatory Agency Discussions

– Purchaser will want right to interview andpotentially negotiate with regulatory agenciesin order to verify schedule/scope of required activities negotiate alternative arrangements (e.g., Prospective Purchaser Agreements)

B. The Environmental Due Diligence Process (cont.)

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C. Seller’s Due Diligence Checklist

1. Objective is to sell property “as-is” with full releasesand indemnification from Purchaser with minimalimpact upon price

– Limited environmental reps and warranties andindemnities

– Broad releases from the Purchaser– Control type and timing of cleanup– Make Purchaser responsible for any change in use of

the property; prohibit certain uses on the site (e.g., daycare centers, residences, schools, parks)

– Make Purchaser responsible for monitoring andmaintaining any engineering and institutional controls

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D. Buyer’s Due Diligence Checklist

1. Objective is to purchase property without anyresponsibility for pre-existing environmentalcontamination

– Broad environmental reps and warranties andindemnities from Seller

– Escrows or purchase price reduction to addressknown environmental conditions

– Ability to control type and timing of cleanup– Conduct Phase I– Determine whether Phase II ESA will be needed/allowed

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1. Determine process for resolving any environmental concerns that have been

identified

– Escrow?– Indemnity?– Pollution Legal Liability Insurance?– Cost Cap Insurance Policy or Guaranteed Fixed Price Remediation contract?– Purchase price reduction?

E. Steps in the Environmental Due Diligence Process

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– Cleanup prior to closing or post-closing by Seller or Purchaser?

NOTE: It will be more difficult for purchasersto recoup “voluntary” cleanup costs from otherResponsible Parties in the wake of U.S. Supreme Court’s decision in Cooper v. Aviall, 543U.S. 157 (2004).

E. Steps in the Environmental Due Diligence Process (cont.)

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1. Real Estate Acquisition Due Diligence - Phase I ESAs

– E 1527-05 – Need to be named or obtain reliance letter

2. Regulatory Compliance Due Diligence

– ASTM E 2107-00– EPA’s Audit Policies

3. EMS Due Diligence - ISO 14000

F. Type of Due Diligence That Should BeConducted

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G. Other Due Diligence Do’s and Don’ts

1. Beware of using outdated boilerplate environmental language!

2. Identify employees who will be going with the deal and separate them from negotiations if possible on the Sellerside and insure that you have access to them from the Buyer side.

3. Don’t hide issues – will result in damage to your credibilityand possible delays in Closing.

4. Be prepared to make the decision as an in-house lawyer. Outside counsel will provide pros and cons but are not inposition to determine risk levels acceptable to a corporation.

5. Assist in setting appropriate environmental reserves andverify they survive closing.

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III. Expanded SEC Requirements for Environmental DisclosuresM&A Transactions and Other Real Estate Deals Are Subject

to Sarbanes-Oxley Requirements

- Environmental issues are already a target of SEC disclosure rules

B. Environmental Disclosure in SEC Filings

- Disclosure in Description of Business (Annual Reports)- Disclosure in Legal Proceedings- Disclosure in Management Discussion and Analysis (SK 103)

C. Staff Accounting Bulleting (SAB) 92

- Estimates for accrual and disclosure of environmental liabilities

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D. Asset Retirement Obligations

- FAS 143 revises accounting treatment of Asset Retirement Obligations (ARO)

- FIN 47 issued to clarify that any current legal obligation to take action upon retirement of asset must be booked as an ARO

III. Expanded SEC Requirements for EnvironmentalDisclosures (cont.)

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E. Global Warming Reporting

- Do companies have to evaluate and disclose the potential impacts of requirements to limit greenhouse gas emissions (GHG)?

- No federal requirements, but several states have adopted legislation to limit GHG emissions.

- Public interest group pressure to report

F. SEC Enforcement

- Action against Ashland Inc. for minimizing cleanup reservesfirst action in over 10 years

III. Expanded SEC Requirements for EnvironmentalDisclosures (cont.)

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IV.IV. Due Diligence and Contamination:Due Diligence and Contamination: AAI, AAI, Landowner Liability Protections, ASTMLandowner Liability Protections, ASTM

E 1527-05 and E 1527-05 and AviallAviall

New CERCLA Liability Protections

1. Brownfields Amendments of 2002 created three potential defenses to CERCLA liability (Landowner Liability Protections (LLPs)):

- Bona fide prospective purchaser (BFPP) (knowingly purchases contaminated property)

- Contiguous property owner (CPO) (groundwater or soil impacted by releases from other parties)

- “Innocent” landowner (no knowledge of contamination afterASTM Phase I)

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2. In order to qualify for the LLPs, purchaser must:

- Conduct All Appropriate Inquiry (“AAI”)

- Provide full cooperation to agencies

- Comply with land use restrictions and institutional controls- Comply with all information requests

- Not be contractually affiliated with PRP

- Take “reasonable steps” and exercise “appropriate care” regarding releases or threatened releases, preserve institutional and

engineering controls, and comply with release reporting obligations

IV.IV. Due Diligence and Contamination:Due Diligence and Contamination: AAI, AAI, Landowner Liability Protections, ASTMLandowner Liability Protections, ASTM

E 1527-05 and E 1527-05 and AviallAviall

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3. AAI can be satisfied by following EPA’s Final AAI Rule (69 Fed.Reg. 66, 070) or the updated ASTM Standard Practice on Phase I

ESAs (ASTM E 1527-05).

4. Environmental due diligence may be impacted further by S.Ct.’s decision in Cooper Industries v. Aviall

- Purchaser may not bring a CERCLA §113 contribution action against other Responsible Parties unless it has been sued or entered into a judicial settlement

- Purchaser has stronger motive to qualify as a BFPP so that it may being a CERCLA §107 cost recovery action

IV.IV. Due Diligence and Contamination:Due Diligence and Contamination: AAI, AAI, Landowner Liability Protections, ASTMLandowner Liability Protections, ASTM

E 1527-05 and E 1527-05 and AviallAviall

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V.V. Early Checklist of Key Areas to CoordinateEarly Checklist of Key Areas to CoordinateWith Transactional Negotiation Team to With Transactional Negotiation Team to

Focus Scope and Priorities of Environmental Focus Scope and Priorities of Environmental DueDueDiligenceDiligence

A. Identify future capital expenditures to meet new or renewed permits

- Need to upgrade pollution control equipment

B. Identify future costs to comply with global warminglegislation and increases in energy spending

- Need to reduce emissions of CO2 and to obtain “credits” for these reductions

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V.V. Key Areas of Environmental Due DiligenceKey Areas of Environmental Due Diligence((contcont.).)

C. Identify future permitting issues for expanded operations, process modifications, new facilities

- New source review/prevention of significant deterioration issues

- Non-attainment issues

- Total maximum daily load issues

D. Identify project constraints, such as protected speciesand wetlands/surface waters

- Presence of wetlands or endangered species may adversely impact ability to expand existing facilities or build new ones

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VI.VI. SummarySummary

Pre-Closing Considerations- Type of deal (asset; stock; real estate acquisition; ongoing operation or surplus property)- Environmental investigations may trigger environmental

disclosures and impact reps and warranties- Use due diligence process to identify environmental

conditions, risks and constraints

Post-Closing Considerations

- Identify person to monitor/manage ongoing issues post- closing- Establish process for triggering environmental indemnities

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