New Requirements for Environmental Due Diligence to Take Effect November 1, 2006

This article appeared in the Minnesota Real Estate Journal September 1, 2006

For commercial real estate deals that will close on or after November 1, 2006, buyers, tenants and others who want to avoid liability for pre-existing contamination need to comply with a new federal rule that takes effect on that date. The rule was issued by the U.S. Environmental Protection Agency (EPA) on November 1, 2005, and defines “all appropriate inquiries” for purposes of establishing the innocent owner, bona fide prospective purchaser and contiguous property owner defenses under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), or federal Superfund law. These defenses (collectively referred to in this article as the “landowner liability defenses”) are the primary legal mechanisms by which parties who acquire real estate can avoid CERCLA liability for pre-existing contamination. The rule has already spawned changes in the industry standard for Phase I Environmental Site Assessments (Phase I ESAs). Parties who want to avail themselves of the landowner liability defenses will need to be sure that their Phase I ESAs conform to the new standard. They will also need to be sure they fulfill certain “user obligations.”  

Why the New Rule Matters

The threshold requirement for establishing a landowner liability defense is that the party asserting the defense must have conducted “all appropriate inquiries” (AAI) into the prior ownership and uses of the property before acquiring title. Although the new rule (AAI Rule) raises some new issues, it goes a long way toward answering a longstanding and critical question under federal Superfund law: What must buyers, tenants and others do in order to demonstrate that they satisfied the AAI requirement? Congress answered this question on an interim basis by declaring through the Small Business Liability Relief and Brownfields Revitalization Act of 2002 (Brownfields Act) that a Phase I ESA conforming to ASTM International’s Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process satisfies the AAI requirement.  ASTM Standard Practice E 1527-00 was the industry standard at that time. Through the 2002 Brownfields Act, Congress also directed the EPA to establish permanent standards that would supersede ASTM Standard Practice E 1527-00. The AAI Rule is EPA’s fulfillment of this Congressional mandate. 

How the New Rule Affects Phase I ESAs

Effective November 1, 2006, Phase I ESAs will need to conform to the standards set out in the AAI Rule in order to satisfy the AAI requirement. Unlike the 2002 Brownfields Act, the AAI Rule does not defer to an established industry standard, but rather sets out specific requirements and performance standards of its own. However, ASTM has published a revised standard entitled Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process, Designation: E 1527-05 which, according to the AAI Rule, may be used to comply with the AAI Rule.

• Phase I ESAs will need to be performed or supervised by persons with specific qualifications, which can be obtained through education, licensure and/or relevant experience.  There are currently no qualification requirements.
• The shelf life of a Phase I ESA has been lengthened from six months to one year.  However, several of the critical elements of a Phase I ESA (viz. interviews, records searches, site inspection and consultant’s certification) will still need to be completed or updated within six months prior to acquiring title.

User Obligations

The AAI Rule requires most of the AAI investigation to be conducted by a qualified consultant. However, parties seeking to satisfy the AAI requirement cannot necessarily rely solely on the consultant’s work. The AAI Rule imposes the following obligations (User Obligations) on the parties themselves:

• Search for environmental cleanup liens that have been filed or recorded under federal, tribal, state or local law. This can be done as part of the Phase I ESA, but since most environmental consultants do not search title or judicial records, searches by the Phase I ESA consultant generally will not be sufficient. 
• Take into account any special knowledge the party has concerning conditions that indicate actual or potential contamination at the property. Any such information should be given to the Phase I ESA consultant at the outset of the consultant’s work.
• Consider whether the purchase price reflects fair market value of the property, assuming it is clean, and whether any difference could be due to contamination. Fulfilling this obligation does not require the party to obtain an appraisal, but ASTM Standard Practice E 1527-05 requires that the party document the explanation for a less-than-market purchase price in writing. 
• If not otherwise obtained by the Phase I ESA consultant, gather and consider commonly known or reasonably ascertainable information that might indicate actual or potential contamination at the property. A careful and thorough Phase I ESA consultant will generally obtain the necessary information. However, any information that a party has should be communicated to the consultant as early as possible.

The Bottom Line: What You Need to Know

Beginning November 1, 2006, buyers, tenants and others who are acquiring an interest in land and who want to be sure they satisfy the AAI requirement for the landowner liability defenses under federal Superfund law will need to conduct a due diligence investigation that conforms to the AAI Rule. The easiest way to do this will be to obtain from a reputable consultant a Phase I ESA that conforms to ASTM Standard Practice E 1527-05 and is completed within 180 days prior to closing. You may also use a Phase I ESA for which the information was completed or updated within one year prior to closing as long as the interviews, records searches, site inspection and consultant’s certification are updated within 180 days before closing.

ASTM Standard Practice E 1527-05 has, for the most part, already become the industry standard.  However, for any transaction that closes between now and October 31, 2006, a Phase I ESA that conforms to either ASTM Standard Practice E 1527-00 or ASTM Standard Practice E 1527-05 will satisfy the AAI requirement. If you do not expect to close before November 1, 2006, you should obtain a Phase I ESA that conforms to ASTM Standard Practice E 1527-05. In addition to obtaining a Phase I ESA, you must also be sure to fulfill the User Obligations to the extent they apply.

It is important to remember that the AAI requirement is only the threshold requirement for establishing the landowner liability defenses. Other requirements, such as complying with use restrictions related to environmental conditions, providing legally required notices concerning discovery of contamination and taking reasonable steps to stop any continuing release of a hazardous substance, are equally important. It is also important to remember that Phase I ESAs do not typically include evaluation of such things as asbestos, regulatory compliance and indoor air quality. Nothing in the AAI Rule or ASTM Standard Practices requires the consultant to evaluate these items. If you want to include these in your due diligence investigation, you must request them in addition to a Phase I ESA.