Buyer beware Law change Will make BEA more crucial

November 29, 2010
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Proposed changes to state environmental law could significantly alter the process of environmental due diligence when it comes to acquiring contaminated property.

In an effort to eliminate the current disparities between due diligence requirements under state and federal environmental law, the Michigan Senate has passed legislation to improve Part 201 of Michigan’s Natural Resources and Environmental Protection Act. The legislation contains some significant amendments to Part 201, most notably a simplification of the baseline environmental assessment, or BEA process, to more closely resemble the requirements under the federal CERCLA statute, aka “Superfund.”

As any potential purchaser of Michigan brownfield property knows, the BEA has become a critical step in the process to protect the new owner from cleanup liability for past contamination.  If the proposed legislation passes later this year, state BEA requirements will become more closely aligned with federal law. Prospective buyers need only to show that the property they plan to purchase is contaminated — not how potential future contamination could be distinguished from existing contamination — in order to be protected against liability for cleanup.

But even though the BEA requirements may be significantly less onerous than in the past, property owners may face other practical considerations that will continue to blur the lines between what is legally required and what may be prudent or required by lenders. In some cases it may be prudent from a business standpoint —or required in order to obtain financing — to go above and beyond Part 201 or CERCLA’s minimum requirements.

By now, most buyers of property take environmental due diligence as a given. Since the 1980s, when strict environmental liability first appeared, the environmental due diligence process has remained relatively consistent.

The first step in any due diligence evaluation is the Phase I environmental site assessment or ESA, which involves review of governmental and historical records and other documents, interviews and a visual site inspection. Phase I is intended to identify red flags: recognized environmental conditions, or RECs. For example, the presence of stained soils or old underground storage tanks would qualify as a REC, prompting the buyer to move on to a Phase II ESA.

Phase II typically consists of soil and groundwater samples designed to more thoroughly evaluate each REC. If the samples come back clean and the buyer could reasonably conclude that there is no reason to know of contamination, then the buyer could proceed with the transaction as an “innocent purchaser.”

But prior to the 1995 amendments to Part 201, and more recent amendments to CERCLA in 2002, if the samples came back showing contamination, the buyer had few choices — either walk away from the deal, reduce the purchase price or secure indemnification from the seller. Many of these transactions simply cratered, and the properties sat vacant as brownfields.

This sad state of affairs changed dramatically as a result of the 1995 amendments to Michigan real property law that replaced the former strict liability standards with one based on causation. Under the amendments, owners and operators of property before June 5, 1995, are only liable for contamination if they were “responsible for an activity causing a release.” 

After that date? To avoid cleanup liability for pre-existing contamination, buyers must now perform a baseline environmental assessment or BEA. The BEA, which was created by the 1995 amendment to Part 201, is an evaluation of environmental conditions that exist at the time of a sale or occupancy. Under current requirements, the BEA must reasonably define the existing conditions and circumstances at the facility so that, in the event of a subsequent release, any new contamination could be distinguished from pre-existing contamination.

This has been the rub under the BEA. Just how much environmental investigation is enough?

The answer has been a bit of a moving target.  The BEA uses the results of the Phase I and Phase II ESAs to determine if enough investigation has been done to enable an owner to differentiate between existing contamination and potential new releases.

Under the existing BEA program, there are three categories of BEAs that can be performed, depending on the intended future use of the property: N (none), S (same) or D (different), referring to whether intended future hazardous substance use will be “none,” the “same” or “different” from existing contamination. For example, turning an old factory into residential condos, the category N BEA requires little more than a Phase I ESA and one sample showing contamination.

The story is different, however, for Category S, such as continued use as a gas station or dry cleaner, or Category D, where a new owner intends to operate the facility using different hazardous substances than those that originally contaminated the facility. In these situations, it can be very difficult to determine the amount of additional investigation to satisfy the BEA requirements.

While the BEA has been a helpful tool in Michigan, it also created a fundamental dichotomy between state and federal law. For example, a purchaser of contaminated property who performs a BEA could be protected under state law but liable for clean up under federal law — until 2002, when the federal Comprehensive Environmental Response, Compensation and Liability Act, or CERCLA, statute was amended to address the same “brownfield” problem that Michigan had addressed in 1995.

In 2002, federal law once again leapfrogged Michigan law, and made it even easier to avoid cleanup liability under CERCLA than under Part 201. “Bona fide prospective purchasers” were now able to buy contaminated property without incurring liability under federal law for the contamination and without having to perform a potentially complicated and expensive BEA. The BEA process, which had been a significant incentive for brownfield development in Michigan, was now seen by some developers as a disincentive, compared with other jurisdictions that either passed legislation that mirrored the new federal scheme, or simply defaulted to the federal due diligence requirements.

Now the Michigan legislature has decided to take up the issue and craft legislation — which is currently being debated in the House — to remove these disparities and eliminate confusion. Under the proposed new rules, the requirements for avoiding cleanup liability under Michigan law will be virtually identical to the requirements under federal law. All a buyer will need to establish is that the site is contaminated in order to avoid cleanup liability. The buyer doesn’t need to assess how contaminated the property is, how old or new the contamination is, or even how much of the site is contaminated.

But the answer to the “how much investigation is enough” question may not be so straightforward. If the purchaser goes with the short-and-sweet approach (the minimum requirements under federal law and under the proposed amendments to Part 201) but later has a new incident of contamination, it will be incumbent on the new owner to distinguish the old contamination from new. If the new contamination is co-mingled with the old contamination, and the owner cannot differentiate the two, the owner may be held liable for the entire cleanup, old contamination and new.

In many instances, that differentiation will be difficult if not impossible if the buyer took the cheapest route at the time of purchase. No doubt, there are some situations where a buyer might choose to go this route. For example, if the property was once used as a dry cleaner and is contaminated with chlorinated solvents, and the new owners plans to operate a gas station, with only petroleum storage, it may be relatively simple to distinguish old contamination from new, even without a lot of additional investigation at the time of purchase. It’s a business risk that must be reviewed on a case-by-case basis.

But in other instances, the smart business decision would be to do more than the minimum requirements. Going forward under this new legislation, it will be prudent for prospective owners and operators to evaluate the costs and benefits associated with getting additional information beyond the legal minimum before deciding which route to take. These business judgments are also likely to be influenced by the risk tolerance — or lack thereof — of lenders financing these transactions.

Kenneth W. Vermeulen is a partner at Warner Norcross & Judd LLP who concentrates his practice in real estate and environmental law. He can be reached at kvermeulen@wnj.com

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