New Standards And Practices For Conducting Environmental Due Diligence

Saturday, April 1, 2006 - 01:00

"No fault" liability for both current and former property owners, and others, of properties impacted by hazardous substances is the purpose of the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), also known as Superfund. The Environmental Protection Agency's new "All Appropriate Inquiry" rule (see 40 CFR Part 312) offers protection from such liability so long as persons or businesses purchasing commercial property pay attention to the necessary requirements for conducting proper "all appropriate inquiry" (i.e. due diligence) in commercial real estate transactions. Protection from CERCLA liability for property owners is established under the following defenses to CERCLA liability: bona fide prospective purchaser defense, innocent land owner defense, and contiguous property owner defense.

Defining The Liability Defenses

Concerning the bona fide prospective purchaser defense, this defense applies to a prospective purchaser who possesses prior knowledge of the presence of contamination. This defense exists provided: (1) the purchaser conducted "all appropriate inquiry" prior to acquiring title to the property, (2) all disposal of hazardous substances at the site occurred prior to the purchaser acquiring title, and (3) the purchaser exercises "appropriate care" post-closing such as stops any continuing release, prevents any threatened future release, and prevents or limits exposure to the contamination. This defense is perhaps the most useful defense of the three available defenses.

Concerning the innocent landowner defense, this potential defense exists if the purchaser was unaware or had no reason to know of contamination existing on the property at the time of acquisition. This defense is available provided: (1) the purchaser conducted "all appropriate inquiry" prior to acquiring title to the property, (2) no contractual relationship exists between the party that caused the contamination and the purchaser, and (3) the purchaser exercised "due care" with respect to the hazardous substances and took precautions concerning foreseeable acts or omissions of third parties.

Concerning the contiguous property owner defense, this potential defense is similar to the innocent landowner defense as the prospective purchaser of the contiguous property must not have known or had reason to know about the contamination at the time of property acquisition. This defense is available provided: (1) the purchaser conducted "all appropriate inquiry" prior to acquiring title to the property, (2) the contamination was a result of hazardous substances migrating from adjacent parcels, and (3) the purchaser takes "reasonable steps" and exercises "appropriate care" post-closing to prevent ongoing and future releases.

The point of beginning for each of the three defenses is the proper performance of "all appropriate inquiry." While the new "all appropriate inquiry" rule is not formally effective until November 1, 2006, adherence to the new rule's requirements now, or the new ASTM E1527-05 Phase I Environmental Site Assessment Standard, which the EPA has determined is consistent and compliant with the EPA's new rule, is prudent.

Key Issues

There are several key issues under the new rule, and prospective purchasers of commercial property are advised to have a conversation with an environmental attorney or an environmental professional, or both, to understand the obligations imposed in order to preserve the available defenses to liability. One key change regards the "shelf life" of an existing environmental site assessment report. Under the new "all appropriate inquiry" rule, a prospective property owner may use an existing environmental site assessment without updating any of the information collected as part of the original inquiry only if the "all appropriate inquiry" investigation was completed less than 180 days prior to the date of acquisition of the property.

If the site information was collected more than 180 days prior to closing, but no more than one year prior to the date of acquisition, certain components of these existing reports must be updated within 180 days prior to closing. The components requiring updating include: (i) interviews with owners, operators, and occupants; (ii) searches for recorded environmental cleanup liens; (iii) reviews of government records; (iv) visual inspections of the subject property and of adjoining properties; and (v) the environmental professional's declaration concerning compliance with the new rule.

Practically speaking, this means a phase I environmental site assessment more than six months old at the time title is acquired is not likely to meet the new "all appropriate inquiry" rule without significant updating. Further, a phase I environmental site assessment greater than twelve months old cannot be relied upon to satisfy this new "all appropriate inquiry" standard. Information collected from prior "all appropriate inquiry" investigations can be used as sources of information even if more than one year old as long as the information is reviewed for accuracy and updated in accordance with the new standard to account for current conditions.

Another issue resulting from the new rule is the requirement for interviews with current owners and occupants of the property to collect information on past uses and identify potential conditions that may indicate the presence of hazardous substances at the subject property. The new rule requires additional interviews with past owners and occupants and others, if necessary, to meet the "objectives and performance factors" of the final rule. (See 40 CFR312.20(e)-(f) (2005)). The interviews of prior owners could be problematic for a number of reasons; thus, consideration of the necessity to interview past owners and operators should receive careful evaluation. The final rule does allow the interviewing environmental professional some discretion in determining whether such interviews are necessary; the final rule, however, mandates interviews with owners and occupants of neighboring and nearby properties in those situations where the property being purchased is abandoned.

A more extensive documentation of "data gaps" is also required under the new rule. The environmental professional must identify data gaps affecting their ability to identify conditions indicative of releases or threatened releases of hazardous substances relating to the subject property. The environmental professional must identify in the report the sources of information consulted to address such data gaps and comment in the report upon the significance of such data gaps and its affects on the ability to identify conditions indicative of releases of hazardous substances on the property.

The new rule requires the prospective property owner and the environmental professional take into account information collected during the "all appropriate inquiry" investigation to consider the "degree of obviousness of the presence or likely presence of contamination at the property." They should take into account the information collected during the inquiries in considering the ability to detect contamination by appropriate investigation. The written report should contain the environmental professional's opinion regarding any additional appropriate investigation necessary to detect the presence of contamination.

Under the prior "all appropriate inquiry" standard, a purchaser with "actual knowledge" of the purchase price being significantly less than the purchase price of comparable properties should try to identify an explanation for the lower price. Under the new rule, if it is concluded that the purchase price does not reasonably reflect the fair market value of the property if the property were not contaminated, consideration must be given whether or not the differential in purchase price and fair market value is due to the presence of releases or threatened releases of contaminants. This new obligation, however, does not require a real estate appraisal be obtained in order to ascertain the fair market value of the property.

The new rule has an increased emphasis upon identifying any institutional and engineering controls present on the subject property. Indeed, to enjoy the liability protections, new property owners must demonstrate affirmatively that nothing was done to interfere with the integrity or effectiveness of institutional controls or engineering controls present at the subject property.

Special Qualifications For Environmental Professionals

To better insure the quality and reliability of "all appropriate inquiry" investigations, the new rule defines specific qualifications for environmental professionals. The definition of an environmental professional, unlike the earlier "all appropriate inquiry" rules, imposes specific educational, certification or licensing, and relevant experience requirements. The new rule requires the written report include a declaration by the environmental professional that the qualifications for environmental professionals were met and a declaration stating the "all appropriate inquiry" was carried out in accordance with the requirements of the new rule. The environmental professional should insure that the objectives and the performance factors contained in the new rule are satisfied. Particular information to be identified includes the following: uses and occupancies of the property; uses of hazardous substances; waste management activities; corrective actions and response activities; institutional and engineering controls; and nearby and adjoining properties with environmental conditions. The agencies will evaluate the thoroughness and reliability of the information gathered by the environmental professional.

Rule Is Performance Based

In short, the new "all appropriate inquiry" rule is performance based, not a mere checklist. Because the need for the defenses to liability will occur years in the future, careful documentation by the property owner and those assisting the property owner in the due diligence inquiry is essential to protecting the viability of the defenses to liability. Consideration by the property owner and those assisting regarding whether sampling and analysis may be prudent to address identified data gaps, though such sampling and analysis is not necessarily required under the new rule, is advisable. Because interviews with past owners and operators at the site may present significant issues for the transaction itself, careful thought is advised as to how this requirement, if necessary, is met.

In sum, every potential owner of commercial property should know changes have occurred to the "all appropriate inquiry" of commercial property necessary to preserve defenses to liability for environmental contamination.

Rory C. Ryan is a Partner in the Orlando office of Holland & Knight LLP, where he practices in the area of environmental litigation. He may be reached at (407) 244-5110.

Please email the author at rory.ryan@hklaw.com with questions about this article.