Mitigating Unforeseen Liabilities in Industrial Mergers and Acquisitions

When competing for assets in the mid-market and enterprise merger and acquisition space, successful transactions go well beyond balance sheet analysis. While standard financial statement audits and thorough legal reviews are the basis of any comprehensive due diligence, they tend to leave latent liabilities inherent in heavy industrial assets unseen.

Acquiring a manufacturing plant, and energy generation facility or other old infrastructure with an in-depth, qualitative assessment frequently leaves the buyer absorbing the entire burden of unseen financial exposure.

Extending Traditional Due Diligence

A corporate restructure requires an examination of the legacy profile of a target asset. Older, heavy industrial sites and manufacturing plants typically contain occupational and environmental risks that are not readily apparent on a balance sheet until a triggering event requires resolution, potentially exposing the acquirer to significant unplanned expenses.

Identify Occupational Risk

In evaluating any legacy site, buyers must rigorously assess past occupational exposures. Deal teams examine historical material-handling methods, review older worker-compensation claims and assess the compliance records of decades old safety systems. Mapping the historical compliance profile of a site provides data to adjust valuations and avoid overpaying for legacy exposures.

Implement Predictive Risk Modeling

Corporations employ predictive risk modeling to forecast likely outcomes and claim costs for legacy exposures, often integrating past historical incident data to assess future liability. Actuaries will pull historical health, settlement, and specialist databases, even those from advocacy platforms such as Mesothelioma Hope, to formulate likely costs of future claims. These comparative data points are critical for understanding exposure at the corporate and individual site levels.

Structuring the Transaction to Insulate Capital

Once risks have been identified via due diligence processes, dealmakers structure the transaction to protect buyer balance sheets. Buyers will frequently use legal and financial mechanisms to protect themselves from legacy issues. 

Strategic Use of Indemnification and Escrow

Strong indemnification clauses represent the first safeguard against potentially overwhelming and unexpected liabilities in any transaction. Buyers seek and demand portions of the purchase price to be placed into an escrow fund for a period to act as a reserve against any pre-closing breaches. Strict indemnification limits are negotiated to prevent the parent entity from shouldering the impact of hidden liabilities.

Representation and Warranty Insurance

Representation and warranty insurance (RWI) has reshaped M&A transactions by shifting transaction risk from both buyer and seller to a third party insurer. RWI coverage for an industrial M&A transaction ensures there are no discrepancies between the seller’s desire for a clear break with the past and the buyer’s demand for long-term protection of capital and a cushion for undiscovered operational failures. This transfer of risk lubricates negotiations and provides an additional layer of security against hidden operational defects.

Endnote

Comprehensive M&A due diligence cannot be confined solely to a review of accounting data but must include potential present-day consequences arising from historical occupational and environmental exposures. Through appropriate application of contractual protections such as indemnification provisions and third party insurance providers as well as adopting stringent, appropriate post-closing governance, the buyer will benefit from prudent application of risk transfer tools.