It’s hard to imagine anyone buying a used car without first taking it for a test drive and having a certified mechanic check under the hood. After all, if you unknowingly purchase a clunker, you’re stuck with it. The same rule applies to corporate mergers and acquisitions, except kicking the tires has a more formal name: due diligence, and the stakes are much higher. Consider, for example, environmental contamination. Companies that perform shoddy pre-purchase investigations can end up with the environmental liabilities of the entities they acquire. They can also miss out on the opportunity to set up a cleanup liability defense, to renegotiate the purchase price if significant contamination is discovered, and to benchmark contamination so that liabilities can be contractually allocated among stakeholders.

When it comes to environmental due diligence, it pays to dig deep. It’s also a good idea to avoid these common mistakes.

Mistake #1: Leaving due diligence until the last minute.

Despite the numerous advantages of performing environmental due diligence early on in a transaction, many investors schedule it too late in the deal to do much good. “It takes one to two weeks to complete a Phase I environmental site assessment, and two to four more weeks to conduct further testing if necessary,” says Kirstin Dolan, a project director with WSP Environment & Energy in Reston, Virginia. If investors leave the investigation until the last minute, Dolan says not only will it cost them a premium, but the assessor may not be able to complete the investigation prior to closing because of long wait times associated with Freedom of Information Act requests.

Susan Phillips, an environmental attorney with Mintz Levin in Boston, agrees that timing is important. “The more you know and the sooner you know it, the better your ability to fold the risk into the negotiations and establish legal and financial mechanisms to ensure that problems are addressed and liability is minimized,” she says. “I tell my clients that while it’s nice to have someone with financial resources to sue, it’s much nicer not to have an issue to begin with. The best way to avoid an issue after closing is to have significant environmental risks identified and on the table before closing, where parties can agree on how to split them.”

Mistake #2: Ignoring the All Appropriate Inquiry rule.

Another common environmental due diligence mistake is ignoring the U.S. Environmental Protection Agency’s All Appropriate Inquiry (AAI) rule pertaining to Phase I environmental site assessments (ESAs). Fail to follow AAI or its equivalent, ASTM’s E 1527-05 standard, and you could be liable for environmental cleanup under federal law, even if the contamination occurred prior to closing. “[Investors should] always conduct an AAI-compliant Phase I ESA for due diligence purposes,” says Steven Hamm, a senior project manager at Weston Solutions in Houston. “Too often, though, I see Phase I reports that lack certain elements of the AAI requirements, either to save money or because the ESA was poorly conducted.”

Hamm cautions investors to hire environmental consultants based on qualifications and experience—not just price. “Mistakes made during the due diligence process can cost millions of dollars, so it’s important to hire the most qualified firm for the project,” he says, adding that the small difference in price from one firm to the next could mean the difference between having “all of your environmental liabilities identified or missing critical issues.”

Mistake #3: Failing to discuss the asset’s future.

Buyers who plan to develop any asset should discuss their plans with an environmental professional so they can decide on the appropriate level of environmental due diligence. (Conversely, consultants who perform due diligence should ask about potential development.) “If, for instance, a buyer intends to develop a surface parking lot with an office building and the consultant isn’t aware of those plans, there may be unintended development expenses associated with soil and groundwater impacts which would not be factored into the cost and schedule for site development and permitting,” explains Sean Dundon, a principal with Blackstone Consulting in Portland, Maine.

Mistake #4: Not thinking beyond the Phase I.

While unforeseen contamination can be costly for investors, so too can issues like environmental compliance and building maintenance. Depending on the circumstances, investors should consider supplementing the ASTM 1527-05–compliant Phase I ESA with additional investigations, such as a compliance audit if the facility is a manufacturer or a property condition assessment if building maintenance is a concern. Phillips says investors also need to understand issues like permit transfer requirements and corporate successor liability concerns such as historic waste disposal. (This is where a good environmental attorney can come in handy.)

The Takeaway

Environmental investigations are an important component of due diligence and should be given careful consideration before a deal is closed. Want to learn more? Join the many Phase I environmental site assessment, environmental due diligence, and EH&S discussions taking place on commonground.

About the Author

Mark Wallace is vice president of social media for Milford, Connecticut-based Environmental Data Resources. The company is the leading provider of environmental risk information services and related workflow applications in the United States. EDR founded commonground to unite environmental and commercial real estate professionals and others interested in real estate due diligence. Since launching two years ago, the business social network has grown to nearly 6,000 members.

Photograph: After the Rain by G&A Scholiers, Belgium.

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