Environmental Concerns for Real Estate Purchases and Sales - Part 3

C.                The Phase I Environmental Site Assessment

The first step in establish the BFPP defense or the innocent owner defense is the purchaser conducting “All Appropriate Inquiries” (“AAI”) PRIOR TO CLOSING ON THE PROPERTY. Failure to conduct AAI prior to taking title cannot be repaired. If you do not complete AAI prior to taking title, you lose the defense.

You’ll recall that to establish the Innocent Owner Defense, you also need to establish that you conducted AAI prior to closing, so it is a critical step, regardless of whether the purchaser is trying to establish the Innocent Owner Defense of the BFPP defense.

When Congress adopted CERCLA in 1980, it required EPA to adopt regulations establishing how a prospective purchaser can complete All Appropriate Inquiries in compliance with the statute.  EPA finally got around to doing that on November 1, 2005, and those regulations became effective on November 1, 2006.[1] They were updated on October 6, 2014.[2]

The first and most important step in completing All Appropriate Inquires is to get a Phase I Environmental Site Assessment. Not just anyone can perform the Phase I investigation for you. The Phase I investigation must be completed by an Environmental Professional, as that term is defined in the federal regulations.

When EPA adopted the All Appropriate Inquiries regulations, it specifically stated that a Phase I completed pursuant to ASTM E 1527-05 is presumed to comply with the federal regulations. ASTM stands for American Society for Testing and Materials and is a group of professionals that works to define appropriate standards for conducting various types of technical investigations. They have publishing their recommendations for completing AAI long before EPA actually adopted the regulations. When EPA updated the AAI regulations, they also updated the appropriate ASTM standard as being ASTM E-1527-13.

So, if you complete your Phase I investigation pursuant to the ASTM standards, it’s presumed that you have done your investigation properly. However, that is a rebuttable presumption. You can’t ignore an obvious source of pollution just because it doesn’t fall within the ASTM standard investigation.

Even so, it’s the correct place to begin your environmental investigation. You hire an Environmental Professional and you contract for a Phase I that complies with ASTM E 1527-13. You can purchase a copy through the ASTM website.

1.                  Contracts With Environmental Consultants For Phase I Investigations

There are a few issues to be aware of when negotiating a contract for the completion of a Phase I Site Assessment.

In Phoenix, Arizona, where I practice, a Phase I can run from $1,200 to $12,000, and it’s not necessarily a matter of getting what you pay for. Some small firms are just as competent as the big firms and charge a lot less.

However, if you are looking at a site you know is contaminated, you may want to pay for the bigger firm because if you need to go to a Phase II investigation the smaller firm may not be able to provide the services you need and it will cost you money to change firms part way through the investigation process.

Make sure to review the limitations of liability language in your contract with the environmental consultant. Most environmental consultants attempt to limit their liability. The limitation can be as extreme as to limit the consultant’s liability to the price you pay for the Phase I. Some use a fixed amount, such as $25,000. Either way, that limitation makes the Phase I virtually useless, because if the consultant makes mistakes, your liability is potentially a lot more than $25,000. Also, be aware that the environmental consultants will try to impose an artificial statute of limitations on you. While the statute of limitations for a contract in Arizona is 6 years, most environmental consultants’ contracts will require you to file suit within one year. Considering that many environmental claims do not arise until years after the environmental investigation is complete, a one-year period after receipt of the Phase I report to file a complaint is not very useful.

Finally, make sure the environmental consultant has sufficient professional liability insurance to cover your risk. Believe it or not, some environmental companies have begun setting up shell companies in an effort to protect themselves from professional liability.

You should be able to delete those provisions from their standard form of contract or negotiate better provisions. If not, find another environmental consultant.

2.                  What Should Be Included In The Phase I

A Phase I Environmental Site Assessment that complies with the AAI rules and ASTM E 1527-13 is made up of several elements. Understand that a Phase I investigation does not include any testing or invasive practices. No holes are punched in the ground and no samples are collected. It is a process of walking the property, talking to people and looking at records to determine if there is any reason to do more than that.

Interviews are an important part of the investigation. The Environmental Professional must interview each current owner of the property. If there is more than one parcel, the owner of each parcel has to be interviewed. Occupants and tenants need to be interviewed by the Environmental Professional.  If there are multiple tenants, the major tenants, and any likely to use, store, or handle hazardous materials must be interviewed. If the environmental professional feels s/he didn’t get enough information from those people to complete All Appropriate Inquiries, she can interview current and past managers, and current and former employees.

The Environmental Consultant needs to learn the history of the property. Therefore, she must review historical sources back to 1940, or the first use of the property for residential, agricultural, commercial, industrial, or government purposes, whichever is earlier. The environmental professional has some discretion on how far back s/he needs to go to meet the objectives of AAI, so long as it is back to at least 1940.

The regulations make some allowance for the availability of records, but the Environmental Professional must review federal, state, tribal and local records. Often, a research service such as Environmental Data Resources is used by the Environmental Professional and the regulations allow for that. The regulations specify the search radius from the property being investigated for the different types of records being reviewed.

In addition to interviews and record searches, the Environmental Professional has to complete a site reconnaissance, where s/he actually goes onto the property and looks for potential environmental problems.

•           Walk the site

•           Look for solid waste

•           Look for staining

•           Look for distressed vegetation

•           Look for sources of contamination – ASTs, USTs, PCBs (generators, hydraulic lifts)

•           Views adjacent properties from the right-of-way or other best vantage point

•           Define current use of the property and the adjacent properties in the report.

Any limitations on the consultant’s ability to view the property, such as snow cover, fog, heavy weeds, etc., has to be documented in the Phase I report. A site reconnaissance when the consultant can’t see the property isn’t terribly helpful.

A big change in the 2013 standards is that the consultant must investigate the potential for vapor intrusion. That was optional in 2005, but is now a requirement.

The Environmental Professional also has to investigate environmental liens and use restrictions. There are multiple ways to do this, but we prefer that the Environmental Professional review a current title report, as that is the only sure way to determine what restrictions are recorded against the property. That takes more work, so some consultants will try to short cut the process by relying on the local regulatory agency’s website, for example, or on a report prepared by the firm that does the document investigation. That’s a dangerous way to proceed, because the website is not always up to date and the information firms to tend to rely on the websites.

The Environmental Professional also needs to interview the prospective purchaser of the property (as opposed to the owner of the property, which s/he should also interview). The point of that interview is simply to make sure the environmental consultant knows the things the prospective purchaser knows before completing the investigation. The best way to do that is through a User Questionnaire so the questions and answers are in writing.

We strongly recommend to our clients that they have an environmental attorney knowledgeable about the All Appropriate Inquiries requirements review the Phase I report. That may sound self-serving, but we’ve found that more than 75% of all Phase I reports we review do NOT meet the basic AAI requirements, and that’s based on a pretty large sample size. I’ve reviewed approximately 1,000 Phase I reports over the past 10 years and at least 75% of them have had fatal flaws. Understand that EPA uses a “bright line” standard. Either you have completed All Appropriate Inquiries or you haven’t. A mistake in one area defeats the entire investigation, even if properly completing that portion of the investigation would not have disclosed the problem.

IV.             Common Phase I Errors

Perhaps the most common error has to do with the Viability Date of the Phase I report. A Phase I report can be relied upon for up to one year prior to closing, if        the interviews, governmental database review,             environmental lien investigation, and site reconnaissance are less than 180 days old at closing.

180 days, by the way, means 180 days, not 6 months. We often see Phase I reports using 6 months as the standard, which means you can miss properly completing critical investigations by as much as 5 days.

Another problem we often run into is that a properly performed Phase I has not been timely updated. Generally, a Phase I may only be updated once. After one year from the date of the original Phase I investigation, an entirely new Phase I ESA must be conducted to complete All Appropriate Inquiries. An Update can only make a Phase I viable for one year. If you needed to extend your closing beyond the one-year anniversary of the original Phase I, you would need an entirely new Phase I to comply with the regulations, regardless of how recent your Update was conducted.

Other Phase I errors we regularly see include:

•           Improper certification for use, i.e. the Purchaser is not authorized to use the Phase I – this often happens if seller is providing the report. It’s absolutely vital that the Phase I report authorize the actual purchaser to use and rely on the report. A lot of clients miss this because the entity that contracts with the environmental firm often is not the entity that is going to take title to the property. Sometimes, the contract is entered into by one entity as the purchaser, but the right to purchase is assigned to another entity prior to closing. A Phase I that authorizes an entity to use and rely on it does not protect another related entity unless the report clearly states that the related entity can also use and rely on the report. Make sure the Phase I report and any other environmental reports are certified to the name of the entity that is actually taking title to the property. Note that if you discover that the Phase I is not certified to the actual purchaser after the Phase I is issued, but you discover it before closing, you can still have the environmental consultant send a letter authorizing reliance by the correct party, so long as it is done before closing.

•           Failure to interview the owner or a critical tenant. This often happens when a broker tells the environmental consultant to not talk to the tenants for one reason or another.

•           Failure to review prior reports. If there are previous environmental reports available, you need to make them available to your consultant and s/he needs to review and comment on them in her report. If you are the lender, you should have gotten at least a Phase I report before you made the loan. Make sure the Environmental Professional sees that report before s/he finishes the Phase I for the foreclosure.

•           Failure to investigate Orphan sites. When an environmental consultant hires one of the research firms to do the governmental database investigation for them, there will always be included in the research firm’s report a list of what they call orphan or unmapped sites. Those are sites listed in government records, but which do not have sufficient address information for the search firm to know where they are located. The research firm’s report won’t talk about those sites, so your environmental consultant needs to make sure none of those sites are located within the required search radius of the property and note that in the Phase I report. Of course, if any of the sites are within the required search radius, that property needs to be investigated like any other site.

•           Failure to identify wells on the property. Dry, irrigation, and production wells all need to be identified by type and location, and the environmental consultant needs to comment on the potential for groundwater contamination as a result of the presence of the well.

•           Failure to investigate landfilling, especially on former farms and ranches, is a problem. It is a fact that farmers do not spend money taking their garbage to a dump. They invariably dig a borrow pit in the “back 40” and put all of their used tractor oil, expired insecticides, dead animals and household garbage in that pit. The environmental consultant needs to figure out where that pit is and whether it constitutes an environmental risk for the property.

•           Failure to inspect the interior of buildings is a problem. The environmental consultant is required to look at the interior of a building as part of the Phase I investigation. Phase I reports often that say that the consultant didn’t go inside a building because it was locked during the site reconnaissance.

•           Failure to identify the source of soil piles located on the property is a common mistake. I had one undeveloped property a few years ago that had hundreds of soil piles on it because it was being used by swimming pool contractors to dispose of the soil dug out during the construction of swimming pools. If there are soil piles, and the environmental consultant can’t determine with any degree of precision where the soil came from, that needs to be identified as a Recognized Environmental Condition in the Phase I report.

•           Failure to interview a local agency likely to have knowledge of environmental issues at the property, or to properly conduct the interview is another problem we see regularly. This is becoming a big issue because many agencies are beginning to charge for the kind of information the consultants are looking for. The consultant needs to understand that there are several different agencies that can be contacted, including state agencies. Also, they have to actually talk to someone. They can’t use e-mail or a fax or the agencies website for the interview.

•           Failure to investigate or improper investigation of environmental liens and use restrictions. I mentioned before that we prefer that a title report be the source of this investigation. Agency websites and third-party research firms are notoriously unreliable for obtaining this information, and often times the consultant won’t look for it because the AAI rules actually make it the responsibility of the user to get this information to the consultant. It’s not unusual to get a Phase I report that says, “We didn’t investigate environmental liens and use restrictions because the user didn’t provide us with any information.” That is not acceptable. I actually prefer to have a lawyer review the title report and give a summary to the environmental consultant. Lawyers tend to be much better at reviewing title reports than environmental consultants.

•           Failure to interview the “user.” You would be surprised how many environmental consultants don’t know who is the user of their report. They think because they’ve interviewed the property owner this requirement is satisfied. But the property owner is not the user. The user is the person who is looking to acquire the property. The User Questionnaire is the best way to satisfy this requirement.