Does Your ESG Advisor Really Understand Environmental Liability?

This is a true story. The names have been changed to protect confidentiality.

The Seller of a manufacturer of machined metal products (primarily US operations) retained an environmental consultant to prepare Sell-Side Phase I environmental site assessments (ESA) for the Company’s manufacturing facilities. A potential Buyer of this business retained an ESG advisor and a legal advisor to conduct pre-investment due diligence for the transaction. No environmental due diligence specialist was retained.

The Co-Investor

As the transaction progressed, the Buyer brought in a co-investor on the deal. At this point, most of the due diligence work had been completed so this stakeholder hired Bridge House to “sanity check” the level of diligence conducted and provide an opinion on the key findings identified to date.

The Miss

The ESG advisor’s overall conclusion regarding the current ESG risk of the business (including environmental management), that was stated in the Investment Committee memo, was that no red flags were identified. Within the ESG advisor’s due diligence report, a more detailed summary of the Company’s environmental management practices acknowledged recognized environmental conditions (RECs) identified by environmental auditors, including potential soil and groundwater impacts and historical use of hazardous products. However, the summary went on to state that the RECs reported were not necessarily indicative of environmental incidents and are often used simply to note the presence of things as common as storage tanks.

Not the case for this deal.

Bridge House was given access to the virtual data room and reviewed the same Phase I ESA reports. One of the Phase I reports disclosed that historically and on numerous occasions, mobile equipment would strike storage tanks, or its adjacent piping, resulting in numerous releases of trichloroethylene (TCE) onto the floor of the facility over a period of many years.

The Potential Exposure

Based on Bridge House’s review and environmental liability experience, the exposure to the primary Buyer could potentially exceed 7-figures. Per the above, the ESG advisor more or less dismissed this issue, and the legal advisor (possibly being informed by the ESG advisor’s report) recognized that potential unfunded environmental liability was an area of risk but failed to elevate or quantify the potential cost exposure. Additionally, Bridge House’s detailed review revealed that two sister locations were under mandated cleanup orders to deal with TCE contamination and the balance of the Company’s manufacturing locations — with essentially the same operations — had never been investigated.

As a result of Bridge House’s due diligence effort, the co-investor encouraged the primary Buyer to secure environmental Pollution Legal Liability insurance post-close to mitigate the financial risk related to contamination being discovered.

Conclusions

Covering “E” in ESG is not the same as traditional environmental due diligence (EDD). Environmental liability requires a different set of skills and experience and your ESG advisor may not have the requisite skillsets to recognize the difference.
This case study, which is an unsatisfactory due diligence outcome, cost the Buyer an unbudgeted post-close pollution liability insurance policy nearing a quarter of a million dollars, rather than negotiating during the diligence period that the seller retain the liability or otherwise pay for the PLL policy. Because the sellers had disclosed the use, storage, and frequent releases of TCE, it is unlikely that the buyers would be able to make claims under Representation & Warranties insurance.
When Bridge House conducts pre-investment ESG due diligence and we encounter current or historical operations which may have environmentally impaired a property, we collaborate with internal environmental risk experts to ensure that we are interpreting available reports and issues with more fulsome due care. Many advisory firms in the ESG space don’t have this capability in house.
To learn more about how Bridge House integrates our pre-investment due diligence services to provide deeper insights to investment teams, reach out to one of our experts below.

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