due diligence

Caveat Emptor - buyer beware

In the aftermath of the Love Canal dump site debacle in 1980, Congress enacted the Comprehensive Environmental Response Compensation and Liability Act (CERCLA) - commonly known as the Superfund Law. Under this law, any owner or operator of a contaminated site is held strictly liable for cleaning up the site. Strict liability means all government has to do is to show that you are the land owner.

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s law put landowners who unknowingly purchased contaminated property at risk for the clean up costs. In 1992, Congress amended the Superfund Law to include an “innocent Land Owner” defense (ILO) against Superfund liability. ILO defense basically says that if a purchaser conducts environmental due diligence BEFORE completing the sale, he will get some protection from Superfund liability if the commercial property he purchases turns out to be contaminated.

The due diligence process for the prospective land owner is codified in the Federal Regulations as All Appropriate Inquiries (AAI). AAI is also commonly referred to as Phase 1 Environmental Assessment. To qualify for the exemption, the AAI must be performed by an Environmental Professional (EP) or under his direct supervision. The qualifications of an EP are also codified in the federal regulations.

The AAI requires the following:

  • Interviews with past and present owners, operators and occupants;
  • Reviews of historical sources of information;
  • reviews of federal, state, tribal and local government records;
  • visual inspections of the facility and adjoining properties;
  • obtain commonly known or reasonably ascertainable information; and
  • degree of obviousness of the presence or likely presence of contamination at the property and the ability to detect the contamination.
  • searches for environmental cleanup liens;
  • assessments of any specialized knowledge or experience of the prospective landowner;
  • an assessment of the relationship of the purchase price to the fair market value of the property, if the property was not contaminated; and
  • commonly known or reasonably ascertainable information.

A professionally prepared Phase 1 report that meets the AAI requirement will general cost the prospective landowner several thousand dollars or more depending on the size and history of the commercial property.

Unfortunately, due to the economic downturn and various other reasons, Phase 1 mills are popping up everywhere. These are firms or sole proprietors that charge $800 or less to “perform” a Phase 1 assessment for a commercial site. Many buyers, lenders (banks) and sellers are hiring these mills because of the low costs.

What they do not understand is that they are putting themselves in great jeopardy in terms of Superfund liability. They may think that the $800 Phase 1 report will provide the necessary shield against future cleanup cost. But they would be wrong.

Here is what could happen when these low cost phase 1 mills are involved:

  • If the seller gives the buyer one of these deficient reports as evidence of “clean health” on the property, the seller can be sued in court for misrepresentation.
  • If a lender pays for one of these reports and gives it to the buyer and approves the loan, the lender can be sued by the buyer if the property turns out to have contaminations that were missed in the report.
  • The buyer may not be able to use his $800 report to claim his ILO exemption because the AAI procedures were not followed.

Just how bad can some of these Phase 1 mill reports get? Here is an example:

A consultant was hired to perform an AAI on a commercial property located in the state of Illinois. His report consists of the following:

6 pages of scope of work and limitations
5 pages from the Illinois Soil Conservation Transect Survey Summary 11 photos without any annotations 13 pages of definitions including one that states that UST means underground storage tank! 17 pages of hydrogeology data from a county in Wisconsin bearing the same name as the county (where the site is located) in Illinois. The meat of the report consists of ONE single page of record review and HALF a page on site reconnaissance. It was capped off by one page of recommendation and final opinion and a signature. The investigation completely missed the presence of a leaking underground storage tank. There were no review of Sanborn maps and hardly any review of agency records. This entire report could have been written in an hour with a 15-minute coffee break thrown in.

The adage “you get what you paid for” is never more true. It is highly doubtful that the new owner would be able to claim his ILO defense. To obtain exemption from Superfund liability, you cannot have a deficient Phase 1 report. It simply will not get you the protection that you want.

There are also a growth of database companies offering banks and buyers “desk top” reviews of historical environmental records. There is nothing wrong with these desk top reviews as long as they are done as part of the site investigation. It is a mandatory requirement under AAI that the EP conducts a physical site visit. No Phase 1 report is complete without that.

Always remember this: Extremely low price = shoddy work = deficient report = huge liability.

A note of caution here. Just because you pay a lot of money for a report does not necessarily mean your report will not be deficient. You may be paying a lot of money to a big consulting firm that employs recent college graduates to do most of the work. On any given day, you will see advertisements from large consulting firms looking for “environmental professionals” with zero to 2 years of experience to work on environmental site assessment projects.

No person with zero to 2 years of experience (even with a college degree) can qualify under the federal definition of an EP within the AAI program. The key question is: are these individuals being properly supervised?

A recent Michigan case illustrates the risks associated with the failure to conduct proper due diligence. In Alfieri v. Bertorelli, 2011 Mich. App. LEXIS 1796 (Mich.Ct. App. 10/18/11), the buyers purchased a condominium unit in a former factory building as an investment. The factory had been impacted with trichloroethylene (TCE) from its former use.  A newspaper article and the real estate agent’s sales brochure indicated the site had been remediated despite the fact that the state agency had advised the realtors that the sales brochure was inaccurate and misleading. The buyers relied on the newspaper article and the sales brochure and did not perform their own due diligence before closing the deal.

The property turned out to be heavily contaminated. The buyers subsequently filed a lawsuit against the real estate agents on theories of silent fraud and negligent misrepresentation. The jury found that the agents engaged in negligent misrepresentation. However, the jury also determined that the buyers were partially responsible for their damages because they had failed to perform their own due diligence. The jury assigned the buyers 35% fault on the negligent misrepresentation claim.

According to noted New York environmental attorney and law professor Larry Schnapf: “An owner could lose its ILO defense and be on the hook for a cleanup if the phase 1 did not identify contamination”. His website
http://www.schnapflaw.com/ lists many recent cases where courts ruled against land owners because of poorly prepared due diligent reports.

Moral of the story: Buyers beware and hire qualified EP to do due diligence.
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