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With the onslaught of new regulations in the last few years, energy companies’ management of environmental, health and safety compliance has become increasingly challenging. But in Texas there’s an indispensable tool for that: the Texas Environmental, Health, and Safety Audit Privilege Act and, in particular, a 2013 amendment. The amendment provides a risk management method for helping owners and operators address gaps in compliance due to, for example, neglected distressed assets, turnover in personnel, unfamiliarity with environmental regulations, or mere oversight.

The Texas Environmental, Health, and Safety Audit Privilege Act, or Audit Act, has been in place since 1995. Here’s the gist: It encourages voluntary compliance with environmental and occupational health and safety (EHS) laws by providing certain benefits, such as immunity from civil and administrative penalties, to owners and operators who conduct a compliance audit. Certain requirements for eligibility must be met to obtain these benefits—for example, prior notice of the audit to the appropriate regulatory agency, voluntary disclosure of the EHS violations identified during the audit, and diligent correction of the violations identified. The Audit Act also provides a confidentiality privilege for audit reports, whether or not prior notice of the audit is given or voluntary disclosures are made.

The 2013 amendment to the Audit Act allowed for a new owner who prudently conducted due diligence, discovered EHS violations during due diligence prior to ownership, and committed to fix those issues upon acquiring ownership to also take advantage of the Audit Act’s benefits. This amendment did so primarily by eliminating the law’s prior notice requirements for new owners.

Before the 2013 new owner amendment, energy companies had used the Audit Act for operations that they currently owned or operated, but couldn’t use it to mitigate the risk of enforcement penalties when they acquired new assets because the act only afforded protection to present owners and operators. These companies were identifying EHS issues such as lack of air permitting and emission control equipment, unreclaimed drilling pits, and noncompliance with requirements for sites handling sour gas during their due diligence activities prior to closing. However, while they had every intention of correcting these issues post-closing, they had limited tools outside of the liability allocation measures in the transaction agreement to address the risk of enforcement penalties. In the meantime, the out-of-compliance assets remained at risk for agency enforcement while the new owner worked to fix issues that a prior owner or operator created. The 2013 new owner amendment to the 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.

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 seems to only now be fully demonstrating its value. Buyers are raising the prospect of its use post-closing, and sellers are insisting on buyers’ use of it to mitigate any potential environmental liability that sellers 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, so it makes sense for both sides of a transaction.

Briefly, here are the mechanics of the Audit Act’s new owner provisions:

  • 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.
  • 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.
  • Disclosed violations must be diligently corrected—typically on a schedule proposed by the new owner that’s consistent with the timeframes allowed by the respective agency for correcting the violations.
  • 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 act have been met, issue a “no further action” determination.

Environmental regulations are often complex. The combination of this complexity with the onslaught of new environmental regulations for the oil and gas industry has made managing EHS compliance challenging. Whether an owner or operator has concerns about the compliance of current operations or has uncovered compliance issues during the course of due diligence for soon-to-be-acquired operations, the Audit Act and its new owner provisions give owners and operators a platform for addressing those concerns by minimizing the risk of enforcement penalties while giving owners and operators time to evaluate and correct those issues.

Ashley T.K. Phillips is a partner in the Austin office of Thompson & Knight and a member of the firm’s government and regulatory practice group, advising on environmental risk and compliance counseling for operations and transactions. The 2013 new owner amendment to the Texas Environmental, Health, and Safety Audit Privilege Act became law on Sept. 1, 2013, as the result of the lobbying efforts of Phillips and her colleagues.