October 27, 2006

Environmental issues play a large role in many real estate transactions today. Current laws impose significant environmental liabilities on purchasers, sellers and lenders involved in real estate deals, regardless of who caused the problem or whether they are present owners of the property. EPA issued a final rule for "All Appropriate Inquiry" on November 1, 2005¹ that will become effective on November 1, 2006. The new rule will affect environmental due diligence conducted by prospective purchasers of commercial real estate, as well as other entities who wish to avail themselves of CERCLA "Superfund" liability protections. The new rule imposes obligations upon users of environmental site assessments (ESAs) to affirmatively provide information to the Environmental Professional (EP) who conducts the diligence, and dictates a more complete and detailed process for examination of the environmental issues surrounding real property subject to acquisition or finance.²

"Innocent purchasers"³ under CERCLA are required to undertake diligence with "all appropriate inquiry" (AAI). The final rule is the result of a two-year process undertaken by EPA that makes several additional requirements part of the environmental diligence process.⁴ The new rule provides further detailed guidelines to prospective purchasers to enable them to conduct the necessary AAI diligence and gain liability protection should contamination issues arise after the purchase.

Specific Changes in Current Environmental Due Diligence Procedures

Site Interviews and Visual Inspections

While perfunctory interviews of a Site representative were often part of due diligence in the past, the new rule requires a more vigorous interview process.⁵ The EP conducting the due diligence must interview both the current owner and occupant of the Site, assuming they are not the same party or person. If there are multiple occupants/tenants, then interviews must be conducted with all major occupants and those likely to use hazardous substances. The rule also requires interviews with current and past facility managers, past owners and operators/occupants of the property, and employees of past and current occupants of the property, if necessary, to meet the objectives of the new AAI rule. If the property is abandoned, the rule requires interviews with owners and occupants of neighboring properties. Visual, on-site inspections of the Site are required as well as visual inspections of neighboring properties and areas where hazardous substances may be stored, treated, handled or disposed.⁶

Historical Records Review and 180-Day "Shelf Life"

The new rule requires a more extensive records review than in the past, including the requirement that the EP review historical records going back to the time the property was first used for residential, agricultural, industrial or commercial purposes.⁷ Moreover, all ESAs conducted more than a year before an acquisition must be updated to reflect current conditions.⁸ Certain aspects of the ESA, such as historical records review, interviews, on-site visual inspections and a search for environmental liens, must be performed within 180 days of the acquisition.⁹ Therefore, an ESA conducted less than 180 days before acquisition can still be relied upon by the user under the new rule and still qualify as AAI.

Identification of "Data Gaps"

The new rule requires the EP to identify data gaps in the available data that impact the ability to identify conditions indicative of releases or threatened releases at the Site.¹⁰ The presence of data gaps may require the EP to opine that there may be conditions at the Site that are indicative of releases or threatened releases, depending on the significance of the data gaps. The documentation and discussion of data gaps in the EP's report is mandatory under the new rule.¹¹ The prior ASTM Standard did not specifically require an EP to identify or address data gaps in a Phase I ESA. Identified data gaps may need to be addressed through standard Phase II-type sampling in order to preserve CERCLA liability defenses.¹²

Prospective Purchaser Participation in the Environmental Site Assessment Process

Perhaps the most dramatic difference in the old versus new rule is the emphasis on user-generated information as part of the ESA. The new rule creates a requirement that the ultimate user of the ESA must conduct its own investigation of the Site and provide the results of that investigation to the EP.¹³ This inquiry includes information regarding specialized knowledge of the subject property or other reasonably ascertainable information about the property. Significantly, the new rule requires the prospective purchaser to compare the fair market value of the property as an uncontaminated parcel to the contemplated purchase price in order to evaluate whether the proposed purchase price is reflective of potential environmental impairments of the subject property.¹⁴ While the rule does not require the user to share this information with the EP, the prospective purchaser is required to perform such an evaluation.

Although the user may decide not to provide information to the EP, doing so may risk the validity of any "innocent purchaser" claim during a subsequent challenge. For example, if an internal evaluation demonstrates a significant difference in the two values, it could be considered evidence of environmental impairment which, if not provided to the EP, may destroy the CERCLA innocent landowner defense if challenged later by any third party. This is also true of any other unique or specialized property information in the possession of the user that is not provided to the EP.

Conclusion

While there are no drastic changes to the new AAI rule, the strength of any "innocent purchaser" or "bona fide prospective purchaser" defense, when subsequently challenged, will rest upon a court's determination of whether the user's pre-purchase inquiry was sufficient. The new measure of this sufficiency includes the user's own evaluation of the available data, and the user's willingness or unwillingness to share this data with the EP. The existence of "data gaps" called out by the EP, and the ability or inability of the EP or user to fill those gaps during pre-purchase diligence, may also impact the strength of any CERCLA defense to liability. More than likely, any unexplained or uninvestigated data gaps will cause an inquiry to be found insufficient and invalidate any CERCLA liability defense. Phase II sampling is recommended to fill these gaps when historical information suggests past industrial use or practices at the Site. Detailed site interviews, visual on-site inspections and more extensive historical records reviews will also be required under the new rule.

Careful consideration must be given to the information gathered and the process used to investigate a site by the EP and the ultimate user of the ESA in order to solidify CERCLA liability defenses against post-purchase challenge. Real estate attorneys and prospective buyers of commercial property should pay close attention to the new AAI rule and be aware of the changes that will be required to adequately complete the environmental due diligence process.

For Further Information

If you would like more information about this Alert, please contact one of the attorneys in our Real Estate Practice Group or the attorney in the firm with whom you are usually in contact.

Footnotes

1. See 40 C.F.R. § 312 - "Innocent Landowners, Standards for Conducting All Appropriate Inquiries."
2. While lending institutions that provide real estate-secured financing are protected by the Secured Creditor exemption (see, CERCLA Section 101(20)(A)), and lenders themselves are not required to perform AAI to obtain the benefit of that exemption, the new AAI rule does benefit lenders through standardization of due diligence in the industry. Lenders should demand that borrowers follow the new rule in order to limit a lender's risk in real estate-secured financing.
3. See CERCLA 101(35) and 107(b) (3); Congress also established additional CERCLA liability protections for "bona fide prospective purchasers" (CERCLA Section 101(40)) and "contiguous property owners" (CERCLA Section 107(g)) who must also comply with the new AAI rule to qualify for CERCLA liability protections.
4. The ASTM has recently revised Standard E1527-05 to conform to the new EPA rule, which EPA has confirmed satisfies the statutory requirements for AAI. See www.astm.org for ASTM E1527-05 "Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process." The ASTM "Transaction Screen" process, set out in ASTM Standard E1528, does not meet the AAI requirements set forth in the new regulations necessary for establishing CERCLA liability defenses. The transaction screen process may still be useful in some limited circumstances as a business risk management tool.
5. See 40 C.F.R. § 312.23 - "Interviews with past and present owners, operators and occupants."
6. See 40 C.F.R. § 312.27 - "Visual inspections of the facility and adjoining properties."
7. See 40 C.F.R. § 312.24(b) "Reviews of historical sources of information."
8. See 40 C.F.R. § 312.20(a) - "All Appropriate Inquiries."
9. See 40 C.F.R. § 312.20(b).
10. See 40 C.F.R. § 312.20(g).
11. See 40 C.F.R. § 312.21(c)(2) - "Results of inquiry by an environmental professional."
12. See 40 C.F.R. § 312.20(g).
13. See 40 C.F.R. § 312.22 - "Additional inquiries."
14. See 40 C.F.R. § 312.29 - "The relationship of the purchase price to the value of the property, if the property was not contaminated."