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Environmental risks used to be focused on conservation, soil contamination and water pollution. These impacts generally have short-term causes and effects. But as environmental risk has become more complex and the extent and timing of hazards more ambiguous, there is a need for the financial and commercial community to think outside its usual approach.

The increasing complexity of environmental legislation globally is having a direct impact on business and how it seeks to operate in various jurisdictions. It is a self-evident truism that business is in the business of making money, but business in today’s environmentally-aware world is bound by regulation, together with voluntary action, and initiatives such as emissions trading schemes and developing corporate social responsibility reports. It is also bound by lenders requirements for large projects, as dictated by the Equator Principles.

So what challenges currently face businesses looking to invest in the UK? The environmental considerations facing a particular business will be shaped by the size and the type of business operations. The challenges are meeting the direct cost of complying with existing EU and UK environmental legislation and the indirect cost of non-compliance.

Legislation Chalenges

The European Union has been responsible for driving most of the development of environmental legislation over the past decade. Since 1970, there have been over 270 environmental European directives. These directives lay down an objective and allow member states discretion as a means of implementation. Although the permitting requirements will address design and operations, there are also large-scale monitoring and compliance requirements set by the environmental regulator. These additional costs must be added to the business investment costs. There are also increasing health and safety compliance issues which can impact directly on directors’ duties and their personal liability and on insurance considerations.

The environmental legislative framework is made up of a number of laws addressing primarily, potential pollution to air, land and water. Any business that has the potential to impact any of these resources should be regulated by permitting requirements and consideration as to how to meet these requirements should be addressed prior to investing in a company. In relation to land where there is potential or real contamination, the allocation of environmental liabilities for historic contamination is addressed by statute in the UK and an investor should consider their potential liabilities for clean up in relation to the land and the UK contaminated land regime. Unlike the US, which has a Superfund to clean up contaminated land, clean up requirements in the UK are met by the causer/knowing permitters of the pollution or the current owners or occupiers of the property.

Cost of Non-compliance

One could say in a strict sense that environmental considerations are liability driven. Apart from the direct cost to business of complying with stricter regulatory controls, the potential liabilities for non-compliance are also increasing. These liabilities fall into five general categories, namely:

1. Criminal Liabilities – the number of criminal offences for noncompliance are increasing.
2. Administrative Sanctions – the regulators have a range of options available such as the suspension of licenses.
3. Clean-up Costs – in most legislation, the regulators are given powers to clean up and recover the cost from the polluter.
4. Civil Liability – there is a growing interest in judicial reviews and nuisance and human rights claims.
5. Adverse Publicity – we live in a CNN world of information (media impact is both positive and negative) and risk of adverse publicity may lead to unqualifiable costs.

Climate Change

Climate change can no longer be ignored as a factor to be considered in most business. The challenges arising from global warming will affect business in respect of either having to meet the direct cost of compliance, by reducing carbon emissions (and this extends to the buildings where a business may seek to operate from. For example Energy Performance Certificates will have to be displayed from public buildings from April 2008 in the EU) or the impact of the environment on business (for example, operating in a carbon restrained world), or to consider their insurance coverage and possibly emerging climate change litigation depending on their business operations.

Due Diligence

During any transaction whether acting for a seller, the buyer or a lender involving the sale/purchase of companies or property, appropriate environmental due diligence should be carried out to ensure that environmental matters are addressed in a proper and timely fashion. Informed parties will assume a stronger negotiating position with regard to price, warranties and indemnities. What is needed is full information.

There are a number of means of obtaining full information to make decisions on environmental risk, for example, obtaining preliminary enquiries, asking for, or commissioning Phase I or Phase II (physical inspections involving intrusive investigations) environmental reports from consultants; data room visits and site walkovers will provide information on the extent of any regulatory or contaminated land risks. An experienced environmental solicitor should provide guidance on these matters. Many UK – and US – companies now produce environmental reports and voluntary disclosure can be of assistance in determining risk allocation. In obtaining credit, companies should be aware that lenders’ concerns from an environmental perspective will involve the following: credit risk, the value of the security, and the risk of liability for breaches of environmental law.

Disclosure

Disclosure of the potential environmental impacts of a business has grown as an issue in both the US and UK since the inception of the Sarbanes Oxley Act. While the US has always been more proactive in addressing environmental risk issues as part of corporate accountability, the EU and the UK are still catching up. Listed companies or large businesses are bound in the EU and UK by the EU Modernisation Directive, which requires companies to provide information on environmental issues in their Business Review, using key performance indicators. Disclosure of nonfinancial factors in companies reports were brought to the fore with the passing of the Sarbanes Oxley Act in the US. While the UK does not go as far as the US requirements, under the EU Modernisation Directive and the recently-amended Companies Act, environmental reporting has been given statutory grounds.

Under Section 417 of the Companies Act, listed companies have to include information about environmental matters (including the impact on the company’s business on the environment) to the extent necessary for an understanding of the development, performance or position of the company’s business. Environmental matters include a company’s environmental impact on the environment as well as how the company is managing or intending to manage those impacts. Directors are required to carry out their duties in good faith and exercise reasonable skill care and diligence. Shareholders seeking to challenge the contents of the reports will have to prove that directors acted contrary to their duties. The impact of greater disclosure on environmental matters will allow shareholders to be able better to access how directors have performed their duties.

Conclusions

A number of other factors will also impact on the decisions of where to invest and how to operate from an environmental perspective. For example, some governments hold a view that the global nature of environmental and ethical concerns can be resolved by the contribution of large businesses. This subtle demand for business to contribute and play a part in solving society’s problems is increasing, as evidenced by the creation of the Equator Principles and the growing importance of CSR. There is also a higher expectation of accountability and transparency. While many companies will be able to more or less tally the cost of compliance in their financial management, the growing challenge will be reflecting the cost (to their reputation and otherwise) in their overall business planning.

Colleen Theron is the head of the Environment department at Lawrence Graham. She is recognised as a specialist in her area by Legal 500 and is widely published in her field.

For more information:
Tel: +44 (0)20 7759 6622
E-mail: colleen.theron@lg-legal.com

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