Enacted in 1980, The Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), gave the federal government the ability to respond to releases or threatened releases of hazardous substances, and to pursue polluters (“responsible parties”) or potential polluters (“potentially responsible parties”) for the cleanup of these contaminated sites. This includes the responsibility to conduct “All Appropriate Inquiries” prior to a property transaction to qualify for exemption from CERCLA liability for cleanup costs.
For most commercial real estate transactions, this means conducting environmental due diligence, in the form of a Phase I Environmental Site Assessment (ESA), prior to the transaction to determine whether the site may have contamination concerns, due to past or current activities, that could present liability concerns for the property stakeholders. Under ideal circumstances, your environmental consultant will provide a report without any potential concerns. But what happens when the Phase 1 ESA report finds a potential problem or a “Recognized Environmental Condition”? For many clients, finding a REC is the most dreaded conclusion, because it can pose a roadblock to their deal or require spending more money than they had allocated to assess and/or mitigate the situation.
There is a common assumption that if a Phase 1 ESA finds a REC, the next step automatically has to mean conducting a Phase II ESA subsurface investigation. Sometimes that is the case, but not always. There are several options beyond the Phase 1 ESA or in lieu of a Phase II that can help mitigate environmental risk.
The first thing we do when we find a recognized environmental condition is contact our client to discuss the issue and try to find a solution. Sometimes, a bit of additional research or interviews to find enough information can show that the REC doesn’t represent a significant risk, has already been resolved, or can be “controlled” through ongoing engineering controls if it doesn’t present a threat to human health. We do this research as part of the Phase 1 ESA automatically, but information sometimes has a way of surfacing when a potential environmental concern is called out – owners may suddenly be more willing to provide additional documentation or point us to other individuals to interview to try to mitigate the concern.
Other options that clients can pursue before conducting a Phase II ESA include the following:
Remedial Cost Estimate. One of the first critical steps after identifying potential risk is to narrow down a range of mitigation needs and put a specific number to them. To help in this process, a Remedial Cost Estimate (RCE) provides a tangible range of cost scenarios (from best to worst case) that allows stakeholders to confidently quantify environmental risk in their real estate transaction decision-making process. An RCE provides financial guidance for environmental insurance and holdback funds (see below).
Environmental Insurance. Some insurance providers provide policies for commercial properties with potential environmental risk.
Holdback of funds in escrow. To cover the estimated cost of an anticipated cleanup or remediation solution, some clients reserve funds in an escrow and go ahead with their transaction in spite of potential contamination.
Parcel Carve-out. Sometimes the asset consists of multiple parcels and the environmental issue is contained on only one of the parcels and can be “carved out” of the collateral. I have even seen some clients create a new separate parcel for this purpose. For instance, if a large shopping center with a gas station on the corner of the parcel has a contamination concern by the gas station, the customer can make the gas station into its own parcel and continue with the purchase/sale or refinance of the shopping center.
Environmental indemnity clauses. For high risk properties or properties where there is a known concern (on-going remediation for instance) often the seller or even the tenant (for instance a large petroleum company) may indemnify a buyer/future owner from any environmental liability associated with the known release or high-risk use. Relatedly, some clients will go through with the purchase but keep the responsibility of the cleanup (this is a spin on indemnification). So, the new owner buys it and operates it while the old owner continues to work on the cleanup. This way the property can start to live it’s “new use” but the contamination is still dealt with.
Site-specific assessments. For specific operations and industries, there are ways to further assess environmental risk without necessarily doing a full Phase 2 ESA. For instance, with gas stations, you can run tank tightness testing or tracer gas analysis to determine if the tanks are leaking.
If, after exhausting all of the above options, the environmental concern is significant enough, then Phase 2 Environmental Testing will likely be recommended for further testing and laboratory analysis, but this process can be streamlined by keeping the scope of work very focused.
Environmental due diligence professionals don’t want to deliver bad news to their clients, but on occasions where we must, it can save you liability and cost in the long run. Proceeding with a transaction where a potential environmental concern isn’t addressed in the due diligence process can be far costlier down the line if the problem resurfaces (or exacerbates) after you purchase it or during a redevelopment activity. In the end it all comes down to managing risk and getting more information. Often, there is a way to address the issue with the help of a knowledgeable and creative consultant who understands your end goal.