Environmental Due Diligence in Real Estate Transactions Blog Series: Part III – Environmental Site Assessments and Compliance Audits
Posted By James J. Periconi, Esq. on May 7, 2012
So now you’ve selected your property and have a proper purchase and sale agreement in place; what do you do next?
A. Protecting Yourself from Potential Liability
Under CERCLA (the Comprehensive Environmental Response, Compensation, and Liability Act) there is a broad range of parties with a connection to the site that could be responsible to clean up the contamination. These parties are known as “potentially responsible parties” (“PRP”s) and include:
- present owners or operators;
- past owners or operators of the site at the time of disposal of the hazardous substances;
- any transporters of such hazardous substances; or
- any party who arranged for disposal at the site, and any transporters that carried hazardous waste to the site.
This is why environmental due diligence is critical: if done properly, you can protect yourself from liability under CERCLA just because you are the present owner of a contaminated property.
Defense vs. Exemption from Liability for Current Owners of Contaminated Properties
There are only three defenses to liability: act of God; act of war; and the “third party” defense, which is denied to a person having a contractual or agency relationship with the PRP. The third party defense can apply to PRPs who, at the time they acquired the contaminated property, did not know and had no reason to know that the property was contaminated.
To establish that the PRP had no reason to know, at the time of the acquisition of the contaminated property, he must undertake “all appropriate inquiry” into the previous ownership and uses of the property “consistent with good commercial or customary practice” in an effort to minimize liability. The all appropriate inquiry or “AAI” standard recognizes the revised ASTM standard, ASTME 1527-05 (i.e., the 2005 standard), as an acceptable guidance document for generally satisfying AAI inquiries.
There is also one exemption from liability – not merely a defense – “bona fide prospective purchasers” (or “BFPP”) who have undertaken AAI into past uses of a property and find that contamination is present. Notwithstanding the strict liability of current owners and operators under CERCLA, this BFPP exemption provides:
A bona fide prospective purchaser whose potential liability for a release…is based solely on the purchaser’s being considered to be an owner or operator of a facility shall not be liable as long as the bona fide prospective purchaser does not impede the performance of a response action or natural resource restoration.
Clearly, neither the third party defense nor the BFPP exemption applies if the current owner actually caused the contamination of the property.
B. Practical Aspects of Deciding What Kind of Environmental Site Assessment You Need
Before undertaking an environmental site assessment (“ESA”), it is crucial to determine the right kind of information you need to develop about the property or facility for, among other things, showing the property conditions at the time of sale. An accurate picture of property conditions, in addition to overcoming the fear and insecurity that comes with facing unknown and therefore frightening problems, also facilitates the contract negotiations, because parties are less likely to posture about theoretical protections or guarantees they think they need, and instead focus on the most likely concerns.
1. Phase I Environmental Site Assessment:
A proper Phase I ESA – that is, one that follows the applicable ASTM standards – will provide you with satisfaction of the AAI standards by a prospective purchaser in order to qualify for the BFPP exemption to liability under CERCLA.
See here for more on Phase I ESAs.
A conservative reading of the BFPP requirement suggests that a Phase I ESA, to suffice for BFPP protection, also requires a lien search that is typically additional to what has traditionally been required in Phase I ESAs.
2. Phase II Environmental Site Assessment:
While a Phase II ESA is not technically required to gain protections under the BFPP exemption to CERCLA liability, it is a critical step for any prospective purchaser of contaminated property.
See here for more on Phase II ESAs.
Note that the Phase II ESA should never be performed before first undertaking a Phase I ESA because the purpose is to further investigate the potential areas of environmental concern (or “recognized environmental conditions”) identified in the Phase I ESA. Without having completed a proper Phase I, the Phase II will lack sufficient direction, or, more typically perhaps, it may focus on only a single problem that “everybody knows” is there, missing the other issues that only a Phase I ESA will uncover; the persons undertaking the Phase II ESA may well fail to investigate problems requiring an investigation, and, therefore, the resulting Phase II ESA may not be a reliable document.
C. Compliance Audits
A compliance audit is required only for properties that contain operating facilities that are known to have environmental permits. It is important because it gives you an understanding of the environmental regulatory compliance (or non-compliance) of operations on the property. It requires an in-depth examination of facility operations and detailed review of environmental (and related) permits, monitoring records and other documents not obtained and/or not reviewed thoroughly on the Phase I ESA process, except for what may perhaps be found, as a past violation, on a data base report. A compliance audit review must include an examination of all air emissions, discharges into all water bodies, waste management and cleanup, Community Right-to-Know compliance, Toxic Substances Control Act issues, asbestos, lead, radioactive materials, and worker safety. The compliance audit report should also detail how well, in the past, significant facility operational and environmental permit deficiencies have been remedied.
When the seller’s facility on the property will continue operation after the buyer closes, the parties may chose to transfer any permits from the seller to the buyer. Issues arise, however, if there are previously unresolved matters, such as consent orders with continuing obligations; for example, quarterly well monitoring, which the seller has recently “forgotten” to do. The federal or state environmental agency will likely take the position that either party can fulfill any agency requirements, as long as the terms of the consent decree are met. The buyer and seller will have to determine in the contract for sale what party must fulfill prior unresolved permit obligations. (If the buyer is likely to be subject to successor liability requirements by virtue of the nature of the deal, those liabilities may pass by operation of law.) In counseling buyers, we recommend that they attempt to resolve the issues, pre-closing, first, to determine how intractable the problems may be, but also for the better reason that one or two meetings with relevant government agencies can help determine whether the facility has such a bad reputation with regulatory officials that you may want to rethink the decision to purchase.
D. Access and Confidentiality Agreements
A “site access agreement” will become necessary if the prospective buyer wants to undertake either a Phase II ESA, with its invasive work, and even more so, if the parties agree that the buyer may undertake pre-closing remediation. It is also necessary if the prospective buyer wants to do a compliance audit.
There are several issues to be mindful of if your client is asked for access:
- Do not allow invasive work on your client’s property unless there is a firm basis in a Phase I ESA;
- Insist on minimal disruption to your client’s (or his tenants’) operations: e.g., require flush mounted wells where periodic monitoring of groundwater is required, rather than wells that stick up a few inches or feet above the ground
- Make sure there is adequate insurance, and the right parties are named;
- Require robust indemnifications by party seeking access, to back up assumption of risk; and
- Require clear property repair and site restoration provisions.
A confidentiality agreement may be necessary (1) before disclosing environmental reports to the prospective buyer, for example, to prevent further dissemination or where trade secrets are involved; and (2) before permitting a compliance audit to be performed. Additionally, the seller may want a confidentiality agreement in place with the environmental consultant.
Some issues to consider in this situation are:
- Non-disclosure except with client consent;
- Exclusions from coverage;
- Degree of resistance to disclosure; and
- Scope of non-disclosure.
Please contact us if you have any questions about environmental due diligence in real estate transactions, if you’re seeking to obtain the “bona fide prospective purchaser” exemption from liability under CERCLA, or if we can help you through the environmental site assessments, compliance audits, or access agreements associated with the purchase or sale of a contaminated property.
This blog series is based on an article written by James J. Periconi and published in the Winter 2008 Bloomberg Corporate News Journal. Mr. Periconi also discusses the details and the nuances of environmental due diligence of commercial real estate transactions in his bi-monthly continuing legal education course.