M&A in 2010:Principles and Processes With International

Thursday October 21 2010

Principles and Processes With International Environmental M&A Due Diligence

Thursday, October 21, 2010

When You Think M&A,Think Fulbright.TM

Today’s Presenters Today s Presenters

Sey Zimmerman

Environmental Partner

Fulbright & Jaworski L.L.P.

Jeff Flanzenbaum

Senior Project ManagerSe o oject a age

ERM

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International Environmental Due DiliDiligence

Typical Approaches● ASTM E 1527-05 Phase I ESA

Limited Environmental Compliance ReviewLi it d H&S C li R iLimited H&S Compliance ReviewOther Add-Ons: Social Due Diligence; ARO AssessmentMost-Likely Case (MLC) & Reasonable Worst-Case (RWC)

i bili i ( l l i )Liability Cost Estimates (e.g., Monte Carlo Analysis)

● Portfolio Site ReviewsData Room Review/Summary – Property & Compliance Issuesata oo ev ew/Su a y ope ty & Co p a ce ssuesSelected Site Visits with Summary of FindingsASTM E 1527-00 Protocol

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International Environmental Due Dili Cli t F V iDiligence – Client Focus Varies

Corporate Lead Due Diligence● Historical Liabilities and Associated Cost Estimate / Reserves● Historical Liabilities and Associated Cost Estimate / Reserves● Regulatory Compliance/ Operational CapEx● Reputational Risk● Facility Integration: EH&S Management Systems Training● Facility Integration: EH&S, Management Systems, Training

Private Equity Lead Due Diligence● Historical Liability Cost Estimates /Reserves● Short-Term ( ~ 5 year) Cash Flow● Short Term ( 5 year) Cash Flow● Reputational Risk

Financial Institution Lead Due Diligence● Historical Liability Cost Estimates /Reserves● Historical Liability Cost Estimates /Reserves● Environmental and Social Risks ● Equator Principles / IFC Performance Standards● Reputational Risk

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Environmental & Social Due Diligence

• Climate and carbon risks• Water Resources• Biodiversity and natural resources

• Compliance Assurance• License to Operate• Enforcement issues: consent

Compliance & Operations Risk Sustainability Risks

y• Energy • Supply chains• Life cycle of products, goods and

services

Enforcement issues: consent orders, fines, project delays

• Health & Safety; Process Safety• Restricted Materials• Corporate v. local standards• Expansion Potential

Backward Looking Present Looking Forward Looking

• Contamination Liability• Active sites• Heritage sites

• Manage Cash Flow

• Social License to Operate • Skills and local expertise• Social issues / Indigenous peoples• Cultural heritage

R ttl t• 3rd Party Claims• Reserves• Financial Reporting • Asset Retirement Obligations

• Resettlement• Stakeholder and community

engagement

Legacy Risks Social & Community Risk

Example: Diligence Affecting Project Development Outcome520 MW N t l G P Pl t (2004 i )520-MW Natural Gas Power Plant (2004 – ongoing)

US company acquires greenfield asset in emerging market

Delays in securing financing ($650-950M): Lenders identify Environmental & Social Risks asset in emerging market

Company conducts “standard” diligence through law firm (2007)Diligence fails to identify critical

● Financing limited higher risk investorsDelays in revenue generation: ● Delayed construction start-up ● Stand-by costs for equipmentg y

E&S risks: ● EIA approval (2004)● Project opposition

y q p● Natural gas contracts

Government’s involvement:● Cumulative impacts and planning ● Fines (due to delayed generation

● Social commitments made (risks)

● Government scrutinyDiligence flaws translate into

Fines (due to delayed generation contract schedule)

● New regulations passed and enforcedPermit renewal required

Company’s reputation:Diligence flaws translate into material E&S risks that impact business outcome (2010)

p y p● Increased public visibility and scrutiny● “Social license to operate” ● Ability to access financing for other

projects

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Non-Technical Risk - ProjectsNon Technical Risk Projects

ERM analysis of 190 oil & gas projects globally● Very few projects (<10%) were delivered on timey p j ( )● Types of project delays experienced related to:

73% of delays were due to sustainability risks, e.g., external affairs, social & community, environment relatedythe remaining delays were related to technical/contract risks

● Business estimates of cost of delays ranged from $100m to greater than $1b, depending on how they valued impact (delayed revenue, reputation losses)

Similar industries● Renewable energy gy● Mining● Infrastructure● Food, Beverage & Agriculture

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, g g● Transportation

Breakdowns in cross-border transactionsWhat we find…

Poor internal business process and communications around EHS due diligencearound EHS due diligence● Multiple internal stakeholders – priorities not always aligned● Transactional concerns differ from integration and operational needs

The transactional momentum overrides judgmentThe transactional momentum overrides judgment● What “the deal team” bought versus what EH&S gets● Strategic acquisitions are done at a high level of materiality

$1 million here, $5 million there and pretty soon you’re talking real p y y gmoney

Adjustments/indemnifications don’t always make it into strategic plan for the business

Li bili i b d ll i i● Liabilities can be managed contractually via price or indemnifications

● Disconnect between Purchase Agreement and operating businessIncreased burden on businesses with out commensurate increase in

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Increased burden on businesses with out commensurate increase in resources

Elements of what has workedWh t fi dWhat we find…

Transaction Issues&Prescribed corporate M&A process

● EH&S is integrated in Business Development team● EH&S participation with Ops, legal, affected business

EH&S required to sign-off on the proposed dealUsing due diligence to inform future integration

Integration IssuesFormalized integration blueprint g pAuditable standards Parachute EH&S professionals into acquired assets during transition

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during transition

Applying “Standards” GloballyApplying Standards Globally

What Standards Must be Met?● Regulatory (Local Compliance)● International Best Practices (e.g., IFC Performance

Std )Stds)● Corporate Global Standards

How to reconcile the varying standards?How to reconcile the varying standards?● Uniform – globally applied reflecting Company’s

values● Compatible/Flexible – local/regional applied

reflecting applicable regs

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The Equator PrinciplesThe Equator Principles

A framework that can be used to reduce Social & Environmental risks associated with investments in emerging marketsEstablished in June 2003 by 10 banks and updated in July 2006. > 65 Financial Institutions todaySocial & Environmental risks and impacts assessed against policies and guidelines of the International Finance Corporation (IFC)Finance Corporation (IFC)www.equator-principles.com

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IFC’s Performance Standards on Social & E i t l S t i bilitEnvironmental Sustainability

Framework to help manage non-technical risk throughout the life of an ewo o e p ge o ec c s oug ou e e oinvestment Developed in 2006; renewal in 2011Eight (8) environmental and social performance standardsMost comprehensive set of social standards for the private sector – global benchmarkEach Performance Standard has a set of corresponding Guidance Notes

● Additional explanations; reference materials● Additional explanations; reference materials● Suggested practices & procedures

Performance-based approach - Not rule-basedSubstantial credit is given for “forward motion” towards the goal (i eSubstantial credit is given for forward motion towards the goal (i.e., continuous improvement)

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IFC Performance StandardsIFC Performance Standards

Labor and Working Conditionsal

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PS2Labor and Working Conditions

Pollution Prevention and Abatement

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yst

PS3

Community, Health, Safety and SecurityPS4

En

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PS5 Land Acquisition and Involuntary Resettlement

Biodiversity Conservation and SustainableNatural Resource Managementia

l a

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& M

an PS5

PS6Natural Resource Management

Indigenous Peoples

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PS7

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Cultural HeritagePS8

PS

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Background and ContextBackground and ContextLink Between EPs and IFC PS

Equator Principles EPs1. Review & Categorization

2. Social & Environmental Assessment

3. Applicable Social & Environmental Standards

4. Action Plan & Management System3. Applicable Social and Environmental Standards IFC PS

5. Consultation & Disclosure

6. Grievance Mechanism

7. Independent Review

8. Covenants

IFC Performance StandardsPS1 S&E Assessment & Management System

PS2 Labour & Working Conditions

PS3 Pollution Prevention & Abatement

WBG EHS

PS3 Pollution Prevention & Abatement9. Independent Monitoring

& Reporting

10. EPFI Reporting

PS3 Pollution Prevention & Abatement

PS4 Community Health, Safety & Security

PS5 Land Acquisition & Involuntary ResettlementPS6 Biodiversity Conservation

& Sustainable NRM EHS Guidelines

PS3 Pollution Prevention & Abatement

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PS7 Indigenous Peoples

PS8 Cultural Heritage

1. General EHS Guidelines

- Environmental- OHS- Community H & S- Construction & Decommissioning

1. General EHS Guidelines

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2. Industry Specific Guidelines2. Industry Specific Guidelines

Today’s Challenge The Transactional Moment

FASB – Asset Retirement ObligationsgCarbon Due Diligence / GHGREACH in the EUREACH in the EUProduct StewardshipSocial Due DiligenceSocial Due DiligenceEquator Principle Obligations for Financial InstitutionsInstitutionsRegulatory Uncertainty Project Investments

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Project Investments

Life Cycle and Supply ChainsHow is product stewardship relevant in transactional settings?

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Product StewardshipProduct Stewardship

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Environmental & Social Due Diligence

• Climate and carbon risks• Water Resources• Biodiversity and natural resources

• Compliance Assurance• License to Operate• Enforcement issues: consent

Compliance & Operations Risk Sustainability Risks

y• Energy • Supply chains• Life cycle of products, goods and

services

Enforcement issues: consent orders, fines, project delays

• Health & Safety• Process Safety• Restricted Materials• Corporate v. local standards

Backward Looking Present Looking Forward Looking

• Contamination Liability• Active sites• Heritage sites

• Manage Cash Flow

• Social License to Operate • Skills and local expertise• Social issues / Indigenous peoples• Cultural heritage

R ttl t• 3rd Party Claims• Reserves• Financial Reporting • Asset Retirement Obligations

• Resettlement• Stakeholder and community

engagement

Legacy Risks Social & Community Risk

Take HomeTake Home

Due diligence should not be a “one size fits all” ffprocess. To achieve the most cost-effective

outcome, the process should be tailored to the specific transaction.p

Through development of a specific due diligence strategy at the transactional moment, we can achieve better business outcomes through environmental and social risk management.g

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Scope of Due Diligence: What Are the Ri k W M t W Ab t?Risks We Must Worry About?

Risks of Permit Failure (e.g. expiration, government enforcement)Risks of Permit Transfer BanRisks of Remediation CostsRisks of Personal Injury | Property Damage from Exposure

On-Site Off-Site

The List not dissimilar from a list for a U.S. only transaction

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though the risks associated with Permits more complicated

Due Diligence: Standards for Evaluation f E i t l I t f O ti of Environmental Impacts of Operations

National Standard for country where assets located (where discernible)discernible)orCompany Policy (e.g. Buyer home country standard, U.S.Company Policy (e.g. Buyer home country standard, U.S. standards, financial institution standard) where Buyer thinks national standard for company are inadequateororU.S. Standards | EU Standard (where national standard not discernible)In instances where future expanded operations or the use of international financing are anticipated by Buyer Due Diligence might cover other issues like cultural resources, impact on

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g , pIndigenous Peoples, etc.

Scope of Due Diligence: What Will Fi i A i / B k R i ?Financing Agencies / Banks Require?

Generally not dissimilar from that experienced in United States with one noted exception:● Where the transactions will involve the assets that are in

thi d ld t i b d b i dthird world countries a broader scope maybe required: cultural resource; impacts on Indigenous Peoples; impacts on National Resources, etc.

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Due Diligence: Permit TransferP it F il Ri kPermit Failure Risk

For Signature Assets permit risks requires detailed i ti tiinvestigation:● Is Permit Assignable? ● Does Assignment require government approval and if so what g q g pp

required to obtain approval?In some instances it will not be clear whether you have a permit that properly covers the ongoing activitiespermit that properly covers the ongoing activitiesIn many countries the rules for (i) permit assignment and for (ii) permit enforcement will be uncertainNeed to evaluate Permit Renewal where Permit near end of term.● What will it take to renew?

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● What will it take to renew?

Responses to Permit RiskResponses to Permit Risk

Role for local counselNeed to consider backup where there is expected to beNeed to consider backup where there is expected to be uncertainty as to permit transfer on transaction date● Asset Deal: Transition Agreement with Seller to continue to

toperate● Types of Transition Agreements

1. Product Supply Agreements2. Services Agreement Issues

● Issues with Transition Agreements• How long will the agreement remain in effect? Incentives to

hi t fachieve transfer.• Financial obligations• Indemnification obligations• Tax and Human Resource Implications

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p● Stock Deal: Continue operations in Seller’s name

Contract Provisions Responding to Remediation I Di d D i D DiliIssues Discovered During Due Diligence

Where Problems are at Identified at Closing For Post-Cl i R di i Id ifi d l d bjClosing Remediation or Identified later and subject to Indemnification. There are common problems:● Who will control remediation?● Who will control remediation?

Often Buyer must control clean-up since Seller will have no more in-country operationsRi k t S ll th t B ill t b i il t i t t i tRisks to Seller that Buyer will not be vigilant in cost containment (Chevy Cleanup v. Cadillac Cleanup)Need for cost sharing mechanism to encourage Buyer moderation ( d d tibl d li i t h t )(e.g. deductibles, declining tranches, etc.)

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Contract Provisions Responding to Remediation I Di d D i D DiliIssues Discovered During Due Diligence

● What will be deemed adequate remediation?Definition of a standard (e.g. legal standard from an advanced nation orDefinition of a standard (e.g. legal standard from an advanced nation or technical / engineering standard)Risk of changing standards

● When will remediation obligation be deemed completed?Certification by independent expert or deemed completed governmental approval (if practically available)● Use of independent expert assures timely resolution for Seller but deprives

Buyer of certainty of no additional effort requiredy y q● Reliance on governmental approval makes resolution time highly uncertain for

Seller but maximizes opportunity reimbursement for Buyer ● Principles applicable to remediation are equally applicable to other

regulatory compliance issues (e g emissions compliance)regulatory compliance issues (e.g., emissions compliance)

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Other Issues Bearing on Environmental Ri k M tRisk ManagementA. Indemnification. Often Not Easy and Usually not Prompt

U f C D M A d B k• Use of Caps, De Minimis Amounts and Baskets• Use of Escrows• Special Concerns for Third-Party Claims

B. Consideration of Currency Exchange Risk in Setting Caps and De Minimis Amounts.

C. Survival PeriodsC. Su v va e ods• Given the various statue of limitations and the variety of rules on

when claim is deemed to have arisen the definition of survival periods important

• Reverse IndemnityD. Resolution of Disputes

• Arbitration or assignment to judicial forum with jurisdiction over

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Arbitration or assignment to judicial forum with jurisdiction over both parties

Working With ConsultantsWorking With Consultants

A. Request Due Diligence Scoping Advise from ConsultantB. Consultants will likely not have offices in each country

of interest.• With respect to evaluating signature assets an in countryWith respect to evaluating signature assets an in country

presence can be very important• Regulatory obligations can be defined at several layers of

government and so knowledge within a particulargovernment and so knowledge within a particular governmental asset can be important (e.g., U.S., Japan, etc.)

• Moving consultants around can be a significant cost issueC Need for a manager with over all client responsibility toC. Need for a manager with over-all client responsibility to

assure needed (i) internal support and (ii) report and scope of work responsibility

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Questions?Questions?

Sey Zimmerman Jeff FlanzenbaumPartner, AustinFulbright & Jaworski L.L.P.szimmerman@fulbright.com

Senior Project ManagerERMjeff.flanzenbaum@erm.comszimmerman@fulbright.com

512 536 4552jeff.flanzenbaum@erm.com 202 471 2111

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Continuing Education InformationContinuing Education Information

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il Vi t i B d t b d@f lb i htemail Victoria Beard at vbeard@fulbright.com32

When You Think M&A,Thi k F lb i h TMThink Fulbright.TM

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