Annemargaret Connolly is a partner and head of the Environmental practice at Weil, Gotshal & Manges LLP. Thomas D. Goslin is counsel at Weil, Gotshal & Manges LLP.
Environmental due diligence in real estate transactions involves the assessment of known, potential, and contingent environmental liabilities and obligations associated with a parcel of property to be acquired. This practice note discusses real estate investments, as compared to evaluating real property that is an element of a larger corporate transaction. In a traditional commercial real estate transaction, the purchaser often intends to purchase the real property for an investment and generally is not intending to be the operator as well as the owner. Often, the purchaser will sign a purchase and sales agreement in advance of conducting its due diligence, essentially agreeing to purchase the property “as is/where is,” but will be able to terminate the transaction if its environmental due diligence does not meet the purchaser’s requirements or expectations or, potentially, use the diligence information to conduct additional diligence and/or renegotiate the terms of the purchase. Environmental due diligence in the real estate context tends to focus on:
Known or potential soil or groundwater contamination beneath the property from current and historic uses
The potential for contamination to migrate to the property to be acquired from offsite locations
The risk that hazardous soil vapors might intrude into onsite buildings from subsurface contamination (particularly when the risk arises from migrating contamination for which the purchaser would not be responsible)
The presence of hazardous building materials, including asbestos and lead-based paints, in onsite structures, and
Compliance with environmental requirements
To the extent a real estate transaction involves a development project, there also may be a need to evaluate the real property for site specific features, such as wetlands, and threatened and endangered species, or to determine the costs to abate any asbestos or lead-based paints if demolition is contemplated. The nature and extent of environmental due diligence is colored by the current use (e.g., commercial, industrial, residential) and historic use of the property, as well as by its location and the nature of the laws and regulations to which the property is subject.
Due diligence is not limited to prospective purchasers. Parties looking to put a property up for sale also may conduct due diligence in advance of taking the deal to the marketplace in order to better evaluate the relative value of potential bids, make informed decisions regarding indemnities, or evaluate possible risk transfer products, such as insurance, recognizing that seller-authorized diligence may not be a complete substitute for a purchaser’s own diligence. Parties involved in financing transactions, such as lenders and underwriters, also participate in diligence exercises, although they may substantially rely on the diligence done by the purchaser/borrower or offeror. Due diligence permits a lender to assess whether contingent environmental liabilities may impair a borrower’s ability to repay the loan or damage the borrower’s credit rating, making it difficult or impossible for the lender to sell or securitize the loan. It also enables the lender to identify any environmental contamination that could take priority over the lender’s lien, affect the desirability of foreclosing on property, or create potential environmental liabilities or adverse publicity for the lender.
For a detailed discussion of purchaser’s preparation for the diligence process, see 1-5A Environmental Law Practice Guide § 5A.17, and for seller’s preparation, see 1-5A Environmental Law Practice Guide § 5A.16.
Liability for Contamination
The primary focus of any real estate due diligence assessment is on the presence or likely presence of contamination. This is because, under the federal Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) and many analogous state laws, owners of real property generally are strictly liable for the costs to address onsite contamination, regardless of fault. 42 U.S.C. § 9601 et seq. Most states have adopted similar liability schemes. Therefore, it is imperative for purchasers of real property to undertake environmental due diligence to understand whether there is known contamination at the property, whether there is a risk of as-yet undiscovered contamination at the property, and the likely range of costs to address such contamination prior to acquiring the property. As discussed in more detail below, doing so may afford a purchaser with certain limited legal protections from liability for preexisting contamination; however, it is important to remember that, even if liability protections exist, the existence of contamination at a property can give rise to tort liability for personal injury or property damage, and may make it difficult, or even impossible, to sell the property at a later date.
For a discussion of liability for contamination under CERCLA, see 1-1 Environmental Law in Real Est. & Bus. Transactions § 1.03.
Environmental Site Assessments
Due diligence aimed at assessing known and potential contamination at real property should almost always involve an environmental site assessment that is consistent with or surpasses the American Society for Testing and Materials’(ASTM) Phase I Environmental Site Assessment (ESA) standard. A Phase I ESA consists of a site visit by an environmental professional and a review of available public information concerning environmental conditions at the site, including information regarding historic site use. The focus of the Phase I ESA is on what ASTM defines as recognized environmental conditions (RECs), or the potential for contamination at the site being evaluated. Specifically, ASTM defines a REC to mean the presence or likely presence of any hazardous substances or petroleum products in, on, or at a property (1) due to any release to the environment, (2) under conditions indicative of a release to the environment, or (3) under conditions that pose a material threat of a future release to the environment.
In addition to RECs, the Phase I ESA may also identify conditions defined under the ASTM standard to be historical recognized environmental conditions (HRECs) or controlled recognized environmental conditions (CRECs). An HREC is defined by ASTM to mean “a past release of any hazardous substances or petroleum products that has occurred in connection with the property and has been addressed to the satisfaction of the applicable regulatory authority or meeting unrestricted use criteria established by a regulatory authority, without subjecting the property to any required controls (e.g., property use restrictions, activity and use limitations, institutional controls, or engineering controls).” In other words, an HREC is a release that has been addressed in accordance with applicable requirements to allow the property to be used for any purpose.
A CREC is defined by ASTM to be a recognized environmental condition resulting from a past release of hazardous substances or petroleum products that has been addressed to the satisfaction of the applicable regulatory authority (e.g., as evidenced by the issuance of a no further action letter or equivalent, or meeting risk-based criteria established by regulatory authority), with hazardous substances or petroleum products allowed to remain in place subject to the implementation of required controls (e.g., property use restrictions, activity and use limitations, institutional controls, or engineering controls). What distinguishes a CREC from a REC and an HREC is that the release has been addressed to meet regulatory standards, but where contaminants have been allowed to remain in place subject to a use limitation. For example, a regulator may grant regulatory closure even when elevated contaminants remain in soil or groundwater, provided that the property owner only uses the site for industrial purposes. Such a situation would be identified as a CREC under the ASTM standard.
In practice, environmental professionals often differ on what conditions constitute a REC, HREC, or CREC. For pure due diligence purposes, whether a condition is classified as a REC of any type typically will not matter because there is no legal significance to such terms; however, lenders and potential purchasers often will give greater scrutiny to conditions identified as RECs in Phase I ESAs, as such conditions, by definition, have not been addressed to the satisfaction of the relevant governmental entities. Therefore, when working with environmental professionals preparing Phase I ESAs, care should be given to ensure that any RECs identified in the report clearly fall within the ASTM definition and that, where RECs are identified, the environmental consultant provides sufficient detail to understand the issue in context.
Where the Phase I ESA identifies a significant concern with respect to contamination (whether or not it is identified as a REC), purchasers may want to conduct what is known as a Phase II ESA, which involves sampling of soil and/or groundwater. Conducting a Phase II ESA can help confirm the existence and extent of any contamination, which can help provide greater certainty concerning the nature and magnitude of the liability. Depending on the terms of the real estate purchase agreement, a purchaser may have a right in the agreement to conduct a Phase II investigation. Where the agreement does not provide an express right to conduct a Phase II, the purchaser may need to negotiate with the seller to obtain that right in the face of evidence that a significant issue exists or, if the seller refuses to allow for sampling, terminate the agreement or renegotiate the terms of the purchase.
In most real estate diligence exercises, the scope of the review will expand beyond the standard Phase I ESA. Potential purchasers often will assess the risk of vapor intrusion; and the presence of mold, lead-based paints, and asbestos-containing materials, water wells, drinking water supplies, radon, lead in drinking water and, if the property is occupied by an industrial business, compliance with laws and permits. For transactions involving future development, potential purchasers will also want to assess the presence of threatened and endangered species and the wetlands. In this practice note, we are going to discuss diligence focused on contamination, including the risk of vapor intrusion, after which we will discuss other diligence issues.
For more on environmental site assessments, see 3-20 Environmental Law in Real Est. & Bus. Transactions § 20.02. For a discussion of the ASTM standard for transaction screens, Phase I and Phase II Environmental Assessments, see 1-5A Environmental Law Practice Guide § 5A.08.
All Appropriate Inquiry
Legal Protections Provided by All Appropriate Inquiry (AAI)
As noted above, CERCLA and similar state laws generally provide that an owner or operator of real property can be held liable for any onsite contamination, regardless of fault; however, CERCLA offers certain statutory defenses to so-called “bona fide prospective purchasers,” among others, provided that the purchaser can prove it conducted “all appropriate inquiry” (AAI), a showing that it made reasonable inquiries to determine whether the property was contaminated prior to the acquisition. 42 U.S.C. §§ 9601(40), 9607(r). In other words, a party that qualifies as a bona fide prospective purchaser may be able to avoid CERCLA liability for any preexisting contamination subsequently found on land acquired by the purchaser. Thus, the bona fide prospective purchaser defense is only available when the purchaser is acquiring assets. Moreover, while parties often are focused on due diligence, it is important to remember that the protection is limited to CERCLA liability and does not necessarily provide protection against state or common law claims, including personal injuries and property damages.
It is important to note that a bona fide prospective purchaser defense is not available when the purchaser acquires the stock of an entity that holds contaminated land. This is because the entity that holds the land (if not itself a bona fide prospective purchaser) is statutorily liable for any onsite contamination, and that liability cannot be erased by a subsequent bona fide prospective purchaser.
Satisfying the AAI Rule
To qualify as a bona fide prospective purchaser, pursuant to 42 U.S.C. § 9601(35)(A) the purchaser must, among other requirements:
(i) Make all appropriate inquiries into the previous uses and ownership of the facility
(ii) Take reasonable steps to stop any continuing release
(iii) Limit exposure to a previously released hazardous substance(s) discovered on the property, and
(iv) Not be affiliated with any person who is potentially liable for the contamination at the facility through any familial, contractual, or corporate relationship
In order to satisfy the AAI standard, specific tasks or inquiries must be undertaken prior to acquiring the property. The inquiry focuses on contamination risks, setting out specified objectives for obtaining information about current and past property uses and uses of hazardous substances, waste management and disposal practices, current and past corrective actions, engineering and institutional controls at the property, and environmental conditions at neighboring properties that could be indicative of releases. Many of the designated tasks must be performed by, or under the directions of, an “environmental professional,” who must meet certain educational and experience requirements to qualify for this position. 40 C.F.R. § 312.21. Inquiries that must be conducted by an environmental professional, or at his or her direction, include:
- Interview past and present owners, operators, and occupants of the property about the handling of hazardous substances. The AAI standard requires at least one knowledgeable person from each period in the property’s history be interviewed.
- Review historical records, such as aerial photographs, fire insurance maps, chain of title documents, and land use records, dating back to the time when the property first contained structures or was put in use.
- Review government records concerning releases and threatened releases of environmental activities on the site, including landfill and disposal unit records and permits, storage tank records and permits, hazardous waste generator records and permits, government listing of sites, and spill reports. Other records to be reviewed include: the Environmental Protection Agency’s (EPA’s) Comprehensive Environmental Response, Compensation, and Liability Information System (CERCLIS) database, public health records, Emergency Response Notification Records, and registries of engineering and industrial controls. In addition, the environmental professional must review records concerning adjoining or neighboring properties, including records of National Priority List (NPL) and the Resource Conservation and Recovery Act (RCRA) corrective action sites within one mile, and records of other sites under investigation, subject to voluntary cleanup or having a leaking underground storage tank within a half mile. The environmental professional must visually inspect the property and its improvements (including areas in which hazardous substances may be stored or handled), and adjoining properties (either from the property line or through aerial photography). Moreover, the environmental professional must take into account commonly known or reasonably ascertainable information about the property as well as the degree of obviousness or likely presence of contamination at the property.
In addition, either the environmental professional or others working on behalf of the purchaser must search for records of environmental cleanup liens.
The AAI rule also requires that the purchaser itself perform certain tasks and inquiries, including:
- Disclose to the environmental professional any specialized knowledge that the purchaser may have about the property, its uses, or surroundings.
- Consider the relationship between the purchase price of the property and the value of the property if not contaminated to determine whether any difference is attributable to releases of hazardous substances, pollutants, contaminants, or petroleum. The Preamble in the Federal Register makes clear that compliance with this requirement does not require the performance of an appraisal. Rather, the purchaser is to consider whether any reduction in purchase price is indicative of the presence of contamination.
- Disclose commonly known or reasonably ascertainable information about the property. Even though this requirement is also part of the mandated environmental professional’s inquiry, the purchaser has an independent obligation to consider this factor.
The ASTM Phase I ESA, described above, generally covers most of the elements for performing AAI, which is why it has become standard practice in environmental due diligence. Once an all appropriate inquiry has been conducted, parties who satisfy the other requirements of the bona fide prospective purchaser exemption under CERCLA will not be liable for contamination at the site providing the party does not impede the performance of a response action or natural resource restoration. 42 U.S.C. § 9607(r)(1).
For further discussion of the all appropriate inquiry rule, see 3-20 Environmental Law in Real Est. & Bus. Transactions § 20.02 and 1-5A Environmental Law Practice Guide § 5A.04.
For more on the innocent purchaser defense, see 1-1 Environmental Law in Real Est. & Bus. Transactions § 1.03[d][ii] and 1-5A Environmental Law Practice Guide § 5A.04.
Scoping Diligence to Address the Deal
As noted above, the nature of a transaction will affect the scope of diligence done. The scope of an environmental due diligence exercise concerning a property on which a chemical manufacturer is located, for example, should be much more thorough than that which might be conducted on an office park. A development deal, on the other hand, may warrant a review for endangered species and wetlands, both of which, if present, could adversely affect development plans or, if discovered during development, could result in fines and penalties or delays during construction, or warrant changes in development plans, all of which cost the developer expenditures beyond the initial budget. An in-depth discussion of potentially relevant considerations continues below.
Federal environmental laws such as CERCLA and RCRA, as well as analogous state statutes, impose broad, joint and several liability on owners and operators of real property for onsite contamination without regard to fault. This means that in many cases a purchaser of real property can be held liable for any onsite contamination, even if that contamination was caused by operations that occurred long in the past, when environmental laws were not as stringent and when the activities giving rise to the contamination were permissible under the laws in place at that time. Therefore, potential purchasers must exercise substantial scrutiny in assessing whether contamination is or may be present at a property. Further, statutorily liable parties may not be able to rely on traditionally available contract, tort, or equitable defenses such as causation by third parties, proximate cause, or adherence to prevailing standards. In addition, owners or operators of potentially contaminated property can face concerns beyond potential costs associated with investigation or remediation. A number of state statutes such as New Jersey’s Industrial Site Recovery Act (N.J. Stat. Ann. § 13:1K-6 et seq.) and Connecticut’s Transfer Act (Conn. Gen. Stat. Ann. § 22a-134) require disclosure of environmental conditions and remediation or other consent before industrial businesses or the underlying real estate may be transferred. Moreover, owners of contaminated property can be vulnerable to common law claims grounded in causes of action such as negligence as well as toxic tort litigation aimed at compensating plaintiffs who claim injury due to exposure to hazardous materials. Accordingly, any party acquiring real estate in connection with a transaction should conduct robust due diligence, including Phase I ESAs, to assess the risk of onsite environmental contamination.
The owner or operator of contaminated real property may also be liable for costs arising out of contaminants migrating from the subject site. Migrating contamination can result in significant liabilities, particularly when the contaminants migrate into a residential area or beneath an environmentally-sensitive site, such as a school or hospital. There may also be a risk of migrating contaminants impacting aquifers used for potable water. The owner of property from which contaminants are migrating can be liable for property damage, remediation costs incurred by an affected property owner, and tort damages resulting from exposure to contaminants. Such liabilities have the potential to be significant. As such, potential purchasers of real property should assess, to the extent they are able, the risk of migrating contamination and the sensitivity of adjacent property occupants to determine the likelihood of the purchaser becoming responsible for such liabilities.
Conversely, the U.S. EPA and most state environmental regulators have determined that an owner of real property that is contaminated solely as a result of contaminants migrating onto the site from an offsite source is not liable for remediation costs. That said, the owner or operator may be liable for tort damages arising from exposure to such contaminants, such as in cases where contaminant vapors migrate into building structures, which is discussed in more detail below. As such, a potential purchaser of real property also should assess the risk of property impacts from migrating contaminants.
An issue drawing increased scrutiny from regulators and lenders on commercial real estate transactions is the risk of vapor intrusion. Vapor intrusion can occur when there is contaminated soil or groundwater located beneath an overlying building. Certain contaminants emit vapors that may rise through soils and into indoor air spaces, where they can pose both short- and long-term safety risks. In the short-term, a buildup of vapor in an enclosed structure can create the risk of explosion, hazardous exposure levels, or aesthetic problems (e.g., odors). Typically, however, the chemical concentration levels are low. In these cases, there is a concern that vapor intrusion may pose an unacceptable risk of chronic health effects due to long-term exposure to these low contaminant levels. Regulatory agencies are increasingly reevaluating certain sites that received regulatory closure, but still have residual contamination, to determine whether vapor intrusion pathways were examined during the original investigation and remediation phase. The EPA recently developed a Vapor Intrusion Screen Level Calculator to help owners and operators of contaminated land assess the risk of vapor intrusion at their site. U.S. EPA, Vapor Intrusion at Superfund Sites, available at http://www.epa.gov/vaporintrusion/vapor-intrusion-superfund-sites. But even where regulators have not established rules concerning vapor intrusion, many lenders have begun to focus on this risk to human health and safety. And because the risk from vapor intrusion can arise at sites that sit adjacent to, or in some cases some distance away from, the location where the contaminants originated, the scope of the due diligence inquiry may need to expand beyond the target property to encompass surrounding locations.
Evaluating the potential risk from vapor intrusion can be difficult, especially when trying to determine whether the same chemicals from emission sources in the building (e.g., household solvents, gasoline, cleaners) may pose, separately or in combination with vapor intrusion, a significant human health risk. In June 2015, the EPA issued vapor intrusion guidance that seeks to provide EPA and property owners with a framework for assessing and addressing vapor intrusion risk. U.S. EPA’s Office of Solid Waste and Emergency Response, Technical Guide For Assessing and Mitigating the Vapor Intrusion Pathway From Subsurface Sources to Indoor Air (June 2015), available at http://www2.epa.gov/vaporintrusion/technical-guide-assessing-and-mitigating-vapor-intrusion-pathway-subsurface-vapor. The EPA’s vapor intrusion guidance provides step-by-step recommendations for identifying, assessing, and mitigating short- and long-term risk associated with vapor intrusion in both commercial and residential buildings. Generally, the guidance recommends that a detailed vapor intrusion investigation, including both indoor and subsurface sampling, take place when available information suggests that volatile chemicals may be present in soil and groundwater beneath an existing or proposed structure. For prospective purchasers of property with known or suspected contamination beneath existing or proposed structures, it will be important to understand the EPA’s vapor intrusion guidance to determine what steps, if any, might be necessary to assess vapor intrusion risk. This is because the EPA (or concerned state regulators) unilaterally may determine that a vapor intrusion risk assessment is necessary if certain conditions exist, raising the prospect of regulatory action, even at locations where contamination previously had been addressed to the satisfaction of the regulator. Moreover, to the extent that property owners become subject to litigation alleging personal injuries from vapor intrusion, the vapor intrusion guidance may serve as a benchmark against which property owners will be measured.
For more on vapor intrusion, see 1-15A Environmental Law in Real Est. & Bus. Transactions § 15A.05 and 3-17B Environmental Law Practice Guide § 17B.01 et seq.
In addition to assessing risks arising from contamination, depending on the nature of the site and the plans for future use, environmental due diligence may also involve assessment of risks associated with the following.
The presence of asbestos in commercial buildings may generate both legal and business concerns for purchasers, developers, and other investors in commercial real estate. Building owners also can potentially face tort liability for personal injuries caused by exposure to asbestos. Moreover, failure to comply with regulations designed (1) to protect employees in the workplace from exposure to airborne asbestos fibers (29 C.F.R. § 1910.1001), including those requiring building owners to inform employees about the presence and location of asbestos containing material (ACM), and (2) to prevent the release of asbestos fibers into the environment during renovation or demolition, can result in substantial fines or penalties.
Regarding preventing the release of asbestos fibers during renovation or demolition, the Asbestos National Emission Standards for Hazardous Air Pollutants (Asbestos NESHAP) establish emission restrictions and work practices for a variety of asbestos-related activities. The Asbestos NESHAP is currently found in 40 C.F.R. § 61.140 et seq. The type and amount of asbestos that will be disturbed during the project determines whether the Asbestos NESHAP applies. 40 C.F.R. § 61.145(a). The Asbestos NESHAP has been amended several times, most comprehensively in November 1990. In 1995, the rule was amended to correct cross-reference citations to OSHA, U.S. Department of Transportation, and other EPA rules governing asbestos.
The mere presence of asbestos in a building is typically not a transaction deal breaker as long as it can be managed in place through an operations and maintenance (O&M) program. O&M programs typically include provisions specifying work processes to (1) maintain ACM in good condition and prevent disturbances, (2) ensure the proper cleanup of asbestos fibers that have been released, (3) prevent the further release of asbestos fibers, and (4) monitor the condition of the ACM present at the property. U.S. EPA’s book, Managing Asbestos in Place, commonly called “The Green Book,” is the primary source of EPA guidance on the topic of managing asbestos in buildings. A copy of the Green Book (July 1990) can be downloaded here.
Since an asbestos evaluation generally falls outside the scope of a Phase I ESA, prospective purchasers should specifically request an asbestos inspection where the presence or condition of ACM is thought to be a concern. First, the purchaser will want to ensure that substantial quantities of friable ACM do not exist in areas that are accessible or otherwise subject to dispersal to the building’s occupants or the public. Next, identifying the location of asbestos can be a critical factor in assessing costs for renovation due to the federal and state requirements that must be met when asbestos is abated as these mandated special work practices, which can only be carried out by specially licensed contractors, can materially increase construction costs. 40 C.F.R. § 61.145(c). These prescribed work practices generally are highly technical; however, they have a single purpose—to keep asbestos fiber release to a minimum. In situations in which the purchaser knows that renovation or demolition is contemplated, the purchaser should conduct an extensive survey of known and suspected ACM, if any, and obtain a budget for any required abatement activities. In situations in which renovation or demolition is not contemplated, the costs of managing the asbestos in place should be considered in relation to the property’s value.
For complete coverage of asbestos in commercial buildings, see 2-15 Environmental Law in Real Est. & Bus. Transactions § 15.01 et seq. and 5A-36 Environmental Law Practice Guide § 36.01 et seq.
Radon is a colorless, odorless gas that comes from the natural radioactive breakdown of uranium in the ground. Radon can infiltrate indoor air through the soil under the building or the water used in the building. According to the EPA, inhalation of radon can increase an individual’s risk for developing lung cancer. U.S. EPA, Radon Health Risks, available at http://www.epa.gov/radon/healthrisks.html. From a regulatory perspective, radon generally is raised as a concern in residential settings. In fact, the EPA has only issued guidelines for radon levels in the residential context, recommending that homeowners should take action when radon levels are between two and four picocuries per liter. In order to identify potential radon risks, the prospective purchaser should test the air at the likely entry point, typically the building’s lowest level. It is worth noting that many lenders will require radon testing involving at least one short-term sample from a ground-level unit or each building onsite. High radon readings can typically be addressed through mitigation measures that usually include vent pipes and fans to prevent radon from seeping into the building. Costs for implementing these types of mitigation measures generally are not considered expensive in the context of most transactions.
For more on radon, see 1-15A Environmental Law in Real Est. & Bus. Transactions § 15A.02.
Lead-based paint generally is recognized as a significant health risk to young children and pregnant women as ingestion can cause permanent damage to the brain and nervous system leading to behavior and learning problems, lower IQ, hearing problems in children, and an increased risk of miscarriage and birth defects for pregnant women. Although the use of lead-based paint has been banned in the United States since 1978, many residential and commercial structures, particularly those built before 1950, potentially contain lead-based paint. Conducting due diligence concerning the presence of lead-based paints is particularly important in transactions involve the sale of residential property, as EPA regulations, as well as many state laws, require notice of potential lead-based hazards during the sale or lease of certain housing (24 C.F.R. pt. 35) and specify that lead-based paint inspections and abatement can be performed legally only by certified parties (40 C.F.R. pt. 745). Prospective purchasers need to be aware that a failure to identify or properly abate lead-based paint hazards ultimately can result in personal injury claims alleging lead poisoning that are based on theories of negligence, strict liability, or breach of express or implied warranty. Buyers of buildings that potentially contain lead-based paint should consider whether they or the seller should bear the cost of an inspection, risk assessment, or the cost of abatement if lead-based paint is identified.
For a general discussion of the implications for owners of buildings and property contaminated with lead-based paint, see 5A-36A Environmental Law Practice Guide § 36A.05.
Mold is a substance that is naturally occurring, so it is always present in the environment. Outdoors, molds are an integral part of natural processes breaking down leaves, wood, and plant debris; however, indoors, mold spores grow by digesting whatever organic substance they land on, including wallpaper, insulation, drywall, and roofs. According to the EPA, exposure to mold can potentially be a health risk ranging from mild and temporary allergic reactions to more severe illnesses such as lung infections. U.S. EPA, Mold Resources, available at http://www.epa.gov/iedmold1/moldresources.html. As such, damages from a toxic mold claim could include repair costs, damages for loss of use of property or items, relocation expenses, depreciation of property value damages, and personal injury-related costs. Conducting due diligence concerning the presence of mold is often done in conjunction with an overall assessment of the physical condition of the property. The focus of an initial mold assessment is on the potential for water intrusion, which means that the consultant is often assessing the condition of the roofs, windows, hot water heaters, HVAC systems, plumbing, and other features in a building where water can saturate building materials and lead to mold growth.
Mold investigations are typically beyond the scope of a traditional ASTM Phase I; however, an environmental evaluation of property should include a non-invasive assessment to identify visual evidence of mold, such as discoloration on surfaces, evidence of water intrusion or leakage or flooding problems, suspect growth within the HVAC system, and any suspect odors. A prospective purchaser also should review maintenance records and pose questions to the seller regarding the history of complaints from building occupants regarding persistent plumbing problems, odors, mold, and air circulation. If a history of building occupant complaints is identified or if an initial inspection detects suspect conditions, it may be necessary to conduct follow up sampling of the air and building materials. While many consultants tend to focus on determining the type of mold, the key to addressing mold is to determine the source of the water, ensure that it is eliminated and then remove damaged materials, including those with mold growth. If such abatement is required, an abatement plan is needed and sampling will be warranted to determine whether cleanup has been completed.
For more on mold, see 1-15A Environmental Law in Real Est. & Bus. Transactions § 15A.04 and 5A-36C Environmental Law Practice Guide § 36C.01 et seq.
Developers of real property need to be aware that stringent laws are in effect regulating construction that impacts potential wetlands. Wetlands subject to federal control are often referred to as jurisdictional wetlands because they are subject to the regulatory jurisdiction of federal law. Jurisdictional wetlands are regulated under Section 404 of the Clean Water Act of 1972 because they are important for the protection of aquatic species and waterfowl, water purification, and flood control. 33 U.S.C. §§ 1251–1387. The EPA and the U.S. Army Corps of Engineers, the two federal agencies with the authority to regulate wetlands, identify wetlands as “those areas that are inundated or saturated by surface or groundwater at a frequency and duration sufficient to support, and that under normal circumstances do support, a prevalence of vegetation typically adapted for life in saturated soil conditions.” Envtl. Technical Servs. Co., Federal Manual for Identifying and Delineating Jurisdictional Wetlands (Jan. 10, 1989), available at http://www.wetlands.com/pdf/89manv3b.pdf.
Prior to purchasing a property for development, the prospective purchaser should conduct a wetlands survey for several reasons. A determination that jurisdictional wetlands are located on the undeveloped property that is the subject of the transaction may profoundly affect the value of the property if the location of the wetlands would present significant hurdles to site development. Such a finding can result in significant delays and extra costs to the developer because the permitting process can be complicated and open to interpretation regarding the potential impact of the development activities and the potential mitigation measures that are necessary. Moreover, heightened public scrutiny with respect to the protection of wetlands increases the possibility that various interests could use the wetlands regulatory scheme to block or delay development. In addition, developers should determine whether wetlands are present because the destruction of wetlands can result in substantial administrative, civil, and criminal penalties under Section 404 of the Clean Water Act. See 33 U.S.C. §§ 1311(a), 1344. Because the Clean Water Act is a strict liability statute, no intent to destroy wetlands needs to be proven to establish a civil violation. Note, while the first step in a wetlands assessment is an onsite visual inspection, which may be followed by a formal delineation, it ultimately may be necessary to involve the government in the process, as it is the only entity that can conclusively determine the presence and location of jurisdictional wetlands.
For more on jurisdictional wetlands, see 1-9 Environmental Law in Real Est. & Bus. Transactions § 9.02 and 4-19 Environmental Law Practice Guide § 19.03.
Threatened and Endangered Species
The federal Endangered Species Act prohibits anyone from harassing, capturing, or killing any protected species. 16 U.S.C. § 1531 et seq. To date, approximately 1,100 species have been designated as endangered or threatened worldwide. However, more than 3,600 have been identified as candidates for endangered or threatened status and are awaiting official action. If a proposed development will disturb or destroy habitat of a protected species, such a development may be a violation of the Endangered Species Act, subjecting the developer to potential fines, penalties, and injunctions. As such, developers need to assess the potential for projects to impact protected species, particularly if the project is sited on undeveloped land, or if it may impact wetlands or water bodies. Typically this involves hiring an environmental consultant to assess the project site for protected species habitat. Protected species assessments should be conducted as early as possible in the project planning stages, as the presence of protected species on a project site may prevent the project from moving forward.
For an in-depth discussion of wildlife and habitat protection, see 4-24 Environmental Law Practice Guide § 24.01 et seq.
Compliance with Current and Pending Laws
When conducting environmental due diligence in a real estate transaction, it may also be necessary to assess the property occupant’s compliance with environmental laws and environmental permitting requirements. This is particularly true in transactions involving properties that are occupied by manufacturers and other businesses that handle large quantities of hazardous materials (and it will always be true in transactions where the purchaser is acquiring both the real property and the business operations), as failure to comply could result in contamination, a lack of authority to operate, and increasingly negative publicity. Since compliance evaluations are beyond the scope of a typical ASTM Phase I, purchasers conducting diligence on property where environmentally sensitive operations take place should consider requiring their consultant to conduct some form of a compliance review or audit as part of the consultant’s evaluation. Topics generally covered by a limited compliance review include:
- An assessment of a target’s or site’s environmental management system
- Permitting status
- Emissions to air, including control measures
- Water and wastewater supply
- Use and management
- Hazardous materials and waste management
- Noise concerns
For coverage of environmental permitting and compliance issues, see 1-5A Environmental Law Practice Guide § 5A.03.
Traditionally, environmental due diligence in real property transactions has focused on the presence of contamination and, if the site is developed, compliance with environmental requirements. Today however, environmental diligence has gone beyond contamination and traditional compliance to consider risks associated with climate change, water availability, and electricity use, which are summarized below. Parties tasked with conducting environmental due diligence must keep informed of these new issues in order to effectively incorporate them into their due diligence review.
Many businesses require a substantial and reliable supply of clean water for industrial purposes, support functions, facility operations, and as an ingredient for many products. Traditionally, these same businesses took an abundant and affordable supply of clean water for granted; however, today, as population growth, industrialization, urbanization, and the impact of climate change place unprecedented stress on the global water supply, attitudes towards water are changing. Globally, fresh water is increasingly becoming an endangered resource. Estimates project that the need for fresh water will exceed supply by 40% by the year 2030. U.S. Office of the Director of National Intelligence, Intelligence Community Assessment: Global Water Security (Feb. 2, 2012), available at http://www.dni.gov/files/documents/Special%20Report_ICA%20Global%20Water%20Security.pdf. Water intensive business sectors include agriculture, beverage production, chemical production, oil and gas exploration, electric power production, semiconductor production, and mining.
There are a variety of ways in which water risks can manifest. First, water risks can arise as direct and specific risks to business operations, such as business interruptions due to water shortages, water quality or treatment issues, supply chain interruptions, or increasing water supply costs. Businesses also may face heightened public scrutiny regarding the volumes of water they are extracting or the pollutants they are discharging to the increasingly coveted resource. Business may become increasingly subject to more stringent regulatory oversight regarding water use, including burdensome restrictions on water allotments or use. Increasingly, water uncertainty could lead to restricted access to capital as lending restrictions or more stringent investment policies are crafted to address water risk. Therefore, in transactions involving real property that may be used by water-intensive businesses, or in areas with severe restrictions on water use, it may be prudent to include an assessment of water risks as part of the due diligence process.
In order to diligence a business’s potential exposure to water risk, several considerations should be evaluated. First, it is imperative to understand direct and indirect water use in order to assess water risk associated with operations and supply chain by:
- Confirming the property’s legal rights and obligations with respect to quantity, quality, price, reliability, and duration of water supply and the viability of these resources
- Determining whether the property is located in a water-stressed region or a region that could foreseeably face water stress in the future, and
- Assessing whether the current or likely operator’s products or services may be impacted by water curtailment
Another area of increased attention in due diligence is energy efficiency and conservation. Depending on the nature of site operations, energy use can represent a significant cost to site occupants. Energy efficiency is also an area experiencing increased regulation at the federal, state, and local level. Many local jurisdictions are requiring new development to meet certain green building codes, which standards relating to energy and, in some cases, water use. While employing efficiency technologies in new building development may reduce costs over the long term, they can increase the short-term cost of development. As such, developers obviously need to be aware of energy efficiency requirements. Purchasers of buildings in areas with energy efficiency regulations also need to be aware of such requirements and should ensure that the acquired structures meet all applicable energy efficiency codes and regulations.
In addition, purchasers of commercial property should be aware that increasingly, corporate tenants are looking to lease space in buildings that have been recognized for their green qualities, which include energy efficiency. Perhaps the best known recognition is that bestowed by the U.S. Green Building Council, which recognizes Leadership in Energy and Environmental Design, or LEED, in building construction and design. As such, potential purchasers of commercial property should assess whether the property has been LEED-certified or, if it has not, the likely costs to obtain LEED certification. Doing so could result in greater demand and higher rents from corporate tenants that have prioritized LEED-certified space.
For more on green buildings, including LEED rating systems and federal, state, and local green building laws and regulations, see 3-17D Environmental Law Practice Guide § 17D.01 et seq.
Climate Related Risks
Climate change risks associated with real property generally focus on the physical risks to land and infrastructure due to the wide-ranging impacts that may be attributed to climate change, including:
- Changes in seasonal patterns
- Rising sea levels
- Increased severity and frequency of extreme weather events, such as tropical storms and cyclones
- Increased severity of drought
Physical risks can be difficult to assess since they may arise well into the future or otherwise be contingent or speculative; however, these risks are being assessed more frequently, particularly in the context of obtaining property insurance.
For more on emerging issues in environmental due diligence, see 3-20 Environmental Law in Real Est. & Bus. Transactions § 20.04.
Special State Programs
Each state has its own environmental requirements and, as noted above, certain liability protections afforded under federal laws will not exempt a responsible party from liability under state laws. As such, it is, of course, necessary during the due diligence process to obtain an understanding of what state (and local) environmental requirements are applicable to the subject property. While many state laws are similar to federal programs, there are often differences. And, in some cases, there may be state programs that provide property owners with liability protections, or that help mitigate costs, associated with environmental contamination. A few examples are summarized below.
Innocent Landowner Programs
In addition to the federal protections provided under CERCLA for innocent landowners that perform AAI, certain states have developed similar protections for purchasers of real property. These programs vary from state to state, but generally require a landowner seeking protection from liability to demonstrate that it did not cause the contamination and, in most cases, that the contamination occurred prior to the innocent owner acquiring the property.
For example, in Illinois, an innocent purchaser of contaminated real property may have a statutory defense to liability for remediation obligations if it can demonstrate it conducted all appropriate inquiries regarding the environmental conditions of the property and had no reason to know of the existence of contamination at the time the property was acquired. 415 Ill. Comp. Stat. § 5/22.2(j)(6)(B). In Iowa, innocent purchasers have blanket immunity from third-party claims for contamination they did not cause. Iowa Code § 455B.752. In addition, the Iowa Supreme Court decided in 1995 that an innocent owner cannot be held liable by the state for contamination it did not cause. Blue Chip Enterprises v. State of Iowa Department of Natural Resources, 528 N.W.2d 619, 624 (Iowa 1995). In Michigan, innocent purchasers can obtain a protection from liability for existing contamination if, at the time they purchase the property, they conduct what is known as a baseline environmental assessment (often referred to as a BEA) prior to, or within 45 days of, acquiring the site and submit the results of the assessment to the state Department of Environmental Quality. Mich. Comp. Laws § 324.20101(c) and (f). Note, to qualify for liability protections under the Michigan BEA program, the property owner may need to comply with certain ongoing obligations that are detailed in the statute. Many other states have similar programs. Purchasers of real property, therefore, should research the availability of state innocent landowner programs prior to acquiring a site to determine what protections might be available and what a purchaser must do to avail itself of such protections.
For a summary of state law innocent landowner provisions, see 1-5A Environmental Law Practice Guide § 5A.04[b].
Voluntary Cleanup Programs
Most states have enacted laws specifically designed to remove or lessen the common barriers to redeveloping contaminated sites. The state programs vary widely; however, many include a voluntary cleanup program under which a property owner can receive expedited state approval for a voluntary cleanup. Usually, a developer must apply and pay a fee to the relevant state environmental agency to enter into the voluntary remediation program. The requirements for the application differ from state to state. For a state-by-state description of voluntary cleanup programs, see 1-24 Environmental Law in Real Est. & Bus. Transactions § 24.06. Many states have issued guidance or policy documents that explain the applicable requirements and have posted such documents on the state’s website to assist applicants.
In some states, performance of a voluntary cleanup releases the owner from future liability to the state for cleanup of preexisting contamination. An agreement with the state also may provide some protection from liability under federal law. Nearly half of the states have entered into memoranda of agreement with the U.S. EPA to coordinate their state cleanup programs with EPA and to provide assurance to parties cleaning up a contaminated site through a state program that the cleanup will satisfy the party’s obligations under federal law. See CERCLA § 128(b)(1)(A)(i)–(ii), 42 U.S.C. § 9628(b)(1)(A)(i)–(ii). Anyone intending to buy or develop a brownfield property should contact the state and local regulatory agencies for detailed information regarding voluntary remediation projects.
Remediation Trust Funds
Certain states maintain trust funds to cover costs associated with the remediation of certain contamination. Common examples are those covering releases of petroleum products from underground storage tanks (USTs) and releases of solvents from dry cleaning operations. UST trust funds typically will reimburse the UST owner for certain costs incurred in response to a release from the UST. For example, California has established a trust fund that reimburses eligible claimants for certain environmental investigation and remediation costs arising from a UST release, as well as costs arising from third party claims for bodily injury or property damage. Cal. Health & Safety Code § 25299.50 et seq. The maximum amount of reimbursement per occurrence from the California fund is $1.5 million, less the eligible claimant’s applicable level of deductible (ranging from $0 to $10,000). In order to submit a claim under the California program, the claimant must (1) be a current or past owner or operator of the UST from which a release has occurred; (2) be required by the regulatory agency to undertake corrective action; and (3) be the individual or entity that has paid or will pay for the costs of cleanup.
Some states also maintain trust funds to provide reimbursement to owners of locations that were contaminated by historic dry cleaning operations. For example, the state of Alabama maintains a fund to reimburse certain owners of current or former dry cleaning facilities, or any adjacent landowners whose property was impacted from dry cleaning operations, for costs incurred to investigate and remediate releases related to dry cleaning activities. Ala. Code § 22-30D-1 et seq. All activities for which reimbursement is sought must be preapproved by the state advisory board tasked with administering the fund, and all work must be done by a preapproved environmental consultant. Under the Alabama program, sites for which reimbursement is sought are ranked in terms of the potential for harm, and available funds are then allocated only to those sites with the highest ranking.
When conducting due diligence on sites that have, or may have had, USTs or dry cleaning operations, one should determine whether such funds are in existence, and if so, understand the eligibility requirements. If funding is available for known or potential contamination at a site, a prospective purchaser can tailor the diligence accordingly, knowing that if potential environmental costs arise in the future, there may be a funding source available to help offset such costs.
In certain jurisdictions, environmental laws may allow for the use of deed restrictions in place of costly remediation. For example, in Texas, an owner of certain land with known contaminated groundwater may apply for what is known as a municipal setting designation (MSD), which prohibits current and future use of groundwater for potable purposes, but also limits the investigation and remediation requirements applicable to the contaminated groundwater. Tex. Health & Safety Code § 361.801 et seq. For a property to be eligible, there cannot be a potable water well located within one-half mile of the borders of the property seeking the MSD. As such, most of the sites with MSDs are located in metropolitan areas, mainly focused in Houston and Dallas. Of note, municipalities are capable of obtaining MSDs for their entire jurisdiction, such that any property within the municipality would be covered under the MSD provisions. If a property is covered under an MSD, a party that would otherwise be required to investigate and remediate groundwater contamination is relieved from such responsibilities unless the groundwater contamination poses a threat to humans from non-potable uses or to ecological resources. That said, while deed restrictions such as the Texas MSD program may elevate the need to conduct remediation, the contamination will remain in place, and there are risks associated with this approach, including those associated with vapor intrusion. In addition, if the property is going to be redeveloped, there may be a need to conduct excavation that will unearth contaminated soil and groundwater, which will need to be addressed and can result in increased construction costs.
Applying Information Obtained During Due Diligence to the Transaction
Upon completion of the environmental due diligence investigation, the purchaser should have obtained a solid understanding of the actual and potential environmental issues affecting the real property. The purchaser also should have a good awareness of the extent to which liability protections are available with respect to the issues identified during diligence. With this knowledge in hand, the purchaser may have several options at the end of due diligence assessment.
Take, for example, the situation in which a Phase I ESA determines that a dry cleaner historically operated at the property the purchaser intends to purchase and identifies as a REC the risk that contamination exists on the property from past releases of the dry cleaning operations. By becoming the owner of the property, the purchaser could be statutorily liable for any onsite contamination; however, if the property resides in a state with a viable trust fund established to reimburse property owners for certain costs associated with remediating past releases from dry cleaning operations, the purchaser may be willing to assume that risk and proceed with the purchase without further diligence.
If, however, such a trust fund is not available, the purchaser may want to conduct a Phase II ESA to confirm whether or not contamination is present onsite. The purchaser likely would also want to sample indoor air to determine if there are issues with vapor intrusion. If the seller permits the purchaser to conduct sampling, which is not uncommon in real estate transactions, and the tests do not identify contamination, then the purchaser can proceed to purchase the site comfortable that the environmental risks have been fully assessed. If, however, contamination is identified, then the purchaser may determine that it no longer wants to proceed and terminate the transaction. The purchaser also may be able to negotiate a reduced purchase price to account for the costs associated with addressing known contamination. Note that a purchaser need not confirm the presence of contamination through sampling to negotiate a reduced purchase price; under certain circumstances, the well-documented risk of contamination may serve as the basis to reopen negotiations.
Another common situation identified in a Phase I ESA is the risk of contamination migrating onto the real property that is the subject of the transaction from an offsite source. Typically, an innocent owner of real property contaminated solely as a result of migrating contamination from an offsite source will not be responsible for any remediation costs. That said, there may be a risk of vapor intrusion if contaminants are migrating beneath buildings, which could affect the health and wellbeing of any onsite tenants and subject the property owner to potential tort liability. In such circumstances, a purchaser should consider conducting indoor air sampling to confirm whether vapor intrusion is occurring, and if it is, the purchaser may want to terminate the transaction or renegotiate the deal terms.
In short, the results of an environmental due diligence process will be as varied as the properties being assessed. In transactions involving the purchase of real estate for investment purposes, environmental due diligence will always be critical to understanding the value of the asset. As discussed throughout this practice note, environmental remediation costs can be significant, and in many cases, the owner of the real property can be held liable for remediation costs, regardless of fault. Moreover, the presence of contamination or other environmental attributes (such as wetlands and endangered species) can impact future site use and development, which also impacts the value of the property. That said, environmental due diligence needs to be tailored to the asset(s) involved in the transactions. A due diligence assessment of a former industrial site will not be the same as that conducted on a residential property. In any event, purchasers, sellers, and lenders need to understand the importance of environmental due diligence and factor these considerations into the real estate transaction. For more on using environmental information in deal negotiations, see 3-20 Environmental Law in Real Est. & Bus. Transactions § 20.05.
For a complete discussion of environmental due diligence, see 3-20 Environmental Law in Real Est. & Bus. Transactions § 20.01 et seq. and 1-5A Environmental Law Practice Guide § 5A.01.
For information on retaining environmental professionals and working with environmental consultants to assist in performing environmental due diligence, see 3-20 Environmental Law in Real Est. & Bus. Transactions § 20.04; 3-23 Environmental Law in Real Est. & Bus. Transactions § 23.01 et seq.; and 1-5 Environmental Law Practice Guide § 5.01 et seq.
For a sample environmental questionnaire that can be used in connection with a due diligence investigation for an environmentally sensitive business, see 3-20 Environmental Law in Real Est. & Bus. Transactions § 20.07. For a sample environmental questionnaire that can be used in connection with a due diligence investigation for a non-environmentally sensitive business, see 3-20 Environmental Law in Real Est. & Bus. Transactions § 20.07.