Volume 20, Number 3
April/May 2003

Inspect, Detect, Protect: Managing Environmental Risks

By Howard Kenison

Howard Kenison is a partner at Lindquist & Vennum, P.L.L.P., in Denver, Colorado. He has practiced environmental law for more than 20 years. He can be reached at hkenison@lindquist.com.

RCRA, CERCLA, EPCRA, FIFRA, NEPA, TSCA, SDWA—the often bewildering list of acronyms for federal environmental statutes and regulations is nearly endless.1 These laws have created a new legal lexicon—all appropriate inquiry, remedial actions, no-further-action letters, brownfields, voluntary cleanup, Phase I and Phase II Environmental Site Assessments—to name only a few. Indeed, only the U.S. tax code exceeds the volume of federal environmental regulations. The potential for unwanted environmental liabilities is not limited to large companies and complicated business transactions. General practitioners can be faced with environmental risks in the most routine client transactions, for example, the simple divorce that includes the sale or transfer of the family’s dry cleaning business, the probate of a will for the deceased owner of a manufacturing business that includes underground storage tanks, the acquisition of a small business or property that is located in an industrial area, or even the purchase of a previously owned home. This article focuses on the basic methods of managing environmental risks that might arise in the voluntary or involuntary transfer of potentially contaminated assets.

Environmental liabilities in the transfer of property derive in large measure from the Comprehensive Environmental Response, Compensation, and Liability Act, known as CERCLA or by its more familiar name, Superfund. Passed in 1980, CERCLA can shift liability regardless of the contractual intentions of the parties and without a party’s active involvement with the property. Many states now have “mini” Superfund laws as well. CERCLA’s strict, joint and several, and retroactive liability scheme can impose liability absent traditional notions of fault, can include all persons who might be in the “chain” of title, and can extend liability back to former owners of the property.

CERCLA provides that where there has been a release or threatened release of “hazardous substances,” the owner or past owner of the property can be held liable for the costs of cleanup of any contamination. This in spite of whether the current owner caused the release of the pollutants or that CERCLA liability did not exist at the time of the release of the pollutants. An owner under CERCLA is, quite simply, anyone who owns or operates or did own or operate property on which hazardous substances are located. A hazardous substance is broadly defined in Superfund and, while it excludes petroleum products, other federal and state laws create similar liabilities for petroleum and other hazardous wastes. Case law has established that even a lessee may be an “owner” under CERCLA if the lessee knew or should have known of the presence of contamination on the property at the time the lease was initiated.

There is, however, an exception to CERCLA’s broad liability scheme—the bona fide prospective purchaser exception (BFPP).2 The BFPP exception allows a person acquiring property to escape Superfund’s liability net if he or she
meet certain criteria. Not every transaction triggers CERCLA’s liability risks. Nonetheless, because of the potential for CERCLA liability, there is rarely a client matter involving the transfer of property or assets of any size that does not include some form of environmental due diligence. If the transaction involves a loan, it is likely that the lender will require some form of due diligence. If the transaction involves the involuntary transfer of potentially contaminated property, such as through probate or in a divorce, environmental due diligence can provide a measure of protection from environmental liabilities and risks. This is especially true given the opportunity to gain a safe harbor by qualifying as a BFPP. While a BFPP must meet several criteria, the most critical for the purposes of this article is the requirement that a person make “all appropriate inquiry” into the previous ownership and uses of the property. The requirement to conduct all appropriate inquiry is met through a Phase I Environmental Site Assessment (see below). Because of Superfund’s broad liability, if clients take steps to limit their environmental risk under Superfund, they are more likely to be safe under other environmental laws.

Due Diligence

Managing environmental risks in either voluntary or involuntary asset or property transactions usually begins with a Phase I Environmental Site Assessment (ESA) and can include a Phase II Site Investigation. A competent, qualified environmental consultant should conduct the Phase I and Phase II assessments. Typically, the consultant is engaged as an expert by counsel. Under the attorney work product doctrine and the attorney-client privilege, the information obtained and opinions of the expert in the Phase I/II may be maintained as confidential. It should be noted that while the privilege may attach to the opinions given by the consultant, the underlying data and facts are generally not privileged. Thus, one cannot use the privilege to avoid requirements to report the presence of contamination to the government where such reporting is required by law. The terms and conditions of the environmental consultant’s contract should be carefully evaluated in the context of the risk and value of the transaction. Many consultants limit their liability to the cost of the project. A high-quality Phase I might cost about $3,000; however, a consultant’s negligence can result in damages to your client in significantly higher sums. In addition, consultants limit the indemnities that they will provide for their failures to those of gross negligence. The terms of consultant contracts can and should be negotiated in light of the scope of the transaction and the risk. This is especially true where the consultants may be undertaking Phase II intrusive site investigations. It goes without saying that you should carefully limit your law firm’s risks from a consultant’s negligence while conducting a Phase I or Phase II assessment by clarifying with the consultant that the true party in interest is the client and by having the client indemnify the consultant if necessary.

Essentially, a Phase I ESA seeks to determine whether there are any recognized environmental concerns (RECs) related to the property or the asset. For example, are there historical uses (a former service station with underground storage tanks on the property) that might give rise to RECs? Is there an old septic tank system that might have been connected to drains that were used to dispose of household chemicals or other pollutants? Are there neighboring business operations that could be a source of concern? A competent Phase I will include a site visit, an interview, and a search of existing environmental agency databases, chain-of-title records, city directories, aerial photos, and maps to determine whether there is any potential for environmental risk at the property. The results of the Phase I ESA will be issued in a report that includes appendices showing the information obtained. Counsel should carefully review the report and all appendices and attached documents to confirm that the consultant’s findings and conclusions follow from the underlying information. The standard established by the BFPP exemption for a Phase I ESA is the ASTM Standard E 1527-97, and it should be specified in the consultant’s contract for any Phase I investigation.

If it is determined that there are RECs, the environmental consultant may recommend that the client conduct a Phase II Site Investigation. A Phase II is a generic term used to describe intrusive subsurface testing, sampling procedures, and laboratory analysis. A Phase II might include, for example, soil borings to obtain subsurface samples around an area where there was a historic underground storage tank. Often a Phase II will include installation of monitoring wells to obtain groundwater samples to determine whether there is groundwater contamination migrating onto the property from a neighboring manufacturing business. A Phase II will also include laboratory testing of soil and groundwater samples. Most, if not all, state environmental agencies have strict requirements that must be followed in taking, storing, and testing soil and groundwater samples. The consultant will be able to advise counsel on these requirements and should be familiar with all sampling and testing procedures. Again, the Phase II results will be contained in a report with appendices, and counsel should become familiar with these underlying documents.

If the transaction involves a building that was constructed prior to the 1980s, the consultant may recommend an inspection of building materials for asbestos. Quite often consultants who conduct the Phase I and Phase II will not conduct asbestos investigations but can refer counsel to certified asbestos inspectors. The asbestos inspection will look for certain types of materials, such as drywall materials and HVAC insulation and floor tiles. Where appropriate, the asbestos consultant may take samples of these materials for further testing. If asbestos is found to be present, a complete asbestos survey may be recommended. If the survey indicates that asbestos-containing building materials are present, an asbestos management plan may be necessary.

Recent focus on mold problems in buildings has created a new area of environmental due diligence. It is not uncommon to find mold or fungi in even newly constructed homes. Many insurance companies that offer homeowners insurance are now drastically limiting the amount of coverage for mold remediation. As a result, consultants are now offering mold and fungal assessments for commercial buildings and residences. There are, however, no generally accepted standards for conducting a mold and fungal assessment. Counsel should require consultants to, at minimum, list their qualifications to conduct these assessments and to state the procedures they will follow. Both the American Conference of Governmental Industrial Hygienists and the American Industrial Hygiene Association have issued general procedures that can be used as a standard for such assessments until further guidance becomes available.

If the consultant concludes that contaminants are present on the property, counsel must analyze applicable federal, state, and local environmental statutes, regulations, and ordinances to determine whether the client’s acquisition of the property will trigger any environmental liabilities. This analysis should include state common law as well. If there are potential environmental liabilities, counsel must advise the client concerning possible risk management options, including indemnities from the seller, pre-closing remediation, and environmental insurance.

Transaction Documents

Assuming the client wishes to proceed with the deal, counsel’s risk management efforts should focus on the transaction agreements and documents. Typically, this will include obtaining environmental representations, warranties, and indemnities from the seller. Buyers might also require the seller to undertake cleanup activities to remove, for example, old septic systems and any contaminated soil. Or a buyer might require the seller to obtain “no further action” assurances from the appropriate government agency. In some states such assurances are given only after cleanup meets certain specified standards and submittal of certificates of compliance following the remedial activities. In other states, the assurances can be obtained if the property owner can show that there is no risk to human health or the environment from any residual contamination, so-called risk-based cleanup standards. In involuntary transactions, such as the acquisition of contaminated property through probate proceedings, the acquiring party will likely want the executor to obtain assurances of no further government action and court approval of any remedial efforts. Sellers often want the sale to be on an “as is” basis without any representations, warranties, or indemnities. In “as is” transactions, the environmental due diligence effort is critical to ensuring the client does not acquire unknown risks. The nature of the transaction, the risk tolerance of the parties, and the extent of the contamination, if any, will drive the type of assurances, indemnities, representations, warranties, and other risk management tools that will be needed to complete the deal to all parties’ satisfaction.

Insurance

During the past few years, the insurance industry has created new policies that cover environmental risks; these policies are becoming an important risk management option. There are now policies that will provide insurance in the event that the government seeks to require a cleanup, while others cover the risk from third-party lawsuits. Typically, insurance products make economic sense only for large transactions. However, depending on the risk tolerance of the parties to the transaction, counsel should consider whether to solicit a proposal for environmental impairment insurance from an insurance company.

The potential for incurring environmental liabilities in the transfer of property or assets has increased in direct proportion to the expansion of federal and state environmental laws. These risks require that counsel carefully manage the environmental due diligence aspects of such transactions and advise clients concerning their risk management options. 

Notes

1. RCRA is the Resource Conservation and Recovery Act, 42 U.S.C. § 6901, et seq.; CERCLA
is the Comprehensive Environmental Response, Compensation, and Liability Act, 42 U.S.C. § 9601, et seq.; EPCRA is the Emergency Planning and Community Right-to-Know Act, 42 U.S.C. § 11001, et seq.; FIFRA is the Federal Insecticide, Fungicide, and Rodenticide Act, 7 U.S.C. § 136, et seq.; NEPA is the National Environmental Policy Act, 42 U.S.C. § 4321, et seq.; TSCA is the Toxic Substances Control Act, 15 U.S.C. § 2601, et seq.; and SDWA is the Safe Drinking Water Act, 42 U.S.C. § 300f, et seq.

2. Superfund’s “innocent purchaser” exemption was amended by the Small Business Revitalization Relief and Brownfields Liability Act on January 11, 2002, Pub. L. No. 107-118.

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