Environmental Risks of Acquiring a Production Site

Tetyana O. Rabczak

While considering a potential acquisition in Ukraine, a foreign investor always wonders what hidden dangers and liabilities he may acquire together with a production site.

Depending on the history of prior ownership of the site and the neighbouring plots, and keeping in mind the typical approach to environmental safety in Soviet times, it is quite common to discover that the land lying under an acquired production site in Ukraine is contaminated with heavy metals.

The site’s infrastructure (particularly the water supply, sewage disposal and purification systems) may also contain some hidden leaks causing water and air pollution, as the infrastructure may not have been constructed or maintained properly, even if the documents say otherwise. It is also quite likely that the site may contain some burials of illegal wastes containing contaminated materials from former owners or neighbouring land plots.

Our practice shows that a thorough technical audit of the acquisition target site, which we usually recommend to implement in addition to a legal and financial due diligence before making any decision, often reveals many of the major and minor issues of various impact on the completion and profitability of a transaction. It is also common that a mere review of the documents (including project and technical documentation and respective approvals) does not reveal many of the potential hidden issues and does not allow for making precise conclusions on the condition and compliance of the site. It should be especially noted that, considering the unpredictability of law enforcement in Ukraine, it is hard to predict precisely how all these minor and major technical shortfalls and environmental or safety issues may effect the investor later. Unfortunately, we have seen many instances when the lack of a thorough technical audit before the acquisition resulted in all kinds of complications in operations of the site (coming from regulatory authorities or used as pressure tools by former sellers in dispute settlement or even by corporate raiders) up to complete blockage of operations.

In this article we would like to focus on a brief overview of potential liability that may be carried forward to the new owner of a site, attributed to the two most typical discoveries of technical audits carried within the pre-acquisition due diligence process — land contamination and a waste storage discovered on the land underlying the acquired production site.

1. Contaminated land

Ukrainian law defines land pollution as the “concentration of pesticides, agrochemical compounds, heavy metals, radionuclides and other substances in soil and underground waters in an amount exceeding natural levels which leads to quantitative or qualitative changes of such soil and underground waters if such concentration is caused by human activity” (Article 1 of the Land Use and Protection State Control Act of 19 June 2003 No.963-IV). The presence of pollution is assessed through the comparison of the concentrations of chemical substances discovered in the soil against the established maximum allowable concentration levels stipulated by law.

As with any other type of liability, liability for pollution is associated with the person that caused such pollution and usually only in cases where the actions causing pollution were illegal. According to the law, the liability for land pollution is to be placed on the person whose guilty actions in violation of the respective laws and regulations aimed at protecting land from pollution (such as regulations on land use, land protection, environmental and sanitary safety, rules for conduct of certain types of commercial activities) caused such pollution. Liability for legitimate actions (e.g. pollution caused while taking required measures or actions not prohibited by law) may be applied in limited cases as specified by law.

In practice, however, the chase for the actual polluter and proving the fact that the pollution was present before the purchase or that the buyer is not the person whose guilty actions caused the pollution, may be quite difficult. Since the owner/operator of the production site is usually the first person to be presumed guilty and is the first point of contact when respective inspections discover contamination, it then becomes the owner/operator’s burden to show no fault and redirect the state authorities to the actual cause of pollution.

Pursuant to Ukrainian law, when contamination of land is discovered, the owner/operator of the production site may, amongst others, face the following potential charges:

Criminal and administrative liability

Article 239 of the Criminal Code of Ukraine establishes criminal liability for pollution of land with substances, waste or other materials, which are hazardous for human life and/or health or the environment, caused by violation of special regulations, if such pollution puts human life and/or health or the environment in danger. However, absence of the indicated consequence qualifies the same actions as administrative misconduct under Article 52 and 53 of the Administrative Misconduct Code of Ukraine.

To establish criminal and administrative liability all of the following elements are required: (1) the fact of pollution; (2) guilty, intentional or negligent actions or failure to act that violate the respective provisions of the law; and (3) a direct cause-and-effect link between the first two elements.

Thus, a buyer of the contaminated land or the new lessee of the land that purchased a real estate object located on it should not be held liable for the contamination caused by the actions of a previous land owner/lessee. However, to avoid any potential claims, such a buyer should make sure that at the time of the purchase he has sufficient evidence that the pollution was present before the acquisition. Liability, however, may arise for a further spread of the pollution to other areas (neighbouring land plots, underground waters) if it is established that the risk of potential spread was known to the buyer and he knowingly did not act to prevent it. It shall also be noted that the new owner/lessee of the land has an ongoing obligation to inform the competent authorities in a timely manner of the pollution of the land, ensure the protection of the land from further pollution, take actions to prevent the negative and environmentally hazardous impact on the land and eliminate any consequences of such impact.

Therefore, if the new owner/lessee knowingly fails to take sufficient actions to prevent the further spread of pollution, and the hazardous substances present in the contaminated soil soak into the underground waters and spread the pollution to other areas outside its site (e.g. pollute the surrounding water, soil, effect local flora and fauna), it may arguably be held liable for such actions under the Criminal Law Code or the Administrative Misconduct Code, depending on the scale of the consequences.

Under Ukrainian law, neither criminal nor administrative liability is applicable to a legal entity. Thus, a respective officer of the legal entity would typically be held liable for this crime/misconduct (e.g. the general director).

Failure to take respective clean-up and pollution prevention measures, as well as a failure to report contamination, may also trigger an administrative liability pursuant to Articles 52, 53, 53-2, 54 of the Administrative Misconduct Code of Ukraine.

Damages

The polluter is also liable for the damages caused to the environment and other land owners/users. If the pollution from the purchased land spreads to other land plots or affects the environment, the new owner may be held liable for respective damages caused by it. Even though fault would usually need to be established for such liability, in practice establishment of fault in Ukrainian courts usually takes a twisted form — as long as the other side brings documents of respective authorities confirming the pollution and some documents alleging even a remote connection of the source of pollution with your land, it is quite difficult to persuade the judge to hold further reviews by experts, investigations and accept other documents establishing lack of your fault in it.

Moreover, please keep in mind the concept of the owner’s liability for damages caused by his property. Thus, regardless of the fact that the pollution was actually caused by the previous owner, if it spreads to other land from the investor’s land plot and eventually results in water pollution or causes a negative environmental impact, there is a high probability that he will have to compensate any respective damage. However, this concept is not applicable to the current land user. A land user, when he discovers contamination of the leased land, may claim compensation of damages against either the actual polluter, if known, or the landowner. However, as with respect to criminal liability, civil liability for damages may arise for any further spread of pollution, a risk of which was known to the current land user and not prevented by him. This is particularly so if the acquisition is intended in the form of a share deal that results in no change of owner of the land rights. Thus, if pollution was caused by the activity of a legal entity before the acquisition of the shares, the same legal entity will remain the entity liable for all the damage caused by land contamination.

Withdrawal of land from commercial use

In addition, if the contamination is considered dangerous for human presence or production of environmentally sound products, such land is classified as “land containing technogenic pollution”. Such land may be withdrawn from commercial use and is subject to conservation. Whenever contamination of such a level is discovered, the local bodies of the land and environmental authorities may request termination of commercial use of such land and request its conservation.

Other potential risks

These may include suspension of activity that is alleged to cause land pollution, request of land clean-up and termination of the lessee agreement by the court. The termination of the lessee and suspension of activities may only be applied in cases if the lessee received a respective order from the state authorities and failed to eliminate indicated violations within the term indicated in such an order. This, among others, applies to pollution by radioactive and chemical substances, waste, waste waters, hazardous organisms and prohibited plants.

2. Abandoned and hidden waste present on purchased site

Hazardous materials present on the surface of the land or buried in it may be classified as waste.

The owner of the waste is responsible for any damages caused by this waste to the land, property, health and environment. It is, thus, critical to identify the owner of any waste present on the territory of the land in order to identify the person liable for the pollution of the land by such waste.

The ownership and liability with respect to waste, however, differs from land contamination since it may be separated from the land and its ownership does not necessarily have to coincide with the ownership of the land.

Under the laws of Ukraine, the initial owner of the waste is the “producer of waste” — a legal entity or individual whose activities lead to generation of the waste. The title to waste may be transferred to any person pursuant to an agreement on in any other way. At the same time, the purchase of the land does not mean automatic purchase of the waste present on it or hidden in it. The title to waste located on the land does not automatically transfer to the new owner of the production site or the underlying land if it is not indicated in the respective acquisition documentation. Thus, the buyer may always request the seller to clear the site from any waste whenever it is discovered. However, in order to avoid any potential disputes, we recommend addressing the issues of waste, known and unknown, expressly in the transaction documents.

In cases when the new owner or lessee of the land discovers waste on his territory, which does not belong to him, and the actual owner of such waste is unknown, it shall report such waste to the local executive authorities or bodies of self-government. These authorities have an obligation pursuant to Article 12 of the Waste Act of 5 March 1998, No.187/98-ВР to take respective measures to identify the actual owner of the waste, as well as to identify its class of hazard, and make a respective decision on its further handling.

Recommendations

Considering the above, and depending on the circumstances, we usually recommend our clients to carry out technical audits of the object and the underlying land before acquisition. It might reveal some of the potential problems and help the investor to make an informed decision on whether to go forward with the deal and help the investor’s lawyers to find ways of mitigating any potential risks.

Theoretically, if the actual polluter is discovered, the new owner may always claim compensation for the clean-up costs, as well as any other potential damages (e.g. respective claims of third parties). If the contamination is discovered before the acquisition it is, however, the seller’s burden to prove when and how the pollution appeared and who caused it. Yet, in many cases, even if the actual polluter is identified, he may appear to be insolvent or unsuitable due to other reasons for compensation claims. Therefore, it is also advisable to make sure that the seller remains responsible for any such discoveries and to have a general or a specific environmental indemnity clause in the transaction document, indemnifying the investor against any future claims of third parties, penalties and fines imposed by state authorities with respect to any violations of environmental regulations that are hidden and will be discovered at a later date.