Guest Column

Trigger events for environmental due diligence

December 27, 2013
| By Joe Berlin |
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The concept of reviewing the “environmental” prior to the purchase of a parcel of commercial real estate is widely understood. What is less widely known is there are many events or transactions, other than a purchase, that should triggersome level ofenvironmental assessment or environmental due diligence.

Buyers, banks and attorneys are accustomed to ordering a Phase I prior to closing to evaluate the environmental condition of property and to enable the purchaser to demonstrate that “all appropriate inquiry” has taken place.

This demonstration is necessary for a purchaser to later establish the Landowner Liability Protections available under the federal Superfund law (CERCLA) and Michigan’s Part 201 of NREPA.

Other events that should trigger environmental due diligence include:

  • Financing or refinancing
  • Foreclosure
  • Governmental actions
  • Estate/valuation
  • Leasing

These events can (and should) trigger an assessment of environmental status. Unfortunately, due to the well-recognized acceptance of the Phase I process in purchases of commercial real estate, the knee-jerk response is often “Get someone out here to do a Phase I now.” While sometimes this is the right response, at other times it can be counterproductive. This is due, in large part, to the standards under which Phase I’s are conducted. 

Phase I’s are, by design, oriented to determining whether a “recognized environmental condition” (i.e., environmental issue that indicates a release has occurred or is likely to occur) is present. Looking at the list above, one can see that identifying a REC in some cases may provide little useful information and could actually complicate the transaction.

In our experience, the context of the transaction is often ignored while scoping the environmental engagement. This is where an experienced environmental professional can add significant value. For example, in a refinance situation, the availability of LLPs would not likely apply; therefore, conducting a traditional Phase I Environmental Site Assessment identifying RECs is unnecessary. In fact, a traditional Phase I may result in imposing additional burdens on the parties to quantify, explain or minimize its findings. 

Alternatively, we see some lenders doing absolutely no EDD when foreclosing even on high-risk property (e.g., an old foundry). Further, some tend to forget that, while the lender is not a regulatory enforcement body, it still requires EDD to assess and protect collateral value. When assessing the applicability and reliance of LLPs, we suggest discussing the nature of the transaction and goals of the environmental assessment with the environmental professional prior to undertaking the evaluation.

As one lender puts it, “The level of inquiry necessary is what is reasonable and appropriate under the circumstances.” Of course, this lender has the benefit of in-house environmental staff to assist in understanding the environmental situation and can, therefore, better match the level of EDD with the lending circumstances.

The purchase or sale of commercial real estate is where the traditional Phase I ESA is most often required by buyers and lenders. In many merger and acquisition transactions today, EDD by sellers is becoming more common. However, we recommend that a seller-conducted EDD be scrutinized by a purchaser’s environmental professionals. Be wary of “clean” Phase I ESAs where no RECs are identified on properties with past industrial or heavy commercial use.

Lenders are being required to undertake more rigorous underwriting, including the consideration of environmental issues. While new purchases may seem fairly straightforward with the availability and use of the LLPs, refinancing provides the opportunity for a more sophisticated lender to add value. Many lenders utilize tailored “limited” environmental assessments that focus the environmental work to support underwriting and risk management, as opposed to meeting a general “off-the-shelf” environmental policy. Collaboration with an experienced environmental professional is important to ensure environmental issues that may have arisen since the original purchase are not overlooked.

Most lenders have strict environmental programs related to foreclosure. However, it is not uncommon for community banks or credit unions to lack a coherent plan or policy for foreclosures. The absence of an environmental policy can increase overall program cost and risks incurred by one “mega-claim.”

We strongly recommend that any governmental environmental notice, request for information or violation letter be immediately referred to experienced environmental legal counsel. What may be perceived as a “small issue” a company believes can be resolved quickly and directly with the regulators can often become prolonged and costly. Environmental assessments and investigations performed to satisfy governmental requirements are commonly conducted in concert with or under the direction of legal counsel.

Environmental issues are often ignored in estate planning and management of trusts. If a contaminated property is transferred into a trust, trust assets may be required to fund investigation and cleanup of the contaminated property before payments can be made to the beneficiaries. In fact, in some cases the cost of cleanup of a property may exceed the property’s worth and could exhaust trust assets. 

There are options that may produce a better outcome. We suggest that an environmental program be tailored to the specific situation, and that it assess issues that actually can impact value of the land or business (e.g., regulatory required capital upgrades, permits or renewals, outstanding environmental issues).

In many situations, a lessee or tenant may be considered an “operator” under federal Superfund law and Michigan’s Part 201. While there are certain exemptions for residential and some commercial uses, lessees often fit the statutory definition of an “operator” due to their direct work at the property. Lessees fitting that definition may be strictly, jointly and severally liable for contamination at the property unless all appropriate inquiry has been undertaken (i.e., performance of an adequate Phase I ESA) prior to occupancy. Additionally, many lease agreements shift environmental liability to tenants. Understanding the condition of the property prior to leasing can be essential to avoiding or minimizing liability upon termination of the lease.

Based on the new Office of Comptroller of the Currency Commercial Real Estate manual (August 2013), the influence that environmental issues have on value will become even more pronounced, as the appraisal process will be required to assess the impact of environmental issues on value. A Phase I may (or may not) be all that is necessary to meet this guidance.

A Phase I is a good tool for many different situations, but it is not always the best one. The type of transaction, the parties, and the goals of the evaluation should be considered prior to ordering the “environmental.”

Joseph Berlin is a professional engineer in multiple states and testifies throughout the country on various environmental issues. He also is the owner of BLDI, a full-service environmental engineering firm headquartered in Grand Rapids.

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