By Alex Adamis*
Recently, corporate spin-offs, transactions in which a parent company separates a business unit into a new entity (“SpinCo”), have proliferated as a means to increase shareholder value. Spin-offs generally enhance value by focusing investors’ attention on higher-growing divisions, while allowing the SpinCo to adopt a tailored, independent strategy.[i] However, recent separations raise concerns that managers can use value generation as pretext to extricate parent companies from legacy liabilities. Most concerning is a trend, exemplified by E.I. du Pont de Nemours Co. (DuPont)’s 2015 spin-off of its Performance Chemicals unit, in which companies simply transfer large environmental liabilities onto a less financially stable SpinCo. This form of liability transfer reduces the resources available for important public objectives, including the cleanup of contaminated industrial sites and compensation for victims of corporate environmental degradation. The State of Delaware, the incorporation jurisdiction for many of America’s largest industrial companies,[ii] must act swiftly to correct this gaping loophole.
The phrase “environmental liabilities” is a catchall for the estimation of future corporate costs related to violations of and compliance with environmental laws.[iii] Liabilities may arise from multiple procedural mechanisms, including government enforcement actions and private causes of action.[iv] Generally, major industrial company liabilities fit into three categories: compliance, remediation, and compensation.[v] Compliance largely relates to business practice changes imposed by environmental laws, such as hiring regulatory oversight personnel or making investments in environmentally-friendly manufacturing processes.[vi] Remediation involves corrective measures imposed to alleviate damage caused by industrial operations.[vii] The most notable of these programs is so-called “Superfund” liability under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA).[viii] Finally, industrial companies frequently settle state enforcement actions or tort lawsuits initiated to provide relief for environmental degradation victims.[ix] The federal government may also fine companies or otherwise compensate victims under schemes such as CERCLA or the Clean Water Act.[x]
Estimating the present value of future liabilities is a difficult actuarial exercise.[xi] Significant uncertainty surrounds the actions future administrations and private litigants may take to assert their respective legal rights.[xii] Even if these actors choose to take action, corporate defendants still may challenge the plaintiffs’ legal and factual claims. Further, if defendants lose or settle these actions, outlays are unlikely to be lump-sum and may occur over long time-periods.[xiii]
In early 2013, DuPont’s Board of Directors convened with advisors to discuss alternatives to increase shareholder value.[xiv] These discussions centered on ways to divest the company’s underperforming Performance Chemicals (“PC”) unit.[xv] PC’s products included pigment chemical titanium dioxide (“TiO2”), as well as the historical DuPont brand Teflon. The unit’s earnings were volatile compared to DuPont’s other businesses, given the cyclicality of the global TiO2 market.[xvi] The Board agreed that selling PC could improve the company’s market valuation.[xvii]
During discussions over PC’s fate, the 2012 sale of DuPont Performance Coatings to private equity firm The Carlyle Group loomed large.[xviii] In that transaction, Carlyle refused to pay full value for Performance Coatings and assume benzene-related compensation liabilities.[xix] DuPont agreed to Carlyle’s terms and kept the liabilities to complete the sale.[xx] PC also had significant environmental liabilities.[xxi] These largely related to the unit’s exposure to PFAS, as well as some others.[xxii] The open-ended liabilities, combined with the cyclicality of the underlying business, made the unit unattractive to prospective buyers.[xxiii]
DuPont’s advisors devised a clever tactic: separate PC into a new company and distribute ownership to shareholders. This step was attractive for two reasons: the SpinCo could assume large environmental liabilities and raise ample debt financing to sustain aggressive shareholder remuneration. Given these advantages, DuPont moved swiftly to consummate a transaction by transferring PC’s assets to a new entity, The Chemours Company, drafting a Separation Agreement, and borrowing nearly $4 billion to finance a dividend to the parent.[xxiv] The Agreement’s environmental provision called for Chemours to assume all liabilities related to its industrial sites.[xxv] However, DuPont also required Chemours to indemnify its former parent for liabilities related to businesses it did not transfer.[xxvi] For example, Chemours is responsible for the benzene liabilities Carlyle did not assume in the Performance Coatings transaction.[xxvii]
By early 2014, Chemours successfully became an independent company. In August 2019, Chemours sued DuPont’s legal successors[xxviii] in Delaware state court challenging the spin-off’s legitimacy and seeking modification of the Separation Agreement’s environmental provisions.[xxix] Under Delaware law, a spin-off must be financially viable to avoid challenges of fraudulent conveyance.[xxx] Chemours’ claims largely rest on the one-sided nature of the spin-off process, whereby DuPont unilaterally imposed untenable terms on the company.[xxxi] In addition, the process by which DuPont certified Chemours’ post-spin viability relied on a capped estimate of $1.42 billion (the “High End Realistic Maximum Exposure”).[xxxii] These estimates proved incorrect, as state litigation outcomes point to dramatically higher compensation numbers.[xxxiii] In its motion to dismiss, DuPont’s successor relied on the Separation Agreement’s arbitration provision to challenge the court’s jurisdiction and did not seriously challenge Chemours’ substantive claims.[xxxiv]
Irrespective of the pending litigation’s outcome, environmental liability-focused spin-offs present major challenges to financing environmental cleanup efforts. Combined with an already stretched balance sheet, Chemours’ open-ended liabilities and volatile business could be a toxic cocktail that bankrupts the company and leaves environmental concerns unaccounted for. The 2005 spin-off of TiO2 manufacturer Tronox from energy giant Kerr-McGee provides a roadmap for where Chemours may be headed. In that transaction, Kerr-McGee, seeking to become a more attractive acquisition target, saddled Tronox with environmental liabilities from the company’s core oil and gas unit alongside those from TiO2 production.[xxxv] By 2009, Tronox declared bankruptcy, citing huge debt and liability burdens.[xxxvi] Indeed, by the time of Tronox’s bankruptcy filing, the company could only afford $90 million of annual environmental expenditures, a fraction of the resources made available by the pre-spin Kerr-McGee.[xxxvii] Discovery in Tronox’s subsequent litigation with Kerr-McGee’s successor Anadarko Petroleum also revealed a fundamental flaw in spin-off procedures. In an email to advisors, Kerr-McGee’s then-associate general counsel disclosed that he was uncomfortable with the conflicts between the company’s moves and the interests of future Tronox shareholders.[xxxviii]
Any solution must address both specific environmental provisions and the generalized conflicts inherent in one-sided spin-off processes. First, Delaware law should require Separation Agreements to cap environmental liability transfers to the estimates used to certify a SpinCo’s viability. This would allow the SpinCo to budget for and finance future environmental payouts. Second, prior to separation, a prospective SpinCo must retain its own advisors that represent future shareholder interests. Preferably, the SpinCo’s legal counsel would have familiarity with environmental matters to vigorously scrutinize liability transfers.
*Alex Adamis is a Junior Editor on MJEAL. They can be reached via email at firstname.lastname@example.org.
[i] Andrew Campbell, When a Spinoff Makes Strategic Sense, Harv. Bus. Rev., Aug. 2012, at 5, 6.
[ii] Leslie Wayne, How Delaware Thrives as a Tax Haven, The New York Times (Jul. 1, 2012), https://www.nytimes.com/2012/07/01/business/how-delaware-thrives-as-a-corporate-tax-haven.html.
[iii] U.S. Environmental Protection Agency, Valuing Potential Environmental Liabilities for Managerial Decision-Making (1996), at 117.
[v] Id. at 118.
[ix] Id. at 119.
[xi] Id. at 123.
[xii] Id. at 124, 125.
[xiv] Verified First Am. Compl. at 9, Chemours Co. v. DowDuPont Inc. et. al., (Del. Ch. 2019) (No. 2019-0351-SG).
[xvi] See Joseph Change, TiO2 producers seek to break the cycle, ICIS, Feb. 22, 2019, https://www.icis.com/explore/resources/news/2019/02/22/10322681/tio2-producers-seek-to-break-the-cycle.
[xvii] Chemours Co., supra note 14 at 10.
[xix] Id. at 19.
[xxiii] Id. at 9.
[xxiv] Id. at 10, 11.
[xxvii] Id. at 19.
[xxviii] After the Chemours transaction, DuPont merged with the Dow Chemical Company to form DowDuPont, Inc. DowDuPont subsequently split into three new companies: Corteva Inc., Dow Inc., and DuPont de Nemours Inc.
[xxix] Chemours Co., supra note 14.
[xxx] See Gibson, Dunn & Crutcher LLP, Spinning Out of Control: Potential Pitfalls and Liabilities in Spin-Off Transactions, (Stephen Glover et. al. eds., 2017).
[xxxi] Chemours Co.., supra note 14.
[xxxii] Id. at 23.; Houlihan Lokey Inc., an investment bank retained by DuPont, constructed a financial model that assumed Chemours would only pay the High-End Realistic Maximum Exposure. Dramatically higher costs may have materially altered the model’s output and convinced Houlihan Lokey that Chemours was not viable post-spin.
[xxxiii] Id. at 37.
[xxxiv] Opening Br. in Support of Defendants’ Mot. to Dismiss the Verified First Am. Compl. for Lack of Subject Matter Jurisdiction, Chemours Co. v. DowDuPont Inc., et. al., (Del. Ch. 2019) (No. 2019-0351-SG).
[xxxv] In re Tronox Inc., 503 B.R. 239 (Bkrtcy.S.D.N.Y. 2013).
[xxxvii] Id. at 261.
[xxxviii] Id. at 254, 257.; J.P. Morgan Partners, a prospective Tronox buyer, referred to the spin-off transaction terms as “criminal.”