In December 2007, FASB issued a revision to Financial AccountingStatement No.141 (FAS-141R) for Business Combinations. Businesscombinations include nearly all business mergers and acquisitions.FAS-141R, which will become effective on December 15, 2008,requires that a buyer recognize all assets and liabilities(including contingent environmental liabilities) in a transactionat the "fair value." A previous FASB pronouncement, FAS 157 FairValue Measurements issued in December 2006, sets the framework formeasuring fair value. FASB defines a "contingent liability" as apresent obligation arising from past events that will requirefuture monetary outflows.

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The manner in which liabilities must be recognized under FAS141R and FAS 157 are a major departure from the way environmentalliabilities were historically recognized in business combinations.The differences between the historical recognition criteria and thenew criteria are summarized in Table 1 (below).

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Under the old FAS 141, accounting recognition of environmentalliabilities could be deferred until the recognition criteria forFAS 5, Accounting for Contingencies, were met. FAS 5 requiresrecognition of a liability only if (1) the loss is "probable,"meaning it is highly likely to occur and (2) can be reasonablyestimated. If a contingent environmental liability did not meeteither of these requirements it did not need to be recognized onaccounting statements or for business combinations.

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The new FAS 141R will require that environmental liabilities berecognized at the fair value as of the acquisition date. Inaddition, different recognition criteria will apply depending onwhether the contingencies stem from contractual or non-contractualobligations. All contractual contingencies must be recognized atfair value as of the acquisition date.

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Contractualagreements would include items such as indemnity agreements andliabilities as a Superfund PRP. Non-contractual contingencies willonly need to be recognized if it is "more likely than not," as ofthe acquisition date, i.e., there is a 51% or greater likelihood ofa liability.
Uncertainty as to the occurrence and amount of a liability will nolonger be a valid reason to defer accounting recognition ofcontingent environmental liabilities in M&A deals. FAS 157allows for the use of statistical probability analysis to determinethe "expected fair value" measurement for contingent liabilities.Looking further to the future, it is likely that FAS 5 will berevised as well to incorporate fair value measurements of existingcontingent liabilities.
The end result will be a significant increase in the number ofcontingent environmental liabilities that will need to berecognized in corporate accounting statements.
New Challenges for Buyers Sellers and EnvironmentalExperts
The most obvious implication of the new accounting pronouncementsis for buyers who must now recognize contingent liabilities ontheir books as of the transaction date. This will necessitate morecareful due diligence concerning the environmental liabilities thatwill be assumed. Sellers also need to be cognizant of the newrules. Before proceeding with any transaction, sellers should get agood handle on the fair value assessment of their environmentalliabilities to aid in negotiations and to avoid being surprised byissues that could derail the deal.
The new rules will also significantly alter the extent andcomplexity of due diligence services that environmental expertswill need to provide. In addition to the traditional service ofidentifying recognized environmental conditions (RECs) there aremyriad additional services that environmental experts may need toprovide for their clients. Environmental experts may need toevaluate and answer any number of the following questions on anygiven deal:
•For each REC, or for the property in general, what is thelikelihood that an environmental investigation or remediation willbe necessary?
•What remediation technologies are potentially applicable to thecontaminants?
•What will the regulators likely approve? Is there a possibilitythat fines or penalties could be levied by regulators?
•What is the range of potential outcomes? What are the estimatedcosts for each potential outcome? And what is the probability ofeach outcome occurring?
•What is the statistical "expected value" for the liability?
•Is there a possibility of natural resource damages (NRD) beingassessed?
•Are there potential third party liabilities? (e.g. off-siteimpacts or toxic torts)
•For all identified liabilities, are they "more likely than not" tooccur?
A combination of experience and judgment are necessary to evaluateall of these complex issues. Most engineers and consultants arecapable of generating cost estimates for a single remediation scopeof work. It takes an extra measure of judgment and experience todevelop multiple outcome scenarios, provide cost estimates andassign probabilities for each outcome, particularly in situationswhere the results may come under the audit scrutiny of valuationexperts.
In order to provide the lowest possible defensible estimate ofenvironmental liabilities, experts will need to have a variety ofcapabilities in their tool box, including the ability to implementTriad investigation approaches where it is necessary to quicklyevaluate the extent and magnitude of contamination in order toprovide fair value cost estimates within the allowable duediligence time frame; expertise in the use of new and innovativeremediation technologies which can reduce environmental remediationcosts; command of statistical approaches and the latest costmodeling tools; experience in the procurement of government grants,insurance products and insurance recovery which can be used tooff-set environmental liabilities; and the ability to conductup-front negotiations with regulators to obtain acceptance inconcept of a proposed remedial approach.
The views expressed here are those of the authors and not ofReal Estate Media or its publications.
Edward Sullivan is senior project manager and DavidRobinson is VP-remedial services for The Whitman Cos., the EastBrunswick, NJ-based environmental engineering and management firm.They can be reached at [email protected] and[email protected]respectively.

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