By Emily R. Paulus, Esq. and Seth R. Tipton, Esq. , Florio Perrucci Steinhardt Cappelli Tipton & Taylor, LLC
Successful businesses often face the challenge of identifying and acquiring new real estate to relocate or expand operations. After you have selected a commercial real estate property, secured a contract and done a physical inspection of the structures on the property, you may feel ready to close on the property and get back to your business. However, your lender is requiring you to obtain a Phase I Environmental Site Assessment (“ESA”). You fear this will delay closing and are not sure why it is required. The ESA is also an extra cost that you would prefer to avoid. However, whether or not a lender requires an ESA, all commercial real estate purchasers absolutely should obtain an ESA prior to any acquisition to avoid any future liability for preexisting environmental conditions.
Why an ESA?
Congress passed the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”) in 1980.1 CERCLA establishes a basis for liability of potentially responsible parties (“PRPs”) to the cleanup of hazardous sites. CERCLA is a strict liability statute that imposes liability on a PRP regardless of whether an owner of the real estate intended to contaminate the property, or did so negligently.2 Simply put, CERCLA assigns liability to all PRPs regardless of fault, including former owners or operators of the property.3
Out of CERCLA, the third-party defense of an “innocent purchaser” or “innocent landowner” developed. The innocent purchaser defense was created in 1986 amendments to CERCLA to except PRPs from any cleanup costs associate with a property if that PRP not know of site contamination.4 A purchaser may only claim this defense to avoid liability under CERCLA by demonstrating that it was “innocent” of the contamination by showing that it performed the required due diligence with respect to the property at the time of acquisition.5 The ESA represents the required diligence a buyer must conduct to assert the innocent purchaser or innocent landowner defense.6 The due diligence required under CERCLA is “all appropriate inquiries,” also called “AAI,” into the property, and the ESA generally constitutes such AAI.7 As a result, a buyer that does not conduct an ESA on a property prior to acquisition may never qualify for innocent purchaser status, and therefore become a potential responsible party for any preexisting contamination.
What does a Phase I ESA look for? What does is not cover?
A Phase I ESA is limited in its scope, so it will not identify every environmental hazard a property may have. Rather, a Phase I ESA identifies “recognized environmental conditions” (“RECs”). An REC is the presence (or the likely presence) of hazardous substances or petroleum products on a property under conditions that show an existing release, a past release, or a material threat of a release of hazardous substances or petroleum products into structures on the property or into the ground, groundwater, or surface water of the property.8 If an ESA identifies a REC, it may not satisfy the AAI standard. Importantly, a Phase I will not confirm if the property’s soil or groundwater is contaminated. It also does not assess other environmental issues at the property, such as asbestos, lead-based paint, mold, radon, and biological agents.9 These can be obtained through what is called an “extended Phase I” and may be required by your lender, depending upon prior use of the property and your intended use.10
How is an ESA Performed?
An ESA must be conducted by an environmental professional. The professional is looking to learn about current and past uses of the property, hazardous substances, and anything that indicates a release of hazardous substances. There are four main components of an ESA: records review, site reconnaissance, interviews, and the final report. The records review includes a review by the environmental professional of historical sources, government records, and any recorded environmental cleanup liens. The site reconnaissance is a visual inspection of the surface level of the property: there is no testing or sampling. 11 Keep in mind, the environmental professional will not be able to complete the ESA without cooperation from the current property owner. If the owner does not want to complete a questionnaire or interview related to the property, this may be a red flag to not proceed with the transaction. A Phase I ESA will typically take 12-14 business days to complete but may be longer depending on the workload of environmental professionals in your area.12 The environmental professional will compile a report that documents their findings, identifies data gaps, and provides conclusions. If there is a REC, the environmental professional will recommend further investigation.13
What Comes After a Phase I ESA?
If a REC is found during the Phase I ESA, your environmental professional will likely recommend a Phase II ESA. A Phase II ESA may also be recommended if there are data gaps in the Phase I. A Phase II tests for hazardous substances in “environmental media” which includes soil, rock, groundwater, surface water, and the air.14 A Phase II will take samples and do various tests of environmental media. If a Phase I identifies a REC, the buyer must conduct a Phase II and complete the required remediation in coordination with the seller to satisfy the innocent purchaser qualifications. Negotiating and documenting how a Phase I with RECs, and the resulting Phase II will be handled is critical in all commercial real estate purchase agreements.
A Phase I is an important investment during the due diligence phase of a commercial real estate purchase because it protects you as a prospective purchaser and landowner from environmental liability resulting from the previous ownership and use of that property. Regardless of whether your lender requires one, a Phase I ESA is a worthy investment of time and money to ensure there is no surprise and expensive liability at a later point in time.