PC&D MAGAZINE
Managing environmental risks in real estate transactions
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From Volume 25, Issue 6 - June 2001
Feature
Protect yourself against environmental risks when buying property.
by: Jason M. DiMarino
 
 Related Information
  Common features of environmental contingencies
  What triggers an indemnification clause?

Managing environmental risk is one of the most significant challenges accompanying the purchase of property in the carwashing industry. Many retail sites once distributed or currently distribute petroleum products or contain waste that is or may be classified as hazardous.

Any transaction involving the transfer of real property which is or may be contaminated with hazardous substances presents difficult challenges to both the seller and the purchaser of the property.

The goal of this article is to highlight some of the environmental risks associated with real property transactions from a purchaser’s perspective and to provide guidance that may be helpful to the purchaser in minimizing these risks.

The ‘innocent purchaser’ defense

Prior to negotiating the environmental provisions of the transaction, a purchaser must understand the environmental risks generally associated with owning a piece of contaminated or potentially contaminated property. At the outset, every purchaser should recognize that federal, state, and possibly local environmental regulations must be considered.

A discussion of potential liabilities for the various states and a full discussion of federal liabilities is beyond the scope of this article. However, a few general points are worth noting.

Under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), four classes of potentially responsible parties may be held jointly and severally liable for the cost of remediating contaminated property such that the Environmental Protection Agency (EPA) may assess the full cost of cleanup to any one responsible party.

One class of potentially responsible parties is current owners (i.e., the purchasers upon closing the transaction). The liability of the current owner is strict and absolute, and generally without regard to whether the owner caused the contamination.

In limited circumstances, a current owner of contaminated property may assert an ‘innocent purchaser’ defense in an attempt to disclaim liability. This defense is unlikely to be of use to those who purchased former or existing gas station and carwash sites, as the defense requires the current owner to show:

1.) The property was acquired after the contamination occurred; and

2.) At the time the current owner acquired the property, he or she did not know and had no reason to know of the contamination.

To successfully establish the defense, the current owner must have undertaken all appropriate inquiries regarding possible contamination of the property at the time of the acquisition in an effort to minimize future liability.

Unless a current owner can establish the ‘innocent purchaser’ defense, a purchaser of contaminated property essentially assumes the cleanup obligations of the seller. As far as the federal government is concerned, any indemnification or other attempt of a purchaser to allocate future liability to the seller or a third party does not affect the purchaser’s legal obligation to pay any cleanup costs associated with the property.

However, this does not mean that a purchaser may not contractually limit liability. Instead, it means that this limit on liability is wholly independent of the purchaser’s obligation to pay cleanup costs to the government.

While CERCLA governs liability for cleanup of contaminated sites in many situations, other environmental obligations may arise as a result of permit violations or violations of other environmental laws.

For example, some acquisitions which include underground petroleum or chemical storage tanks may make a purchaser subject to permitting and remedial obligations under the Resource Conservation and Recovery Act (RCRA) and/or a delegated state equivalent. In addition to CERCLA, RCRA and other federal and state statutes and regulations must be kept in mind while negotiating any acquisition of potentially contaminated property.

For example, spills of petroleum are excluded from CERCLA, but still subject to other federal and state statutes governing petroleum bulk storage.

Assessing compliance history

A buyer can begin to minimize the risk of incurring environmental obligations by fully assessing the compliance history of the seller and evaluating the condition of the property to be acquired. Ordinarily, the completion of the assessment to the purchaser’s satisfaction is a pre-condition to the closing of the transaction. This risk assessment is often called the due diligence process.

The due diligence process is a crucial part of the transaction for the buyer as it allows the purchaser to both identify potential obligations, and to assess the likelihood of assuming financial responsibility for such obligations. Note that a lender will perform similar due diligence with respect to the property and the purchaser if the acquisition is to be financed. For simplicity, we will focus on a transaction involving only a seller and a purchaser.

The appropriate scope of an environmental assessment is transaction-specific and will depend upon not only the past use of the property, but also whether contamination is known or suspected. In many cases, soil and groundwater sampling is recommended. If the property is in a region afforded special protection, such as a wetlands area, a more thorough assessment may be necessary.

In all cases, the purchaser should determine whether the seller holds all permits or licenses that may be required for the particular business. The purchaser should also determine whether such permits and licenses are current and transferable. Depending on the construction date of any building on the property, asbestos, lead-paint, and PCBs may all be of concern. For even the newest buildings, the need for building improvements and/or pollution-control devices must be assessed.

The scope of assessments

While the scope of environmental assessments and pre-closing environmental-assessment contingencies vary widely, there are some common aspects. Any contingency allows the buyer to walk away from the deal if the assessment reveals risks the purchaser is unwilling to take. Environmental contingencies may have some of the following common features:

1.) If the assessment reveals any environmental violations, it is the obligation of the seller to remediate the condition at his or her sole cost and discretion. A failure to remediate gives the buyer the right to terminate the agreement by written notice of termination to the seller within a limited time period. Proper termination requires the seller to return any money paid by the purchaser.

2.) The amount of contamination and associated remediation costs required to trigger the purchaser’s right to terminate must be above a certain de minimis level. This is a protection for the seller that assures the seller that the buyer will not be relieved of his or her obligations to close the transaction because of the discovery of insignificant contamination.

3.) Where the seller is willing to remediate a discovered violation, a time limit for such remediation is generally imposed.

4.) The parties may agree to apportion the cost of remediating any discovered contamination. This is difficult to do prior to the assessment.

5.) The buyer must generally agree to maintain confidentiality of any assessment reports until title has passed to the buyer at closing.

6.) The buyer may desire a signed document from EPA and/or a state environmental agency stating that any violation is actually resolved.

Managing the risks

Assuming that the environmental assessment does not reveal any issues that cause the purchaser to walk away from the transaction, the purchaser still must consider minimizing risks revealed by the assessment.

Various mechanisms are available to a purchaser wishing to manage or shift known and unknown environmental risks. Depending on the level of protection needed or desired by the purchaser and the amount of protection the seller is willing to offer, appropriate risk management may include a combination of multiple options.

Purchase price reduction

A purchase price reduction is often appropriate when the assessment reveals that some corrective measures are likely to be necessary and the seller wishes to eliminate future liability for cleanup costs with respect to the property. In this situation, the seller may be willing to accept a reduced price for the property in exchange for the purchaser assuming the risk of potential liability.

The purchaser, of course, benefits from an up-front reduction in the purchase price. However, courts will generally view such a reduction as part of the seller’s share of cleanup costs should the purchaser later seek contribution from the seller under CERCLA or other environmental cost-recovery statutes for the seller’s fair share of cleanup costs. For this reason, purchase price reductions should be utilized only when the potential remediation costs can be reasonably quantified and the appropriate amount of the price reduction can be determined.

Indemnification

This agreement between the purchaser and the seller will include representations and warranties of each party. In the event the seller breaches a warranty contained in the agreement, the purchaser may bring an action against the seller for breach of contract.

The indemnity is a critical backstop to the representations and warranties of the seller and should be written to expressly survive the closing of the transaction. Indemnities in transactions involving environmental issues are particularly important because environmental obligations are often difficult to discover and may not be discovered until long after the seller has breached a warranty given to the purchaser.

While the statute of limitations for action alleging breach of warranty begins to run from the date the warranty is breached, an indemnity will effectively extend the statute of limitations because it does not begin to run until the seller has breached a duty to indemnify.

Crafting indemnification agreements

The events that trigger the indemnification obligation and the amount and structure of the indemnity agreement will vary by transaction, but generally should address the following occurrences, often called ‘triggering events:’

1.) The presence in, on or under, or the leakage, spillage, discharge, disposal, or release from the property of any hazardous materials. As there may be disagreement about what constitutes a hazardous material, this should be carefully defined in the agreement.

2.) Claims asserted or arising under any environmental laws, regulations, or other requirement.

3.) Any representation or warranty by the seller in the agreement being discovered as false in any material respect.

Once the triggering events are defined by the purchaser and the seller, the scope of the indemnity must be considered. Clearly a seller will not agree to unlimited obligations to the purchaser for any future environmental liability incurred with respect to the property. Among other issues, the purchaser and seller should consider the following questions when drafting the indemnity:

1.) Should the indemnity be made only by the seller or should it also apply to the seller’s successors and assigns? A buyer concerned about his or her future ability to enforce the indemnity may wish to request a guarantee from the seller’s corporate parent or a solvent principal.

2.) Should the indemnity extend to any party who succeeds to the rights of the purchaser under the agreement?

3.) Should there be any exceptions to the indemnity obligation, such as for the negligence or willful misconduct of the purchaser?

4.) Should the indemnity be capped or limited to a fixed amount of money? Under a cap, the seller indemnifies the buyer for all losses up to a pre-determined sum and then the buyer assumes the risk of all additional losses.

5.) Should the indemnity obligation of the seller trigger only after the purchaser’s losses have exceeded a minimum dollar amount? This option is often referred to as a ‘basket.’ Under a basket option, the purchaser must expend the minimum dollar amount before seeking indemnification from the seller for losses incurred. Note that an indemnity may contain a combination of a cap and a basket.

6.) Should the indemnity survive for a fixed amount of time?

Environmental insurance

Environmental insurance is an option that further reduces the purchaser’s risk of incurring expenses for environmental liabilities and should be considered separately from efforts to contractually allocate costs for potential environmental obligations. Various insurance products currently exist, including insurance against third-party claims, cleanup cost overruns and pre-existing contamination.

When considering purchasing insurance, the purchaser must weigh the costs of the premiums against the need to be insured. Premiums for environmental liability insurance can be quite costly and policies generally must be renewed annually to maintain coverage.

Additionally, it must be noted that because state insurance regulators typically must approve insurance policies, coverage may be limited or not available at all in particular states.

Be smart

While any acquisition of property will involve certain environmental risks for the purchaser, an educated purchaser has many options available to minimize the risks. It is important for the purchaser to enter the transaction with open eyes to avoid costly surprises in the future.

A purchaser will be able to avail him or herself of risk-reducing options by understanding the nature of the obligations under environmental laws, conducting appropriate environmental assessments of the property, and carefully drafting the documents necessary to the transaction.

Jason M. DiMarino is an Associate Attorney in the Corporate Practice Group of Whiteman Osterman & Hanna in Albany, NY. Although Whiteman Osterman & Hanna strives to make all contributed articles as accurate as possible, the complex and rapidly changing world of environmental law makes this difficult. This article is intended as a guide and does not constitute legal advice. For more information on this topic and how laws mentioned affect your facilities, consult your corporate counsel.
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