Expanded Site Assessments Required Under EPA's Proposed "All Appropriate Inquiry" Due Diligence Standard - Part I

Jean H. McCreary is a Partner and Chair of the Energy & Environment Practice Group of Nixon Peabody LLP. She has been certified by the Board of Environmental Auditor Certifications as a Certified Professional Environmental Auditor and participated in the comment process for the AAI rulemaking on behalf of three professional associations representing auditor interests. She advises clients in real estate transactions and corporate mergers and acquisitions representing the buyer, seller, lender and occasionally consulting interests.

Part I focuses on the legal framework that underlies the Superfund liability structure giving rise to the need for an innocent landowner defense to protect individuals who, despite conducting appropriate inquiries into the historical uses of a property before purchasing it, discover site contamination after acquiring the property. Part I also describes the recently expanded statutory defenses and the legislation that drove EPA to adopt a standard of its own despite the well-accepted existing ASTM Phase I site assessment standard. Part II, which appears in the May 2005 issue, describes EPA's proposed "all appropriate inquiry" standard and compares it to the ASTM Phase I standard. Part II also includes a critical analysis of EPA's proposal and some of the cost and timing considerations that will affect real property transactions.

I. Introduction

On August 26, 2004, the U.S. Environmental Protection Agency published a proposed regulation called the "All Appropriate Inquiries" Rule.1 If adopted as proposed, it will transform the way environmental due diligence is conducted for corporate and real estate transactions. When finalized, the new rule will replace the ASTM Phase I due diligence criteria with expanded requirements that form the prerequisite for any party to qualify for liability defenses under the federal Superfund Law.2 These new requirements will likely add time and expense for parties involved in real property transactions, and have sparked controversy over whether the expanded burdens on a system that has worked well for many years are justified.

EPA was mandated to issue this rulemaking under the Brownfields Law.3 EPA's docket for comments closed on November 30, 2004,4 and EPA is expected to finalize the proposal within a year. Since the proposal was developed through a "negotiated rulemaking" process that involved many stakeholders, most expect the final version to be very similar to the proposed draft.

This article explains the liability framework that has caused consternation among buyers of properties that are potentially impacted by environmental conditions (called "brownfields") and the liability defenses that hinge on the due diligence activities required by the proposed rule. The article highlights the differences between the existing ASTM Phase I standard and new practices that will be required by the proposal, and analyzes some of the problematic issues facing parties to transactions resulting from the changes driven by the proposed rule.

II. Background

(a) Liability Framework: CERCLA imposes liability for all response costs relating to investigating and responding to actual or threatened releases of hazardous substances at a site on, among others, the current owner or operator5 unless that party shows that it had no reason to know the site was contaminated after having performed "all appropriate inquiry" into the prior uses and ownership of the property.6 Known as the "Innocent Landowner Defense," this is the provision that has triggered an entire industry devoted to conducting pre-acquisition environmental due diligence. If a party, despite having conducted such appropriate inquiry, buys the property thinking it to be free from contamination and subsequently finds that it is contaminated, that party was eligible for a defense to liability for costs of cleaning up previously undiscovered conditions. If the party failed to conduct such inquiry, its potential liability for costs of addressing any environmental conditions found at the site was not limited to its investment in the property and was imposed without regard to any fault, wrongdoing or contribution to the conditions by the new owner. Quite literally, absent due diligence conducted before acquiring the property, the owner was strictly liable to the government for all costs of remediation even if the owner had nothing to do with causing or contributing to the environmental conditions.

(b) ASTM Phase I Standard: Until now, however, EPA had never defined what constituted "all appropriate inquiry" consistent with "good and customary practice" to qualify for the defense. In order to eliminate the potential chilling effect on transactions any uncertainty about what level of inquiry was required could cause, in 1993 the American Society of Testing and Methods (ASTM) developed a "Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process."7 This has become the widely accepted standard currently in use by lenders and buyers of commercial and industrial property for defining what constitutes transactional due diligence. Courts generally have given deference to compliance with this standard in interpreting the innocent landowner defense under CERCLA.8 The basic framework of the ASTM Phase I standard requires the buyer to consult various publicly available databases and other readily ascertainable information about the site, and to couple that with interviews with former owners/operators and a non-intrusive site inspection in order to assess whether historical information or visible evidence suggests that there is a potential "recognized environmental condition" ("REC") at the site.9 If a potential REC is found, then the party must proceed to a Phase II10 (involving intrusive investigations, such as sampling of environmental media) in order to confirm or eliminate the presence of the REC.

(c) New Liability Defenses Added in Brownfields Law: In January 2002, Congress amended CERCLA11 to expand the requirements to be met to qualify for the Innocent Landowner Defense, and to codify two other emerging defenses that EPA had been applying through written guidance: (a) the "bona fide prospective purchaser" ("BFPP") defense;12 and (b) the "contiguous property owner" ("CPO") defense.13 The BFPP defense protects a party who, during due diligence, identifies an REC and proceeds to acquire the property. Such a party could not qualify as an "innocent landowner" having discovered a known condition since the innocent landowner defense required that the new owner did not know of or have reason to believe the existence of the condition at the time of purchase. Before the BFPP defense, parties that identified RECs during due diligence either proceeded to acquire the property with all environmental liabilities, or obtained an indemnity from the seller in the private transaction documents (but still assumed the environmental risks if the seller was unavailable in future years to honor an indemnity). This issue was addressed with the BFPP, and allowed the purchaser to acquire the property with knowledge of a condition but without taking the liability for it. The contiguous property owner ("CPO") defense protects an owner whose property is impacted by the passive migration of contamination from an adjacent off-site source (a source other than one on the parcel being purchased). These amendments detailed the basic factors to be used in defining the level of inquiry and clarified the qualifying criteria for all three defenses, and required EPA to develop a regulation defining "all appropriate inquiry" by January 2004.

(d) Negotiated Rulemaking Process: EPA developed the rule using a negotiated rulemaking process involving many stakeholders (bankers and lenders; consultants, real estate developers; environmental interest groups; federal, state. local and tribal governments; and environmental professionals).14 In late 2003, EPA published the report of the Negotiated Rulemaking Committee, and in August, 2004, officially proposed draft 40 CFR Part 31215 consistent with the Negotiated Rulemaking Committee Report. The Committee Report reflects the extensive efforts made to reconcile the many competing interests among stakeholders particularly with respect to the time/cost considerations and issues surrounding the qualifications of environmental professionals performing pre-acquisition environmental due diligence activities.

In our next issue, the author describes the key features of EPA's proposed "all appropriate inquiry" standard, compares it to the existing ASTM Phase I site assessment standard, and offers a critical analysis of the proposal, including the timing and cost considerations likely to affect transactions.

1 69 Fed. Reg. 52,542 (August 26, 2004).
2 42 U.S.C. Sec. 9601 et seq., known as the Comprehensive Environmental Response Compensation and Liability Act, or "CERCLA."
3 Small Business Liability Relief and Brownfields Revitalization Act of 2002, known as the "Brownfields Law."
4 69 Fed. Reg. 56,016 (September 17, 2004), extending to November 30, 2004, the original comment deadline of October 25, 2004 established in the initial proposal (69 Fed. Reg. 52,542).
5 42 U.S.C. Sec. 9607(a).
6 42 U.S.C. Sec. 9601(35)(B)(i).
7 Currently designated "E 1527-00" (approved May 10, 2000 and published July 2000), the original publication was in 1993, and the last previous edition was in 1997.
8 The innocent landowner defense available under the federal Superfund law is also found in many, but not all, state counterpart laws.
9 "The presence or likely presence of any hazardous substances or petroleum products on a property under conditions that indicate an existing release, a past release, or a material threat of a release of any hazardous substances or petroleum products into structures on the property or into the ground, groundwater, or surface water of the property. The term includes hazardous substances or petroleum products even under conditions in compliance with laws. The term is not intended to include de minimis conditions that generally do not present a material risk of harm to public health or the environment and that generally would not be the subject of an enforcement action if brought to the attention of appropriate governmental agencies." 3.3.31, ASTM E 1527
10 Standard Guide for Environmental Site Assessments: Phase II Environmental Site Assessment Process" (ASTM Designation E 1903 - 97).
11 Small Business Liability Relief and Brownfields Revitalization Act of 2002, known as the "Brownfields Law." This law also codified other defenses not discussed here.
12 42 U.S.C. Sec. 9601 (40). Also, 69 Fed. Reg. at 52546; and Interim Guidance Regarding Criteria Landowners Must Meet in Order to Qualify for Bona Fide Prospective Purchaser, Contiguous Property Owner, or Innocent Landowner Limitations on CERCLA Liability (EPA, 2003).
13 Id. Also, 42 U.S.C. Sec. 9607(q).
The proposed rule, the Committee Report, and extensive materials concerning the negotiated rulemaking process and its participants are available on the world wide web at: www.gpoaccess.gov/fr/index.html (enter "all appropriate inquiries" in the search field) or www.epa.gov/swerosps/bf/index.html (the EPA Brownfields home page). The preamble to the Federal Register notice proposing the rule also describes the negotiated rulemaking process (see, 69 Fed. Reg. at 52547-8).
15 69 Fed. Reg. 52,542. Hereafter, all sections of the proposed rule will be referred to using the proposed section numbers assigned in the Federal Register notice (specifically, pages 52576 to 52581).

Please email the author at jmccreary@nixonpeabody.com with questions about this article.


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