Important to Do Environmental Due Diligence

Michael J. Quinn
Director, Administrative Law and Litigation Departments and Managing Director Portsmouth Office
Published: Portsmouth Herald
December 6, 2020

People buying commercial property understand the importance of conducting a Phase I Environmental Site Assessment (ESA) prior to closing. Although a properly performed ESA in the closing binder can bring with it substantial benefits should the new owner of the property someday need to avail him or herself of a landowner liability defense, as a recent case makes clear, doing it wrong can result in millions of dollars of liability. Below is an example of what can happen if the ESA is not performed properly.

As background, the Superfund law imposes strict liability (liability without fault) on an owner of contaminated property. A defense may be available if a landowner can demonstrate contaminated property was acquired after adequate inquiry, and without knowledge of the contamination (such as a bona fide prospective purchaser (BFPP), contiguous property owner (CPO), or innocent landowners (ILO) defense). These defenses require the owner to establish that at the time of acquisition “all appropriate inquiries” into the previous ownership and uses of the property was undertaken, so the new owner took title to the property with no knowledge of, nor reason to know of, preexisting contamination.

ASTM International has developed standard practices for the conduct of ESAs specifically intended to satisfy these requirements. Today, ASTM-compliant ESAs are routinely performed for transactions involving real property.

A prospective purchaser (or counsel) must have a working understanding of the ASTM requirements and definitions in order to preserve the benefit of landowner liability defenses. The ESA includes numerous defined terms that are critical to the purchaser and counsel. Section 3.3 of the Standard defines over 25 acronyms – RECs, CRECs, HRECs, PRPs, NPL etc. that all need to be understood.

Sometimes overlooked in the rush to closing is who the ESA identifies as its authorized “user.” The “user” is defined as “a potential purchaser of property, a potential tenant of property, an owner of property, a lender, or a property manager.”  To be eligible for a landowner liability defense, it is critical that the party asserting the defense is identified in the ESA as a “user.”

A potential problem arises when a buyer/borrower relies on its lender to commission the ESA. Although paid for by the buyer as a cost of closing, it may be that only the lender is identified as the “user.” When that happens, the borrower/owner has no contractual relationship with the environmental consultant, and will be ineligible to assert an innocent landowner defense and so is, at least potentially, strictly liable for all the costs of remediation as the current owner of contaminated property. In other words, the defenses will be entirely unavailable.

This is the situation the borrower/property owner faced in a federal New York case. In that case, the lender bank entered into contract with a consultant to perform an ESA on borrower’s property, but only the lender was the defined “user.”  The bank’s customer was not party to the contract nor identified as a “user.”

After closing, the property owner claimed an environmental condition that should have been documented in the ESA was missed. The court describes radioactive contamination dating back to World War II that was not addressed in the ESA. As reported, the contamination could amount to $30 million in remediation liability. The buyer brought suit against the consultant, but had the claim dismissed because it was not a party to the contract.

Further, the failure to be properly identified as an authorized “user” means the borrower/owner loses the ability to successfully assert a landowner defense to liability under Superfund based on the “all appropriate inquiry,” consequently facing potential strict liability in a government enforcement action. So, the borrower could be responsible for $30 million in study and remediation costs resulting from distant historical activities with which it had no involvement. The correct way to have handled the transaction would have been for the borrower to have obtained a reliance letter from the consultant explicitly identifying the borrower as a “user” of the ESA. Reliance letters are typically given in this situation, but they need to be requested.

The lesson is never to treat ESA as a commodity and just another box to be checked off the closing list. It is not only a technical endeavor entrusted to environmental consultants, but a legal document of potentially very significant importance that may not become evident until years in the future.