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Environmental Due Diligence for
Real Estate Buyers, Sellers and Lenders Identifying and Mitigating Risks and Liabilities in Real Estate Transactions
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TUESDAY, MAY 19, 2015
Presenting a live 90-minute webinar with interactive Q&A
Derek Ezovski, President, Outsourced Risk Management Solutions, West Hartford, Conn.
Cindy Karlson, Founder, Law Offices of Cindy J. Karlson, East Hampton, Conn.
Rachel Rosen, Department Manager, Burns & McDonnell, Wallingford, Conn.
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Agenda
Introduction - Environmental Due Diligence
Site Assessment
Lenders/CMBS Perspectives
Drafting Environmental Provisions for Contracts
Questions
5
Framework for Environmental Due Diligence
Compliance with Environmental Laws
Common Law Issues
Statutory Obligations
Evaluate Potential for Liability under Regulatory Regimes
CERCLA, RCRA, Clean Air Act, Clean Water Act, state analogs
CERCLA Issues
Site nexus will be established with transaction
Assess Liabilities and possible defenses
Defenses – very limited
Innocent landowner defense
Bona fide prospective purchaser defense
Contiguous landowner defense
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Lease & Finance Agreements
Stock & Asset Acquisition
Company transitioning unchanged - Corporate liabilities of company unchanged by transition
Liabilities arise only as related to the assets transitioning
Contamination present, contamination originating from, and current compliance status of the asset(s)
Transactional Considerations
Due Diligence Strategy Considerations
All Appropriate Inquiry Primary function – Support CERCLA defenses
Evolved into de facto commercial standard – ASTM – 1527-05
Specific elements required
Still responsible for any new conditions on the Site
Specific State Considerations Connecticut Transfer Act
New Jersey Industrial Site Recovery Act
Common Law Compliance Contractually required disclosures
SEC disclosure review
8
Environmental Due Diligence Considerations
Rachel M. Rosen, LEP
May 19, 2015
• Strategy & Tips
• AAI Standard
• ASTM Standard
• Vapor Encroachment
• The Findings
• Related Topics & Considerations
10
Buyer’s Due Diligence
• Evaluate consultant and/or attorney’s
experience and credibility
• Evaluate the business acumen and
negotiation skills of the key individuals
• Scrutinize the scope of work
• Carefully review the consultant’s terms and
conditions to the contract
11
Strategy: Selecting Consultants & Counsel
• What is necessary vs. recommended
• All Appropriate Inquiry & ASTM E1527-
05 ► What is included?
What is not included?
• Vapor Encroachment – ASTM E2600-
10
• Potable water, mold, asbestos,
wetlands, lead-based paint and indoor
air quality
Appreciate the factors that guide various
lenders and your own liability tolerance
Strategy: Tips For Due Diligence
12
• Transactional Factors Size of the deal vs. nature and extent of Buyer’s due diligence efforts
Buyer’s risk tolerance
Financing conditions
Commercial lender, private equity issues
Schedule constraints
Buyer does not have to compromise on due diligence even under tight timeframes (i.e., e-due diligence rooms can be accessed 24/7)
Budget limitations
• Corporate Governance Fiduciary duties
What’s Needed? Developing A Due Diligence Strategy
13
• 2002 SARA and the Small Business Liability Relief
& Revitalization Act (Brownfield Amendment)
Innocent landowner defense
Bona fide purchaser defense
Contiguous landowner defense
• What work is required to qualify for liability
protections
All Appropriate Inquiry
42 U.S.C. § 9601(35)(B)
40 C.F.R. 312 (2005)
All Appropriate Inquiry and Liability Protection
For Buyers
14
► Regulatory Considerations - All Appropriate Inquiries
Eligible persons for liability protection under CERCLA
Innocent landowners, contiguous property owners
Bona fide prospective purchasers
State or local government that acquire ownership/control
involuntarily through bankruptcy, tax delinquency or abandonment
Conditions to satisfy AAI:
Must perform due diligence in accordance with 40 CFR Part 312
AAI timelines prior to acquiring ownership of property:
Within 1 year prior to acquisition, perform or update AAI
Within 180 days prior to acquisition, perform interviews of current
and past owners; review government records; on-site visual
inspection and search for environmental cleanup liens
All Appropriate Inquiry
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► AAI alone does not guarantee CERCLA protection, the following conditions
must also be met:
Comply with Continuing Obligations after acquiring the property
Provide all legally required notices with regard to discovery of
releases of hazardous substances
Comply with land use restrictions, fully cooperate with persons
conducting response actions and information requests; use due
care with respect to hazardous substances
Buyer must not be affiliated with any liable party through family,
contractual, corporate or financial relationship (other than the property
conveyance instrument)
All Appropriate Inquiry (Cont.)
16
The presence or likely presence of any hazardous substance 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. 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.
ASTM 1527-13 The Findings: Recognized
Environmental Conditions (“RECs”)
17
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 residential use
established by a regulatory authority, without subjecting the
property to any required controls (e.g. property use restrictions,
AULs, institutional controls, or engineering controls). Before
calling the past release an HREC, the environmental
professional must determine whether the past release is a REC at
the time the Phase I ESA is conducted
The Findings: Historical Recognized
Environmental Conditions (“HRECs”)
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A REC 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, AULs, institutional controls, or engineering
controls).
The Findings: Controlled Recognized
Environmental Conditions (“CRECs”)
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• Varying interpretations
• Read Your Report!
• Does the “Story” Make
Sense?
• No RECs = Clean Site
The Findings: Read Between the Lines
20
• Know Why Due Diligence was
Performed
► Real Estate Transfer?
► Funding/Insurance?
► Regulatory Program?
The Findings: Read Between the Lines
Identify potential risks related to
adjacent properties
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• Potential “buried” risks in due diligence
findings:
► Scrutinize waste disposal practices – no
matter how small the quantity of waste
► Understand implications of water
use/availability for your site and development
plans
• Evaluate status of regulatory permits (any
permit transfers necessary?)
• Identify potential risks related to adjacent
properties
The Findings: Read Between The Lines
22
► ASTM E1527-13 requires
► Assess potential for hazardous
vapors to migrate onto or within
the target property
► How to comply?
23
Vapor Encroachment Standard
• Definition
► Encroachment = movement of hazardous
substances or petroleum products
► Solid, liquid, vapor
► Surface and subsurface
• Requires
► Analysis of surrounding property uses
► Data-base record review
► No other guidance, but refers to ASTM E2600-10
24
Encroachment Standard per ASTM E1527-13
► Encroachment of volatile chemicals from
the subsurface into buildings – vapor
Encroachment now gets as much
attention as groundwater
► Encroachment from a risk evaluation
perspective
► Potential liability exposure Tenant and third party claims
The CERCLA definition of “release” includes vapor
Encroachment
Continuing obligations at site
Vapor Encroachment – What is It?
25
► Identify a Vapor Encroachment Condition (VEC)
► VEC = Presence or likely presence of [chemicals of concern]
vapors in the sub-surface of the target property
► Caused by the release of vapors from contaminated soil or
groundwater
► On or near the target property
► Tier 1 or Tier 2 procedures
26
Goal of ASTM E 2600 (Vapor Encroachment Screening)
► Historical records
► Historical uses
► Federal, state, local and tribal governmental
records
► Physical setting information
► User-specialized knowledge
27
Tier 1 - Vapor Encroachment Screen Resources
► Minimum search distances
► Potential petroleum releases within
1/10 of a mile
► Up to 1/3 of a mile for hazardous
material releases
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Tier 1 – Vapor Encroachment Screen Search Distances
• Unless a Tier 1 screen can rules out a VEC, may
want to do:
► Additional regulatory file reviews and/or
► Soil, soil gas or groundwater
29
Tier 2 - Vapor Encroachment Screen Resources
► Process similar to the Phase I ESA Process
► Research Goes hand in hand with Phase I ESA
research
► Can order with the Phase I ESA
► Moderate additional cost
30
Conclusions Re Vapor Encroachment Screening
• ASTM E1527-13 Caveat:
► “nothing in this practice should be construed to
require application of the Guide E2600 standard to
achieve compliance with all appropriate inquiries.”
• However, using E2600 to fulfil the ASTM E1527-13 vapor
encroachment assessment is relatively easy
31
Conclusions Re: Vapor Encroachment Screening
► Potable water
► Indoor air
► PCB in caulk
► Property Condition Assessments
(ASTM Standard E 2018 )
► Building Energy Performance
Assessments (BEPA)
► Reliance Letters
► Continuing Obligations (ASTM
Standard E2790-11)
Related Topics & Considerations
32
► New ASTM standard: Standard Practice for Building Involved in a
Real Estate Transaction
► It is a tool to calculate a building’s energy consumption and cost
– different from an energy audit
► Can be used for disclosure to an interested party
► Intended to supplement ASTM E 2018 and E 1527 environmental
site assessments
► Consultant may offer bundle pricing for ESA, PCA and BEPA
Building Energy Performance Assessments
33
► Not A Given
► Not a Guarantee of Buyer Protection
► Text Varies Widely
► Tied to Other Contracts
► Conflicting Obligations
Reliance Letters
34
Rachel M. Rosen, LEP
Burns & McDonnell
(Direct) 203-294-2357
(Cell) 203-464-3573
Contact Information
35
Drafting Environmental
Provisions For
Real Estate
Contracts
Cindy J. Karlson, Esq.
Discussion Points
Structuring the deal to manage potential/actual environmental risk
Contract provision options and tools
Key negotiated definitions
Strategy practice pointers
37
Structuring the Deal
Purchase and Sale Agreement
- Environmental liability risk allocation
- Walk away after due diligence
- Representations, warranties and covenants
- Remedies
- Indemnities
- Guarantees
- Releases and waivers
- Post-closing considerations
38
Structuring the Deal
Modifying the Agreement After Due Diligence Period
- Purchase price reduction
- Environmental side agreement
- Site access terms and conditions
- Separate indemnity
- Pre-closing conditions
- Escrow agreement
- Environmental insurance
39
Contract Provisions “As-Is” provisions
Boiler-plate language is a good starting point - The devil is in the details
- Drafting with due diligence goals in mind
Strategy on how you define terms is key
- Whether to use broad or very specific definitions and terms
depends on the deal context
40
The Basics: Definitions What is a “Liability” for purposes of the contract?
- As broad as “violation and/or any noncompliance with any environmental law”
“Environmental Laws” - applicable federal, state, and local laws, including statutes, regulations, codes, judicial or administrative orders, and ordinances, relating to the protection of public health and welfare and the environment, including without limitation, those relating to the storage, handling and use of chemicals, or regulated substances to the generation, processing, treatment, storage, transport, disposal, investigation, remediation or other management of waste materials of any kind, and for the protection of environmental sensitive areas or threatened or endangered species.”
- Options :
- common law
- OSHA, health and safety considerations
- Define “Environment” separately
41
The Basics: Definitions “Hazardous substance” — any and all substances or wastes that have been defined or
classified as hazardous, toxic, or harmful pursuant to any environmental laws or that are
regulated pursuant to such environmental laws, including petroleum and each of its
chemical constituents and by-products, PCBs, and asbestos in any form.
- Options include mold, lead-based paint, urea formaldehyde foam insulation
“Release” - depositing, spilling, leaking, pumping, pouring, emitting, emptying, discharging, injecting, escaping, leaching, dumping or disposing into the environment, whether intentional or unintentional.
- Keep in mind your indemnity when you determine the scope of these definitions
42
Definitions: Vague or Specific?
43
If too vague:
-Potential arguments over what is and is not included
If too specific:
-You could be cutting yourself off at the knees in the future depending on site developments
Deal strategy will effect the drafting of the definitions
Is simple better in some cases? Pick your battles.
Due Diligence Provisions
Materiality
- Pros and cons of defining Material Adverse Effect
Set the playing rules
– Communications with regulators (file reviews)
- Scope of allowed investigation (who is present and when)
Confidentiality
- How can you handle existing and potential sample results
44
Due Diligence Provisions
Site access requirements - Notice, insurance, approved individuals
Limitations
- Time periods; sampling
Potential ramifications – disclosures and reporting (liability, contract breach, insurance issues)
45
Reps and Warranties What issues are typically covered:
1. Compliance with environmental laws;
2. Compliance with environmental permits;
3. Release of hazardous materials on- and off-site; and
4. Pending and threatened environmental claims from governmental authorities and/or third parties.
Limits/carve-outs:
1. Materiality - Material Adverse Effect
2. Knowledge
3. Disclosure schedules
46
Reps and Warranties Practice pointers
-Bring down provision and post-closing survival
- Third party consent obtained if required
- Buyer’s satisfaction with due diligence results
- Connecticut Transfer Act
- New Jersey Industrial Site Recovery Act
- Link to indemnification for breach of reps and warranties
- Trigger termination provision
47
Indemnification Scope – what to include?
- Breach of environmental reps and warranties
- Pre-closing environmental conditions
- Undisclosed liabilities
- Reciprocal indemnity
Who is covered?
- Any successor or assign
- Directors, officers, shareholders, partners, agents
48
Indemnification Setting limits
- Monetary basket and ceiling
- Time duration
- At conclusion of environmental work
- Tied to approval by a consultant or a government entity
- Regulatory audit periods after remediation work
- Sunset provisions
- Breach of environmental reps and warranties
- Specific pre-closing environmental conditions
- Undisclosed liabilities
49
Escrow Determining the amount of the escrow
- Consultants and lender input
What costs will be covered by the escrow
Who has rights to approve payment from the escrow
Potential hidden costs
Time and money involved with objections to escrow payment requests
Potential litigation
Lender’s role
50
Practice Pointers Survival of the Fittest
Successors and assigns – “The indemnity obligations of Seller shall continue until Seller’s obligations under this agreement have been met and compliance achieved as set forth in Section X below.”
Buyer’s Remorse
“Buyer shall indemnify, defend and hold harmless Seller from any loss, cost, damage, or expense (including attorneys’ fees) actually incurred or sustained by Seller in connection with the release or disposal of Hazardous Substances on the Property by Buyer, its agents, tenants, employees and contractors.”
51
Contact Information:
Cindy J. Karlson, Esq.
Law Offices of Cindy J. Karlson, LLC
(860) 365-5167
(860) 614-0184 (cell)
52
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Environmental Due
Diligence in
Real Estate Transactions
Environmental Trends in
Lending and Commercial Real Estate
Derek Ezovski
54
Current Trends in Lending/Financing of Commercial
Real Estate
• Pressure from regulators
• Newer ASTM Standard for Phase I’s
• OCC Updated their Environmental Guidelines
• SBA Lending
• Lenders updating environmental/appraisal policies
• More levels/forms of due diligence than ever before on more loans
• Seems to be a big push in the CRE market again…
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CRE Lending
• While increasing bank leniency and improved fundamentals have helped revive the CRE market, the high level of maturing debt remains a significant concern.
- excerpt from Deloitte CRE Study
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Issues Important to Lenders
• Collateral Devaluation
• Direct Liability - Loan origination to foreclosure
• Reputational Risk (Brand and Image)
• Operational & Enterprise Risk
• Credit & Trust Risk
•…but at the end of the day, the primary issue
for lenders is Business Risk
65
How Did AAI Affect Lenders
• For the first time, there was a federal statutory
authority saying what is needed for a Phase I
environmental site assessment
• Biggest impact of AAI on lenders were the
changes to regulatory and government agencies
– specifically FDIC guidelines and the SBA
66
“New” FDIC Guidance
• FDIC updated its Guidelines in November 2006.
• NCUA updated their guidelines and issued guidance in May
2008.
• FDIC’s guidance set the standard; FDIC is regarded as a
leader in terms of environmental requirements.
• FFIEC implemented environmental policy training/education for
examiners across all agencies (October 2007, May and June
2008)
• A majority of lenders have reconsidered and revised their
environmental policies.
67
OCC Updates
• Develop policies and procedures that reflect potential environmental risks associated with lending
• Provide for receipt and evaluation of environmental reports prior to making final commitment.
• Ensure that persons responsible for evaluating environmental risk possess relevant knowledge, skill and competence.
• A bank’s policy should reflect the EPA’s AAI rule.
68
NCUA Environmental Guidance
69
Small Business Administration Update
• SBA updated its Environmental Policy
• Effective August 1, 2008 and updated six times
since (most recently in January 2014).
• Went from 1000 pages to 400 pages.
• Especially important for institutions with
preferred status who do SBA underwriting.
• 7A and 504 lenders must adhere to this policy.
• Has become default policy for many lenders.
70
SBA Environmental Due Diligence Policy
2 levels of Environmental Due Diligence for SBA
1. Phase I – for high risk properties
• If property type/use matches the list of NAICS codes for Environmentally Sensitive Conditions
2. Records Search with Risk Assessment – low risk properties
• Includes a search of the government databases (compliant with AAI);
• A search of historical use records, and;
• A risk assessment by an environmental professional determining
whether the site is “High”, “Elevated” or “Low” risk
• New Gas Station/Dry Cleaner Requirements
71
Impact of Lender Size/Resources
Regional & National Lenders
• Resources in place to understand environmental issues on the property
• Screen for lower-risk loans
• Have staff/internal resources to manage environmental risk
Credit Unions/Community Banks
• No on-staff environmental expertise (typically)
• Not as sophisticated with regard to environmental issues or due diligence options available
• Often rely only on environmental questionnaires and/or proceed without accurate knowledge of environmental condition of property
• Rely on external guidance to dictate their practices
72
Trends from EBA Survey of National Banks
• Less “Command and Control” by ERM departments
• More flexible than in the past;
• More time going into reviewing reports provided by the
borrowers vs. bank commissioned reports.
• Slow adoption of sustainability and “green” programs • High default rates/foreclosures might be contributing
• Very consistent with past practices
• Continue to outpace credit unions/community banks in
risk management
73
Environmental Due Diligence Options
• Environmental questionnaire (EQ)
• Desktop due diligence
• Transaction Screen Assessment (TSA)
• Phase I Environmental Site Assessments
• Phase II, III, Remediation, etc.
• Environmental insurance
• Storm water Issues
• Sustainability/Green Issues
• Environmental Insurance
• Others
74
Common Commercial Issues
• USTs
• Fuel Oil Tanks
• Spills
• Storage/disposal of
Hazardous Waste
• Vapor Intrusion
• Gas Stations
• Dry Cleaners
• Mold, lead, asbestos,
radon, etc.
• Storm water Runoff
• Superfund
75
Examples of Environmental Concerns for
Lenders
• Originations
• Foreclosures
• “Boring” property that used to be auto shop…
• Retail that used to be Gas Station
• Removal of waste from a property by lender triggers
possible action
76
Summary
• Lenders have unique processes and reasons for conducting
due diligence.
• Market pressures have reinforced long-term trend to increased
due diligence.
• Regulators enforcing risk management due to a perceived
over-concentration of risk regarding commercial real estate.
• Risk Management (Credit, Collateral, Environmental, etc.) is as
critical as ever to lenders.
• Environmental and appraisals are both pieces of the puzzle
that are being revised under the current environment.
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It’s Risk Management…
