New Owner Environmental Audits in Texas

During the 2013 Texas Legislative Session, a colleague and I lobbied for an amendment to the Texas Environmental, Health, and Safety Audit Privilege Act (the “Audit Act”).[1]  In case that law isn’t a familiar one, here’s the gist: It provides immunity from civil and administrative penalties for environmental, health, and safety (“EHS”) violations that are identified during a compliance audit, voluntarily disclosed to the appropriate regulatory agency, and diligently corrected.  Prior notice of the audit is required, as is notification to the agency upon completion of required corrective actions.  The 2013 amendment to the Audit Act creates the opportunity for a new owner who identified EHS violations during due diligence to disclose the violations to the appropriate regulatory agency within 45 days after closing and also be eligible for immunity under the Audit Act, without the need for the otherwise required prior notice of audit to the agency. The idea for the new owner amendment to the Audit Act occurred to us because we had a number of oil and gas exploration and production and midstream clients who at the time were users of the Audit Act for operations that they currently owned or operated but couldn’t use the Audit Act to mitigate the risk of enforcement penalties when they acquired new assets because the Audit Act only afforded protection to present owners and operators.  Our clients were identifying EHS issues such as lack of air permitting, noncompliance with New Source Performance Standards (“NSPS”) for storage vessels (e.g., Subparts Kb and OOOO) and engines (e.g., Subpart JJJJ), unreclaimed drilling pits, and requirements for sites handling sour gas during their due diligence activities prior to closing.  While they had every intention of correcting these issues post-closing, they had limited tools outside of the liability allocation measures in the deal documents to address the risk of enforcement penalties.  In the meantime, the out-of-compliance assets remained at risk for agency enforcement.  The 2013 new owner amendment to the Audit Act changed that.  However, it became law in September 2013, just months before the oil price crash and the sharp reduction in transactions in the oil and gas industry, and it seems to only now be demonstrating its value to the industry it was in large part developed to assist.  As the price of oil has since stabilized somewhat and transaction activity in the industry has increased again, particularly transactions involving distressed assets where EHS compliance may not have been a priority, the risk management tool that the Audit Act’s new owner provisions provide has again become highly relevant.  We’re seeing buyers raising the prospect of its use post-closing and sellers insisting on a buyer’s use of it to mitigate any potential environmental liability that seller might retain.  Use of the Audit Act’s new owner provisions reduces regulatory penalty risks, risks that flow to both prior and current owners and operators, and, thus, makes sense for both sides of a transaction.To recap the mechanics of the Audit Act’s New Owner provisions that establish eligibility for immunity from civil and administrative penalties for EHS:A buyer who identifies EHS compliance issues during due diligence activities must voluntarily disclose those violations to the appropriate state agency (e.g., Railroad Commission of Texas, Texas Commission on Environmental Quality) within 45 days after closing.[2]The new owner may continue the audit after closing that commenced as due diligence prior to closing by also giving notice to the appropriate agency within 45 days after closing. In such a case, the new owner has six months after the date of closing to complete the ongoing EHS audit.  Any additional compliance issues identified during the audit must be “promptly” disclosed to preserve eligibility for immunity from civil and administrative penalties for those violations.[3]Disclosed violations must be diligently corrected, but typically on a (reasonable) schedule proposed by the new owner, rather than within timelines established by the agency.The new owner must notify the agency once all corrective actions are completed.The relevant agency will review the audit submittals, request additional information if needed, or, if all requirements of the Audit Act have been met, issue a “no further action” determination.With the onslaught of new environmental regulations in the last few years, managing EHS compliance has become increasingly challenging.  The Audit Act’s new owner provisions provide a risk management tool to address gaps in compliance due to, for example, neglected distressed assets, owners or operators that are unfamiliar with environmental regulation, or mere oversight.  And it’s a tool that can benefit both sides of a transaction. [1] Tex. Rev. Civ. Stat. Ann. art. 4447cc; see also Senate Bill 1300 (83rd Leg., R.S. (2013)).[2] Tex. Rev. Civ. Stat. Ann. art. 4447cc § 10(b)(1)(B).[3]Id. § 10(b)(1)(A) and (g-1). Ashley PhillipsThompson & Knight, LLP