A final rule issued by the United States Environmental Protection Agency ("EPA") on November 1, 20051 will have a significant effect on how environmental due diligence is conducted by prospective purchasers of commercial real estate, as well as other entities who wish to avail themselves of CERCLA "Superfund" liability protections. The rule creates new obligations for users of environmental site assessments (ESAs) (commonly known as "Phase I reports"), including an obligation to affirmatively provide information to the Environmental Professional ("EP") who conducts the diligence.

In order to achieve the status of an "innocent purchaser"2 under CERCLA, a party is required to undertake diligence with "all appropriate inquiry" ("AAI"). Unfortunately, the CERCLA statute as originally enacted did not define the criteria for conducting an "appropriate" inquiry. Therefore, the American Society for Testing and Materials ("ASTM") promulgated ASTM Standard E1527 in order to provide a definition of the AAI standard for EPs retained to perform environmental due diligence. The ASTM standard became the accepted method by which environmental diligence was conducted to achieve AAI under CERCLA.

In 2002, Congress amended CERCLA and directed the EPA to issue regulations that define AAI. The final rule, issued November 1, 2005 and effective November 1, 2006, follows a two-year public comment period and stakeholder meeting process. The final rules incorporate the ASTM E1527-00 protocol, but makes several additional requirements part of the environmental diligence process.3

Specific Changes in Current Environmental Due Diligence Procedures

Site Interviews and Visual Inspections

While perfunctory interviews of a site representative were often part of due diligence in the past, the new rules require a more vigorous interview process.4 The EP conducting the due diligence must interview both the current owner and occupant of the site, assuming they are not the same party or person. If there are multiple occupants/tenants, then interviews must be conducted with all major occupants and those likely to use hazardous substances. The rule also requires interviews with current and past facility managers, past owners and operators/occupants of the property, and employees of past and current occupants of the property, if necessary, to meet the objectives of the new AAI rules. If past owners, operators or facility managers are unavailable, information on past uses or physical characteristics of the property may be obtained through interviews with persons most likely to be knowledgeable about current and past uses of the property, including long-time employees of the current owner or operator. If the property is abandoned, the rule requires interviews with owners and occupants of neighboring properties. Visual, on-site inspections of the site are required, as well as visual inspections of neighboring properties and areas where hazardous substances may be stored, treated, handled or disposed.5

Historical Records Review and 180-Day "Shelf Life"

The new rule requires a more extensive records review than in the past, including the requirement that the EP review historical records going back to the time the property was first used for residential, agricultural, industrial or commercial purposes.6 Past practice regarding records reviews was unstructured but generally required identification of past uses of the property back to its first developed use, or back to 1940, whichever was earlier. Specific requirements of the new rule also dictate searches of recorded environmental liens7 and tribal and local records, as well as an expanded government record review.8 Moreover, all ESAs conducted more than a year before an acquisition must be updated to reflect current conditions.9 Certain aspects of the ESA, such as historical records review, interviews, on-site visual inspections and a search for environmental liens, must be performed within 180 days of the acquisition.10 Therefore, under the new rule, an ESA conducted less than 180 days before acquisition can still be relied upon by the user.

Identification of "Data Gaps"

The new rule requires the EP to identify gaps in the available data that impact the ability to identify conditions indicative of releases or threatened releases at the site.11 The presence of data gaps may require the EP to opine that there may be conditions at the site which are indicative of releases or threatened releases, depending on the significance of the data gaps. The documentation and discussion of data gaps in the EP's report is mandatory under the new rule.12 The prior ASTM Standard did not specifically require an EP to identify or address data gaps in a Phase I ESA. Although sampling and analysis is not required under the new rule, identified data gaps may need to be addressed through standard Phase II-type sampling in order to preserve CERCLA liability defenses.13

Prospective Purchaser Participation in the Environmental Site Assessment Process

Perhaps the most dramatic difference in the old versus new rule is the emphasis on user-generated information as part of the ESA. The new rule creates a requirement that the ultimate user of the ESA conduct its own investigation of the site and consider providing the results of that investigation to the EP.14 This inquiry includes information regarding specialized knowledge of the subject property or other reasonably ascertainable information about the property. Significantly, the new rule requires the prospective purchaser to compare the fair market value of the property as an uncontaminated parcel to the contemplated purchase price in order to evaluate whether the proposed purchase price is reflective of potential environmental impairments of the subject property.15

Although the user may decide not to provide information to the EP, doing so may risk the validity of any "innocent purchaser" claim during a subsequent challenge. For example, if an internal evaluation demonstrates a significant difference between the fair market value (if uncontaminated) and the purchase price, it could be considered evidence of environmental impairment which, if not provided to the EP, may destroy the CERCLA innocent landowner defense if challenged later by the EPA or any other third party. This is also true of any other unique or specialized property-related information in the possession of the user that is not provided to the EP.

Environmental Professional Opinion

Under the new rule, the EP must prepare a report that summarizes the results of the inquiry and opines "as to whether the inquiry has identified conditions indicative of releases or threatened releases of hazardous substances . . . on, at, in or to the subject property."16 Although the new rule eliminates the term "recognized environmental conditions" (or "RECs"), the new rule closely tracks the REC concept as established in the previous ASTM Phase I Standard.

Conclusion

While there are no drastic changes to the AAI rules, the "innocent purchaser" and "bona fide prospective purchaser" defenses to CERCLA liability will be more difficult to establish. The strength of these defenses, in any given case, will rest upon a court's determination of whether the user's pre-purchase inquiry was sufficient. The new measure of this sufficiency includes the user's own evaluation of the available data and the user's willingness or unwillingness to share this data with the EP. The existence of "data gaps" called out by the EP, and the ability or inability of the EP or user to fill those gaps during pre-purchase diligence, may also impact the strength of any CERCLA defense to liability. More than likely, any unexplained or uninvestigated data gaps will cause an inquiry to be found insufficient and will invalidate any CERCLA liability defense. Although lending institutions are protected by the secured creditor exemption,17 and lenders themselves are not required to perform AAI to obtain the benefit of that exemption, the new AAI rule does benefit lenders through standardization of due diligence in the industry. Lenders should demand that borrowers follow the new rule in order to limit a lender's risk in secured real estate financing. Finally, it is likely that the new rule will cause increases in the cost of AAI - both direct (EP fees) and indirect (user time and effort). Careful consideration must be given to the information gathered and the process used to investigate a site - by both the EP and the ultimate user of the ESA - in order to minimize the likelihood of a Phase II investigation while solidifying CERCLA liability defenses against post-purchase challenge.

For more information, please contact Vincent S. Oleszkiewicz of the Duane Morris Environmental Law Practice.

Footnotes

  1. See 40 C.F.R. 312 - "Innocent Landowners, Standards for Conducting All Appropriate Inquiries."
  2. See CERCLA 101(35) and 107(b) (3); Congress also established additional CERCLA liability protections for "bona fide prospective purchasers" (CERCLA Section 101(40)) and "contiguous property owners" (CERCLA Section 107(g)), who must also comply with the new all appropriate inquiry rules to qualify for CERCLA liability protections.
  3. The ASTM has recently revised its AAI Standard (now numbered Standard E1527-05) to conform to the new EPA rules. EPA has confirmed that Standard E1527-05 satisfies the statutory requirements for AAI. See www.astm.org for ASTM E1527-05 "Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process." The ASTM "Transaction Screen" process, set out in ASTM Standard E1528, does not meet the AAI requirements set forth in the new regulations necessary for establishing CERCLA liability defenses. The transaction screen process may still be useful in some limited circumstances as a business risk management tool.
  4. See 40 C.F.R. §312.23 - "Interviews with past and present owners, operators and occupants."
  5. See 40 C.F.R. §312.27 - "Visual inspections of the facility and adjoining properties."
  6. See 40 C.F.R. §312.24(b) "Reviews of historical sources of information."
  7. See 40 C.F.R. 312.25 - "Searches for recorded environmental cleanup liens."
  8. See 40 C.F.R. 312.26 - "Reviews of Federal, State, Tribal and Local government records."
  9. See 40 C.F.R. §312.20(a) - "All Appropriate Inquiries."
  10. See 40 C.F.R. §312.20(b).
  11. See 40 C.F.R. §312.20(g).
  12. See 40 C.F.R. §312.21(c)(2) - "Results of inquiry by an environmental professional."
  13. See 40 C.F.R. §312.20(g).
  14. See 40 C.F.R. §312.22 - "Additional inquiries."
  15. See 40 C.F.R. §312.29 - "The relationship of the purchase price to the value of the property, if the property was not contaminated."
  16. See C.F.R. §312.21(c)(1).
  17. CERCLA §101(20)(F); 42 U.S.C. §9601(20)(F).

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