EPA Addresses 'Due Diligence' In Real Estate Transactions

Saturday, April 1, 2006 - 00:00

Background: Securing Liability Protection

To anyone seeking to purchase or develop real estate, a rule recently promulgated by the federal Environmental Protection Agency (EPA) should be of interest. The rule was published in the Federal Register on Nov. 1, 2005 (70 Fed. Reg. 66069, to be codifed at 40 CFR 312)(the 'Rule'). It establishes federal standards and practices for conducting 'all appropriate inquiry' as required under sections 101(35)(B)(ii) and (iii) of the Comprehensive Environmental Response Compensation and Liability Act (CERCLA), also known as the Superfund law. The reason the Rule may be of interest to owners and developers is that it establishes a basis for eliminating liability for environmental discharges, spills or leaks which occurred prior to the owner/developer taking title to or control of the property. It also can be viewed as establishing a baseline standard for the performance of environmental due diligence for companies which are acquiring real estate through mergers and acquisitions and, possibly, companies who have reporting obligations under other regulatory frameworks for real estate-based liabilities.

Since its enactment in 1980, CERCLA has always contained a requirement that prospective purchasers of real estate perform 'all appropriate inquiry,' but that phrase was never really defined, despite several rule-making efforts and numerous interpretations by federal courts. The statute, itself, was likewise amended, yet the need to clarify the extent of investigation necessary to be conducted prior to purchase to shield the purchaser from liability still remained unaddressed. Not until this latest rule-making has a true bright-line test, long sought by real estate owners, operators, investors and secured creditors, been established. Prospective landowners who do not conduct all appropriate inquiries prior to or on the date of obtaining ownership of the property lose their ability to claim protection from CERCLA liability.

Practical Ramifications

The Rule has necessitated the modification of the existing ASTM method for performing a Phase I Environmental Site Assessment. That standard was prepared by a consensus committee of ASTM in the early 1990's to attempt to fill the gap in the statute and in EPA's rules and guidance for what constitutes 'all appropriate inquiry' under CERCLA.It remains the preeminent method for the conduct of initial inquiries into the condition of real estate.Specific changes to the ASTM method due to the new due diligence definition in the Rule include the establishment of the requirement to perform title searches for each Phase I report. Although always designated as a good source of historical data about a particular property, title searches had previously not been a mandatory requirement. The value of title searches as a primary source of information is unquestionable, but may cause some delay in preparing the final report due to the time it may take to obtain the search data.

The Rule requires the environmental professional to record all results of inquiries and his or her conclusions regarding conditions related to any releases or potential release of hazardous materials on and around the property, and that a written report be presented to the property owner. The Rule also requires that the written report include the certification of the environmental professional as to whether the 'all appropriate inquiry' activities conducted identified conditions indicative of releases or threatened releases of hazardous substances on, at, in or to the subject property. The professional is now obligated to identify data gaps in the information collected that affect the professional's ability to render such an opinion. The new and expanded certification may increase the cost of Phase I Site Assessments, and cause the professional to disclose when a client requires a deviation from the activities mandated by the Rule.

In addition to the changes in the site assessment methodology, the Rule also requires the potential owner/developer to demonstrate that they are not potentially liable or affiliated with any other person that is potentially liable for response costs at the property. In the case of contiguous property owners, the landowner claiming to be a contiguous property owner also must demonstrate that he did not cause, contribute, or consent to any release or threatened release of hazardous substances. To meet the statutory requirements for prospective purchasers, a property owner must have acquired a property subsequent to any disposal activities involving hazardous substances at the property.

Not A Panacea

The Rule does not modify any state-specific assessment method, as those state-based assessment methods are used to determine protection from state, not federal, liability. Therefore, any environmental due diligence activities must still take into account the regulatory vagaries of the various states. Parties wishing to establish protection from, or a defense to, liability under a state superfund or other related law must also still comply with any liability exemption or defense criteria established under state laws, including any standards for conducting the site assessments necessary to secure the exemption or defense under applicable state statutes or regulations. If foreign real estate is involved, the requirements of the individual country in which the real estate is located must likewise be considered.

Other Caveats To Keep In Mind

In some ways, the 'innocent purchaser' defense under CERCLA has been perceived as illusory due to the difficulty in satisfying its myriad of prerequisites, starting with the lack of a bright-line standard for establishing whether 'all appropriate inquiry' had been conducted. While this Rule addresses the need to define the quote phrase, it does not provide a straight line path to securing protection from pre-existing environmental liability. CERCLA mandates certain continuing obligations, such as complying with land use restrictions and not impeding the effectiveness or integrity of institutional controls; taking ''reasonable steps'' with respect to hazardous substances affecting a landowner's property to prevent releases; providing cooperation, assistance and access to EPA, a state, or other party conducting response actions or natural resource restoration at the property; complying with CERCLA information requests and administrative subpoenas; and providing legally required notices. The EPA notes that persons conducting 'all appropriate inquiry' in compliance with the new Rule are not entitled to the CERCLA liability protections provided for innocent landowners, bona fide prospective purchasers, and contiguous property owners, unless they also comply with all of the continuing obligations established under the statute. Further, the Rule will also affect any person or business who receives a Brownfields grant awarded under CERCLA who uses that grant money to conduct site characterization or assessment activities. Such parties are required to conduct the designated activities in compliance with the standards and practices established by the EPA for the conduct of all appropriate inquiries. A buyer of contaminated property who wishes to enter into a prospective purchaser agreement with EPA to secure the innocent landowner defense under CERCLA will also have to comply with the new due diligence standards in the Rule before they enter into the agreement. Compliance with the Rule is therefore only one requirement necessary to secure the desired CERCLA liability protection.

It should also be noted that the Rule addresses only potential liabilities arising out of the environmental condition of real estate. It does not focus on the potential liabilities associated with compliance issues arising out of the operation of industries occupying the real estate (that is, liability which may exist in connection with permitting or health and safety requirements). Those issues are outside the scope of CERCLA.

The Future Of EnvironmentalDue Diligence?

While the Rule was adopted to address a seeming deficiency or gap which existed in the CERCLA regulations and guidance, the real impact of the Rule may be in the future evolution of environmental due diligence. The Rule will undoubtedly play a role in the standardization of environmental due diligence activities and, consequently, the standardization of how information revealed by such activities is processed. One area where the Rule may have an impact is in the reporting of environmental due diligence in the context of mergers and acquisitions, financing and other secured transactions.

Given the reporting obligations imposed by other regulatory frameworks, such as Sarbanes-Oxley, there is increased pressure on companies to report information and to report it in a format which, if not standardized, is at least trending toward a common format. Reporting of environmental due diligence may follow that trend of standardization, especially if significant liability potential is revealed. Therefore, while mergers and acquisitions typically do not hinge on real estate liabilities (due to other factors driving the transaction which may be perceived as overwhelming any potential real estate liability issues), one real effect that the Rule may have is on the standardization of the reporting of environmental information in other contexts. It may, for example, come to be referenced or cited by other regulatory schemes as a baseline for the reporting, consideration or disclosure of liabilities associated with real estate.

While the majority of real estate transactions do not involve issues which trigger the applicability of CERCLA liability, the lack of other standardized guidance in environmental due diligence activities renders the Rule important to all real estate transactions. For these reasons set forth above, the Rule should be understood and its elements incorporated into checklists used in the evaluation of environmental issues affecting real estate. Environmental professionals (attorneys and consultants) should be incorporating the Rule guidance into their activities conducted in connection with any real estate transaction, whether acquisition, disposition, or securitization.

Catherine M. Ward is Of Counsel in Stradley Ronon's Cherry Hill, N.J., office. She represents both private and public entities in environmental, real estate and land use matters. She may be reached at 856-321-2402.

Please email the author at cward@stradley.com with questions about this article.