managing environmental risks in mergers, acquisitions,...
TRANSCRIPT
Presenting a live 90-minute webinar with interactive Q&A
Managing Environmental Risks in Mergers,Acquisitions, Spin-Offs and ReorganizationsIdentifying, Quantifying and Allocating PotentialLiabilities and Long-Term Environmental Obligations
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
TUESDAY, OCTOBER 10, 2017
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Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
Daniella D. Landers, Reed Smith LLP, Houston, TX
David J. Owens, Leger Ketchum & Cohoon, PLLC, The Woodlands, TX
Michael O. Hill, Alba Risk Management, LLC, Washington, D.C.
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Managing Environmental RisksManaging Environmental RisksIn Mergers, Acquisitions, SpinIn Mergers, Acquisitions, Spin--
Offs and ReorganizationsOffs and ReorganizationsIdentifying, Quantifying and Allocating PotentialIdentifying, Quantifying and Allocating Potential
Liabilities and LongLiabilities and Long--Term Environmental ObligationsTerm Environmental Obligations
PRESENTED BY:Daniella D. Landers, Reed Smith LLP, Houston, TX
David J. Owens, Leger Ketchum & Cohoon, PLLC, The Woodlands, TXMichael O. Hill, Alba Risk Management, Washington, D.C.
Identifying and Assessing Environmental Risks◦ Common Environmental Risks◦ Due Diligence◦ Contractual Issues◦ Mitigation Tools
Brief Overview of Tronox Decision & Lessons Learned
Quantification and Forward Management of Environmental Costs
OverviewOverview Identifying and Assessing Environmental Risks
◦ Common Environmental Risks◦ Due Diligence◦ Contractual Issues◦ Mitigation Tools
Brief Overview of Tronox Decision & Lessons Learned
Quantification and Forward Management of Environmental Costs
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Identifying and AssessingIdentifying and AssessingEnvironmental RisksEnvironmental Risks
Presented by:Daniella D. LandersReed Smith LLP
Presented by:Daniella D. LandersReed Smith LLP
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Statutory liability under environmental laws (e.g., CERCLA, RCRA, etc.)
Past Penalties (e.g., air, waste, water, etc.)
On-going operations/permit compliance
Underground storage tanks
Institutional controls/Deed restrictions/Environmental Liens
Vapor Intrusion
Indoor Conditions (e.g., asbestos, mold, lead paint, radon)
Common Environmental RisksCommon Environmental Risks Statutory liability under environmental laws (e.g., CERCLA, RCRA, etc.)
Past Penalties (e.g., air, waste, water, etc.)
On-going operations/permit compliance
Underground storage tanks
Institutional controls/Deed restrictions/Environmental Liens
Vapor Intrusion
Indoor Conditions (e.g., asbestos, mold, lead paint, radon)
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The cost of compliance with law; The cost of remediation; Business interruption costs; Loss of value of asset as a direct result of environmental
condition; Loss of value of asset resulting from market reaction to
publicity about a possible or actual environmental condition; Liability to third parties, e.g., toxic tort, adjacent property
damage, etc.; and Legal costs of environmental claims or litigation without
regard to liability.
Business Risks associated withBusiness Risks associated withEnvironmental RisksEnvironmental Risks
The cost of compliance with law; The cost of remediation; Business interruption costs; Loss of value of asset as a direct result of environmental
condition; Loss of value of asset resulting from market reaction to
publicity about a possible or actual environmental condition; Liability to third parties, e.g., toxic tort, adjacent property
damage, etc.; and Legal costs of environmental claims or litigation without
regard to liability.
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Identify potentially material adverse environmentalconditions that may be a deal killer◦ Physical condition of property to be acquired◦ Compliance history and past violations
Establish defenses to potential future CERCLAliability (e.g., All Appropriate Inquiry)
Identify and quantify environmental risks that mayimpact value of target company/asset◦ Create negotiating leverage◦ Determine purchase price◦ Evaluate and calculate environmental hold back amounts
Why Conduct Environmental DueWhy Conduct Environmental DueDiligenceDiligence
Identify potentially material adverse environmentalconditions that may be a deal killer◦ Physical condition of property to be acquired◦ Compliance history and past violations
Establish defenses to potential future CERCLAliability (e.g., All Appropriate Inquiry)
Identify and quantify environmental risks that mayimpact value of target company/asset◦ Create negotiating leverage◦ Determine purchase price◦ Evaluate and calculate environmental hold back amounts
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Facilitate planning for dealing with environmentalissues once the deal closes
Gain an understanding of the target company’sculture of compliance or noncompliance withenvironmental laws
Determine transferability of any environmentalpermits or other restrictions on future operations
Determine need for and scope of environmentalindemnities
Why Conduct Environmental DueWhy Conduct Environmental DueDiligenceDiligence
Facilitate planning for dealing with environmentalissues once the deal closes
Gain an understanding of the target company’sculture of compliance or noncompliance withenvironmental laws
Determine transferability of any environmentalpermits or other restrictions on future operations
Determine need for and scope of environmentalindemnities
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Key Due Diligence ConsiderationsKey Due Diligence Considerations
How much is enough? Timing of transaction plays a part What is client’s/company’s risk
tolerance? What indemnities will be
offered/negotiated? Do Phase I investigations recommend
Phase II work?◦ Intrusive sampling◦ Split/duplicate samples◦ Responsibility for reporting to
agencies What are requirements of lender or other
party financing deal?
How much is enough? Timing of transaction plays a part What is client’s/company’s risk
tolerance? What indemnities will be
offered/negotiated? Do Phase I investigations recommend
Phase II work?◦ Intrusive sampling◦ Split/duplicate samples◦ Responsibility for reporting to
agencies What are requirements of lender or other
party financing deal?
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Scope?◦ What type of diligence for what properties?◦ Is the inquiry limited to environmental compliance issues?◦ Does the scope also include workplace safety issues?◦ Beware of “mission creep”
Materiality Threshold?
Priorities & Timing?
Logistics and other issues?◦ Data Room◦ Desktop Screening◦ Environmental Consultants
Key Diligence ConsiderationsKey Diligence Considerations Scope?
◦ What type of diligence for what properties?◦ Is the inquiry limited to environmental compliance issues?◦ Does the scope also include workplace safety issues?◦ Beware of “mission creep”
Materiality Threshold?
Priorities & Timing?
Logistics and other issues?◦ Data Room◦ Desktop Screening◦ Environmental Consultants
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Electronic v. Hard Copy Data Rooms With electronic data rooms, you are at the mercy of the target
company’s relevancy determination and indexing system◦ (i.e., environmental documents may be filed under “litigation” or
“corporate documents” or “real estate” sub-folders)
Common Issues: Missing Documents Recurring Compliance Issues (NOVs, consent orders) Deferred CapEx on Pollution Controls Contractual Liabilities from divestitures/acquisitions/leases
Key Diligence ConsiderationsKey Diligence ConsiderationsElectronic v. Hard Copy Data Rooms With electronic data rooms, you are at the mercy of the target
company’s relevancy determination and indexing system◦ (i.e., environmental documents may be filed under “litigation” or
“corporate documents” or “real estate” sub-folders)
Common Issues: Missing Documents Recurring Compliance Issues (NOVs, consent orders) Deferred CapEx on Pollution Controls Contractual Liabilities from divestitures/acquisitions/leases
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Typically Smaller Data Room Management Interviews May focus on Publicly-Available Information
◦ EPA Websites (ECHO, etc.)◦ Database Companies◦ SEC Filings◦ Company Website◦ Google Searches◦ Industry-specific issues
Desktop ReviewsDesktop Reviews Typically Smaller Data Room Management Interviews May focus on Publicly-Available Information
◦ EPA Websites (ECHO, etc.)◦ Database Companies◦ SEC Filings◦ Company Website◦ Google Searches◦ Industry-specific issues
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Diligence Requests
Review Data Room/Desktop Review
Management Interviews
Select Sites For Further Study (site visits)◦ Key facilities◦ Sites likely to have significant environmental issues◦ Leased vs. owned
Develop Preliminary Cost Estimates
Follow-up on Diligence Requests
PrePre--Bid Diligence ProcessBid Diligence Process(including in bankruptcy context)(including in bankruptcy context)
Diligence Requests
Review Data Room/Desktop Review
Management Interviews
Select Sites For Further Study (site visits)◦ Key facilities◦ Sites likely to have significant environmental issues◦ Leased vs. owned
Develop Preliminary Cost Estimates
Follow-up on Diligence Requests
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Review diligence results
Refine cost estimates
Explore Mitigation “Tools”◦ Price adjustments◦ Indemnity◦ Escrow◦ Insurance◦ Audit policies for compliance issues◦ State brownfield or voluntary cleanup programs
PrePre--Bid Diligence ProcessBid Diligence Process(including in bankruptcy context)(including in bankruptcy context)
Review diligence results
Refine cost estimates
Explore Mitigation “Tools”◦ Price adjustments◦ Indemnity◦ Escrow◦ Insurance◦ Audit policies for compliance issues◦ State brownfield or voluntary cleanup programs
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ASTM E1527 Focused on Complying With CERCLA“All Appropriate Inquiry” (AAI) protection◦ RECs◦ CRECs◦ HRECs
Include Non-Scope Items?◦ Compliance
Opinion and Conclusions Recommendations (not required) Beware of Phase 1 “commodity” shops
Phase 1 Site AssessmentPhase 1 Site Assessment ASTM E1527 Focused on Complying With CERCLA
“All Appropriate Inquiry” (AAI) protection◦ RECs◦ CRECs◦ HRECs
Include Non-Scope Items?◦ Compliance
Opinion and Conclusions Recommendations (not required) Beware of Phase 1 “commodity” shops
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AAI completed when release identified◦ No further investigation required◦ Sampling may be conducted to obtain address/explain data gaps◦ May valuable for determining how a landowner may best fulfill his
or her post-acquisition Continuing Obligations.
Caution: Preamble states:◦ “the fact that the all appropriate inquiry standards do not require
sampling and analysis does not prevent a court from concludingthat, under the circumstances of a particular case, sampling andanalysis should have been conducted to meet ‘‘the degree ofobviousness of the presence or likely presence of contaminationat the property, and the ability to detect the contamination byappropriate investigation” (70 FR 66101)
Does AAI Require Sampling?Does AAI Require Sampling? AAI completed when release identified
◦ No further investigation required◦ Sampling may be conducted to obtain address/explain data gaps◦ May valuable for determining how a landowner may best fulfill his
or her post-acquisition Continuing Obligations.
Caution: Preamble states:◦ “the fact that the all appropriate inquiry standards do not require
sampling and analysis does not prevent a court from concludingthat, under the circumstances of a particular case, sampling andanalysis should have been conducted to meet ‘‘the degree ofobviousness of the presence or likely presence of contaminationat the property, and the ability to detect the contamination byappropriate investigation” (70 FR 66101)
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“In certain instances, depending upon site-specificcircumstances and the totality of the informationcollected during the all appropriate inquiries priorto the property acquisition, it may be necessary toconduct sampling and analysis, either pre-or post-acquisition, to fully understand the conditions at aproperty, and fully comply with the statutoryrequirements for the CERCLA liability protections”Id.
Sampling (cont’d)Sampling (cont’d) “In certain instances, depending upon site-specific
circumstances and the totality of the informationcollected during the all appropriate inquiries priorto the property acquisition, it may be necessary toconduct sampling and analysis, either pre-or post-acquisition, to fully understand the conditions at aproperty, and fully comply with the statutoryrequirements for the CERCLA liability protections”Id.
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AAI Does Not Apply To:AAI Does Not Apply To: Third Party Defense Secured Credit Exemption UST Sites (unless Brownfield Site) RCRA 7002 Actions RCRA Corrective Actions State Superfund Programs Unless Specifically
Incorporated Common Law
Third Party Defense Secured Credit Exemption UST Sites (unless Brownfield Site) RCRA 7002 Actions RCRA Corrective Actions State Superfund Programs Unless Specifically
Incorporated Common Law
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Buyer-◦ Want to limit liability to post-closing operations◦ Want Indemnity/reps/warranties
Seller-◦ seeking to “walk away” from environmental liabilities◦ “No-hunt” provisions for indemnity, time
limitations, baskets, deductibles, etc.
Buyer/Seller PerspectivesBuyer/Seller Perspectives
Buyer-◦ Want to limit liability to post-closing operations◦ Want Indemnity/reps/warranties
Seller-◦ seeking to “walk away” from environmental liabilities◦ “No-hunt” provisions for indemnity, time
limitations, baskets, deductibles, etc.
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Environmental Reps and Warranties SurviveClosing?
If not, due diligence is acquiring company’s best protection◦ No recourse after closing
If yes, how long?◦ Make sure and calendar
Scope and Term of Environmental Indemnities?
Known versus Confidential Sale? Do employees of target company know about
potential sale? Confidential sale makes investigation more
difficult
Contractual IssuesContractual Issues
Environmental Reps and Warranties SurviveClosing?
If not, due diligence is acquiring company’s best protection◦ No recourse after closing
If yes, how long?◦ Make sure and calendar
Scope and Term of Environmental Indemnities?
Known versus Confidential Sale? Do employees of target company know about
potential sale? Confidential sale makes investigation more
difficult
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Asset purchase -◦ Absent exposure to a successor-liability theory or express assumption of
liability in the agreement, pre-acquisition liability should stay with seller
Stock purchase -◦ Absent liability under U.S. v. Bestfoods, 524 U.S. 51 (1998) analysis,
environmental liabilities remain with company purchased unless otherwiseprovided by agreement
Merger -◦ Acquiring company assumes all liability of target company
Bankruptcy -◦ Coordination with bankruptcy trustee and environmental agencies critical
Impact of Deal StructureImpact of Deal Structure
Asset purchase -◦ Absent exposure to a successor-liability theory or express assumption of
liability in the agreement, pre-acquisition liability should stay with seller
Stock purchase -◦ Absent liability under U.S. v. Bestfoods, 524 U.S. 51 (1998) analysis,
environmental liabilities remain with company purchased unless otherwiseprovided by agreement
Merger -◦ Acquiring company assumes all liability of target company
Bankruptcy -◦ Coordination with bankruptcy trustee and environmental agencies critical
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CERCLA Liability Protections◦ Innocent Landowner Policy◦ Bonafide Prospective Purchaser Policy◦ Contiguous Property Owner Policy
EPA Audit Policy
New Owner Policy
Small Business Policy
eDisclosure Portal
Federal Mitigation ToolsFederal Mitigation Tools CERCLA Liability Protections
◦ Innocent Landowner Policy◦ Bonafide Prospective Purchaser Policy◦ Contiguous Property Owner Policy
EPA Audit Policy
New Owner Policy
Small Business Policy
eDisclosure Portal
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Voluntary Cleanup/Brownfield Programs
Self-disclosure/audit policies
Property Transfer Laws triggered by certaintransactions (e.g., IL, NJ, CN)
State Mitigation ToolsState Mitigation Tools Voluntary Cleanup/Brownfield Programs
Self-disclosure/audit policies
Property Transfer Laws triggered by certaintransactions (e.g., IL, NJ, CN)
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1. Poorly Planned Due DiligenceProcess/Inadequate Review Time
2. Failure to Evaluate Historical Information
3. Reliance on Outdated Information
4. Reliance on Seller’s Representations andWarranties, Due Diligence and Information
5. Acceptance of Unreasonable or InappropriateLiability Estimates
5 Common Mistakes to Avoid In5 Common Mistakes to Avoid InConducting Due DiligenceConducting Due Diligence
1. Poorly Planned Due DiligenceProcess/Inadequate Review Time
2. Failure to Evaluate Historical Information
3. Reliance on Outdated Information
4. Reliance on Seller’s Representations andWarranties, Due Diligence and Information
5. Acceptance of Unreasonable or InappropriateLiability Estimates
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Overview of Tronox andOverview of Tronox andLessons LearnedLessons Learned
Presented by:David J. OwensLeger, Ketchum & Cohoon PLLC
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SettingThis case involved claims for actual and constructive fraud based onallegations that Tronox was, among other things, insolvent or undercapitalizedat the date of its IPO.
The U.S. government intervened in the adversary proceeding asserting separateclaims against Anadarko and Kerr-McGee under the Federal Debt CollectionProcedures Act.
This was one of the largest environmental claims ever filed by the USDOJ,covering well over 1000 sites, touching upon nearly every state.
This presentation is not intended to be a detailed summary of the entireTronox matter. This program is focused on environmental due diligence andthe valuation of environmental liabilities in mergers and acquisitions.
TronoxTronoxTronox Inc., et al. v. Kerr McGee, et al. (In re Tronox Inc.),Tronox Inc., et al. v. Kerr McGee, et al. (In re Tronox Inc.), 503 B.R. 239503 B.R. 239
(Bankr. S.D.N.Y. Dec. 12, 2013)(Bankr. S.D.N.Y. Dec. 12, 2013)SettingThis case involved claims for actual and constructive fraud based onallegations that Tronox was, among other things, insolvent or undercapitalizedat the date of its IPO.
The U.S. government intervened in the adversary proceeding asserting separateclaims against Anadarko and Kerr-McGee under the Federal Debt CollectionProcedures Act.
This was one of the largest environmental claims ever filed by the USDOJ,covering well over 1000 sites, touching upon nearly every state.
This presentation is not intended to be a detailed summary of the entireTronox matter. This program is focused on environmental due diligence andthe valuation of environmental liabilities in mergers and acquisitions.
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BackgroundKerr McGee Corporation (KMG) was an energy and chemical company with a widerange of operations and liabilities spanning more than 70 years.
In 2002, Anadarko Petroleum Corp. (APC) rejected an acquisition of KMG due to themisalignment of business lines with Anadarko’s core business.
Later in 2002, KMG began a corporate reorganization to segregate its oil & gas andnon-oil & gas business units through 11 transactions from 2002-5. As a result of this reorganization the original KMG was renamed Tronox and
became a subsidiary of a newly formed parent, named Kerr McGee Corporation(NKMG).
Tronox became the non-oil and gas subsidiary and retained all non-oil & gasassets and their associated liabilities.
On November 28, 2005, Tronox, at the time a subsidiary of NKMG, completedan initial public offering and was subsequently spun-off from NKMG.
In June 2006, APC acquired NKMG
Tronox filed for Chapter 11 bankruptcy in 2009. Tronox filed lawsuits against NKMGseeking to avoid as fraudulent transfers the corporate reorganization transactionsand sought $15 billion in damages.
TronoxTronoxTronox Inc., et al. v. Kerr McGee, et al. (In re Tronox Inc.),Tronox Inc., et al. v. Kerr McGee, et al. (In re Tronox Inc.), 503 B.R. 239503 B.R. 239
(Bankr. S.D.N.Y. Dec. 12, 2013)(Bankr. S.D.N.Y. Dec. 12, 2013)BackgroundKerr McGee Corporation (KMG) was an energy and chemical company with a widerange of operations and liabilities spanning more than 70 years.
In 2002, Anadarko Petroleum Corp. (APC) rejected an acquisition of KMG due to themisalignment of business lines with Anadarko’s core business.
Later in 2002, KMG began a corporate reorganization to segregate its oil & gas andnon-oil & gas business units through 11 transactions from 2002-5. As a result of this reorganization the original KMG was renamed Tronox and
became a subsidiary of a newly formed parent, named Kerr McGee Corporation(NKMG).
Tronox became the non-oil and gas subsidiary and retained all non-oil & gasassets and their associated liabilities.
On November 28, 2005, Tronox, at the time a subsidiary of NKMG, completedan initial public offering and was subsequently spun-off from NKMG.
In June 2006, APC acquired NKMG
Tronox filed for Chapter 11 bankruptcy in 2009. Tronox filed lawsuits against NKMGseeking to avoid as fraudulent transfers the corporate reorganization transactionsand sought $15 billion in damages.
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Why did KMG need to restructure?Over time, corporate organizational structures can become“organizationally challenged”.
◦With numerous acquisitions, assets tend to become scattered throughoutmultiple subsidiaries resulting in a confused organizational structure.
Benefits of Consolidation◦Simplify the organizational structure along business lines.◦Reduces external confusion.◦Tax benefits.◦Merger and Acquisition benefits.
Reorganization and Entity ConsolidationReorganization and Entity ConsolidationWhy did KMG need to restructure?Over time, corporate organizational structures can become“organizationally challenged”.
◦With numerous acquisitions, assets tend to become scattered throughoutmultiple subsidiaries resulting in a confused organizational structure.
Benefits of Consolidation◦Simplify the organizational structure along business lines.◦Reduces external confusion.◦Tax benefits.◦Merger and Acquisition benefits.
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The Decision to SeparateKMG had struggled with its diversification for years. However,due to its complicated organizational structure it was unable toefficiently divest itself of certain business lines.
KMG…and now NKMG believed that it was undervalued, in part,due to this diversification.
So, In order to unlock shareholder value, NKMG decided to sellits non-oil & gas subsidiary.
TronoxTronox Sale/SpinSale/Spin
The Decision to SeparateKMG had struggled with its diversification for years. However,due to its complicated organizational structure it was unable toefficiently divest itself of certain business lines.
KMG…and now NKMG believed that it was undervalued, in part,due to this diversification.
So, In order to unlock shareholder value, NKMG decided to sellits non-oil & gas subsidiary.
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The Sale ProcessIn preparation for the sale of Tronox, NKMG undertook amassive search for all relevant environmental data/information.This information was placed in a virtual data room and madeavailable to all potential bidders.The successful bidder reviewed the environmental data andused NKMG’s reserves as an approximation of theenvironmental liability and sought an indemnity for theenvironmental conditions.Before the sale was finalized, the bidder attempted torenegotiate other terms with resulted in NKMG’s decision tohalt the sale process and consider the Spin.
TronoxTronox Sale/SpinSale/Spin
The Sale ProcessIn preparation for the sale of Tronox, NKMG undertook amassive search for all relevant environmental data/information.This information was placed in a virtual data room and madeavailable to all potential bidders.The successful bidder reviewed the environmental data andused NKMG’s reserves as an approximation of theenvironmental liability and sought an indemnity for theenvironmental conditions.Before the sale was finalized, the bidder attempted torenegotiate other terms with resulted in NKMG’s decision tohalt the sale process and consider the Spin.
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The Spin ProcessIn the Spin, NKMG also used its accounting reserves as asurrogate for the value of the environmental liabilities.
◦In considering the effect on capitalization, NKMG looked at multiples of theaccounting reserves.◦NKMG also looked at its historic annual expenditures for the environmentalconditions.◦NKMG then concluded that, with an additional environmental indemnity ofapproximately $100MM, Tronox would be adequately capitalized.
NKMG did not undertake any other attempt to value theenvironmental liabilities.
TronoxTronox Sale/SpinSale/Spin
The Spin ProcessIn the Spin, NKMG also used its accounting reserves as asurrogate for the value of the environmental liabilities.
◦In considering the effect on capitalization, NKMG looked at multiples of theaccounting reserves.◦NKMG also looked at its historic annual expenditures for the environmentalconditions.◦NKMG then concluded that, with an additional environmental indemnity ofapproximately $100MM, Tronox would be adequately capitalized.
NKMG did not undertake any other attempt to value theenvironmental liabilities.
34
Accounting AccrualsFinancial Accounting Standards (FAS5)
An estimated loss…shall be accrued…if both of the followingconditions are met:
Information available prior to the issuance of the financialstatements indicates that it is probable than an asset had beenimpaired or a liability had been incurred…and
The amount of the loss can be reasonably estimated.
Valuing Environmental LiabilitiesValuing Environmental LiabilitiesAccounting AccrualsFinancial Accounting Standards (FAS5)
An estimated loss…shall be accrued…if both of the followingconditions are met:
Information available prior to the issuance of the financialstatements indicates that it is probable than an asset had beenimpaired or a liability had been incurred…and
The amount of the loss can be reasonably estimated.
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Fair ValueFair Value (FAS 157): Fair value is the price that would bereceived to sell an asset, or paid to transfer a liability, in anorderly transaction between market participants at themeasurement date.
Fair Value Determination.◦Income approach. The income approach uses valuation techniques toconvert future amounts (e.g., cash flows or earnings) to a single presentamount (discounted).◦Market approach: The market approach uses prices and other relevantinformation generated by market transactions involving identical orcomparable assets or liabilities.◦Cost approach: Current replacement cost.
Valuing Environmental LiabilitiesValuing Environmental LiabilitiesFair ValueFair Value (FAS 157): Fair value is the price that would bereceived to sell an asset, or paid to transfer a liability, in anorderly transaction between market participants at themeasurement date.
Fair Value Determination.◦Income approach. The income approach uses valuation techniques toconvert future amounts (e.g., cash flows or earnings) to a single presentamount (discounted).◦Market approach: The market approach uses prices and other relevantinformation generated by market transactions involving identical orcomparable assets or liabilities.◦Cost approach: Current replacement cost.
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Practicle ApproachesFAS5 Reporting v. Fair Market Determinations.
Probabilistic v. Deterministic Models.
Valuing Environmental LiabilitiesValuing Environmental LiabilitiesPracticle ApproachesFAS5 Reporting v. Fair Market Determinations.
Probabilistic v. Deterministic Models.
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Fraudulent Transfers
There are two types of fraudulent transfers in bankruptcy.
“Actual Fraud” involves the intent to defraud creditors.
“Constructive Fraud” involves a transfer which was made inexchange for grossly inadequate consideration.
The Fraud ComponentThe Fraud ComponentFraudulent Transfers
There are two types of fraudulent transfers in bankruptcy.
“Actual Fraud” involves the intent to defraud creditors.
“Constructive Fraud” involves a transfer which was made inexchange for grossly inadequate consideration.
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Badges of Fraud
Because evidence of actual intent is rarely available, creditorsoften have to rely on circumstantial evidence of fraud. “[T]hefinding of the requisite intent may be predicated upon theconcurrence of facts which, while not direct evidence of actualintent, lead to the irresistible conclusion that the transferor'sconduct was motivated by such intent.
◦5 Collier on Bankruptcy, ¶ 548.04[2][a], at 548-23 to 548-24.
The Fraud ComponentThe Fraud ComponentBadges of Fraud
Because evidence of actual intent is rarely available, creditorsoften have to rely on circumstantial evidence of fraud. “[T]hefinding of the requisite intent may be predicated upon theconcurrence of facts which, while not direct evidence of actualintent, lead to the irresistible conclusion that the transferor'sconduct was motivated by such intent.
◦5 Collier on Bankruptcy, ¶ 548.04[2][a], at 548-23 to 548-24.
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Badges of FraudThe transfer or obligation was to an insider.The transfer or obligation was concealed.The transfer was of substantially all the debtor’s assets.The debtor removed or concealed assets.The value of the consideration received by the debtor was reasonablyequivalent to the value of the asset transferred or the amount of the obligationincurred.The transfer occurred shortly before or shortly after a substantial debt wasincurred.The debtor retained possession or control of the property transferred.The existence or the threat of litigation.The debtor was insolvent or became insolvent shortly after the transfer wasmade.The debtor absconded.The debtor transferred the essential assets of the business to a lienor whotransferred the assets to an insider of the debtor.
The Fraud ComponentThe Fraud ComponentBadges of FraudThe transfer or obligation was to an insider.The transfer or obligation was concealed.The transfer was of substantially all the debtor’s assets.The debtor removed or concealed assets.The value of the consideration received by the debtor was reasonablyequivalent to the value of the asset transferred or the amount of the obligationincurred.The transfer occurred shortly before or shortly after a substantial debt wasincurred.The debtor retained possession or control of the property transferred.The existence or the threat of litigation.The debtor was insolvent or became insolvent shortly after the transfer wasmade.The debtor absconded.The debtor transferred the essential assets of the business to a lienor whotransferred the assets to an insider of the debtor.
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DefinedA legal hold is a process that an organization uses to preserveall forms of relevant information to avoid spoliation whenlitigation, governmental investigations or other such mattersare reasonably anticipated.
The legal hold is initiated by a notice or communication fromcounsel to an organization that suspends the normalrecords/document management processes.
Legal Hold NotificationsLegal Hold NotificationsDefinedA legal hold is a process that an organization uses to preserveall forms of relevant information to avoid spoliation whenlitigation, governmental investigations or other such mattersare reasonably anticipated.
The legal hold is initiated by a notice or communication fromcounsel to an organization that suspends the normalrecords/document management processes.
41
In 2002, Anadarko Petroleum Corp. (APC) rejected an acquisition ofKMG due to the misalignment of business lines with Anadarko’s corebusiness.
APC acquired NKMG in August 2006.
It was alleged that APC conspired with KMG to defraud creditors.
APC was dismissed as a defendant from the adversary proceeding.
Anadarko’s Role in the AdversaryAnadarko’s Role in the AdversaryProceedingProceeding
In 2002, Anadarko Petroleum Corp. (APC) rejected an acquisition ofKMG due to the misalignment of business lines with Anadarko’s corebusiness.
APC acquired NKMG in August 2006.
It was alleged that APC conspired with KMG to defraud creditors.
APC was dismissed as a defendant from the adversary proceeding.
42
Bankruptcy & TrialCourt confirmed the Tronox reorganization plan pursuant towhich environmental and tort plaintiffs agreed to accept theproceeds of any pending fraudulent transfer action.
Trial hotly contested – 34 days, over 6100 exhibits, 40witnesses and 14 experts.
Memorandum of Opinion After Trial: Found NKMG liable forfraudulent transfers in connection with the 2002 internalrestructuring and subsequent IPO of Tronox, and concludedthat the damages could range from approximately $5 billion to$14.5 billion. The Court sought additional briefing concerningthe calculation of damages.
TronoxTronox DecisionDecision
Bankruptcy & TrialCourt confirmed the Tronox reorganization plan pursuant towhich environmental and tort plaintiffs agreed to accept theproceeds of any pending fraudulent transfer action.
Trial hotly contested – 34 days, over 6100 exhibits, 40witnesses and 14 experts.
Memorandum of Opinion After Trial: Found NKMG liable forfraudulent transfers in connection with the 2002 internalrestructuring and subsequent IPO of Tronox, and concludedthat the damages could range from approximately $5 billion to$14.5 billion. The Court sought additional briefing concerningthe calculation of damages.
43
PracticePractice PointsPoints
Key Points to Remember
Entity Consolidation Projects◦ Structure and Purpose◦ Who owns the privilege?
FAS5 and Accruals Fair Value Determinations Legal Hold Notifications Environmental Due Diligence
Key Points to Remember
Entity Consolidation Projects◦ Structure and Purpose◦ Who owns the privilege?
FAS5 and Accruals Fair Value Determinations Legal Hold Notifications Environmental Due Diligence
First time this bankruptcy court has addressed whether a transaction(or series of transactions) resulting in the assumption of significantlegacy liabilities, including contingent environmental liabilities, canserve as the basis for a fraudulent transfer.
Decision could have potential chilling effects on ongoingrestructuring transactions as well as the quantification ofenvironmental costs. It will significantly impact how most financialactors evaluate fraudulent transfer risks involved in any transaction,including spin-offs, leveraged buy outs and dividendrecapitalizations.
Opens the door for unsecured creditors to challenge a broader arrayof transactions over a longer period of time by seeking to collapsetransactions that are not directly linked, but that can becharacterized as part of a common scheme.
Importance ofImportance of TronoxTronox DecisionDecision
First time this bankruptcy court has addressed whether a transaction(or series of transactions) resulting in the assumption of significantlegacy liabilities, including contingent environmental liabilities, canserve as the basis for a fraudulent transfer.
Decision could have potential chilling effects on ongoingrestructuring transactions as well as the quantification ofenvironmental costs. It will significantly impact how most financialactors evaluate fraudulent transfer risks involved in any transaction,including spin-offs, leveraged buy outs and dividendrecapitalizations.
Opens the door for unsecured creditors to challenge a broader arrayof transactions over a longer period of time by seeking to collapsetransactions that are not directly linked, but that can becharacterized as part of a common scheme.
45
Quantification andQuantification andManagement ofManagement of
Environmental CostsEnvironmental CostsPresented by:Michael O. HillAlba Risk Management Services, LLC
Presented by:Michael O. HillAlba Risk Management Services, LLC
46
Tronox Notes (Misc.)Tronox Notes (Misc.) “[T]here is no dispute that accounting reserves for environmental
costs do not purport to be useful in a UFTA solvency analysis. Inre. Tronox, 503 B.R. 239, 310 (Bankr. S.D.N.Y. 2013). The samemay be true more broadly. E.g., S. Goodman & T. Little, The Gapin GAAP, at 7 (Rose Foundation 2003), citing, EPA finding that75% of publicly-traded companies under-report.
Possible preference for market approach. See id. at 292 & n.61;see also, In re. Tronox, No. 14·cv·5495, slip op at (S.D.N.Y.Nov. 10, 2014) (in affirming Bankruptcy Court Report andRecommendation, District Court noted that that a key factor indetermining whether a settlement is fair and equitable is “theextent to which the settlement is the product of arm’s lengthbargaining.”)
Fixed-Price Cleanups lack any of the court-cited indicia of fraud,including the 1st of 5 (e.g., transfer is not to an insider). Id. at284. For that and other reasons, may present best defenseagainst allegations of fraud.
“[T]here is no dispute that accounting reserves for environmentalcosts do not purport to be useful in a UFTA solvency analysis. Inre. Tronox, 503 B.R. 239, 310 (Bankr. S.D.N.Y. 2013). The samemay be true more broadly. E.g., S. Goodman & T. Little, The Gapin GAAP, at 7 (Rose Foundation 2003), citing, EPA finding that75% of publicly-traded companies under-report.
Possible preference for market approach. See id. at 292 & n.61;see also, In re. Tronox, No. 14·cv·5495, slip op at (S.D.N.Y.Nov. 10, 2014) (in affirming Bankruptcy Court Report andRecommendation, District Court noted that that a key factor indetermining whether a settlement is fair and equitable is “theextent to which the settlement is the product of arm’s lengthbargaining.”)
Fixed-Price Cleanups lack any of the court-cited indicia of fraud,including the 1st of 5 (e.g., transfer is not to an insider). Id. at284. For that and other reasons, may present best defenseagainst allegations of fraud.
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Large (typically, publicly-traded) RemediationContractor Assumes All Environmental RegulatoryCosts up to Two Times (2X) the Initially-AgreedEstimated Costs. Roughly 70% of the OverrunRisks are hedged with insurance, escrow, or othermechanism.
Insurer may cover some non-regulatory (e.g.,toxic tort) risks, but typically only up to period of10 years.
Cleanup certainty is maximized, while cleanupsare generally less costly as well as faster andwithout sacrifice to quality.
Overview of Insured FixedOverview of Insured Fixed--PricePriceCleanupsCleanups
Large (typically, publicly-traded) RemediationContractor Assumes All Environmental RegulatoryCosts up to Two Times (2X) the Initially-AgreedEstimated Costs. Roughly 70% of the OverrunRisks are hedged with insurance, escrow, or othermechanism.
Insurer may cover some non-regulatory (e.g.,toxic tort) risks, but typically only up to period of10 years.
Cleanup certainty is maximized, while cleanupsare generally less costly as well as faster andwithout sacrifice to quality.
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Fixed-Price Cleanups are generally less costly,faster, and better. E.g., 42-Site Army Study:• Costs averaged 21% below Independent Government Estimates.• “Contractors … meeting or beating schedule dates.”• “Quality of work … reported from good to going beyond requirements.”*Source: U.S. Army, Tracking Performance on the Army’s Performance-BasedContracts, at 4, 24, 31 (May 16, 2006); see also U.S. Air Force, Transformation ofEnvironmental Remediation, (2005) (http://www.p2pays.org/ref/34/33984.ppt)(discussing PBR cost and schedule reductions); Compare R. Durant, The Greening ofthe U.S. Military, at 1 & n.4 (2007) (“average cleanup costs at closing [military] basesare typically 60 percent higher than estimated originally);
Favored by EPA and other regulators for policyreasons.*Source: EPA Inspector General, EPA Should Increase Fixed-Price Contracting for
Remedial Actions, Rept. 13-P-0208 (March 28, 2013); CCA approved by EPAAdministrator and California Governor in 2013 and 2015 in context of NPL FOSETs.
Fixed-Price Cleanups are generally less costly,faster, and better. E.g., 42-Site Army Study:• Costs averaged 21% below Independent Government Estimates.• “Contractors … meeting or beating schedule dates.”• “Quality of work … reported from good to going beyond requirements.”*Source: U.S. Army, Tracking Performance on the Army’s Performance-BasedContracts, at 4, 24, 31 (May 16, 2006); see also U.S. Air Force, Transformation ofEnvironmental Remediation, (2005) (http://www.p2pays.org/ref/34/33984.ppt)(discussing PBR cost and schedule reductions); Compare R. Durant, The Greening ofthe U.S. Military, at 1 & n.4 (2007) (“average cleanup costs at closing [military] basesare typically 60 percent higher than estimated originally);
Favored by EPA and other regulators for policyreasons.*Source: EPA Inspector General, EPA Should Increase Fixed-Price Contracting for
Remedial Actions, Rept. 13-P-0208 (March 28, 2013); CCA approved by EPAAdministrator and California Governor in 2013 and 2015 in context of NPL FOSETs.
49
50
Financial Incentives Help Ensure (And, IfNecessary, Defend) Accuracy Of Cost Estimates:◦ Contractors incentivized not to over-estimate (because
won’t be awarded the contract, assuming competitive bidding).◦ Contractors incentivized not to under-estimate (because
won’t have sufficient funds to accomplish the cleanup).◦ Insurers’ incentives not dissimilar.
FPCs as a Means to Quantify CostsFPCs as a Means to Quantify Costs
Financial Incentives Help Ensure (And, IfNecessary, Defend) Accuracy Of Cost Estimates:◦ Contractors incentivized not to over-estimate (because
won’t be awarded the contract, assuming competitive bidding).◦ Contractors incentivized not to under-estimate (because
won’t have sufficient funds to accomplish the cleanup).◦ Insurers’ incentives not dissimilar.
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‣ Ongoing Financial Incentives Help Ensure That The InitialEstimate Will Not Be Exceeded And Cleanup Will Not Be Delayed• “Carrot” to complete under budget• “Stick” to avoid completing over budget• Carrot and stick also encourage prompt cleanup (by accelerating income and
avoiding increased risk)
FPCs as a Means to Manage CostsFPCs as a Means to Manage Costs
52
Owner ExcessExposures
($10M)
$10M
Benefits from Owner/DebtorBenefits from Owner/DebtorPerspectivePerspective
Contractor($2M)
Cost CapPolicy
Limits orCCA CostOverage
Fund($6.8M)
Contractor ($1.2M)
$10M
ExpectedCleanupCosts
($10M)
$10M
ExpectedCleanupCosts
($10M)
$10M
Without an FPC With an FPC
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At appropriate sites, FPCs offer distinctbenefits to Contractors:◦ Potential for “windfall” from cleanup cost reductions.◦ Greater flexibility and lower internal costs; improved
long-term planning abilities.
◦ Greater market share and visibility.
Risks from FPCs are reasonably manageable(well-capitalized Contractors will give meaningful indemnities onlarger cleanups only with the downside risks rationally hedged).
Benefits from Contractor PerspectiveBenefits from Contractor Perspective At appropriate sites, FPCs offer distinct
benefits to Contractors:◦ Potential for “windfall” from cleanup cost reductions.◦ Greater flexibility and lower internal costs; improved
long-term planning abilities.
◦ Greater market share and visibility.
Risks from FPCs are reasonably manageable(well-capitalized Contractors will give meaningful indemnities onlarger cleanups only with the downside risks rationally hedged).
54
Cost Cap (aka Stop Loss):◦ Covers overruns of expected costs for Known pollution
conditions, plus Unknowns discovered in course of addressingKnowns.
◦ Robust market from traditional insurers 1998 - 2011. Only 1traditional insurer today, and traditional coverage is limited,but Captives and other Cost Cap Alternatives are available.
Pollution Legal Liability (PLL): (with some exceptions, for “unknowns”)o For Unknowns discovered apart from execution of remediation of
Knowns.o For 3rd-party claims (bodily injury, property cleanup, reduced property value).o Other (new releases; natural resource damages; business interruption; disposal
sites).
**Environmental Policies are “surplus lines,” and thus vary byinsurer and even by policy. Each “customizable” and mustbe reviewed/manuscripted by counsel to same extent asany other contract.
Environmental Insurance ProductsEnvironmental Insurance Products Cost Cap (aka Stop Loss):
◦ Covers overruns of expected costs for Known pollutionconditions, plus Unknowns discovered in course of addressingKnowns.
◦ Robust market from traditional insurers 1998 - 2011. Only 1traditional insurer today, and traditional coverage is limited,but Captives and other Cost Cap Alternatives are available.
Pollution Legal Liability (PLL): (with some exceptions, for “unknowns”)o For Unknowns discovered apart from execution of remediation of
Knowns.o For 3rd-party claims (bodily injury, property cleanup, reduced property value).o Other (new releases; natural resource damages; business interruption; disposal
sites).
**Environmental Policies are “surplus lines,” and thus vary byinsurer and even by policy. Each “customizable” and mustbe reviewed/manuscripted by counsel to same extent asany other contract.
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Like Cost Cap insurance, except Owner, Escrow Agent,Captive or other entity covers the “Cost Cap” risks(Contractor continues to self-insure 32%).
• CCA advantages over traditional Cost Caps:o Limits (can go >$25M); duration (can go >10 yrs.).o Avoid delay, transactions costs, and uncertainty in terms/availability.o Claim review by financially-independent 3rd party.o Avoid “down-selection” of Contractors by Insurers.o Avoid “down-selection” of PLL providers.o Depending on how structured, avoid premium, surplus lines tax, and
underwriting costs/fees.
Broad Description ofBroad Description ofCost Cap Alternative (“CCA”)Cost Cap Alternative (“CCA”)
Like Cost Cap insurance, except Owner, Escrow Agent,Captive or other entity covers the “Cost Cap” risks(Contractor continues to self-insure 32%).
• CCA advantages over traditional Cost Caps:o Limits (can go >$25M); duration (can go >10 yrs.).o Avoid delay, transactions costs, and uncertainty in terms/availability.o Claim review by financially-independent 3rd party.o Avoid “down-selection” of Contractors by Insurers.o Avoid “down-selection” of PLL providers.o Depending on how structured, avoid premium, surplus lines tax, and
underwriting costs/fees.
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Captives Emergence and Growth in U.S.Captives Emergence and Growth in U.S.o Insuring risks that were otherwise uninsurable (or only at
unreasonably high cost).o Modern-day concept emerged in the late 1950’s. Mostly
off-shore.o VT passed 1st statute, in 1981. Today, over 30 states have
statutes (most since 2000). Roughly half are in VT.o By early ‘80’s, still <500 worldwide. Today, >7,000.o >90% of Fortune 1,000 companies have captives, as do
many smaller companies, non-profits, and associations.o >50% of all Property & Casualty premium is written
through captives.
o Insuring risks that were otherwise uninsurable (or only atunreasonably high cost).
o Modern-day concept emerged in the late 1950’s. Mostlyoff-shore.
o VT passed 1st statute, in 1981. Today, over 30 states havestatutes (most since 2000). Roughly half are in VT.
o By early ‘80’s, still <500 worldwide. Today, >7,000.o >90% of Fortune 1,000 companies have captives, as do
many smaller companies, non-profits, and associations.o >50% of all Property & Casualty premium is written
through captives.
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Cost Cap Alternative MixturesCost Cap Alternative Mixtures
• Captive supported with reinsurance: Captive pays portionof premium to Reinsurer to cover portion of the risks.
• Captive fronted with traditional insurance: Providesgreater familiarity to regulators and other stakeholders.Provides second contractual commitment.
• Mixtures: Pure contracts; traditional; captive (with or w/oreinsurance or fronting)
• Captive supported with reinsurance: Captive pays portionof premium to Reinsurer to cover portion of the risks.
• Captive fronted with traditional insurance: Providesgreater familiarity to regulators and other stakeholders.Provides second contractual commitment.
• Mixtures: Pure contracts; traditional; captive (with or w/oreinsurance or fronting)
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BrownfieldBrownfield•Two conventional estimates, with
no guarantee: $15-$20M.•Insured FPC done for $10.1M.•City contributed $5M via
Brownfield grants and TaxIncremental Financing, andreceived title to property fromOwner essentially for free.
•Owner exited for lower cost($5.1M) and greater goodwill.
*Reference: C. Olson, R. Bursek, and M. Jones,Urban Renaissance: From Brass ManufacturingTo Uptown Brass Center, Air & Waste Mgt. Ass’n.(Dec. 2005).
•Two conventional estimates, withno guarantee: $15-$20M.
•Insured FPC done for $10.1M.•City contributed $5M via
Brownfield grants and TaxIncremental Financing, andreceived title to property fromOwner essentially for free.
•Owner exited for lower cost($5.1M) and greater goodwill.
*Reference: C. Olson, R. Bursek, and M. Jones,Urban Renaissance: From Brass ManufacturingTo Uptown Brass Center, Air & Waste Mgt. Ass’n.(Dec. 2005).
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McClellan FOSET Transfers 2007McClellan FOSET Transfers 2007--20152015(w/ Cost Caps, then with CCAs)(w/ Cost Caps, then with CCAs)
Parcel C6 ($11M; 62 acres) (2007) Nation’s 1st
privatized FOSET at NPL Site. FOSET #1 ($14M; 545 acres) (2010). FOSET #2 ($16M; 528 acres). CCA used. EPA
Administrator and CA Governor approved (2013). FOSET #3 (>20M; 207 acres). CCA used. EPA
Administrator and CA Governor approved (2015).
M. Hill, Insured Fixed-Price Cleanups: Still Possible Even AfterCommercial Insurers’ 2011 Exit from the Cost Cap Market, 70 CWLR955 (Oct. 2015).
Parcel C6 ($11M; 62 acres) (2007) Nation’s 1st
privatized FOSET at NPL Site. FOSET #1 ($14M; 545 acres) (2010). FOSET #2 ($16M; 528 acres). CCA used. EPA
Administrator and CA Governor approved (2013). FOSET #3 (>20M; 207 acres). CCA used. EPA
Administrator and CA Governor approved (2015).
M. Hill, Insured Fixed-Price Cleanups: Still Possible Even AfterCommercial Insurers’ 2011 Exit from the Cost Cap Market, 70 CWLR955 (Oct. 2015).
6010/9/2017
SpinSpin--Off of SubsidiaryOff of Subsidiary
Cleanup of 23 sites.
Cleanup and insurance for <80% of prior estimates.
Construction completed within 3 years (80% within 18months).
Sold sites at full “market value” (that is, without premiumdue to the uncertainty of environmental costs).
Cleanup of 23 sites.
Cleanup and insurance for <80% of prior estimates.
Construction completed within 3 years (80% within 18months).
Sold sites at full “market value” (that is, without premiumdue to the uncertainty of environmental costs).
6110/9/2017
Sale/Purchase of Operating FacilitiesSale/Purchase of Operating Facilities
Covering all pre-existing pollutants at operatingplant.
Guaranteed & insured for 87% of anticipated costs.
62
Qualified Settlement Fund?◦ GM Decree ¶ 83 (“Trustee must ‘seek to have the Trust treated as a qualified
settlement fund’ as … defined in Treasury Regulation section 1.468B-1”)◦ IRC § 468B (established pursuant to order of U.S. Gov’t. and subject to its
continuing jurisdiction; established to resolve contested claim(s) under CERCLA;a trust under state law or its assets otherwise segregated)
Budgets (Environmental and Administrative)
Transparency (Reports; Document Databases andRetention; Audits; Community Relations; Website;Separation from NewCo?)
Employees (contracts; health and retirement benefits)
Misc. Issues In Creation/OperationMisc. Issues In Creation/Operationof Environmental Trustof Environmental Trust
Qualified Settlement Fund?◦ GM Decree ¶ 83 (“Trustee must ‘seek to have the Trust treated as a qualified
settlement fund’ as … defined in Treasury Regulation section 1.468B-1”)◦ IRC § 468B (established pursuant to order of U.S. Gov’t. and subject to its
continuing jurisdiction; established to resolve contested claim(s) under CERCLA;a trust under state law or its assets otherwise segregated)
Budgets (Environmental and Administrative)
Transparency (Reports; Document Databases andRetention; Audits; Community Relations; Website;Separation from NewCo?)
Employees (contracts; health and retirement benefits)
63
Questions & Final Thoughts?Questions & Final Thoughts?
64
Daniella D. Landers, Esq.Reed Smith LLP811 Main Street, Suite 1700 / Houston, TX 77002p / [email protected] / www.reedsmith.com
David J. Owens, Esq.Leger Ketchum & Cohoon, PLLC10077 Grogans Mill Road, Suite 325 / The Woodlands, Texas 77380p / [email protected] / www.lkclawfirm.com
Michael O. Hill, Esq.Alba Risk Management Services, LLC910 17th St. NW, Suite 800Washington, DC 20006p/ [email protected] / www.albaenvironmental.com
PanelistsPanelistsDaniella D. Landers, Esq.Reed Smith LLP811 Main Street, Suite 1700 / Houston, TX 77002p / [email protected] / www.reedsmith.com
David J. Owens, Esq.Leger Ketchum & Cohoon, PLLC10077 Grogans Mill Road, Suite 325 / The Woodlands, Texas 77380p / [email protected] / www.lkclawfirm.com
Michael O. Hill, Esq.Alba Risk Management Services, LLC910 17th St. NW, Suite 800Washington, DC 20006p/ [email protected] / www.albaenvironmental.com
65