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Organisations need to act now in order to meet the requirements of the new Electronic Identification and Signature (eIDAS) legislation

Electronic signatures present a huge potential for businesses to improve their operations, create better customer experiences, improve security, and increase potential revenue. E-signature technology now offers cross-border recognition of electronically-signed documents, and instant verification of signer identities and document authenticity – which are essential for businesses operating in increasingly digital and mobile environments.

However, transitioning to e-signatures brings a number of challenges —both regulatory and operational— that businesses need to be aware of. With e-signature adoption increasing, and it becoming mandatory for businesses to recognise electronic identities (eIDs) from mid-2018, it is crucial organisations prepare themselves now.

The changing e-signature landscape

Adoption of e-signatures is still uneven across different industries. A lack of technology standards has been an issue, as has the fact that e-signatures historically have not had the same legal standing as handwritten signatures.

Major changes are underway: this year the EU’s new regulation on electronic identification (eIDAS) became legally binding. The regulation provides a common legal framework for understanding and categorizing e-signature processes; makes it easier for citizens and businesses within EU member states to understand and use e-signatures; and gives e-transactions and other e-signed documents the same legal status as paper documents.

What’s more, this summer also saw Adobe help launch the Cloud Signature Consortium, a group of leading industry and academic organisations brought together to build a new open standard for cloud-based digital signatures across mobile and web. The aim of the initiative is to make electronic signing consistent, secure and scalable, so that anyone can sign digital documents from any digital channel or device.

Under eIDAS, only certain business entities, called Trust Service Providers (TSPs), will be able to issue digital IDs that can be used to create legally verifiable “qualified electronic signatures”. eIDAS establishes a common foundation for mutual recognition of electronic signatures across EU member states, making qualified electronic signatures compatible across all 28 participating EU countries and within the 236 trust providers recognized by the EU.

By providing legal and regulatory standardisation around e-signatures, the eIDAS regulation lays down a predictable legal structure for individuals, companies (in particular SMEs), and public entities to safely access services and conduct transactions online and across borders in just “one click”. With this framework, businesses across Europe can finally and confidently embrace digital transformation with electronic signatures.

Classification of e-signatures

Any business that utilises e-signatures will have to be eIDAS-compliant, and so it is crucial that owners become familiar with the new legislation, and review and identify which business processes need to be updated for compliance.

eIDAS considers three categories of e-signatures, and defines a class of providers—called Trust Service Providers (TSPs)—who offer electronic IDs, time stamping, and other services that support electronic signatures. It goes into significant detail about security requirements, burden of proof, rules for mutual recognition, and supervision of TSPs. eIDAS offers a standardised mechanism for a business or corporate entity to understand the legal standing of the signatory, based on the following signature categories:

  1. Electronic Signatures

An electronic signature under eIDAS is data in electronic form attached to or logically associated with other data, and which is used by the signatory to sign a document. eIDAS provides that an electronic signature shall not be denied legal effect and admissibility as evidence in legal proceedings solely based on the fact that it is in electronic form. In other words, courts cannot discard them as evidence only because they are electronic, with a legal principle called non-discrimination.

  1. Advanced Electronic Signatures

Advanced signatures are a specific type, or a subset of, the larger category of electronic signatures. They are: uniquely linked to the signatory; capable of identifying the signatory; created using data that the signatory can use under his sole control; and are linked to the signed document in a way that any subsequent change is detectable. This requirement can be met with a specific type of digital ID, called a “certificate”, which is typically issued by a Trust Service Provider.

  1. Qualified Electronic Signatures

Qualified signatures are a very specific form of an advanced signature, and they are the only signatures defined in eIDAS that have the equivalent legal effect as a handwritten signature. They’re also the only type that will be automatically recognized by other member states. For businesses to work with Qualified Electronic Signatures, the signer needs to work with a certificate-based digital ID issued by a Trust Service Provider that has been specifically accredited in a member state. In addition, qualified signatures require the use of a qualified signature creation device. For example, the certificate is stored on a smart card, and the signer uses a smart card reader when signing the document.

When it comes to e-signatures, qualified electronic signatures really are the gold standard. These tend to apply to document processes that have high monetary value or where the risk associated with identity fraud is too high to bear. Processes related to government benefits or clinical research are good examples. This category also applies to any business process where applicable law requires, exceptionally, a specific form with a handwritten signature. Example of these types of exceptions are employment termination proceedings in Germany or the transfer of real estate in some countries.

The majority of the use cases, however, don’t require written forms, with businesses typically having the flexibility to utilize Advanced Signatures. These require that each signer have a certificate-based digital ID, which may be practical for employees or favoured business partners, but is more difficult to implement when working with new customers, partners, or the public at large.

The eIDAS legislation also introduces the idea of “electronic seals”: With eIDAS, only an individual person can use an electronic signature. A legal entity, such as a business, cannot. The business can, however “seal” a document to ensure certainty of a document’s origin and integrity.

Preparing for the future of e-signatures

It will be mandatory for businesses to recognise electronic identities (eIDs) from mid-2018. A business that is unprepared for the eIDAS regulation may find that it risks restricting potential customers and partners, as it will not be able to facilitate long distance digital signing or legally verify a documentation due to the absence of the right technical infrastructure. And beyond the potential loss of new trade, a business may face legal repercussions for failing to comply with eIDAS adequately.

Any business using e-signatures will, naturally, also have to be compliant with the Data Protection act, which governs data security and compliance for a new breed of businesses services which are increasingly based on the Cloud. Regardless of its size, any business handling personal data is responsible for its protections.

Besides regulatory concerns, business owners will also have to evaluate which technologies can best advance this transition by engaging with the specialist vendor community, which can provide expert counsel on compliant solutions. Doing so will enable them to test their in-house expertise and verify that their current and planned technologies will continue to operate within regulatory boundaries.

With the arrival of eIDAS, businesses have been given the flexibility to deploy electronic signature solutions that meet their specific requirements. The use of e-signatures is only set to grow, as businesses continue to operate in an increasingly connected environment. By ensuring compliance as early as possible, businesses can better guarantee that they won’t be superseded by more agile, technologically savvy competitors, while having the capability to conduct cross-border business securely and safely.

Ex-Spouses could face travel bans for failing to pay divorce settlements

Paul Lancaster, partner of the Family Law team at Blacks Solicitors, looks into the latest proposals from the Law Commission:

“The Law Commission has published new proposals which aim to make the enforcement of family financial orders ‘more effective, accessible and fair’ and implement tough sanctions for those who refuse to pay their former spouse’s divorce settlement.

The Commission states that many divorcees are ignoring the orders, with as many as 4,200 enforcement cases each year amounting to an estimate of £15m to £20m of debts each year which go unrecovered, leaving the recipient spouses at a serious detriment and hardship.

The current position allows those that are owed money to take their ex-spouses to Court where a jail sentence may be ordered however, because a criminal standard of proof is required, in reality this type of sanction is rarely enforced.

The report recommends a wide-ranging reform, including the power for the Courts to obtain information about debtors, broadening the range of assets available for enforcement purposes and introducing further punitive measures such as disqualifying debtors from driving and prohibiting them from travelling out of the UK.

The Commission has, however, confirmed that they will not put ex-spouses in a self-defeating position whereby they can no longer earn a living as a result of a driving ban. The commission is therefore also recommending that the Courts have the power to confiscate passports which would be returned once the debt is settled. It is believed these measures will go some way to tackling the growing culture of non-payment.

The proposal will now be considered by government and the Justice Secretary over the course of the upcoming year to decide if the proposals will be legislated.”

The Brexit Effect; how employment legislation will be affected by the UK’s new independence

More than six months have passed since the historic Brexit vote and the subject has remained ever present on the news agenda. Recent events have now revealed a date to look towards as PM Theresa May has announced she will trigger article 50 by the end of March 2017, which means the UK will be non EU members by the middle of 2019.

Here, Richard Thomas, Employment Law specialist and Partner at Cardiff and London based law firm, Capital Law, looks at the potential legal implications the UK could face during the withdrawal process of Brexit, focusing on the potential repercussions on employment law.

Ever since the result of the much anticipated vote was announced, lawyers and civilians were cautious of the legalities that would be involved in the process of leaving the EU. This is predominantly because the Brexit camp never put forward any clear blueprint or model as to how the UK would govern its legal and trading relations once out of Europe.

This was in stark contrast to 2014’s Scottish Independence Referendum when the then Scottish Government published a prospective detailing how an independent Scotland would exist and function.

Theresa May’s decision to invoke Article 5O will serve irrecoverable notice of Britain’s decision to leave the EU. This will then trigger the two year negotiation period in which to conclude a withdrawal agreement.  We’re repeatedly told that ‘Brexit means Brexit’, but ambiguity abounds about what the term actually means in real terms.

The legal implications of such a withdrawal for the UK’s current laws are considerable. For example, the treaties, directives and regulations (and rulings of the European Court of Justice) will cease to apply in the UK unless their affect is specifically preserved by UK national law. Furthermore, the EU Court will no longer have jurisdiction over the UK and UK citizens will no longer have the rights of EU citizens.

What is clear is that there will be significant practical difficulties associated with the need to disentangle EU derived requirements from non-EU derived requirements, especially where case law has, for over 20 years, drawn on the UK Courts interpretation of EU directives and ECJ rulings.

In the employment law field, a significant amount of UK legislation and case law developments have stemmed from the EU and this has strengthened workers individual rights in areas such as working time and annual holidays. Other benefits that have arisen from our EU membership include family friendly policies, anti-discrimination legislation, and employment protection in the event of a change of employer.

Worker collective rights have also been strengthened by EU directives in the areas of collective redundancies, TUPE, European works councils and information and consultation obligations.

Redundancy consultation is a valuable piece of employment protection which could very well be watered down when we leave the EU. The current laws stem from an EU directive and state that collective consultation is required when over 20 people are affected. I suspect that this number will change after our withdrawal and will more likely increase to a minimum of 100 employees that need to be under consultation, although I doubt this will be a legislative priority in the immediate aftermath.

Most of the Working Time Regulations will remain. Paid holiday will certainly stay, and of course the UK gold-plated the European four weeks paid annual leave in the UK.

We also suspect that a ‘week’s pay’, which currently includes commission and overtime following ECJ rulings, will be pared back to what it was a few years ago, with just basic salary being paid as holiday pay.

Possibly the most talked about issue relating to employment is the future of British nationals living and working in other EU countries and vice versa. Previously, Liam Fox, the Secretary of State for International Trade, said that the future of British nationals in Europe is ‘one of our main cards’ in the ongoing Brexit negotiations. He said that no guarantee would be given to the two million EU nationals living in the UK until more information about the fate of British citizens living in Europe has been revealed.

Following Brexit, EU nationals would no longer have the automatic right to continue to work in the UK. It seems likely that the UK Government will agree with the EU a position whereby existing EU migrants can stay (at least for an agreed period) in return for permission for UK citizens working in the EU to remain where they are. It is also likely that the UK will introduce an immigration system similar to the current system for non-EU citizens, whereby skilled workers and students can gain permission to stay for a limited period. Undoubtedly, this could have an impact on some UK businesses if significant restrictions are imposed on their ability to recruit labour from the EU.

While the Brexit effect has already been felt across a number of industries, this is a fraction of what the implications will be when we formally leave the EU. Employment law will certainly be affected not only in the areas touched upon here but also within discrimination cases and data protection, which will both be reviewed upon our withdrawal.

Companies and employers should keep an eye on the news agenda to assess any further impact Brexit could have on recruitment, employment and immigration in order to stay ahead and safeguard their current employees before the legislation changes.

GDPR and the effect on data breaches

The Information Commissioner’s office have now confirmed that the UK will have to enact the General Data Protection Regulation (GDPR) by May 2018 given this implementation date will occur before the expiry of the two year period from the giving of the UK’s Article 50 notice to leave the EU.

The introduction of the GDPR is the biggest overhaul of data protection legislation in 18 years, 18 years which have seen a major boom in data and advancements in technology which the previous legislation has failed to keep pace with. Furthermore, the introduction of the GDPR will impact, to some degree, every single business and organisation in the UK.

Under the current legislation only public bodies, via a voluntary arrangement, have a positive obligation to report data breaches to the Information Commissioner. As such when a data breach occurs many private sector organisations simply batten down the hatches and hope no-one traces a data breach back to them, and in most cases they will get away with this.

However, the GDPR introduces a new positive notification requirement where certain types of breaches (i.e. those likely to result in a risk to the rights and freedoms of individuals) have to be reported to the Information Commissioner within 72 hours of becoming aware of the breach and, if the breach is likely to result in a high risk to the rights and freedoms of individuals (e.g. the data lost could result in identity theft), then the individuals whose data has been breached, which could be customers or employees, without undue delay.

The thought of having to write, on a firm’s headed paper, to individuals telling them your firm has lost their data constitutes a significant reputational risk, especially in today’s era of social media where that letter could be photographed, published online and shared thousands of times. This, combined with the threat of fines for not reporting breaches of up to €10m or 2% of global turnover, should firmly put data protection compliance and the introduction of the GDPR on the boardroom agenda of every organisation in the UK.

Rather than waiting until May 2018 and then trying to get everyone in an organisation up-to-speed on the new legislation every business should be taking steps now so that when May 2018 arrives they are already up-to-speed with the new legislation which significantly reduces the risk of having to report data breaches to the Information Commissioner and possibly customers, employees and other third parties, from May 2018 onwards.

Whilst a lot of the press attention has been on high profile data breaches caused by hackers and cyber-attacks, the one area that often gets overlooked, and is traditionally the weakest link in any data protection system, is the human element.

The vast majority of data breaches occur due to human error. This is someone such as an employee or sub-contractor doing something they shouldn’t be doing or simply making a mistake such as the fax or e-mail to the wrong recipient, losing a memory stick or failing to encrypt data or destroy data properly.

Any business can have a superb written data protection policy, however that policy is not worth the paper it is written on unless employees are trained so they understand the reason there is a policy in the first place, the personal consequences on them from an employment/disciplinary perspective in not complying with that policy, the wider financial and reputational damage consequences to the organisation itself and how practically that policy impacts on them as they go about their day-to-day tasks.

Without the benefit of rolling out a comprehensive system of staff training (both initially and on an on-going basis) businesses will continue to put themselves at risk, both from a financial and reputational point of view, as employees go about their daily task oblivious to how their actions can have serious consequences down the line.

Counseling Early Stage Companies: Advance Preparation for the Exit

Representing early stage, high-growth companies often involves supporting a team of entrepreneurs to take a business from an idea, through commercial launch and market penetration, to a successful exit, often through an acquisition by a strategic or financial purchaser.  The speed and intensity of the client’s activity can be tremendous.  Under the pressure of achieving critical product development or revenue milestones – often driven by the client company’s investors – management will sometimes forego certain basic contracting, human resources and capitalisation  management measures.   Unfortunately, these short cuts will surface during the exit transaction, where the acquirer’s due diligence on the target company will spot these shortcomings in order to identify potential risks as well as opportunities to revalue the target company’s assets and business and reduce the purchase price.  The attorney representing the early stage company can streamline the exit transaction and minimise adverse due diligence discoveries by helping the client institute the following four relatively simple disciplines at the company’s outset (or at least at the outset of the counsel’s engagement), well in advance of any merger and acquisition considerations.

  1. Protect and Preserve Company Intellectual Property. For many early stage companies, intellectual property assets can represent the core of the company’s value at exit.  Those assets, of course, are generated by employees and contractors working on behalf of the company.  In the course of the company’s history, employees and independent contractors come and go.  However, sophisticated acquirers will often probe the target company’s files for potential intellectual property “leaks” or gaps – situations where employee or contractor inventions or developments may not clearly belong to the target company.The simple but often neglected solution to this due diligence red flag is drafting and religiously using a standard employment agreement or independent contractor/consultancy agreement with all new employees and service providers. These standard agreements should contain the following basic covenants:I. Confidentiality: Provisions prohibiting an employee or independent contractor from disclosing or otherwise using the company’s confidential information both during the relationship and for multiple years beyond the term of the agreement.ii. Invention Assignment: Provisions indicating that all “inventions, original works of authorship, trade secrets, concepts, ideas, discoveries, developments, improvements, combinations, methods, designs, trademarks, trade names, software, data, mask works, and know-how, whether or not patentable or registrable under copyright, trademark or similar laws” developed during the term of employment or contractor service belong to the company.  This covenant should similarly include an acknowledgement that all copyrightable material is a “work made for hire.”  Note that company counsel should confirm the impact of the applicable state laws on these covenants. For example, the “work made for hire” clause should be excluded from independent contractor/consultancy agreements governed by California law, as California law dictates that individuals subject to this type of covenant in a services agreement may be deemed employees under the California Labour Code .  Avoid the temptation to limit company ownership of employee or contractor developments to only those generated “on company time” or “using company resources.”  This limitation will only act to invite ownership ambiguity – an unnecessary impediment in the acquisition due diligence process.iii. Pre-existing Intellectual Property Disclosure and Licenses: Provisions obligating employees or contractors utilising pre-existing intellectual property in their work for the company to (i) clearly identify the pre-existing IP and (ii) grant the company a perpetual, transferrable license to use, in the course of its business, any relevant pre-existing IP included in works created by the employee or contractor for the company.
  2. Facilitate Shareholder Decisions. The decision to exit the business will naturally require the approval of both the Board of Directors and the shareholders of the company.  Minority shareholders who are no longer associated with the business, or who have a different perspective on the company’s direction and objectives, can seek appraisal rights, demand certain concessions, or take other steps to block or disrupt the transaction.  While reverse merger structures can be used to minimise the disruption caused by dissenting minority shareholders, these structures increase both transaction costs and the potential liability to the target company.The pre-emptive solution here is a basic shareholder agreement, prepared and negotiated when the early stage company’s shareholder base is relative small and cohesive. The shareholder agreement should include the following elements:i. Dragalong Rights. Terms requiring minority shareholders to support and vote with the majority on fundamental company decisions, including a vote to sell the company and/or waive of appraisal rights.ii. Buy/Sell Arrangements. Structures that ensure that the equity interests of disaffiliating shareholders are (or can be) repurchased by the company or the remaining shareholders;iii. Joinder Provisions. Requirements that all new shareholders (including those acquiring their equity interests through the conversion of debt) become signatories to the shareholder agreement.
  3. Simplify Contract Assignment. A major factor in the acquired business’ valuation is the status of its contractual relationships with customers, vendors, strategic partners and other third parties, and how easily an acquirer can continue to take advantage of those contracts following the acquisition. Contracts that include non-assignability clauses – provisions requiring counterparty’s consent prior to assignment – can greatly obstruct this transition, particularly if the transaction is structured as an asset sale (vs. a stock sale or merger). At best, these clauses can delay a closing while the target company pursues the counterparty’s consent, who may see an opportunity to extract a contractual concession from a vulnerable target.  At worst, the target company’s inability to obtain a counterparty’s consent may result in the termination or rejection of the contract by the acquirer, which can reduce the target company’s valuation.Since non-assignability clauses are often a standard part of the “boilerplate” sections of many agreements, and since solving the anti-assignment clause problem once the contract has been signed is difficult, if not impossible, company counsel should help the client implement the following prophylactic measures at the outset of the negotiations:i. Removal: Generally, the absence of a non-assignability clause in a contract allows both parties to assign the contract freely.ii. Change of Control Carve-Out: An exception that eliminates the need for the counterparty’s consent when the contract is assigned to a successor organization in the event of a merger, spin-off, or other reorganization, or any sale to any entity which buys all or substantially all of the assigning party’s assets, equity interests or business can eliminate the issue in an exit transaction.iii. Reasonableness Standard. As a fallback, incorporate a requirement that the counterparty’s consent to a contract assignment may not be “unreasonably withheld.” While this does not eliminate the need to secure the counterparty’s consent, it will impose a baseline legal standard which may facilitate the assignment negotiation.
  4. Maintain Good Corporate Capitalisation Hygiene. While cases of mystery shareholders appearing at the closing of an acquisition transaction are rare, confusion over the accuracy of the capital structure of the target company, as well as the identification of non-compliance with securities laws, can materially disrupt an exit transaction.  Common causes of capitalisation problems most often relate to (i) failing to either register or file a registration exemption with the Securities and Exchange Commission and/or state authorities in connection with the sale of private securities issued by the target company to early investors, which are usually friends and family, (ii) issues involving the company’s equity incentive plan, including unsigned documents, unclear vesting schedules, and uncertain stock repurchase provisions and exercise; and (iii) overlapping and conflicting convertible securities, including securities with conflicting conversion terms or circular conversion formulas. Many buyers will avoid assuming any risks associated with an ambiguous capital structure or improperly issued shares, preferring instead to let the target company identify and resolve discrepancies before closing.As with the other sets of issues described in this article, the preventive solutions are straightforward and, in most cases, inexpensive:i. Comply With Applicable Federal and State Securities Laws in Securities Offerings: Most states and the SEC have numerous exemptions allowing early stage companies to issue securities without the need for a formal registration.  The exemption process, however, often requires the issuing company to file a registration exemption with the appropriate securities regulator. Failing to file a registration exemption may not require the company to register its shares, but it may prevent the company from utilising a “safehabour ” in future transactions, including an exit transaction with another private company.  Filing the necessary registration exemption forms will not only help ensure securities law compliance; it will also provide assurance to a potential acquirer that these registration exemptions will remain in effect in future transactions.ii. Invest in a Commercial Cap Table Management Software. There are a number of quality, low cost software solutions on the market that can help track and automate company cap tables and “date-stamp” capital structure changes, in order to allow for a simple analysis of capitalisation changes and confirmation of issuances.iii. Automate the Effect of Certain Equity Incentive Plan Triggers. For example, if a company’s restricted stock plan provides for the buyback of unvested shares if the employee terminates, the company’s repurchase of those unvested shares should occur automatically.  Relying on the affirmative action of the company (and potentially the memory, or filing system, of the company’s executives) can result in inconsistent equity incentive plan operation and unintended equity ownership.

    iv. Create Pro Forma Models to Reflect the Terms of Convertible Securities. Going through the exercise of translating the terms of convertible securities – particularly where different securities are issued at different times to multiple parties – will help pressure test the conversion terms and validate that they function as intended.

The foregoing measures, designed to minimise exit disruption, are neither difficult nor time-consuming.  In fact, the most difficult task is often convincing the client company to expend the time, effort and resources to implement these disciplines, even years in advance of a potential exit.  As noted above, it is ultimately time and energy well spent.

Protection of Assets or Tax Evasion? Recent Trends of Russian Court Practice in Light of the De-Offshorisation Policy

The de-offshorisation of the Russian economy that started in 2014, introduced a new reality for Russian business, which requires adaptation by way of revising business structuring schemes that have been used for years. Within the framework of the battle against tax evasion, the government is establishing new rules aimed at the prevention of profit related to Russian assets being taken abroad. This provided, considering the international policy, according to which all countries of the world should be engaged in a joint battle against aggressive tax planning within the BEPS plan, each year the tax authorities have more and more instruments for exercising control over transactions.

Many precedent decisions for taxpayers have been made by Russian courts in the last year, reflecting new approaches in the law enforcement practice, including approaches to using international treaties. In particular, analysis of court decisions shows intensification of the trend in restricting benefits under double tax treaties (hereinafter the “DTTs”).

This is due to the fact that the courts began to actively use the doctrine of a beneficiary or entity actually entitled to income, which was entered into the Russian tax law at the end of 2014, and as a result the practice turned to a notable extent against the taxpayers. The so-called conduit structures, in other words, transit companies which are actually entitled to benefits under international agreements (DTTs), but have no actual right to income, may be said to have become victims of the government policy. In the event such a structure is revealed, the tax authorities and courts acknowledge the use of benefits under the respective DTTs as unjustified and insist on payment of tax in Russia if the ultimate beneficiaries are unknown or are located in jurisdictions which do not have international agreements with Russia.

It is worth noting that in order to make a decision as to who the entity that actually controls the assets is, tax authorities assess the economic nature of transactions on transferring assets and define a taxpayer’s rights and obligations in terms of the true economic purpose of the transaction (in the inspector’s judgement). The problem is that such assessment can be rather subjective and can disregard or ignore objectives of the business on protecting its assets. As a result, even though under the law it is the tax authority’s responsibility to prove that a scheme was created for receiving unjustified tax benefits, in such disputes the taxpayer also has to collect sufficient evidence in order to prove reasonable economic grounds for transferring assets to a particular company, as well as to substantiate the entire ownership legal structure in general.

Meanwhile, court practise shows that simple arguments regarding the multistage scheme for transferring shares being created for protecting them against being seized unlawfully, are insufficient for justifying a company’s position. For example, in one of the most high-profile cases this year on a complex share holding structure in a Russian company, the tax authorities assessed the following: aggregate of actual relations within the entire group of foreign companies, the interdependency between all members of the group and the rights of owners holding Class A and Class B shares. The tax authority, having analysed the said circumstances, determined that the Cyprus company was a formal/technical one to which the assets were transferred, and the BVI entity was the one with actual control over the shares.

As a result, the tax authority, and later the court, arrived at a conclusion that the Russian company has not fulfilled its obligations of a fiscal agent and has not paid taxes to the Russian state budget on the foreign organization’s income received from sources in Russia in form of property divided in transactions among foreign companies to the benefit of companies on the British Virgin Islands which do not have a DTT with Russia.[1]

At the same time, the tax authority and court also referred to “the actual goal pursued by the taxpayer when conducting disputable operations,” which according to the conclusion of the tax inspectorate was solely that of transferring the property to an offshore company and of tax evasion. It is worth noting that this scheme of creating a holding company for better legal protection of assets did not violate legislation in force during the time period being inspected. Therefore, the decision of the tax authority and court was not based on any legal regulations, but only on the court concept of “unjustified tax benefits,” which is interpreted more and more broadly each year.

As the main argument in court, the tax authorities use the legal position of the Russian Supreme Commercial Arbitration Court that tax benefit can be recognised as unjustified, in particular, in casesfor tax purposes when transactions are registered not in accordance with their true economic essence or operations are included that are not supported by reasonable economic or other grounds (business purposes).[2] The broad  interpretation of this position eventually leads to taxes on a transaction, which are paid in a reduced amount or are not paid at all (which is lawful from a formal perspective), being by default recognised  by the supervisory authorities as an unjustified tax benefit.

The case described above confirms that the redistribution of Russian assets among foreign structures is now under the scrutiny of the tax authorities which are very sensitive to Russian companies being owned using offshore companies. At the same time, it is necessary to take into account that irrespective of the fact that the de-offshorisation  policy was adopted in 2014, and the respective concepts were introduced into law and became applicable from 2015, the courts acknowledge the right of the tax authorities to determine the tax consequences after identifying the beneficiary of income for periods before 2015, when such notion did not yet exist in the tax law.

It should be noted that pursuant to the tax legislation, the depth of a tax inspection is restricted by a three-year period. Meanwhile, the regulatory authorities are entitled to go beyond these limits and inspect the taxpayer’s actions for the preceding 10 years within the framework of criminal cases initiated in respect to tax crimes.

It is important to note that due to the changes in the criminal procedure laws in 2014, the law enforcement bodies got an opportunity to initiate criminal cases independently without the need to obtain results of tax inspections performed by territorial tax inspectorates. Based on information of the General Prosecutor’s Office and investigating agencies, after the said changes, and after the police were once again granted the powers to perform investigative activities on tax crimes, the number of tax evasion criminal cases increased approximately by 68% in 2015, as compared to 2014, and it seems that the figures in 2016 will not decline.

Such frightening statistics mean that companies adopting decisions on using offshore entities when building cross-border business structuring schemes are under risk. And at the same time, such business decisions can become the subject matter of an inspection conducted by the investigating agencies for a period exceeding 3 years.

Considering the court practise being formed, the trend of inspecting companies whose assets are owned by foreign structures, as well as the development of cross-border exchange of tax information, companies need to assess all existing tax risks within the conditions of a new economic reality and, if needed, to revise their business structure.

[1]     Resolution of the Commercial Arbitration Court for North-West Circuit dated 15 March, 2016 on case No.А13-5850/2014.

[2]   Decree No.53 “On Commercial Arbitration Courts’ assessment of grounds for a taxpayer receiving tax benefit as to being justified” of the Plenum of the Russian Supreme Commercial Arbitration Court dated 12.10.2006



Navigating through Malta’s Unrivalled Potential

Danielle Hermansen, of PKF Malta, discusses recent developments in the insurance market and latest event for promoting Malta, as a domicile of choice for European Captives in October 2016 – New York, the success of the industry’s latest events and what essential elements remain talking points across the financial landscape

  1. What was the event and why was it held?

PKF Malta sponsored a Captive Owners Summit on  31 October 2016, being the third initiative in its kind this year in New York. This event was one of a series of events in the PKF Malta calendar with the aim of promoting Malta as a domicile of choice. This Captive Owners Summit, organised by Captive Review, is a highly exclusive learning and networking event for US-based leading captive owners. It offered a unique opportunity to network and share ideas with industry peers in a safe and intimate environment where insurance buyers are proficient and lead the content.

The event was hosted at the prestigious Essex House, where an innovative approach to networking was introduced, having delegates attending a series of in-depth roundtable sessions. PKF Malta was invited to host the “Writing European Risk Through a Captive” during the full day event. The event was spread over 15 topics, for which PKF Malta had the privilege of hosting two round tables featuring European Risks. Other sought after topics included “Using Your Captive As a ProfitCentre ”, “Self-Procurement Taxes and Re-domestication Pressures” and “Bringing Multi-national Employee Benefits Into Your Captive”.

  1. How successful was the event? Why?

The round table linked to Writing European Risks, having the author as the speaker, discussed a number of pertinent points connected with insuring European risks. This pointed to a long list of benefits of Malta as a domicile of choice in Europe in particular in view of its Protected Cell Companies Legislation. Both roundtables where successful and in-depth discussions centred on how Cells may be used. Most of the Captive Owner representatives present were still in-tuned on using fronting arrangements for their European risks. Many where pleased to learn of an alternative solution to using fronters, namely that of creating insurance Cells in Malta to satisfy this purpose. Some were curious to know what they should look out for and finally what the benefits would be for them if they consider Malta. With fronting arrangements becoming more onerous and fronters in Europe becoming more choosy following Solvency II, this was seen as a viable option.

  1. Did Solvency II discussions feature in the Round Tables?

Solvency II was a heated topic amongst participants at the summit, surfacing repeatedly during both roundtables, including a discussion on the future ramifications of Brexit. Solvency II is the result of a decade of anticipation to the European Union’s harmonisation of laws governing the insurance industry. The new regime came into force in January 2016, with insurance companies across the EU having to submit their Day 1 and QRT Reporting to their respective regulators. It is accepted that insurers and insurance managers invested in human resources in order to embrace this new regime, while finding a way to justify the costs of implementing an internal model or alternatively scale down to the standard model. Once the emphasis on the new regulatory regime is fully embraced it is expected to become second nature to the day to day workflow, then one hopes that the benefits of solvency II will start being appreciated even more. One hopes that the risk based approach of solvency II will act as a catalyst for risk managers overseeing how capital is best allocated and hence more aligned to underwriting criteria.

  1. What other main topics featured in discussions?

Cyber risk was by far the most sought after topic of the day so that industry specialists offered their experiences on how best to handle this risk. While the majority noted that insurance was in place, they all agreed that the limits in place are by far too low to cover an actual full scale event. The debate evolved on the need for the risk managers to first see how they evaluate the cyber risk policy, then approach reinsurers accordingly, this albeit representing the ideal scenario achieved by some, possess better leverage in their negotiations with their reinsurers.

  1. How would you describe the overall experience of the Summit?

This event was well received and attracted a gathering of US-based risk and insurance professionals playing an integral role in directing their corporate captive. The event also attracted heads of State like the State of Vermont and Consultants and Risk Management specialists such as Spring and Beecher Carlson. More importantly, it also gave the opportunity for participants to meet a number of Captive Owners, Fortune Global 500 list, some in the top 100 list, who shared their invaluable experiences and innovation utilised in their Captives. Without any doubt, with the collaboration of Finance Malta, this event served as a platform to raise the profile of Malta as an insurance domicile, to establish leads of interest to set up in Europe and to create new contacts within the market. PKF Malta are pleased that the event created interest in placing Malta squarely on the radar considering the merits of other European options.

Part of the services PKF Malta offers includes a core Internal and External Audit service to the insurance industry, so we work closely with specialised service providers within the local industry. Being an integrated member firm of PKF International, we also work closely with 120 offices to deliver specialised technical solutions to the local insurance industry. We have the ability to give a tailor-made service which goes beyond mere compliance to provide a whole range of flexible services, the likes of which larger consultancies may find harder to achieve.

Earlier this year, PKF staff also attended the SIFMA – Insurance and Risk Linked Securities Conference in New York, taking the opportunity to discuss further the emerging trend concerning the ILS market in an effort to expand their products to cater for a more diverse range of cedents such as Captives. It goes without saying that the ILS provides a means by which the Captive may now also transfer its catastrophe risks, other than solely relying on the traditional reinsurers. This vehicle is still gathering momentum, in the same way that the non-traditional use of ILS’s for embryonic cat risks such as cyber risk and operational risk. It is evident that opportunities for growth in US market are ripe for Malta in its policy to partake of the growing market.

Croatia: Tax Reform to Promote Economic Goals

As the Croatian Government announced tax reform and sent several amendments of the tax legislation to the Parliament procedure, it is likely that 2017 will bring significant changes to the Croatian tax system[1]. The two main objectives of the reforms are: increasing the sustainability of the general state debt and promotion of growth and employment in the Croatian economy. The aim is to reduce the overall tax burden, to promote the competitiveness of the economy and to introduce a sustainable and simple tax system that may be supported by cheaper tax administration.

In the corporate profit tax sphere, the general tax rate will be reduced to 18%, while the lower rate of 12% will apply to taxpayers with annual turnover up to TEUR 400. The popular incentive (tax exemption) for reinvested profit is being abandoned and regional and other tax related incentives are kept only under the Investment Promotion Law.

In order to combat illiquidity and insolvency of the private sector, the proposal aims to reduce the share of non performing loans in the finance sector by introducing one time measure to write off bad and doubtful debts with the relevant cost being fully tax recognized.

Obstacles to the development of foreign and domestic investment should be further eliminated by introducing the possibility to sign the advance pricing agreements. Further details are also introduced with respect to interest applied in the related party financing.

In the personal income tax sphere, the increase of the tax-free allowance and the reduction of the top tax rate is aimed to reduce the overall personal income tax burden, allowing Croatia to be a more competitive environment for highly skilled personnel and professionals. At the same time, the reform introduces social security liabilities to specific non-employment types of income as well as synthetic taxation of other income (leading to more fair participation in the overall tax / social security burden).

In the VAT system, VAT rate on certain goods and services (e.g. electricity supply) is reduced from 25% to 13%, while increased from 13% to 25% for example on hospitality services (but not for tourism and hotel accommodation services generally, which will continue to apply reduced VAT rate of 13%). As of 2018, both VAT rates will be reduced: to 24% and 12% respectively.

Threshold for entering the VAT system is increased to TEUR 40. Billing method (as opposite to payment method) will be applied for VAT due at import of high value machinery and equipment.

Amendments to the VAT Law also address VAT treatment of transfer and utilization of value-coupons.

Further liabilities are introduced to taxpayers who participated in Carousel fraud or similar fraudulent activities where VAT obligation remained unsettled as well as to taxpayers who did not pay to the supplier at least the amount of VAT charged for the supply received in the prescribed deadlines.

Changes are introduced also with respect to the tax procedures, whereas the 3-year relative statute of limitation is abandoned and a single 6-year statute of limitation is introduced. The tax inspections, however, will be allowed only within 3 years from the commencement of the statute of limitation. Deadline for correction of the tax return is prolonged from 1 to 3 years.

The above represent only a high-level overview of most significant changes to the Croatian tax system, while details and several other types of fiscal liabilities are not addressed.

The entrepreneur community in Croatia would really like to see the reduction in overall tax burden and promotion of the competitiveness of the Croatian economy, through assertive strategies and the much-needed predictability of economy. It, however, remains to be seen whether the new tax reform and its many specifics, such as increased amounts of tax-deductible entertainment expenses, deductible input VAT on cars, elimination of exemption for first property acquisition while reducing of real estate transfer tax rate from 5% to 4%, are indeed the real answer to Croatian economic challenges.


[1] This Article is prepared under the assumption that the Parliament will adopt changes of laws as currently proposed

Immigration – Indian Business and Employment Law Updates

In a world that is characterized by globalization and a constant mobility of people across borders, countries are re-defining policies and enhancing compliance initiatives.

India has over the past few years seen a healthy surge in foreign nationals coming to India on employment visas. The Government of India through the Ministry of Home Affairs deals with all matters relating to visa, immigration, citizenship, overseas citizenship of India, acceptance of foreign contribution as well as hospitality. This article elucidates certain important, recent changes pertaining to foreign nationals in India as well as Indian origin foreign nationals.

Mandatory Reporting of Foreign National’s Stay

The Ministry of Home Affairs (MHA) has vide notification dated March 18, 2016[1] made it mandatory to report the stay of foreign nationals on the premises by a landlord.  This has been a requirement for several years but has not been enforced strictly prior to this.

Foreign nationals in India are under heightened scrutiny regarding their entry and stay in the country. Thus, the MHA has emphasized the mandatory requirement for hotel, guest houses, hostels, and private homes among others, to report the arrival and stay of any foreign national, within 24 hours of arrival at their premises. Rented accommodation falls within the ambit of ‘hotel’ specified under this notification. An online application in this regard has been made applicable. This reporting requirement is separate from the police verification that needs to be completed prior to registering at an FRRO/FRO or applying for a visa extension at an FRRO/ FRO.

Landlords also must register online and then generate Form C for each of its foreign national tenants.  To limit the liability of the landlord it is imperative that they also report the departure of any foreign national from their premises and the foreign national is required to sign the Annexure to the Order Form.

It is imperative for foreign nationals to register with the FRRO/FRO concerned having jurisdiction over the place where he or she intends to stay within 14 days of arrival when they are visiting India long term (more than 180 days) on a Student Visa, Employment Visa, Research Visa or Medical Visa.  Pakistani nationals however must register with the concerned FRRO/FRO within 24 hours of their arrival.  Usually, the entity that sponsors the visa is required to submit an undertaking to the FRRO/FRO on behalf of the foreign national “to ensure good conduct of the foreign national during his/her stay in India.” No registration for minors below the age of 16 is required.

Reporting the Repatriation of Foreign National Employees

During the course of employment, in case the employer wants to withdraw the “undertaking for good conduct” the employer is required to visit the office in person along with the foreign national to report and record the withdrawal.  This is likely to happen when the employee has been found to violate some law or when the employee wishes to change his employer etc.

The MHA has published a notification making it mandatory for employers to report the termination and/or departure of all foreign nationals working in India. Please note that this applies to all foreign national employees whether they are required to register or not.

Investment Related Residence Rights

The Government of India has decided to woo foreign investors with permanent residency rights and to provide financial support to facilitate trade with South–East Asian countries including Cambodia, Vietnam, Laos and Myanmar through the Export Import Bank of India to investors who bring a minimum of about USD 1.5 million in 18 months about USD 3.6 million in 36 months and generate at least 20 jobs every year[2].

The permanent residence status to foreign investors is expected to be for a period of 20 years. The foreign investor will be entitled to own one residential property and the spouse will be allowed to work or study here. This scheme will however not be made available to Pakistani or Chinese nationals.

An official statement issued states, “Permanent residence status will serve as a multiple entry visa without any stay stipulation and holders will be exempted from registration requirements. They will be allowed to purchase one residential property for dwelling purpose. Spouse and dependents will be allowed to take up employment in private sector (in relaxation to salary stipulations for employment visa) and undertake studies in India”. The statement further added that the fund will help to benefit domestic companies’ business expansion and grant access to cost competitive supply chains in addition to helping them integrate with global production networks.

Further, under current regulations most foreign nationals could qualify for naturalization as Indian citizens after staying in India for 12 years in qualifying long term status subject to certain criteria.

Expanded use of eVisas

With an eye to make Indian yoga and its age-old medicine system accessible to all nationals, the Government of India has decided to include ‘attending a short-term yoga programme’ to its existing list of permissible activities under Tourist and E-Tourist Visa[3].  The Government has also included ‘short duration medical treatment under Indian systems of medicine’ thus expanding the list of permissible activities for an E-Tourist Visa.

A foreign national may apply for a tourist visa for the purposes of recreation, sightseeing, casual visit to meet friends or relatives or attending a short-term yoga programme while a foreign national whose sole objective of visiting India is recreation, sightseeing, casual visit to meet friends or relatives, attending a short-term yoga programme, short duration medical treatment including treatment under Indian Systems of medicine or casual business visit may apply for an E-Tourist Visa.

It is pertinent to note that the main difference between a Tourist Visa and an E-Tourist Visa is that while an E-Tourist Visa must be applied online minimum four days prior to the date of travel.  This visa is issued with a validity of a period of 30 days and may be used twice in a calendar year.  Whereas, a Tourist Visa has to be obtained from the concerned Indian Mission prior to arrival in India and the duration of stay differs on a case to case basis.

Grant of Citizenship Made Easier for Certain Pakistan Nationals

A proposal has been put forth to simplify the procedures to grant Indian citizenship to minority Hindus from Pakistan[4].  Under the proposal, such Pakistani nationals staying in India on a Long-Term Visa will be permitted to open bank accounts with prior RBI approval, subject to certain conditions, to buy property, obtain a Permanent Account Number (PAN) and Aadhar Number, will be given permission to take up self-employment or for doing business.

The Collectors or District Magistrates of the following 18 districts will be empowered to grant citizenship to such individuals at heavily discounted fees:

  • Raipur in Chhattisgarh;
  • Ahmedabad, Gandhinagar, Rajkot, Kutch and Patan in Gujarat;
  • Bhopal and Indore in Madhya Pradesh;
  • Nagpur, Pune, Mumbai and Thane in Maharashtra;
  • West Delhi and South Delhi in The National Capital Territory;
  • Jodhpur, Jaisalmer and Jaipur in Rajasthan; and
  • Lucknow in Uttar Pradesh

PIOs to OCIs

The Government of India issued a notification dated January 9, 2015 regarding the merger of the Persons of Indian Origin (PIO) and Overseas Citizens of India (OCI) Schemes[5]. It stated that all existing PIO card holders registered as such under the new PIO card scheme of 2002 are expected to apply for an OCI card before December 31, 2016.

The deadline for the conversion of the cards has been extended several times since implementation of the scheme to give more time to PIO card holders to submit their applications for registration as an OCI card holder.  The previous deadline was June 30, 2016. 

Biometrics in London

The High Commission of India in London announced by way of a press release on August 5, 2016[6] that applicants for seven visa categories but not including business or tourist visas are required to register their bio-metric data effective August 19, 2016.

Individuals applying for any of the visas as set out below at the Indian Visa Application Centers in the U.K. will now be required to appear in person and submit bio-metrics – finger print data and facial photograph:

  • Employment Visa;
  • Journalist Visa;
  • Research Visa;
  • Student Visa;
  • Visit Visa (applicable only to Pakistani nationals);
  • Project Visa; and
  • Missionary Visa

It is pertinent to note that applicants under the age of 12 or over the age of 70 are exempt from the new biometric enrollment requirement.

It may thus be noted, that 2016 has seen a growth by 6.8% of foreign arrivals in India due to a series of initiatives taken by the government including the online visa facility which has now been extended to over 100 countries and other visa reforms whose impact is now being felt.

Disclaimer: The contents of this publication are not a comprehensive consideration of the subjects discussed and are designed to provide preliminary, general information.  Readers should not conclusively rely on the information as legal advice and should seek independent counsel before any action is taken with respect to these or other specific issues.

[1] (Accessed on November 20, 2016)

[2] (Accessed on November 21, 2016)

[3] (Accessed on November 21, 2016)

[4] (Accessed on November 20, 2016)

[5] (Accessed on November 20, 2016)

[6]  (Accessed on November 20, 2016)

Evaluating and Managing Environmental Risk in Real Estate and M&A Transactions in the United States

The complex environmental regulatory regime in the United States can raise a variety of legal and financial risks in real estate or corporate acquisitions.  Accordingly, lawyers should understand the nature of potential environmental liabilities for different transactions, the relevant facts, and how to structure environmental due diligence tools to provide clients meaningful advice.

Tailoring Environmental Due Diligence to the Transaction

Environmental due diligence is not a “one-size-fits-all” activity.  The type of transaction, and the client’s objectives, often dictate the appropriate scope of due diligence.

Transactions take a variety of forms, such as the purchase or lease of real property, acquisition of the assets of operating businesses or facilities, stock acquisitions, corporate mergers and divestitures.  In real estate acquisitions, primary environmental due diligence concerns include identifying potential contamination, and either protecting against cleanup liability or evaluating remediation methods.  These transactions usually rely on Phase 1 and 2 environmental site assessments to identify contamination, help establish landowner liability protections, and assess cleanup strategies.  Analyzing other environmental regulatory constraints on site development may also be prudent.

Conversely, acquisitions of operating businesses or facilities, or corporate transactions such as stock deals and mergers, raise additional environmental due diligence concerns.  These include evaluating the target company or facility’s regulatory compliance status, the availability of permits to conduct and grow the business, and capital and operating costs needed to achieve compliance, implement permit conditions, and satisfy other environmental requirements.  For these deals, evaluating regulatory compliance and permitting issues may be equally, if not more, important than contamination concerns.

Superfund Liability and Defenses

In the U.S., fear of liability for contaminated property is largely driven by the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (“CERCLA” or “Superfund”).  CERCLA establishes four categories of parties liable for the release or threat of release of hazardous substances into the environment, including current facility owners or operators, former owners or operators at the time of disposal, those who arrange for hazardous substance disposal at a facility, and those who transport hazardous substances to a facility for disposal.   Superfund liability can be severe, as it is retroactive, strict (i.e., regardless of fault), and joint and several.

Moreover, CERCLA offers only very limited defenses for landowners.  The most useful of these is the bona fide prospective purchaser (“BFPP”) defense.  This provision allows prospective purchasers to acquire facilities that the purchaser knows to be contaminated while avoiding Superfund liability.  To establish the defense, the purchaser must satisfy several conditions.  Pre-acquisition conditions include taking title to the facility after January 11, 2002 and after all disposal occurred; making “all appropriate inquiry” into the former uses and ownership of the facility consistent with good commercial and customary standards; and not being a potentially liable party or affiliated with such a party through certain relationships.  The purchaser must also comply with several post-acquisition requirements, including making legally required notices; taking reasonable steps to stop continuing releases, prevent future releases, and limit exposure; cooperating with persons performing remediation; complying with any land use restrictions or institutional controls; and responding to governmental information requests.  (Tenants may also utilize the BFPP defense in certain situations.)

Although the BFPP defense provides a valuable tool to protect against Superfund liability when obtaining contaminated property, the defense does not protect against potential liability under other federal or state environmental statutes. It is also not a defense to claims under other liability schemes such as tort, occupational safety and health laws, or breach of contract.

All Appropriate Inquiry (“AAI”) – Phase 1 Environmental Site Assessments

While all of the statutory requirements must be satisfied to support the BFPP defense, the primary objective of environmental due diligence in the U.S. involves performing AAI.  In 2005, the U.S. Environmental Protection Agency (“EPA”) published a rule, 40 C.F.R. Part 312, establishing the regulatory requirements for AAI.  In coordination with EPA, the standard-setting organization ASTM International revised its existing standard for Phase 1 environmental site assessments (“ESAs”) to comport with the Rule.  In practice, purchasers seeking to perform AAI do so by following the ASTM Phase 1 standard (currently E1527-13).

Phase 1 ESAs are non-invasive property investigations that seek to identify and document recognized environmental conditions (“RECs”) indicating a release or threat of release of a CERCLA hazardous substance (or petroleum, which is not regulated by CERCLA). Unlike Phase 2 investigations, Phase 1 ESAs do not include sampling and analysis of environmental media.  In addition to establishing one of the CERCLA BFPP defense conditions, a Phase 1 ESA (perhaps combined with Phase 2 testing) may also provide insight into possible common law and toxic tort risks posed by acquiring property, should the investigations identify contamination that could impact residential neighborhoods, potable water sources, or other sensitive receptors.

Most AAI tasks must be undertaken by an “environmental professional” meeting certain qualifications, or someone under his or her direct supervision. Basic Phase 2 elements include interviews with the current site owner, any occupiers likely to handle hazardous substances, state or local government officials, and potentially others; review of historical information sources (e.g., aerial photographs, fire insurance maps, land title records, and building permits) dating back to the earlier of 1940 or the property’s earliest developed use; review of federal, state and local regulatory agency records involving the property and other sites within defined search radii; and visual inspection of the property and of adjoining properties.  In addition, the standard calls for certain information from the user of the Phase 1 (typically the prospective purchaser), such as a review of title and judicial records for environmental cleanup liens and activity and use limitations; any specialized knowledge the user may have of the property and surrounding area; and whether the purchase price reflects any discount for contamination. The environmental professional must document the evaluation in a written report containing, among other things, the professional’s opinion as to whether conditions indicative of a release or threatened release exist, and a list of any data gaps and their significance.

Although Phase 1 ESAs have become extremely commonplace in environmental due diligence, a few important points are worth noting.  First, to satisfy the AAI rule a Phase 1 must be completed no sooner than one year prior to property acquisition, and certain elements must be completed or updated within six months before acquisition.  Also, remember that Phase 1 ESAs are designed to identify potential contamination, and do not evaluate other environmental issues (e.g., the presence of asbestos or lead-based paint in buildings, mold damage, or wetlands and other natural constraints on site development) unless expressly added as “non-scope” items.  In addition, given increasing scientific knowledge and regulatory concern regarding the potential for certain contaminants (such as those associated with petroleum and chlorinated solvent releases) to volatilize and enter occupied structures in vapor form, a 2013 update to the ASTM Phase 1 standard now requires evaluating the vapor intrusion pathway as part of identifying RECs.  Finally, as mentioned above, the BFPP defense requires more than satisfying AAI; the purchaser must meet several post-acquisition conditions as well.

Phase 2 ESAs – Evaluating Contamination and other Due Diligence Concerns

When a Phase 1 ESA identifies one or more RECs at a property, the next step often involves performing invasive “Phase 2” testing to confirm the presence and extent of any contamination.  Information from Phase 2 ESAs can serve several due diligence purposes, including deciding whether to proceed with or terminate the transaction; identifying post-acquisition tasks to satisfy the BFPP “reasonable steps” condition; allocating environmental responsibility through contract provisions such as purchase price adjustments, indemnities, cleanup obligations, and environmental insurance; developing remediation strategies and cost estimates to obtain liability protection through federal or state voluntary “brownfield” cleanup programs; and identifying natural or other constraints to site development.

Given their varying objectives, Phase 2 ESAs, unlike Phase 1 investigations, typically do not follow a single protocol.  A Phase 2 investigation may involve one or more of several elements, such as collecting samples of soil, groundwater, soil gas, indoor air, or other environmental media for laboratory analysis; searching for underground tanks, vaults, and other subsurface structures using geophysical techniques; evaluating the presence and extent of environmental conditions inside structures such as asbestos-containing materials, lead-based paint, mold, and radon; and identifying potential site development constraints such as wetlands, endangered species, and cultural or historic resources.

Phase 1 and 2 ESA Practical Considerations

To protect their interests, both parties in a real estate or corporate transaction should negotiate access provisions governing the performance of Phase 1 and 2 ESAs during due diligence.  These provisions should cover issues including, at a minimum, submission of a work plan for  owner approval; permissible entry times, pre-entry notice requirements, and non-interference with ongoing site operations; restoration of any property damage; compliance with applicable law and proper disposal of any investigation-derived waste; provision of split samples, test results, and reports to the site owner; and insurance and indemnification related to liability arising from the investigations.

Access provisions should also address confidentiality of environmental due diligence results.  Generally, owners require buyers to keep due diligence data and reports confidential, but buyers should seek certain exceptions including the ability to share results with lenders, counsel, and other due diligence team members (who may also be required to keep the results confidential), and to make disclosures if required by law (in which case the owner will want to control the reporting process).

Aside from access and confidentiality issues, parties planning to perform Phase 1 and 2 ESAs should keep a few other points in mind.  First, although Phase 1 and 2 ESAs can be performed concurrently, it is better to use Phase 1 results to develop the Phase 2 scope.  Also, take care when identifying and retaining an environmental consultant for the due diligence team.  Phase 1 and 2 investigations can vary significantly in scope and extent, and therefore potential consultants and firms should be evaluated for the necessary experience and skills appropriate to the type of site and anticipated tasks.  In addition, carefully review and negotiate consultant proposals regarding cost structure, markup of subcontractor and other expenses, anticipated timing for deliverables, and “boilerplate” terms and conditions such as insurance coverages, indemnity provisions, limits on liability, and confidentiality.

Evaluating Regulatory Compliance in Acquiring Ongoing Operations

In addition to assessing potential site contamination and development constraints, acquisition of an active facility or business requires evaluating the target’s compliance status with environmental regulatory requirements. These evaluations typically include issues such as whether the business or facility holds all permits and other approvals necessary to continue operations; whether these authorizations can or will need to be transferred as part of the transaction; and whether the business or facility currently has any significant noncompliance, or a history of noncompliance, with regulatory requirements or permit conditions (as evidenced by notices of violation, penalty assessments, administrative or judicial orders, consent decrees, etc.).

Depending on the type of operation, regulatory programs to evaluate for compliance issues may include, among others, air pollution control, wastewater and stormwater discharges, solid and hazardous waste management, emergency planning and community right-to-know reporting, management of storage tanks, use of pesticides, and maintenance and removal of asbestos-containing building materials.  Information on a business or facility’s compliance status may be found by reviewing facility and agency files, interviewing the target’s environmental health and safety personnel, and searching agency on-line databases.  In addition to identifying regulatory noncompliance issues, the due diligence effort should also attempt to estimate the potential costs of bringing the business or facility back into compliance.

Wrapping Up

Environmental due diligence in real estate and corporate transactions can be a complex and time-consuming task.  To make this process as efficient and productive as possible, tailor the scope of the diligence effort to the type of transaction, the client’s objectives, and the time and resources available to complete the process before closing.  Assembling a qualified and experienced team of technical and legal professionals to lead the diligence effort can help ensure that the client goes into a transaction with eyes wide open to potential environmental pitfalls.