Anadarko shares plunged 9.3 percent in after-hours trading on December 12, 2013, cutting its market value from approximately $42 to $38 billion after a judge ruled money can be recovered from a successor to a polluting company, even after bankruptcy has seemingly cleansed the slate of obligations. The case stems from Kerr-McGee’s spin-off of its chemicals business along with its old environmental liabilities as a new company, Tronox, on March 30, 2006, three months before Anadarko made an offer to purchase Kerr-McGee.
“This is a very interesting and chilling development,” stated Robert L. Moore, Jr., Managing Director of Stout Risius Ross. “It points to the dangers of acquiring the stock in a public company (the Anadarko/Kerr-McGee deal), transactions in which there are typically few representations and warranties or remedies for the acquirer. In these situations, such elements must be vetted and quantified by the acquirer.”
Contingent assets and liabilities exist in many forms and generally maintain significantly different risks, payout streams, and timing requirements. As a result, the unique facts and circumstances of each particular situation warrant consideration by the parties in any transaction. What we have seen from the Tronox situation is that these liabilities can follow a successor, and as a result must be considered by executives and advisors during corporate restructures and spin-offs. Due diligence of recent transactions is critical whether it is an internal restructuring of asset ownership or an external transaction with a third party.
As the judge moves this case into the damages stage, and the appellate process egins, it is worth exploring questions for executives and business advisors to consider:
How do you value environmental or other contingent liabilities when evaluating a transaction? Consideration of contingent assets and liabilities represents one of the more unique and difficult issues encountered by companies and their advisors. Nevertheless, such assets and liabilities can be valued using multiple valuation methodologies, including Discounted Cash Flow, Binomial Option Pricing Method, and the Monte Carlo Method. In addition, consideration should be given to insurance coverage and anticipated costs.
How should contingent future liabilities be considered in your analysis of adequacy of capital? To address these risks, companies and their directors often choose to engage a financial advisor to prepare a solvency opinion, which is an analysis of whether a company will remain solvent in consideration of, and taking into account, the amount of debt in the new entity. Most solvency opinions apply three financial tests to assess a subject company’s solvency: 1) the Balance Sheet Test, 2) the Cash Flow Test, and 3) the Reasonable Capital Test.
When acquiring another entity how do you perform due diligence on transactions that have been recently completed that would transfer assets, environmental liability, or other contingencies? Every recent transaction, regardless of its apparent size, should be carefully evaluated to determine what was actually transferred.
View the complete article in the upcoming Spring 2014 SRR Journal where we explore each of these questions in detail.