Environmental Due Diligence: The Basics
February 21, 2019
When it comes to making a commercial real estate transaction – a purchase, an investment, lease, etc. – there are a number of environmental liabilities concerning the commercial property in question that must be accounted for. In commercial real estate, environmental liabilities can be devastating, both financially and fundamentally. If you’re about to make a commercial property transaction, then environmental due diligence will be a key tool for managing risks and avoiding liabilities.
What is Environmental Due Diligence?
Environmental due diligence is the formal process of assessing real estate for the potential risk of environmental contamination that will impact the property in question, such as hazardous chemicals present in the soil or groundwater contamination.
Standards for conducting environmental due diligence are set forth by the Environmental Protection Agency (EPA) concerning real estate transactions. Environmental professionals determine the extent and type of assessment warranted, which varies based on the property.
Environmental due diligence can take many forms, depending on the transaction type and the known environmental risk of the property. Types of due diligence can include Environmental Questionnaires, Transaction Screens, Internal Environmental Screens, Phase I Environmental Site Assessments (ESAs) and Phase II ESAs.
All Appropriate Inquiry
An All Appropriate Inquiry (AAI) is the process of conducting the due diligence – assessing properties for the presence of environmental contamination. It involves evaluating the current and historical uses of the subject property in an effort to identify recognized environmental conditions and historical recognized environmental conditions in connection with the subject property.
AAI is obtained by completing a Phase I Environmental Site Assessment in accordance with the American Society for Testing and Materials (ASTM) standards and/or the Small Business Liability and Brownfield Revitalization Act of 2002 (the Federal rule which describes what constitutes AAI).
The Process Protects You
Proper AAI assessments made through environmental due diligence can protect you from the potentially crippling environmental liabilities, even if hazardous contamination is found after the transaction has already been made. Protection under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) is for owners, innocent landowners, and prospective purchasers. To demonstrate qualification for one of these parties, AAI must be conducted prior to acquiring the property. This means conducting environmental due diligence through a Phase I ESA, which is where most due diligence investigations would begin regardless.
In addition to demonstrating that AAI were taken, continuing obligations must be followed during property ownership. Continuing obligations include exercising appropriate care with respect to hazardous substances and complying with land use restrictions.
Conducting Due Diligence Early: The Benefits
There are several reasons why conducting environmental due diligence during the early stages of a transaction is beneficial.
- The earlier the purchaser starts the environmental due diligence process, the more time the purchaser will have to examine all its options to fairly allocate the liabilities identified during document reviews, site visits, and investigations.
- The purchaser will be in a better position to draft indemnities, determine appropriate environmental escrow amounts, and negotiate the pricing for the transaction.
- Many lenders have requirements for environmental due diligence that must be met before they will authorize financing for the transaction.
- The information can be used to apply for federal or state financial assistance that is available to parties that purchase Brownfield properties or properties with contamination from a known source. This type of assistance may require significant lead time.
- The information can be used to obtain environmental insurance.
Who is Liable When Contamination is Present?
CERCLA establishes a process to determine who is liable if hazardous substances are present in the specified area. The act authorizes regulators to fine property owners and require the removal of hazardous materials at the owner’s expense, even if the owner is not responsible for the contamination itself. This means that the owner may be held liable by simply owning the property.
From site cleanup to compliance obligations and even third party legal actions, remediation costs for this process can easily run into the millions for the liable party.
Gather All of the Info You Need
It’s important for the purchaser to request a list of environmental documents and information from the property seller. The request should include a request for current environmental permits, compliance reports, government notices and violations, prior environmental reports, a description of response actions or remediation projects, a description of claims by any government agency or third party, contingent liabilities, and the company’s environmental reserves.
Using Environmental Due Diligence to Your Advantage
Though it may come off as daunting, environmental due diligence is an extremely helpful tool for commercial property buyers. Buyers can use environmental due diligence to ensure they are getting the best investment value for a property based on what the assessment reveals.
On the other hand, a seller faced with the realization that their property is contaminated may be able to mitigate the potential reduced value of their sale, as well as the financial cost of remediation, by locating old insurance policies that do not contain an effective pollution exclusion.
If you are faced with an environmental liability, there may be a hidden asset to fund these unforeseen costs in the form of Commercial General Liability (CGL) insurance policies. These policies may have been forgotten, lost, or simply ignored. So, do your due diligence, do it early, and do it well. The process, when done correctly, acts as your protection against costly environmental liability and a tool to preserve your property value in a real estate transaction.
Don’t Go at it Alone
The good news here is that you can team up with professionals who can help you locate and obtain all pertinent documents needed to complete a successful environmental due diligence report, which can provide coverage to clean up your contaminated property and preserve the value of your commercial real estate.
At Valbridge, we have teamed up with industry leaders who can provide the Environmental due diligence alongside our complimentary real estate valuation and advisory services. Reach out to the professionals at Valbridge Property Advisors today to learn more.