From PLI’s Course Handbook

Eleventh Annual Commercial Real Estate Institute

#18165

27

Managing environmental risk

Jacqueline M. Vidmar

Seyfarth Shaw LLP

An Introduction to Environmental Issues in the Real Estate Context

Environmental due diligence in real estate transactions is important because environmental liabilities can be costly. Buyers need to assess potential costs that may be associated with contamination, and developers need to be sure contamination will not stand in the way of their future plans.

In any potential acquisition, the goals of environmental due diligence are no different than due diligence for other risks: identify the risks, quantify the risks, and allocate the known and unknown liabilities. To identify and quantify environmental risks, a purchaser will need sufficient information concerning site conditions to assess risk and estimate potential cleanup costs. In addition, a purchaser should tailor its inquiry to take advantage of available statutory defenses.

Environmental Liability

In the commercial real estate context, environmental liability is a legal obligation caused by the presence, release or threatened release of hazardous substances that adversely affect the environment and/or human health. This covers soil and contamination, and hazardous substances located in and on the improvements, such as asbestos and lead-based paint. It also covers regulatory obligations, such as having the necessary permits, and meeting underground storage tank requirements for leak detection.

While environmental liability can be based on common law causes of action, it is liability arising under state and federal environmental statutes that presents the greatest risks. The best-known and widely-used environmental statute is the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, better known as “Superfund” or “CERCLA” which was enacted in the wake of the discovery of toxic waste dumps such as Love Canal and Times Beach in the 1970s. Superfund allows the United States Environmental Protection Agency (EPA) to clean up such sites and to compel responsible parties to perform cleanups or reimburse the government for EPA-lead cleanups. It also allows private parties to sue potentially responsible parties for costs incurred in remdiating a site.

CERCLA is an onerous “polluter pays” law; liability is joint and several and strict, regardless of fault. Under CERCLA, there are four classes of parties, termed "potential responsible parties," who may be liable for contamination at a site: (1) the current owner or operator of a site; (2) the owner or operator of a site at the time that disposal of a hazardous substance, pollutant or contaminant occurred; (3) a person who arranged for the disposal of a hazardous substance, pollutant or contaminant at a site; and (4) a person who transported a hazardous substance, pollutant or contaminant to a site.

The bona fide prospective purchaser (BFPP) provision in the 2002 Brownfields Amendments dramatically changed the Superfund liability landscape for prospective purchasers of property. Persons may now acquire property knowing, or having reason to know, of contamination on the property if they: (1) acquire property after January 11, 2002; (2) meet the threshold criteria and ongoing obligations outlined below; and (3) do not impede the performance of a response action or natural resource restoration. To qualify as a BFPP, a landowner must meet certain criteria, which are described in the "Interim Guidance Regarding Criteria Landowners Must Meet in Order to Qualify for Bona Fide Prospective Purchasers, Contiguous Property Owner, or Innocent Landowner Limitations on CERCLA Liability.” (A similar defense for contiguous property owners is available). To receive the liability protection under Superfund, a BFPP must perform an "all appropriate inquiry" prior to acquiring the property, and demonstrate "no affiliation" with a liable party. Inquiry must be made in accordance with commercial and customary practices.”

A BFPP must also satisfy the following obligations: (1) compliance with land use restrictions and not impeding the effectiveness or integrity of institutional controls; (2) taking “reasonable steps” with respect to hazardous substances affecting a landowner’s property; (3) providing cooperation, assistance and access to governmental agencies; (4) complying with information requests and administrative subpoenas; and (5) providing legally required notices.

EPA’s regulations provide that an “all appropriate inquiry” must include:

(1) The results of an inquiry by an environmental professional.

(2) Interviews with past and present owners, operators, and occupants of the facility for the purpose of gathering information regarding the potential for contamination at the facility.

(3) Reviews of historical sources, such as chain of title documents, aerial photographs, building department records, and land use records, to determine previous uses and occupancies of the real property since the property was first developed.

(4) Searches for recorded environmental cleanup liens against the facility that are filed under Federal, State, or local law.

(5) Reviews of Federal, State, and local government records, waste disposal records, underground storage tank records, and hazardous waste handling, generation, treatment, disposal, and spill records, concerning contamination at or near the facility.

(6) Visual inspections of the facility and of adjoining properties.

(7) Specialized knowledge or experience on the part of the defendant.

(8) The relationship of the purchase price to the value of the property, if the property was not contaminated.

(9) Commonly known or reasonably ascertainable information about the property.

(10) The degree of obviousness of the presence or likely presence of contamination at the property, and the ability to detect the contamination by appropriate investigation.

EPA now recognizes both ASTM International's E1527-05 "Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process" and ASTM E2247-08 "Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process for Forestland and Rural Property" as compliant with the All Appropriate Inquiries regulation.

Structuring the Deal

Environmental liabilities are different from other types of liabilities and require special attention and special contract terms. Parties should not assume general contract terms, like “as is” clauses (discussed below) effectively deal with potential environmental risks and claims.

Each transaction is different, so it is best to tailor the terms to the facts of each deal. Even before an offer is given on a particular piece of real estate, a potential purchaser should make preliminary inquiries to identify environmental liabilities. What disclosures has the seller made? In offering memorandum? In other marketing materials? You should consider follow-up questions at this stage. Take the sellers’ assessments or assertions (often offered without warranty) with healthy skepticism, particularly since these are often made with incomplete or outdated information.

Drafting Pointer: When defining the term “environmental law,” the agreement should specify whether it covers existing environmental requirements, or requirements that may be in effect in the future. When defining “hazardous substances,” consider a general, all-encompassing definition that includes substances that “may pose a risk to human health or the environment” without regard to whether the substances are regulated by law.

Purchasers and developers should decide from the beginning whether they have an adequate comfort level with the known environmental issues with the property, given the significant environmental costs associated with additional due diligence to discover the “unknown” risks. Know upfront what your lender’s requirements are regarding environmental due diligence. Some lenders have approved environmental engineering consultant’s lists; others have minimum level of due diligence requirements.

At the offer or letter of intent stage, the purchaser should condition its obligation to close on the completion of environmental due diligence, which diligence is satisfactory, based on the sole discretion of the buyer, or alternatively, where there is no material issue uncovered. To carry out due diligence, purchasers will need access to the property so an access agreement is needed. Seller must also agree to cooperate by providing available documentation and related business operations. Interviews will be needed.

In structuring the deal, keep in mind that you may need the right of access to perform testing. Your agreement should spell out what the rights of the parties are in the event the due diligence uncover environmental risks. In cases of “material” risks, the potential buyer should be able to walk away or receive a purchase price reduction. In some cases, the seller may wish to have the option of addressing any risk (including remediation). A provision covering these might read:

Environmental Investigation. Purchaser acknowledges receipt of a copy of a Phase I Environmental Site Assessment Report with respect to the Premises [describe] dated ______(hereinafter, the “Phase I Report”), such copy Seller represents to be a complete and accurate copy of the most current environmental report prepared with respect to the Premises in Seller’s possession. Purchaser desires to undertake additional environmental investigation in areas identified as recognized environmental conditions in the Phase I Report as well as other areas at or near the Premises (hereinafter, the “Work”). Purchaser has engaged ______(hereinafter, the “Phase II Contractor”) to conduct the Work. The Phase II Contractor has prepared a Scope of Work dated _____, incorporated herein by reference, to perform and prepare a Phase II Environmental Inspection and Report for the Premises (hereinafter, the “Phase II Inspection and Report”). Seller and Purchaser shall equally share the cost of the Phase II Inspection and Report performed and prepared by the Phase II Contractor. In addition to reimbursing the Purchaser for half of the cost the Purchaser actually incurs with respect to the Phase II Inspection and Report, Seller agrees to provide the Phase II Contractor with access to the Premises during reasonable hours to perform the work specified in the Scope of Work provided the Phase II Contractor provides Seller with reasonable advance notice prior to entering the Premises. Purchaser agrees to require the Phase II Contractor to waive all rights to assert any lien or claim against Seller or the Premises arising out of the Work, to name Seller as an additional insured on its applicable insurance and to provide Seller with reasonable evidence of insurance prior to beginning the Work. Purchaser also agrees that all Work undertaken by the Phase II Contractor on the Premises shall be (a) commenced, prosecuted and completed in a professional manner and in compliance with all applicable legal and regulatory requirements, (b) undertaken so that no threat to the safety or health of any person or the environment occurs, (c) implemented so as to cause no damage to the Premises not inherent in the nature of the Work, (d) performed expeditiously and so as to minimize interference with or disruption of Seller’s business on and use of the Premises, and (e) consistent with the Scope of Work dated _____. All information and materials resulting from or discovered pursuant to the Work, including the Phase II Report, shall be considered confidential and, except as may be required by law, shall not be disclosed to or discussed with any third party, including any governmental authority, without the prior written consent of each party. All sampling results from the Work performed and the Phase II Report shall be addressed to both Seller and Purchaser, and copies thereof shall be delivered to each party at the same time. If Purchaser, in its absolute discretion, is dissatisfied with the Premises based on the Phase II Inspection and Report, then Purchaser may terminate this Contract by giving written notice to Seller and Escrowee of such termination at any time within ninety (90) days following the date of this contract.

Environmental representations, warranties and indemnities

Typically, a seller is expected to provide the purchaser with a number of warranties and representations relating to the environmental history or condition of the property. The warranties and representations should focus on current conditions and operations, as well as past conditions and operations, that could reasonably lead to environmental liabilities, including the following:

(1) The presence or releases of hazardous substances or petroleum products on or near the property;

(2) The generation, storage, treatment, handling and disposal of hazardous waste at the property;

(3) Existence and condition of underground storage tanks, PCB transformers, lead-based paint or asbestos containing materials;

(4) Compliance with all applicable environmental laws, including possessing any necessary permits;

(5) Notices from any third-party regarding liability under the environmental laws;

(6) Liens imposed by any governmental agency for environmental costs incurred;

(7) Impacts from off-site sources; and

(8) Past environmental compliance.

Environmental warranties and representations will often provide for schedules listing specific exemptions to the warranties and representations. The seller sometimes wants to list environmental documents as exceptions, which can create ambiguities, particularly when a document (e.g., a Phase I report) mentions a potential issue, but does not conclude that the issue poses an environmental risk. A seller may argue later that the issue was “disclosed.” A buyer may well be served by insisting that the representation and warranty language read, “Except as specifically indentified and quantified in [the Report]…. Better still, a purchaser should resist general language in the environmental schedule, and instead ask for a specific description of issues that will serve as the exceptions to seller’s warranties and representations.

It is important to keep in mind when drafting the environmental warranties and representations that there is a distinction between being “in compliance with laws” and the existence of contamination. Not all contamination is a violation of law. Property can be “in compliance” and still be seriously contaminated.

Note too that courts have uniformly found that that an “as-is” clause does not place environmental risks on the buyer of property. While effectively precluding breach of warranty claims, it does not preclude Superfund or other statutory claims.

Drafting Pointer: The seller may seek to limit its representations to a “materiality” standard, on the basis that perfect compliance with environmental laws is not possible. The seller may also attempt to limit the warranties and representations to its “best knowledge” or to the knowledge of certain specified individuals. Care should be taken when negotiating these limitations, especially their impact on the indemnity rights of the purchaser.

An important negotiation point between buyer and seller is whether, and what kind, of environmental indemnifications will be part of the agreement. Traditional ways of grouping environmental risks include: (1) pre and post-closing liabilities; (2) known and unknown liabilities; and (3) off-site and on-site liabilities. An environmental indemnity can run from seller to buyer, buyer to seller, or both ways, as environmental risks are assessed, valued and allocated. The indemnities should be drafted as specifically as possible, and cover any applicable penalties and cost of defense. The indemnities may be limited as to time, monetary amount (including a cap and deductible) and kind of claim, e.g., third party claims.