Environmental Due Diligence: Careful Use of Phase I Environmental Site Assessments

Real estate buyers and sellers commonly use Phase I Environmental Site Assessments (ESA's) to evaluate whether environmental cleanup liabilities are present at a target property. However, these parties often unintentionally document the regulatory compliance status of the facility. If the parties are prepared to aggressively manage any regulatory violations, this information is valuable and helpful. However, if the parties are not ready to immediately correct all items of potential non-compliance or are not aware that violations have been documented in their due diligence files, these reports could be used to establish knowing, potentially criminal violations in government enforcement actions or related civil litigation. Thus, parties to real property transactions must consciously select and manage the scope of environmental due diligence investigations.
  

Purpose of Phase I's

The primary purpose of performing a Phase I ESA is to satisfy the "Innocent Owner Defense" to liability under the Comprehensive Environmental Response Compensation and Liability Act (CERCLA) a.k.a., the Superfund law. To establish the Innocent Owner Defense, a purchaser of property which is later found to be contaminated must document that, at the time of acquisition, the purchaser had no reason to believe that the property was contaminated, and that the purchaser made an appropriate inquiry into the previous ownership and uses of the property.

Because the purpose of the Phase I study is to support the Innocent Owner Defense by identifying evidence of contamination on a subject property, Phase I's have historically not attempted to address regulatory compliance issues that do not indicate the existence of contamination.

However, environmental consultants who perform the ESA's more and more frequently recommend that Phase I studies evaluate "business environmental risks," including evaluation of non-compliance with environmental regulations. Although compliance auditing can create significant value as part of a comprehensive risk management/loss prevention program, the inclusion of these "non-mandatory" items in the recommended scope of Phase I ESA's risks several bad outcomes:

• Creation of confusion as to the purpose and goals of the Phase I.
• Generation of an unnecessary and undesirable compliance paper trail.
• The Phase I consultant may make inaccurate compliance-related observations which may require expensive and unnecessary corrective response by the facility operator.
    

Recommendations:

• Be aware that the Innocent Owner Defense under CERCLA does not require analysis of regulatory compliance status.
• Understand that compliance audits are not required unless the parties have an independent desire to evaluate the seller's current business practices (e.g., merger transaction).
• Because Phase I's have typically had a limited scope of inquiry, many Phase I's are ordered over the phone and a scope of work is subsequently added on at publication of the report. Parties requesting Phase I's should always obtain and approve a written scope of work in advance of the Phase I audit.
• Unless a conscious election is made to do a self-audit of regulatory compliance status, the Phase I scope should exclude "business environmental risks" and should be very clearly limited to the inquiry necessary to detect soil or groundwater contamination.
• Because consultants often exceed the agreed upon scope of work by inquiring into and documenting compliance issues, sellers should limit the use of the audit in future litigation by retention of the consultant by counsel, or if the consultant is retained by the buyer, a confidentiality agreement should be required.
• For transactions involving Texas facilities, if regulatory compliance will be evaluated, a "Notice of Intent" to self-audit should be filed with the Texas Natural Resource Conservation Commission (TNRCC) in order to obtain immunity through TNRCC's self-audit/self-disclosure program. Follow-up reporting to TNRCC is not required after filing the Notice of Intent.

For further information on this topic, please contact Pat Larkin at patrick.larkin@strasburger.com or Beth Tiggelaar at beth.tiggelaar@strasburger.com.

     
STRASBURGER & PRICE, LLP  •  DISCLAIMER
Articles contained within this newsletter provide information on general legal issues and are not intended to provide advice on any specific legal matter. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this information without seeking professional counsel.