The growing influence of chemical risk evaluation on the M&A market
October 2019 | SPECIAL REPORT: ENERGY & NATURAL RESOURCES
Financier Worldwide Magazine
October 2019 Issue
In 2018, the global M&A market achieved a transaction volume of $4.1 trillion, the third highest year ever for M&A volumes. Divestitures, spin-offs and split-offs are essential to defining corporate identity, a key shareholder imperative. This brisk pace is expected to continue. Whatever the motivation, M&A activity demands razor-sharp due diligence. The premise of this article is that due diligence often underestimates or, worse, ignores the impact implementation of revisions to the Toxic Substances Control Act (TSCA), the US industrial chemical safety law, has on commercial transactions. Implementation of these revisions is now influencing key sectors of the economy, making it essential that TSCA chemical risk evaluations be routinely included in M&A due diligence protocols.
New TSCA
Congress amended TSCA in 2016 by enacting the Frank R. Lautenberg Chemical Safety for the 21st Century Act (Lautenberg). Lautenberg greatly expands the US Environmental Protection Agency’s (EPA) authority in many areas. For present purposes, EPA must evaluate existing chemicals (chemicals in commerce) in all conditions of use, and requires that the EPA regulate, including banning, chemical uses believed to pose unreasonable risks. Lautenberg adds prioritisation and risk evaluation steps to the existing chemical review process, deletes the problematic ‘least burdensome requirement’, the implementation of which had long plagued the EPA, and mandates aggressive timelines for completion of the risk evaluation process, the results of which we are now seeing.
The risk evaluation process is not a regulatory abstraction occurring in a rarified Washington, DC, bubble. Lautenberg set into motion a highly visible and relentlessly interactive process where chemical substances critically important to virtually every sector of the economy are reviewed to determine if any poses an unreasonable risk to human health or the environment. Chemical industry detractors, public health activists, retailers, corporate competitors, consumers and other stakeholders wishing to weigh in are encouraged to do so. If any unreasonable risk is identified, the EPA must regulate it to the extent necessary to abate the risk. Although Lautenberg was passed in 2016, the EPA’s regulatory implementation of it is being felt now and will be for many years to come as it will have a profound impact on the marketability of thousands of chemical substances and the products that include them.
The chemical prioritisation scheme under Lautenberg establishes a mandatory risk-based screening process, including criteria for designating high-priority and low-priority chemicals for the risk evaluation step. The EPA is required to prioritise for evaluation all chemicals in commerce deemed ‘active’ and to categorise them as ‘high priority’ or ‘low priority’. All high-priority chemicals must be evaluated for risk, with unreasonable risks under this process regulated to eliminate the risk.
Words are important, and from the get-go, a certain bias attaches to substances classified as ‘high’ priority. These adverse inferences carry through the entire risk prioritisation and evaluation process, which spans years, thus imposing sustained optical and communication management burdens on affected stakeholders. With the help of social media, motivated stakeholders, and a highly participatory and transparent administrative process, even chemical uses ultimately ‘cleared’ of an unreasonable risk finding may succumb to a hurly-burly risk evaluation process that can cause extensive collateral damage.
Recent case studies
Methylene chloride. Lautenberg requires the EPA to initiate risk evaluations for 10 chemicals and to identify, by the end of 2019, 20 high-priority and 20 low-priority substances to ensure a continuous supply of candidates for risk evaluation. The EPA timely identified the 10 chemicals in 2016 and has released over the past nine months or so four of the 10 required risk evaluations that it must complete by the end of 2019. Certain chemical substances were identified as priority substances pre-Lautenberg and are listed in the EPA’s 2014 update to its ‘TSCA Work Plan for Chemical Assessments’. For Work Plan chemicals for which the EPA completed a risk assessment prior to Lautenberg’s enactment, TSCA Section 26(l)(4) provides that the EPA may publish final rules regulating these chemicals if the assessment is deemed consistent with Lautenberg’s revised provisions. Methylene chloride is such a chemical substance, and the EPA issued a final rule in March 2019 resulting in the banning of methylene chloride in consumer paint and coating removal products. Methylene chloride has long been used as a solvent in many industrial, commercial and consumer applications, including adhesives, pharmaceuticals, metal cleaning and feedstock in the production of the hydrofluorocarbon refrigerant HFC-32.
This rule is noteworthy for many reasons, two of which bear mentioning here. First, any product ban is a big deal. It means the EPA has determined that the specific uses at issue are unsafe at any speed, as it were, and must cease. This is a regulatory determination, but it resonates in other contexts as well, product and tort liability chief among them. Second, at least one large retailer, Lowe’s, voluntarily stopped stocking paint and coating removal products with methylene chloride for consumer use well before the EPA mandated this result. If nothing else, this action illustrates the power of the TSCA’s spotlight on chemical safety and the nimbleness of the market to act unilaterally regardless of final agency action. This article does not explore whether this is a good development, only that it is very much a component of a complicated commercial calculus of which M&A stakeholders must be mindful.
1-bromopropane. More recently, on 12 August 2019, the EPA released a draft risk evaluation for 1-bromopropane, a solvent used in diverse commercial and consumer applications, including: cleaning metal, plastics and electronic and optical components, adhesive spray applications, dry cleaning, solvent sprays used in asphalt production, aircraft maintenance and synthetic fibre production, and consumer uses, including aerosol spray degreasers, spot cleaners and insulation for building and construction materials. The draft risk evaluation states that there could be unreasonable risks to workers, occupational non-users, consumers and bystanders under certain conditions of use. The EPA did not find unreasonable risk to the environment under any conditions of use.
Use of 1-bromopropane had been on the uptick because of its use as an alternative to ozone-depleting substances and chlorinated solvents. Unless the rulemaking elicits fairly remarkable errors in the EPA’s draft risk determinations, it is reasonable to expect that the EPA may issue significant risk management measures for these uses. Given the diversity of risks that the EPA has preliminarily identified as unreasonable, it is unclear at this early stage how the market will react and whether the retail community, or other stakeholders, will react more quickly than the EPA. In any case, 1-bromopropane’s market may well diminish once the EPA completes the risk management phase of the evaluation.
Incorporating the new normal into due diligence practices
While the outcome of any TSCA risk evaluation and its market impact are necessarily uncertain, the EPA’s process and key timing considerations are clear. What is known and fairly predictable now can be optimised to facilitate the due diligence process and incorporated into due diligence protocols. Below are some practical tips for risk managers to achieve that goal.
First, understand the TSCA and the risk evaluation process. This step involves both an understanding of pertinent legislative and regulatory provisions, and the heavily nuanced meaning of the evolving nomenclature of the TSCA – “conditions of use”, “to the extent necessary” and “unreasonable risk” are key terms, among many others. Reliance upon experienced and trusted professionals is essential. Monitoring the outcome of the spate of federal appellate challenges to various aspects of Lautenberg’s ‘framework’ rules is also essential.
Second, understand where the EPA directionally is headed in prioritising chemicals for review. The ‘Work Plan for Chemical Assessments’ lists some 92 chemicals and is a reliable road map for identifying the objects of the EPA’s attention in this regard. Know the identity of these chemicals, know the risk prioritisation process, and be prepared to anticipate how the process will affect markets relevant to M&A activity under consideration.
Third, understand the role key stakeholders play in a risk evaluation. The EPA’s role as regulator is clear. We are in the shadow of an election, however, and if the administration changes, so also will the EPA’s interpretation of a law that is still considered relatively new and an implementation programme that is very much in flux. Aside from the election, other stakeholder interests are critically important to anticipate as consumer and public health activists, the non-governmental organisation (NGO) community, social media, retailers, unions, Congress through its oversight function and others will all drive the debate and influence the outcome. Recall that Lowe’s acted unilaterally and well before government action. This illustrates that market erosion may occur well before the EPA acts.
Finally, understand that the news is not all bad and that there is considerable market upside for chemical substances that are replacements for incumbent substances burdened by risks deemed unreasonable, whether by retailers or by the EPA. With product demise comes commercial opportunity. Thoughtful focus on identifying chemicals likely to be prioritised for risk evaluation is a useful exercise for any risk assessor taking the long view and diligently anticipating challenges and optimising opportunities.
Lautenberg is game changing. Knowing how it works and knowing where to look for help in understanding its growing influence on commercial markets will minimise surprises and ensure successful due diligence outcomes.
Lynn L. Bergeson is managing partner of Bergeson & Campbell, P.C. She can be contacted on +1 (202) 557 3801 or by email: lbergeson@lawbc.com.
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Lynn L. Bergeson
Bergeson & Campbell, P.C.