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Environmental Due Diligence of Commercial Property

Written by: David K. Moynihan

Published in NH Business Review (3/26/2021)

Under federal environmental laws, purchasers of commercial real estate who conduct an environmental due diligence inquiry may be entitled to rely on safe harbor provisions under federal law limiting otherwise unlimited cleanup response costs should contamination be discovered after purchase.  This is especially significant if contaminated groundwater, for example, has migrated off site.

Under the Comprehensive Environmental Response, Compensation, and Liability Act, commonly known as CERCLA, if hazardous substances are found on a property, the owner of the property is generally liable for the costs of cleanup.  Purchasers of commercial properties want to know what they are purchasing, particularly for properties with past industrial uses.

So how does a purchaser determine a property’s environmental condition without triggering unlimited liability post-closing or on the owner if the sale terminates?  By retaining an “environmental professional” to conduct a Phase I Environmental Site Assessment of the specific commercial property.  The Phase I assessment must include making “all appropriate inquiries” into the prior ownership and use of the property, with no “recognized environmental conditions” (RECs) observed.  In doing so, the purchaser is entitled to assert the “innocent purchaser defense” if contamination is later discovered.

While “turning a blind eye” is not a defense to CERCLA liability, “looking deep enough and finding nothing” is a defense.  

So what constitutes “all appropriate inquiries”?  A search of all available public records, interviews with current (and if possible, past) owners and operators of the property, as well as a visual inspection of the property.  Collectively, this is known as a “Phase I Inquiry.” 

To begin a Phase I Inquiry, a purchaser of commercial property must retain an experienced “environmental professional” fully knowledgeable with the industry consensus standard: American Society for Testing and Materials (ASTM) 1527-13.  Only an environmental professional can prepare the Phase I Site Assessment to comply with ASTM 1527-13.

What is required to be designated an environmental professional?  One must: (i) possess a current professional engineer or professional geologist license or registration from a state and have the equivalent of 3 years full-time experience (with environmental due diligence activities); or (ii) possess a bachelor's degree or higher degree from an accredited institution in engineering or science and 5 years equivalent full-time experience; or (iii) have 10 years full-time experience.

Working closely with the environmental professional and experienced environmental counsel, a Phase I Inquiry will develop a Phase I Site Assessment of “all appropriate inquiries” to determine if the property contains “recognized environmental conditions”.  Done correctly, a Phase I Site Assessment finding no “recognized environmental conditions” will allow the purchaser or owner of commercial property to assert the “innocent purchaser defense”, limiting CERCLA liability if contamination is subsequently discovered.

The determination of “all appropriate inquires” is specific to the property.  No practical standard can be designed to eliminate the role of judgment and the value and need for experience in the party performing the Phase I Inquiry.  It is the professional judgment of an environmental professional that is critical to the determination of making “all appropriate inquiries” during the due diligence process.  At some point, the cost of further information that might be obtained or the time required to gather it outweighs the usefulness of the information and may jeopardize the purchase transaction.  An experienced “environmental professional” working with an experienced environmental attorney are the best parties to make that determination. 

Accordingly, before engaging the environmental professional, it is prudent to engage an experienced environmental attorney to carefully draft a Scope of Work for the environmental professional performing the Phase I Inquiry.  This is a critical first step to ensuring that the Phase I Inquiry meets ASTM 1527-13 standards.

Other important considerations include identifying the recipient or “user” of the report, confidentiality regarding distribution, and reliance.  The prospective purchaser should be the “user” of the Phase I Inquiry to preserve the CERCLA defense.  An experienced environmental attorney should review the Phase I report, assess liability issues, and review the findings with the purchaser.

The consequences of an improperly drafted environmental due diligence plan can be expensive for the purchaser.  If the environmental professional does not conduct “all appropriate inquiries,” the purchaser will lose the CERCLA defense and may end up paying for an expensive cleanup.  In that case, liability may go far beyond the fair market value of the property, particularly if contamination has migrated off site.  Unfortunately, many environmental due diligence reports do not comply with the ASTM 1527-13 standard leaving the purchaser unable to invoke the “innocent purchaser defense” and exposed to unlimited liability under federal and state environmental laws.  

The key to conducting the “all appropriate inquires” to invoke the “innocent landowner defense” is ensuring that the inquiry is “just right” from the start.  An inquiry that is too deep risks requiring an invasive Phase II Inquiry, which usually includes soil borings, vapor monitoring, and other investigations and testing.  Aside from being costly, many purchase and sale agreements require the consent of the owner to a Phase II.  Typically, an owner may limit or reject an intrusive investigation due to the concern of the buyer uncovering unknown liabilities and then terminating the transaction leaving the owner with a likely reporting obligation and subsequent cleanup.  An experienced environmental consultant and attorney knowledgeable with the current ASTM standards should be involved at the outset to guide the purchaser through the regulatory process.

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