Reducing Risk with Environmental Due Diligence

by Karen McCurdy

What is environmental due diligence and why would someone spend time and mon-

ey to do it? Broadly, environmental due diligence is the process of assessing commercial real estate to identify possible risk of environmental contamination, either past or potential. This is important to a lender for several reasons. Environmental liabilities can decrease a property’s collateral value in a real estate loan. A borrower’s ability to repay a loan can be impacted by unforeseen costs of cleaning up contamination or complying with environmental regulations. And, if a property is foreclosed upon, the lender may find itself holding title to a contaminated property and the responsibilities that go with it.

Numerous federal, state and local environmental laws affect commercial real estate. The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), also commonly referred to as Superfund, established liability provisions that drive the need for environmental due diligence. The Resource Conservation and Recovery Act (RCRA), the Superfund Amendments and Reauthorization Act (SARA), and the Small Business Liability Relief and Brownfields Revitalization Act each provide additional complexity and considerations.

The United States Environmental Protection Agency established the Standards and Practices for All Appropriate Inquiries (AAI Rule), which provides the specific regulatory requirements for conducting “all appropriate inquiries” for property acquisitions and qualifying for landowner liability protections under CERCLA. This is an important risk reduction tool. Without liability protection, landowners can be liable for the costs associated with environmental contamination and site remediation regardless of whether they were responsible for the contamination. Lenders are shielded from these potential substantial costs as long as they are careful to properly manage their activities and relationship to property management. This requires attention, especially when taking control of a foreclosed property. Limiting liability under CERCLA and other laws is the strongest driver of environmental due diligence efforts.

Many people who work with commercial real estate transactions are familiar with the Phase I Environmental Site Assessment (Phase I ESA), arguably the most recognized form of environmental due diligence. By conducting a Phase I ESA, potential purchasers can satisfy the requirements for “all appropriate inquiries” and benefit from landowner liability protection under CERCLA law. Phase I ESAs are conducted in accordance with ASTM Standard E1527-13 or, less commonly, per ASTM Standard E2247-16 for Forestland or

Rural Property. Proper timing of the inquiry is crucial. A Phase I ESA is only valid for 180 days and must be completed in advance of transfer of title.

A Phase I ESA seeks to review the comprehensive use of a property going back to its initial development or to 1940, whichever is earlier. This review attempts to determine whether there are, or ever have been, any possible releases or threat of releases of hazardous substances or petroleum products on the property. The primary goal of a Phase I ESA is to assess a piece of commercial property to determine the presence of any “recognized environmental conditions.” A recognized environmental condition (REC) is defined as “the presence or likely presence of any hazardous substances or petroleum products in, on, or at a property: (1) due to any release to the environment; (2) under conditions that are indicative of a release to the environment; or (3) under conditions that pose a material threat of a future release to the environment.” Finding RECs does not mean a property is contaminated, but it does mean there are potential environmental issues to evaluate as risks.

A good Phase I ESA will go a long way toward providing valuable information on a piece of property. It will provide CERCLA landowner liability protection, which may be enough for one purchaser but not for another, depending upon the individual’s needs. It is important to understand the benefit of conducting a Phase I ESA, but it is equally important to understand what a Phase I does not provide. A Phase I ESA includes a visual inspection of the property, interviews with property owners, and a records review, but it does not include testing of soils or any other materials found at the site. In addition, a Phase I ESA only addresses hazardous substances and petroleum products. Other potentially important environmental considerations are not included in the standard scope of a Phase I ESA. For example, asbestos-containing building materials, lead-based paints, operational environmental regulatory compliance, mold, radon, endangered species, and wetlands are out-of-scope for Phase I ESAs.

A Phase I ESA will satisfy environmental due diligence needs in many cases, but it is wise to consider in advance what the effort seeks to achieve. If less in-depth analyses are appropriate for a particular property, the Transaction Screen (ASTM E1528-14) and/ or the Records Search with Risk Assessment (SBA SOP 50 10 6) are available. These desktop review tools may provide adequate information to support a transaction moving forward. However, they do not satisfy the EPA’s AAI Rule and, therefore, do not enjoy the liability protections afforded by conducting the Phase I ESA.

Likewise, a Phase I ESA may not provide enough information for certain properties. Suppose particular concerns about possible contamination or suitability for future redevelopment use exist. In that case, additional investigation beyond the scope of the Phase I is likely warranted to adequately evaluate business environmental risk. Asbestos and/or lead-based paint inspections for structures and environmental compliance audits for manufacturing facilities can be important inquiries. Wetland studies can be critical to understanding the development potential of a specific site. A Phase II Environmental Site Assessment,

A Phase I ESA includes a visual inspection of the property, interviews with property owners, and a records review, but it does not include testing of soils or any other materials found at the site.

which consists of actual sampling and analysis to evaluate whether contaminants are present and at what levels, may be necessary to support a transaction proceeding.

Environmental due diligence produces findings that are valuable resources for lenders to use in crafting informed and risk-limited transactions. Lenders can gain significant liability protections through these tools, but they must navigate actions carefully to avoid inadvertently losing those protections. Maintaining good environmental counsel, training employees well, and conducting proper due diligence are all practices that will reduce risk. Environmental legal counsel and/or environmental consultants can help evaluate the breadth and depth of scope and investigation needed on a project-by-project basis. These items work together to build a due diligence package that protects liability, helps manage risk, and eases the minds of both purchaser and lender alike.

ABOUT THE AUTHOR

Karen McCurdy is leads Crafton Tull's Environmental Division and is an experienced environmental professional with specialized expertise in industrial air pollution permitting and regulatory compliance.