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11.01.2008 EPA Issues New Compliance Audit Policy for Purchasers of Regulated Facilities NC Bar Association Energy & Natural Resources Law Section Newsletter; Vol. 20, No. 1
Article
11.01.2008
Reproduced with the express and limited permission of the North Carolina Bar Association. All rights reserved.

EPA recently published a new compliance audit incentive policy for parties who acquire a regulated facility (the “New Owner Policy”). The New Owner Policy encourages purchasers to evaluate whether their facilities are in compliance with environmental laws, and to disclose and correct any violations shortly after closing, by offering additional civil penalty reductions beyond the reductions already available under EPA’s existing Audit Policy (the “Audit Policy”). The New Owner Policy represents a modification of the Audit Policy for certain regulated parties, but the substance of the Audit Policy is otherwise unaffected. The New Owner Policy is effective immediately, as an interim policy, but EPA will accept public comments on it until November 3, 2008.

Background

Under EPA’s existing civil penalty policies, the agency assesses two types of penalties for regulatory violations: an economic benefit penalty and a gravity-based penalty. The intent of the former is to take away any economic benefit that a violator has realized as a result of its non-compliance, and the latter is intended to discourage future violations. To encourage the regulated community to perform compliance audits, EPA reduces – and in some cases eliminates – the gravity-based penalties that it would otherwise assess for a violation, if the facility complies with the Audit Policy. However, the Audit Policy does not reduce the economic benefit portion of a civil penalty and violators remain liable for that amount.

The New Owner Policy

If a party qualifies as a “new owner” and complies with the other requirements of the New Owner Policy, the purchaser is eligible for a reduction of economic benefit penalties, in addition to any reduction in gravity-based penalties for which it is eligible. In particular, EPA will not assess any penalties against a new owner for the benefit associated with delayed capital expenditures or unfair competitive advantage, and it will only assess penalties for avoided operation and maintenance costs for the post-closing period. Further, EPA will not consider any benefits that might accrue to a new owner as a result of contractual indemnities by the seller to the buyer regarding historic violations. As such, new owners have a substantial additional incentive to bring newly acquired facilities into compliance quickly because the economic benefit component of a civil penalty may be substantial.

Definition of a New Owner

In order to qualify for the additional penalty reductions available under the New Owner Policy, a facility owner must first meet the definition of a “new owner.” EPA will treat a purchaser as a “new owner” if it satisfies all three of the following criteria: 
 
  1. Prior to the transaction, the purchaser was not responsible for environmental compliance at the facility, did not cause the violations, and could not have prevented them;
  2. The violations at issue originated with the previous owner; and
  3. Prior to the transaction, neither the buyer nor the seller held the single, largest ownership interest in the other, and they did not have a common corporate parent.

The goal of these criteria is to ensure that the New Owner Policy applies only to violations that were not within the purchaser’s control pre-closing and to limit the situations in which transactions between related corporate entities can qualify for the New Owner Policy.

In addition, a purchaser can only qualify as “new” owner of a facility for nine months after a transaction closes. To satisfy this timeline, a purchaser must either enter into a comprehensive audit agreement with EPA, or complete all of its individual disclosures, by that date. Otherwise, the reductions in gravity-based penalties under the Audit Policy may still be available, but the reductions in economic benefit penalties will not.

The Differences between the Audit Policy and the New Owner Policy

In general, the New Owner Policy incorporates the substantive requirements of the Audit Policy, but modifies them to address the unique circumstances that arise immediately after the sale of a regulated facility. A brief comparison of the requirements of each policy is below. 
 
  1. Systemic Discovery – Under the Audit Policy, a facility must discover violations through a periodic auditing program. Under the New Owner Policy, EPA recognizes that transactional due diligence is a singular event, as opposed to a periodic one, and allows a new owner to disclose violations that are discovered through pre-closing due diligence.
  2. Voluntary Discovery and Disclosure – Under the Audit Policy, the discovery of a violation cannot occur through legally mandated monitoring or testing. For example, a facility cannot take advantage of the Audit Policy by disclosing the results of effluent sampling that is required by an NPDES permit. The New Owner Policy makes an exception to this rule for violations that are discovered and disclosed prior to the first required sampling or monitoring event. Thus, if a facility identifies an effluent exceedence through voluntary testing and reports the violation prior to the first mandatory sampling event, then EPA would consider the discovery and the disclosure to be voluntary.
  3. Prompt Disclosure – Unless a facility has an audit agreement with EPA, the Audit Policy requires the facility to disclose a violation within twenty-one days of discovery in order to receive a reduced gravity-based penalty. Under the New Owner Policy, a purchaser has forty-five days after closing to disclose any violation that it identified during due diligence and must disclose any violations that it identifies post-closing within either forty-five days of closing or twenty-one days of discovery, whichever is longer.
  4. Discovery by a Third Party – EPA did not modify its policy regarding this criterion. A new owner can only take advantage of the New Owner Policy if it reports a violation before EPA or a state would have identified the violation on its own. However, the discovery of a violation at one facility does not prevent a party from investigating the existence of similar violations at other facilities, disclosing them to EPA, and taking advantage of either the New Owner Policy (if applicable) or the Audit Policy.
  5. Prompt Correction of the Violation – EPA did not modify its general rule that a facility must correct any violations that it discovers within sixty days of discovery. However, the agency did clarify that if a new owner discovers a violation during its pre-closing due diligence, EPA will treat the closing date as the date the new owner discovered the violation.
  6. No Repeat Violations – Purchasers of facilities are not disqualified from taking advantage of the New Owner Policy as a result of similar violations that occurred at the facility prior to closing.
  7. Excluded Violations – Under the Audit Policy, EPA will not allow a facility to obtain a reduction of gravity-based penalties for violations that cause serious environmental harm, or that present an imminent and substantial endangerment, or that violate the terms of an administrative or judicial order. For new owners, if the otherwise excluded violation arose prior to closing, a purchaser can still qualify for the New Owner Policy as long as the violation does not cause a fatality, a community evacuation, or a similar catastrophic event.

As is the case under the Audit Policy, new owners must agree in writing to take steps to prevent a recurrence of any violations and, not surprisingly, they must cooperate with EPA.

Comment

Protections for sellers are notably absent from the New Owner Policy. In fact, EPA explicitly retained its discretion to take enforcement action against a previous owner when a new owner discloses historic violations to the agency. EPA acknowledged the potential for sellers to demand non-disclosure agreements as a result, but opined that such provisions would be unenforceable as a matter of public policy. Though EPA’s opinion may prove to be right in the long run, it is unlikely the agency’s position on the enforceability of a contractual provision is entitled to any deference from a court. As a result, we are likely to see these provisions in future transactional documents.

For buyers, it is important to realize that the New Owner Policy creates a limited window in which they can obtain reductions of both economic benefit and gravity-based penalties. Most importantly, buyers have nine months after closing to either complete their disclosures to EPA or to enter into an audit agreement. After that time, a new owner may be able to obtain relief from gravity-based penalties under the Audit Policy, but it will face liability for economic benefit penalties. Buyers also need to be aware of the time limits to disclose violations that they discover during due diligence and the deadlines to correct those violations.

73 Fed. Reg. 44,991 (Aug. 1, 2008).