Contaminated Real Estate: Bargain or Boondoggle?
In the past, knowing that a piece of real estate was contaminated meant that a purchaser had two options: walk away, or be prepared to assume full responsibility for cleaning it up. The origin of this dilemma was the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA), more commonly known as Superfund. This federal law assigned complete liability to current owners of contaminated sites, regardless of their fault. Only an “innocent” purchaser, who looked for contamination but did not find it, could escape liability.
All that changed with the Brownfield Amendments to CERCLA in 2002, which established new defenses to liability, including one for a “bona fide prospective purchaser” (BFPP). A purchaser who qualifies as a BFPP can buy land—even knowing that it is contaminated—and not be liable.
This had the very significant effect of opening up the market to redevelopment in many urban areas. While you may or may not have heard of a BFPP defense, it has become a part of basic environmental due diligence and a standard component of a real estate purchase, just like reviewing zoning and title.
Look Before You Leap
To qualify as a BFPP, a purchaser must complete environmental due diligence, known as “all appropriate inquiries” (AAI). This is a process of evaluating a property’s environmental conditions and assessing the likelihood of any contamination.
It is important to note that the AAI process must be completed before closing on the property. This requirement makes sense, as the BFPP defense only applies to liability for contamination occurring before the purchase. Otherwise, the purchaser’s liability would derive simply from being a current owner. The requirement also has the benefit of forcing a prospective purchaser to research the information needed to make an informed decision about any potential implications of site conditions or redevelopment plans before committing to the purchase.
Get What You Pay For
Most parties involved in real estate transactions are familiar with the Phase I Environmental Site Assessment (ESA), which has traditionally been performed by a third party provider to identify potential or existing contamination. The Environmental protection Agency (EPA) and the American Society of Testing and Materials (ASTM) have developed standards for the Phase I ESA that allow it to qualify as AAI.
But many Phase I reports—especially those that are low-bid and fast-turnaround—fail to address certain requirements of AAI. In fact, the EPA Inspector General reviewed 35 reports in a 2011 investigation and found that none of them contained all the required elements.
There are a variety of common failure points in many Phase I reports. One of these pertains to interviews. The AAI and ASTM standards have requirements for interviews that vary based on the occupancy of the property, whether it is abandoned, and the availability of the owner. Sometimes the required interviews are missed by consultants and others because of the effort it takes to track down people who have little incentive to help.
Frequently there are also gaps in the available information to address all the elements of AAI, including, for example, a record of the use of property that dates back to 1940, or its first development. These data gaps are not necessarily fatal to a report, but they do require that the environmental professional (EP) evaluate their significance, and provide some analysis as to whether these gaps inhibit the EP’s ability to draw conclusions about recognized environmental conditions at the site. If the data gaps are significant, they may mean that AAI is incomplete. This process requires a certain level of engagement that may not be in the budget for low-bid providers.
AAI also requires that the Phase I ESA be conducted by, or under supervision of, an EP who meets certain qualifications. A “cheap” Phase I may not provide adequate involvement by the EP to meet the AAI requirement. In addition, the EP is required to certify his or her involvement using specific language from the EPA rules. Consultants sometimes modify the certification for their own purposes, which could mean the requirement is not satisfied. This was a frequent finding in the Inspector General’s 2011 report.
Another point of failure involves the opinion statement. The AAI standards call for a formulaic opinion statement that indicates that assessors have or have not identified evidence of recognized environmental conditions. Many consultants modify the required language, which puts the report’s utility at risk.
As a result of these common errors, users of Phase I reports need to review them carefully and be on the lookout for these and other failings. Otherwise, they may not be getting the liability protection they are expecting.
Updates in the Phase I Standard
ASTM is in the process of finalizing an update to its standard for Phase I reports, and it is likely to be adopted by the EPA in the AAI regulations by the end of 2013. The updated standard includes several additions that may require an increased level of professionalism in conducting AAI.
Among these updates are new terms and definitions. A “controlled recognized environmental condition” (CREC), for example, is a release that has received closure from a regulatory agency, but with ongoing restrictions or requirements. Identifying a CREC may require that the EP analyze whether additional investigations are needed to determine if further actions to protect the public are necessary.
The ASTM has also addressed the problem of vapor intrusion. In recent years, EPA has realized certain contaminants can move through soil in a vapor phase and accumulate in buildings at dangerous levels. The new ASTM standard will require that the EP consider this migration pathway in its determination about the environmental condition of property. The science and art of determining when vapor intrusion may be a problem is evolving, and a number of competing technical approaches could be applied to a given case. This will require more high-level involvement in preparing a Phase I ESA than has been necessary in the past.
The new ASTM standard also requires the EP to review government files for facilities that are identified within the database search radius. In the past, consultants have made judgment calls about the relevance of a listing simply based on the scant information in the database. While reviewing regulatory files will require more time and expense, the result will be more accurate determinations about potential impacts to the subject property.
Each of these changes will present additional challenges for ensuring that a consultant complies with the ASTM standard, but those reports that do comply should provide more comprehensive information for evaluating environmental risks at a property.
What Are “Reasonable Steps?”: Two Court Rulings Provide Guidance
It can be tricky to define just what “reasonable steps” are, as required by the EPA to address future contamination issues. Two relatively recent court decisions, however, have provided some guidance.
In one case, a federal court in California evaluated whether a party that purchased property with underground storage tanks in 2006, sampled and removed the contents of the tanks in 2007, but did not remove the tanks from the ground until 2009 qualified as a BFPP under CERCLA. The court ruled that removing the contents of the tanks constituted timely, reasonable steps to stop continuing releases and prevent threatened releases. Delaying the more expensive process of removing the tanks was not unreasonable.
In another case, a developer purchased property along the Ashley River in Charleston, S.C., for redevelopment and deliberately sought to establish a BFPP defense to future claims of liability. After closing on the property, the purchaser cleared certain structures, but left two sumps in place, uncovered. While redevelopment was pending, the new owner allowed a debris pile to accumulate for a year, without investigating and removing it. In addition, some of the rock cover on the site eroded over time, leaving contaminated soil exposed to storm water. The District of South Carolina and the Fourth Circuit Court of Appeals agreed: the purchaser did not take “reasonable steps” with respect to releases of hazardous substances from the sumps or the debris pile.
While the California court had taken a relatively relaxed view of what is “reasonable” to require of a new purchaser, the Fourth Circuit held that the standard for a BFPP should at least meet the standard required of an innocent purchaser, and that “logic seems to suggest” that the standard of care for a BFPP should actually be higher. Prospective redevelopers of contaminated property are still sifting through the implications of this ruling, and whether it sets a standard of care that is beyond what the market will bear in some instances.
Do All the Due Diligence
So once you have a Phase I report, you are done, right? Not necessarily. If the Phase I report identifies recognized environmental conditions, the user is now faced with a decision about whether to proceed with sampling of soil, groundwater, soil vapor or other environmental media.
EPA’s rules specifically state that sampling is not required to comply with AAI. It does, however, leave open the question of what other options may be available to investigate the nature and extent of environmental issues at the site.
In particular, a purchaser of contaminated property should be aware that establishing BFPP status requires that, after closing, the new owner must take “reasonable steps” to prevent future releases of hazardous substances (see sidebar for more on “reasonable steps”). The owner also must stop existing releases and prevent public exposure to hazardous substances at the site. This frequently means conducting Phase II testing to develop enough information about the contamination to determine what the “reasonable steps” might be in that particular case.
In addition, a purchaser should not forget that AAI and a standard Phase I simply evaluate a property for releases of hazardous substances. While there are a number of other issues that are considered “environmental,” they are not included in the standard scope of work. What’s more, if any existing buildings are present, a purchaser may need to know about asbestos-containing materials, lead-containing paint or PCBs in caulk to plan a budget for redevelopment.
Wetlands or streams on the site may affect development plans significantly. If any federal permits, loans or other federal action is involved in the development, impacts on cultural resources must be evaluated.
In addition, naturally-occurring radon gas can accumulate in buildings if a vapor barrier is not included in the specifications. This is a simple, inexpensive item if installed before construction, but a difficult retrofit. None of these items are included in the standard scope for a Phase I ESA. Purchasers should be careful to define the scope of work they need for their particular project, and complete all the diligence that is “due.”
Meet Your Continuing Obligations
Closing on contaminated property is not the end of the process of establishing and maintaining BFPP status. CERCLA establishes several “continuing obligations” that a new owner must meet indefinitely to maintain BFPP status, including:
- Providing legally-required notices, such as release reporting under CERCLA and other environmental laws.
- Providing “cooperation, assistance and access” to regulatory agencies and those conducting response actions.
- Complying with information requests or subpoenas from government agencies investigating contamination at the site.
- Complying with land use restrictions or other institutional controls imposed on the property as part of the environmental remedy.
- Taking “reasonable steps” to stop continuing releases, prevent threatened releases and prevent exposure to earlier releases.
While most of these continuing obligations are reasonably straightforward, determining the “reasonable steps” can be difficult. The EPA believes that this provision does not impose obligations on a BFPP that are of a similar level to those of a responsible party, such as removal of contaminated soil or the treatment of groundwater. However, the EPA does believe that, because a BFPP has an opportunity for investigation and planning prior to purchasing contaminated property, their obligations may still be significant.
Keep Your Fingers Crossed
The ultimate difficulty in purchasing contaminated property as a BFPP is that you do not know whether you have succeeded until the court rules at the end of a federal lawsuit. Before litigation, a prospective purchaser can only take steps intended to document compliance with the elements of the BFPP defense and hope that they have done it right.
In one instance, a South Carolina developer, formed specifically to invest in redevelopment of brownfields, attempted to establish a BFPP defense for a property it purchased along the Ashley River. It completed AAI, coordinated with regulatory agencies, responded to information requests, and even went so far as to ask EPA if the agency could identify any “reasonable steps” it should take at the site. Nevertheless, the courts ruled that it failed to qualify for BFPP status.
Given the uncertainties involved in establishing BFPP status to purchase contaminated property, how can a purchaser evaluate the risk posed?
The first step is to conduct robust due diligence, including evaluating “non-scope” items such as asbestos-containing materials, mold, lead-based paint, radon, mercury poisoning, wetlands, and threatened or endangered species, as appropriate for the particular site. In addition, ask the experts writing the reports to suggest reasonable steps to deal with any releases, so you build an early record of implementing them. Coordinate your redevelopment plans with state or federal authorities. Consider entering a consent order or brownfield agreement with environmental agencies, which can provide additional liability relief, but at the cost of inviting additional government oversight. And, above all, keep your fingers crossed.