U.S. EPA Issues an Addendum to its Auditing Policy to Encourage Voluntary Disclosures by New Owners

August 5, 2008

In the August 1, 2008, edition of the Federal Register, U.S. EPA announced an interim program that allows new owners to be forgiven for civil penalties if they voluntarily disclose environmental violations that originate with the prior owner within a certain period after the closing.

The interim program operates effectively as an addendum to the Agency’s existing April 11, 2000, policy entitled “Incentives for Self-Policing: Discovery, Disclosure, Correction and Prevention of Violations,” commonly referred to as U.S. EPA’s “Auditing Policy.” Under that policy, existing owners that timely and voluntarily disclose violations can be forgiven for a substantial amount, and in some cases all, of the civil penalties that would otherwise be assessed under the federal environmental statutes. Until the announcement of the interim program, purchasers involved in stock acquisitions, mergers, and sometimes even asset deals, had to be concerned about potential liability for past or ongoing violations originating with the prior owner. Now new owners will have a window of opportunity, generally up to nine months after the closing, to enter into an agreement with the Agency to conduct a compliance audit of the affected facilities and disclose the results, or to privately audit the facilities and disclose individual violations within 21 days after discovery or 45 days after the closing, whichever is longer.

The interim program crafts a narrow definition of the term “new owner” designed to guard against “paper” or sham transactions between related entities. Importantly, however, to encourage the use of the program, U.S. EPA agreed to waive or limit several requirements or restrictions under the existing Auditing Policy, namely

(1) allowing forgiveness of both economic benefit and gravity-based penalties for many new owners;

(2) allowing 100% forgiveness of gravity-based penalties even if the discovery did not occur pursuant to a formal environmental audit or an existing compliance management system (in recognition that pre-closing due diligence effectively meets the elements of an audit);

(3) allowing forgiveness of penalties even if the disclosure is mandated by an existing statute, regulation, permit, settlement agreement or court order, as long as the disclosure occurs before the applicable deadline;

(4) allowing longer periods for the disclosure to be made, including allowing violations discovered before closing to be disclosed up to 45 days after the closing; and

(5) allowing forgiveness of penalties even if the violations caused serious harm or imminent and substantial endangerment to human health or the environment, or violated an existing settlement or order, as long as no fatality, widespread evacuation, or catastrophic event occurred.

The new program is particularly helpful to businesses involved in stock acquisitions because of the general rule that such transactions transfer existing liabilities of the present owner to the new owner. It is also helpful to businesses involved in joint ventures or asset deals where the terms and conditions increase the risk that regulators will assert that the transaction results in, for example, an actual or de facto merger, an assumption of liabilities, or a fraudulent transfer.

Although the new program is interim rather than final, it is effective immediately. U.S. EPA is requesting comments from interested parties for the next 90 days. The Agency will then reexamine the program before deciding whether to finalize and/or modify its criteria.

The lawyers and professional staff of the Frost Brown Todd Environmental Department are available to consult with companies to evaluate the potential applicability of the new program to their business transactions.

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