Bar News - May 20, 2015
Real Property Law: Environmental Risks in Real Estate Transactions
By: Lynn Preston
At every step along the way and for every party involved, contamination and even potential contamination can pose significant and expensive risks
Environmental contamination can pose multi-faceted risk to those involved in real estate transactions. Exposure related to environmental factors can affect each phase of the transaction, including purchasing, financing, development and sale.
These risks can vary greatly depending on the property and nature of the transaction. Consideration should be given to identifying environmental risks associated with each stage of the transaction to properly mitigate and manage exposure.
Environmental liability associated with the purchase of property can result from the mere status as an owner or operator of contaminated property. Also, if the target property is not in compliance with environmental laws, regulations, or permits, the buyer risks becoming responsible for potential penalties and future costs for complying and maintaining compliance.
State and federal environmental laws can involve strict, retroactive, and joint and several liability provisions. In particular, the federal Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), known as Superfund, imposes joint and several liability for remediation, response costs and damages to natural resources for any release or threatened release of hazardous substances on the owners or operators of property, regardless of whether they caused the contamination.
As a result, subject to certain defenses, the buyer could be exposed to substantial liability upon owning or operating contaminated property, including substantial cost to investigate and remediate the contamination.
In an effort to mitigate such risk, it is important that the purchaser identify potential environmental liability prior to owning or operating the property. Assessing the environmental risk associated with the acquisition of property is often done during the due diligence phase and begins with the performance of a Phase I Environmental Site Assessment.
The Phase I Assessment is performed to identify conditions that indicate a release or potential release of hazardous substances has occurred. The result of the Phase I assessment determines the need for any additional investigation (e.g., Phase II assessment), which could include invasive sampling of soil and groundwater. The performance of the site assessments can alert the buyer to conditions that may require remedial measures and involve substantial expenditures. Additionally, the performance of the Phase I assessment is a necessary element and the first step in attempting to satisfy certain defenses to Superfund liability.
Performing the site assessment does not, however, provide protection for liability imposed under most state clean-up laws. Moreover, the buyer’s environmental risks extend beyond that which may be identified in the site assessments, including compliance with other environmental regulations and potential property development conditions. Thus, performance of a compliance review or audit concurrent with the site assessment should be included in the due diligence process, in an effort to establish pre-purchase compliance status and determine whether allocation of risk is needed.
Financing the purchase of contaminated property could expose the financial institution to legal and financial liability.
Lenders holding a security interest are often afforded liability protection under CERCLA for environmental contamination prior to the vesting of title in the lender’s ownership. However, such protection only exists where the lender is not considered to be participating in the management and decision-making control of the property and holds ownership solely to protect its security interest. Thus, the protection is not absolute and doesn’t necessarily extend to other federal and state statutory and regulatory requirements.
Lender exposure can also exist where contamination and compliance deficiencies jeopardize a borrower’s ability to repay a loan. A lender might also be exposed to liability when the contamination and compliance deficiencies cause a significant reduction in the market value of collateral, or result in a higher priority lien being placed on the collateral than that of the lender.
For example, where a borrower is held liable for contamination on the property, the borrower may be forced to use all available funds to provide for the cleanup or penalties for noncompliance, thereby impairing the borrower’s ability to repay the loan. In addition, where the property is subsequently found or suspected to have contamination, the value of the collateral could be greatly affected, causing the lender to endure financial loss. Moreover, where environmental liens have been placed on the property, such liens may constitute a “super lien,” having priority over the lender’s security interest, making foreclosure by the lender problematic.
As a result, when considering financial investments in real estate transactions, lenders should take steps to assess the environmental risks involved with financing the transaction in an effort to minimize their legal and financial exposure.
Environmental risks affecting the development of property may include the presence of existing on-site conditions, such as the presence of wetlands, contamination migrating from off-site and endangered species issues.
Addressing these issues during the development phase can greatly affect the timing and cost of development and, where non-compliant, the assessment of penalties for violating environmental requirements.
For example, where the property contains wetlands, strict laws and regulations can apply to most development activities. Dredging and filing wetlands will, in most instances, require extensive permitting and possible mitigation activities, substantially increasing the time and cost of development – not to mention extensive penalties for failure to comply.
In addition, where contamination exists on the property or has migrated onto the property, expensive protections may be mandated to safeguard workers or inhabitants. Where soil or groundwater is contaminated close to or under an existing or future building, for example, expensive mitigation measures may be required to protect inhabitants. Similarly, certain uses may be prohibited by applicable land use regulations and restrictions.
Thus, the risk of environmental development impacts should be assessed as part of the due diligence before purchasing the property, to ensure the value is appropriate and to avoid unforeseen development costs and possible regulatory penalties for noncompliance.
Potential environmental risk concerns for sellers include liability for contamination found after the property transfer due to past owner and operator status. Risk may also be present when possible contamination or violations of environmental requirements are identified during the due diligence phase.
Superfund requirements impose liability on, among others, any person who owned or operated the facility (property) at the time of the hazardous substance disposal. Thus, a seller will be liable for contaminated property, even after the sale, if the seller owned or operated the property when the contamination occurred. In addition, the due diligence process may divulge existing contamination and non-compliance issues that may require notification to regulators and trigger costly remedial actions and penalties.
Because either the buyer, the lender, or both will likely perform a site assessment prior to the purchase, the seller should consider performing its own site assessment to determine the scope of potential exposure and mitigate pre-sale risks.
Environmental issues can arise in different aspects of a real estate transaction, and these risks should be adequately assessed and managed to ensure liability and costs are minimized.
Lynn Preston is an attorney at Sheehan Phinney Bass + Green, where she practices in environmental compliance, regulatory issues and corporate transactional matters. She can be reached by email or at (603) 668-0300.