With the retail industry going through a lot of flux these days, many shopping centers have been, and continue to be, targets for acquisition, redevelopment or repositioning. Because many shopping centers have had a dry-cleaner tenant on site at one point or another, releases of perchloreoethylene (PCE) and other volatile organic compounds (VOCs) are a common risk in the transaction of such properties. The current or historic presence of a dry-cleaner can create considerable risks and liabilities because of the high toxicity of the chemicals involved, stringent cleanup standards for these contaminants, and the regulatory requirements adopted by states around the country to address potential human health concerns.
Because of this, chlorinated solvents or former dry-cleaner operations identified during the due diligence stage are seen as a deal-killer by many shopping center investors, lenders and their attorneys – but they don’t have to be! There are a number of things that can be done to enable transaction parties to move ahead with these potentially lucrative deals while adequately mitigating risks and liabilities.
First Things First – Be Duly Diligent
For the sake of this discussion, let’s assume you’ve done your pre-purchase due diligence, which should likely include a thorough Phase I Environmental Site Assessment (ESA). The ESA is the gold standard for identifying current and/or historic dry-cleaning operations and the risk of a potential release, and is also a necessary step to protect the new buyer from inheriting liability for cleaning up existing releases (under CERCLA – see here). A subsequent Phase II ESA can confirm whether there was in fact a release with targeted subsurface sampling in key locations.
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If you identify a release – you have options for addressing liability and cleanup costs.
Given that a dry-cleaning release can become an ongoing property management line item until remediation has been completed, being clear about liability and ongoing costs is critical to determining the viability of a deal.
A file review (typically done during the Phase I ESA) will help determine the current status and extent of the release and whether a responsible party has been identified. If so, the buyer may consider obtaining an environmental indemnification agreement that will ensure liability for the cleanup remains with the responsible party after the purchase.
When the seller has not conducted a detailed evaluation of the extent of a release, buyer beware! If the seller will retain liability, the buyer should verify that remedial cost estimates are accurate, that remediation goals are achievable, and that adequate funding is secure to ensure they do not take on unmanaged, ongoing risks by acquiring the property. If the scope of the release is not well understood, escrow dollars may be underfunded, exposing the buyer to a liability if the seller defaults. In the same light, a seller with modest assets may not remain viable to handle a problem that costs significantly more to resolve than estimated.
Insurance products may also be available to address future risk. However, relying on insurance can be risky in itself because managing PCE (and other solvent) releases can be complicated, and many buyers and insurance companies have been burned by the inability to reach regulatory closure within reasonable timeframes. Natural degradation can take decades to hundreds of years depending on the geology (such as silts and clays). Many of the chlorinated solvent releases that I have worked on occurred 50-60 years ago, and VOC concentrations are still many times the clean-up standards. Because of this, finding an insurance provider willing to insure a known release at a dry-cleaner can be a very difficult task.
Delineating the Concern
If the release hasn’t been fully delineated but you still want to consider the deal, you’ll likely want to get a better handle on how big the problem is and how much it will cost to clean up. In order to do this, you may need additional subsurface investigation than what an initial Phase II ESA provides. This may include additional and/or deeper sampling, sampling more media (soil, soil-gas, groundwater, and/or indoor air), and analyzing for additional contaminants. The goal is to define the full, 3D extent of the contamination.
Because PCE is a highly mobile and heavier than water, contamination can spread very quickly and deeply. It can also travel upward in the form of vapor intrusion – which is the migration of VOCs into buildings from contaminated soil or groundwater. This is a particular concern associated with dry-cleaner operations and should be specifically addressed during the assessment process. In fact, because of human health risks, the presence and extent of vapor intrusion is often what determines remediation goals and strategies because of human health risk concerns (building occupants are likely to be the most at-risk “receptors.”)
Other key questions to ask at this stage are: Is a risk-based site clean-up (i.e. the use of site specific variables to arrive at risk-adjusted clean-up criteria) an option? Is the site’s geology conducive to in-situ remediation, and are the clean-up estimates reliable? Clean-up estimates are often predicated on an incomplete characterization of the release and overly optimistic closure scenarios and are therefore biased low, often by orders of magnitude. Failing to understand the true nature and extent of a solvent release and the regulatory setting can create major financial liability that is often not insurable.
An accurate understanding of the scope of the release, however, will provide lenders, investors and their attorneys with a more reliable cleanup cost. This information can be used as a bargaining tool in negotiating deal terms, and will also help to determine the most suitable remediation method.
What Funds Are Available?
The financial impact of a dry-cleaner release may be offset through national or local funding programs that aim to assist with the cost of cleaning up environmental issues. Most states have Brownfield Remediation Programs that administer funds towards the remediation of contaminated groundwater and soil. A number of states, including Alabama, Connecticut, Florida, Kansas, North Carolina and Texas for example, have targeted Dry-cleaning Remediation programs that can be used to recover costs to clean up dry-cleaning solvent releases and bring sites into compliance. A local environmental consultant can help to identify all applicable rebates to accurately quantify the financial impact of the concern.
Structuring Costs into The Deal
A remedial cost estimate will help quantify the environmental liability of a dry-cleaner release, and can be used to incorporate this risk into the deal terms. Structuring a closing in a way that accounts for a dry-cleaning solvent release may include a purchase price reduction, assigning liability to the seller or buyer (often with a price reduction), insuring the risk if possible, and developing a site redevelopment plan to include release mitigation components (such as remediation systems and vapor barriers). During redevelopment projects, remediation can often be built into the deal to reduce overall costs. (For more on development due diligence check out a recent webinar a few of my colleagues presented on Globe Street.)
Importantly, many states have risk assessment models that can allow you to reach regulatory closure without cleaning up (substantially) all of the contamination. Risk-based closure, combined with other forms of remediation, is usually the most cost-effective approach to dealing with dry-cleaners. However certain states, such as my home state of Connecticut, do not allow risk-based closure. In most parts of Connecticut, for example, where groundwater is considered a potential drinking water supply, the clean-up standards are in the low parts per billion. As a result, remediation to reach these low numbers is extremely difficult. Remediation costs and timeframes can escalate accordingly, and this should be taken into account when negotiating the deal terms.
Where regulatory closure cannot be achieved without near complete remediation, the prospective purchaser may have to live with the issue throughout the duration of their ownership. When this may be the case, it is important to understand that such releases could represent significant barriers to resale, and that dealing with the release may become more of an ongoing property maintenance line item and less of a regulatory closure reality.
Leaving Less to the Imagination
The bottom line is that prospective purchasers and lenders need to understand the nature and extent of a dry-cleaning solvent release, determine if remedial cost estimates are accurate and reliable, understand the regulatory setting and requirements, and structure the deal around the issue accordingly. If risk-based cleanup goals cannot be used, then regulatory closure may not be a reality.
There are countless dry-cleaner releases across the country, but the issue need not be an impediment to closing lucrative shopping center or other commercial real estate deals. Fully understanding the issues upfront can control and mitigate the risk, and help close the deal. If that means spending short dollars on more soil and groundwater sampling during the due diligence phase, then those dollars are well spent.
When this due diligence process provides the results to move forward with the deal, there are a number of remediation techniques that may be employed to ensure regulatory compliance and optimal return on investment. I will discuss these in an upcoming blog.