Feature

Environmental Issues in Real Estate Purchase and Sale Agreements

By George P. Bernhardt
Greenfield site will have a low likelihood of environmental contamination, and the parties will treat it accordingly.

Greenfield site will have a low likelihood of environmental contamination, and the parties will treat it accordingly.

(credit: iStockphoto)

All purchase and sale agreements have environmental considerations, no matter how slight. There are environmental risks involved in purchasing even seemingly clean properties that have no history of industrial usage. Consider, for example, the following:

  • A greenfield site could have arsenic contamination from pesticides, and an old office building could contain lead-based paints or asbestos or may have radon gas intrusion.
  • A retail strip center may have chlorinated solvents from dry cleaning solution (typically perchloroethylene or “perc”).
  • Any property might have poly-chlorinated biphenyl contamination from an on-site electrical transformer.
  • Even new buildings may have mold if not properly constructed and maintained.

The availability of bona fide prospective purchaser or innocent landowner defenses under state and federal law, most notably the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA or, as it is commonly known, “Superfund”) is another important reason to carefully consider environmental issues in all purchases of real property.

This article provides a basic background on environmental issues relevant to purchases and sales of real estate and discusses typical due diligence, drafting, and issues involved in negotiating purchase agreements for both affected properties and properties not thought to be affected.

Environmental Due Diligence

Although limited environmental legislation has been in effect for more than 120 years (the Rivers and Harbors Act of 1899), these early acts did not significantly prevent industrial pollution. Most of our current environmental regulations can be traced to laws enacted between 1960 and 1980, including such important legislation as the following:

  • Clean Air Act of 1963 (42 U.S.C. § 7401)
  • Federal Water Pollution Control Act Amendments of 1972 (33 U.S.C. § 1361)
  • Federal Environmental Pesticide Control Act (1972) (7 U.S.C .§§ 136-136y)
  • Safe Drinking Water Act (SDWA) (1974) (42 U.S.C. § 300f)
  • Resource Conservation and Recovery Act (RCRA) (1976) (42 U.S.C. § 6901)
  • Toxic Substances Control Act (TSCA) of 1976 (15 U.S.C. § 2601)
  • CERCLA (42 U.S.C. § 9601).

With no strong environmental regulations in effect until relatively recently, it is highly likely that older industrial properties are now or at some time in the past have been affected by hazardous materials. Accordingly, an environmental investigation should be part of every buyer’s pre-closing due diligence.

In 2006, the US Environmental Protection Agency (EPA) issued the “All Appropriate Inquiries Rule” clarifying what a buyer must do to avoid liability for pre-existing environmental contamination in the purchase of real property under CERCLA. According to the EPA, the All Appropriate Inquiries Rule is a process of evaluating a property’s environmental conditions and assessing potential liability for any contamination. All appropriate inquiries must be conducted to obtain certain protections from liability under the federal Superfund law. EPA Fact Sheet, https://bit.ly/3bSVRXJ.

The All Appropriate Inquiries Rule is met by a full ASTM International (formerly American Society for Testing and Materials) Phase 1 Environmental Site Assessment. Id. The rule was updated on December 30, 2013, to reference the most recent version of the ASTM Phase 1 standards (E1527–13, Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process) and “[to] make clear that persons conducting all appropriate inquiries may use the procedures included in this standard to comply with the All Appropriate Inquiries Rule.” Amendment to Standards and Practices for All Appropriate Inquiries under CERCLA, 78 Fed. Reg. 79319 (Dec. 30, 2013). Note that the current standard is expected to be replaced by a new ASTM International E1527–21 standard some time in 2020.

What is involved in a Phase 1 Environmental Site Assessment? Generally, the assessment will include the following:

  • A site visit to look at how current and past usage of the property could have resulted in contamination;
  • Review of various databases to identify storage tanks, possible releases of hazardous materials, disposal information, and engineering controls;
  • Review of historical records such as aerial maps and fire insurance maps;
  • Review of state and local agency records; and
  • Interviews with the owner to obtain information that might indicate possible contamination.

Note that a Phase 1 environmental site assessment does not include environmental testing. When the assessment is completed and the report issued, the report may note certain “recognized environmental conditions” (RECs). A REC is “the presence or likely presence of any hazardous substances or petroleum products in, on, or at a property: (1) due to release to the environment; (2) under conditions indicative of a release to the environment; or (3) under conditions that pose a material threat of a future release to the environment. De minimis conditions are not recognized environmental conditions.” ASTM International Standard E1527-13.

If a Phase I site assessment notes a REC, the buyer should review this matter in more detail with the owner and the environmental consultant and decide whether soil or water testing is necessary. Such invasive due diligence is referred to as a Phase 2 environmental review. One important consideration in reviewing RECs is that, even if a matter was previously investigated, the buyer and consultant should confirm that no changes in standards occurred since the original investigation. For example, investigations done before the 2013 update of the definition of a recognized environmental condition would likely not have considered vapor intrusion, as the old definition was limited to contamination of the ground, groundwater, or surface water, but the current definition includes releases to the “environment,” including the air.

If Phase 2 testing will be included in the due diligence, the parties will typically negotiate either for the buyer to pay for the cost of the testing, the seller to pay the cost of the testing, the parties to share the cost of the testing, or the seller to pay the cost if contamination is discovered.

If contamination is discovered, the parties and their respective consultants should review the testing results and determine how to best deal with the situation based on the level and type of contamination and the buyer’s proposed use of the property. If the property is going to be used for something like housing, a school, or day care center, the viability of the project and proposed solution are going to be very different than if the proposed use is a chemical plant. In some cases, remediation may not even be necessary if the contamination falls below action levels for the proposed land use and the property can be administratively closed. Because certain contaminants, particularly heavy metals, occur naturally in the soil, the parties may even determine that the suspicious results are simply a part of the normal soil in the area.

If a Phase 1 audit indicates the possibility of hazardous building materials such as lead-based paints or asbestos, additional testing should be conducted and then reviewed to determine both whether such materials are present and, if so, whether they pose a danger. Often it is possible to encapsulate or otherwise manage the materials rather than requiring removal.

Environmental Provisions in Purchase and Sale Agreements

Greenfield Sites

Properties are often referred to as either “greenfield” (property with no history of prior development) or “brownfield” (property that is being redeveloped after prior industrial use). Although agricultural land is often referred to as greenfield land, the existence of contamination is possible depending on prior use of pesticides and herbicides or an on-site gasoline or diesel tank, as noted above. Less likely, but also possible on any property (and unfortunately difficult to detect), is the presence of illegal dumping.

Typically, though, a greenfield site will have a low likelihood of environmental contamination, and the parties will treat it accordingly in drafting and negotiating a purchase and sale agreement. Often a seller’s first draft of a greenfield purchase agreement will either be silent on environmental matters or will include a release and possibly a reverse indemnity requiring the purchaser to accept all environmental conditions on the property and absolving the seller of all responsibility.

Even with a greenfield site, the buyer should insist on the ability to perform a Phase 1 audit and otherwise complete normal environmental due diligence. The buyer will want to have the ability to meet the All Appropriate Inquiries Rule, as well as to investigate the possibility of less likely and obvious environmental issues such as off-site migration, agricultural contamination, including former petroleum or herbicide storage tanks, or long-forgotten prior industrial use. A more sophisticated seller will encourage the buyer to perform its own investigation rather than relying on the seller’s representations that the property is not contaminated or even the seller’s environmental reports. Note that just inserting an “as is” clause in a purchase agreement may not protect the seller from future environmental liability, depending on the jurisdiction, type of liability, and the knowledge and fault of the seller.

A reasonable buyer’s response or initial draft of a purchase agreement might include some basic representations as to the presence of hazardous materials on the property, the prior use of the property, and compliance with law as well as an indemnity for any hazardous materials or violations of environmental laws as of the date of closing. If the buyer is preparing the initial contract, the buyer’s typical first draft purchase agreement will include some basic (or perhaps extensive, depending on the size of the deal) environmental warranties and a strong environmental indemnity unlimited as to time and amount.

The seller would respond by either removing the environmental provisions and replacing them with strict “as is” provisions, a release of liability, and an indemnity in favor of the seller or by countering with a limited indemnity for matters discovered during the due diligence period or a short period following closing. Perhaps the seller would make some of the more basic representations and warranties requested by the buyer, such as that the seller has no knowledge of existing contamination or violations of law and that the seller did not use the property in ways that would likely result in contamination.

At this point, depending on the price of the property, the sophistication and financial strength of the parties, their relative bargaining positions, and other relevant considerations, the parties will negotiate a mutually agreeable position. Some examples of how these considerations affect contract negotiations include the following:

  • Many large corporations have policies that require complete transfer of all potential liabilities on sales of property. That type of seller will likely move on to another buyer if the initial buyer will not agree to accept responsibility. Such a seller may even demand that the buyer indemnify the seller for any existing environmental matters.
  • An unsophisticated buyer may agree to any number of the seller’s demands “because he knows that the property is clean.”
  • The parties may adjust the purchase price upwards or downwards to reach an agreement allocating liability to one party or the other.
  • A party with a particular need to complete the transaction may agree to certain conditions despite some misgivings.
  • A buyer purchasing from a seller with extremely limited assets, perhaps an individual or a single purpose entity, may agree to releasing the seller for the simple fact that the seller would be highly unlikely to have the ability to pay an environmental claim.
  • A high net worth seller is going to have greater concerns for future liability than one that is for practical purposes judgment-proof.
  • Depending on the location and known liability of the property (that is, the likelihood of possible contamination), the parties may be more willing to accept responsibility for potential environmental liabilities.
  • The parties may consider the use of environmental insurance to cover unknown risks (though this is much more common on brownfield sites).

Of course, every negotiation is unique and depends on many factors including the above list. Assuming an agreement can be reached on environmental provisions for the contract, the parties may agree to any number of possible positions on indemnification, release of liability, and representations. Some of the most common resolutions regarding release and indemnification include:

  • Seller is relieved of all liability and receives an indemnity from the purchaser.
  • Seller receives a release from liability from the buyer but does not receive an indemnity from the purchaser. This leaves the seller potentially liable for third-party actions, including governmental actions.
  • Seller agrees to be responsible for any contamination discovered by the purchaser during its due diligence, but not for anything subsequently discovered. Note that a prudent seller will want to have the ability to terminate the contract if the purchaser discovers contamination that it finds uneconomic to remediate under the terms of the existing contract.
  • Seller agrees to be responsible for any contamination discovered within some period, such as one to five years following closing. The indemnity may be coupled with a de minimis “basket” excluding individual items below a threshold expense or all items cumulatively below a threshold expense and a cap.
  • Any indemnification may be limited only to breach of a representation and warranty as opposed to any contamination discovered after closing. Representations may or may not be limited to the knowledge of the seller.
  • Occasionally a seller indemnity will be coupled with a “don’t look” provision, which prohibits the buyer from actively investigating to try to find contamination before the indemnity expires.

With regard to representations, many sellers may be reluctant to provide representations and warranties, but the parties will often agree to certain minimal representations on a greenfield transaction. These will typically be limited to the prior use of the property and the existence of any hazardous materials on the property.

A sophisticated seller will limit any such representations to the seller’s knowledge. If the seller is a large organization, the seller will want to limit such knowledge qualification to the knowledge of particular individuals who would be in a position to have the relevant information. Whether limited to a particular individual or not, the seller will want to specify that knowledge means “the current, actual knowledge of the seller, without inquiry” or something similar to avoid imputation of information that perhaps was never properly reported or passed on through the organization. A buyer, on the other hand, may want the representation to function as an indemnity trigger for any contamination, known or unknown, and not agree to a knowledge qualification.

Brownfield Sites

A brownfield site can range from a developed property that has little likelihood of contamination to one with major ongoing environmental remediation projects. A redevelopment of a former office building or other site where no hazardous materials were ever used will often be treated quite similarly to a greenfield development. Accordingly, this paper focuses on sites that either have preexisting contamination or have a significant history of hazardous materials usage when referring to brownfields sites.

All the considerations noted for greenfield transactions will generally apply to brownfield transactions; however, the parties will negotiate in light of the much greater likelihood of contamination. Sellers will often start with much more detailed and far reaching releases and buyers will ask for lengthy representations and warranties and far-reaching indemnities. In the end, the parties often end up with contracts conceptually similar to those used by sophisticated parties in greenfield sites, just spelled out in much greater detail.

To the extent that there is ongoing remediation or known contamination requiring remediation, the seller will normally retain the liability for completing an environmental closure of the property with the appropriate agency. One significant exception would be sales to environmental companies specializing in the purchase, remediation, and resale of contaminated properties, typically at a significant discount to market value of a clean site. Where the seller agrees to retain responsibility for existing environmental matters, the parties should pay close attention to exactly how and when the cleanup will occur.

There are several matters that need to be agreed upon and specified in the purchase agreement. First, the parties need to determine whether the buyer will complete the purchase of the property before or after the seller completes its environmental obligations. A quick and generally straightforward project, such as cleaning up a small surface spill or removing an electrical transformer or underground storage tank, can typically be completed prior to closing. Remediating historical contamination covering a large portion of property, such as that which might occur from a large manufacturing site or a significant release of chlorinated solvents into the groundwater, might take years to clean up and may take place after closing, especially if the property can still be used while the remediation is ongoing.

The parties might also move forward with closing if the parties believe that the project is eligible for an administrative closure. An administrative closure is one in which the buyer has fully identified the contamination, but the parties agree the transaction can be closed simply by filing notices or restrictive covenants, without physically remediating the contamination.

A third option that the parties might use is to close into escrow or enter into a pre-closing lease until such time as the seller meets certain conditions precedent to closing. These conditions usually involve issuance of a no-further-action letter or similar confirmation from the relevant agency that the seller has met its legal obligations. If there is a small area that cannot be cleaned up or will take much longer to clean up than the remainder of the property, the parties may agree to have the seller retain the small parcel until it has been satisfactorily remediated. The buyer may occupy the retained property under a long-term lease if necessary. Note that, when read closely, a no-further-action letter issued by most states is more of a “no-further-action-until-we-change-the-rules” letter. There is almost always some ability of the state to reopen the remediation.

The parties will specify in detail exactly what the seller is required to do to meet its obligations. This may include remediating to specific standards, obtaining a no-further-action letter, installing engineering controls such as vapor barriers or clay or concrete caps over contamination, and filing use restrictions. The more that is known about the existing contamination at the time of contracting or at least by the time of closing, the better. It is generally best for both parties to wait until such time as all investigative work has been completed and the relevant agency has given at least initial guidance prior to closing so that the seller’s obligations are well defined. Of course, no matter how much investigation has been completed, the parties must be prepared for the possibility that something unexpected will be discovered during the remediation or that a change in direction at the regulatory agency may result in unexpected additional requirements.

If the seller is going to complete work following closing, the seller will want to include an access agreement in the closing documents. This is typically a license to the seller that is unrecorded, though the seller may wish to obtain a recorded easement if the remediation project will continue for a number of years. If the seller has only a license, the buyer may eventually sell the property and the new owner may either refuse to allow continued access to the property or may attempt to impose restrictions on the access or charge the seller for continued access. If the buyer insists on a license, the seller should include a clause noting that the license is coupled with an interest and may not be terminated without the seller’s consent.

The access agreement should continue in effect until such time as the seller has met all of its contractual obligations or the regulatory agency has issued its no-further-action letter. If the buyer does not want to have the details of the environmental issue placed of record, another option would be to place a memorandum of record noting the existence of the seller’s access rights.

The parties may agree to remediate all contamination to background levels, remediate the contamination to unrestricted use (or residential) levels, or remediate to levels based on commercial or industrial use of the property. Remediation of less than all of the existing contamination is referred to as a “risk-based closure,” as the agency sets limits as to what level of exposure to contamination through various exposure pathways (soil, water, and air) is safe based upon the permitted use of the property. For example, if the contamination is limited to the groundwater and the property is served by city water, it may be possible to close the property to residential standards despite the presence of contamination if no vapors are entering the improvements at the property and a prohibition of groundwater use is placed on the property. Similarly, if there is soil contamination at a certain level, it might be unsafe for residential or similar uses such as schools or day care facilities where there is a danger of a child ingesting contaminated soil, but it could be perfectly fine to leave the contamination in place under an industrial closure and permit redevelopment of the site for industrial or other commercial use, especially if it is under a building or parking lot.

When an agency agrees that contamination is to be left in place at levels above that permitted for residential use, it is common to require a deed notice and possibly a restrictive covenant to be filed in the real property records. Where this is a possibility, the parties will want to be clear on what types of notices and restrictions may be filed. The seller will also want to provide that the buyer will cooperate in placing notices and restrictions in the public record.

Most commonly these restrictions prohibit residential and similar uses and covenants prohibiting groundwater use. Other common covenants may require installation of a vapor barrier or placement of a cap (typically a building or concrete or asphalt parking lot) over a contaminated area. The seller will want to ensure that all restrictions are entered into pursuant to applicable environmental statutes and regulations.

As a general rule, absent specific environmental covenants legislation, a restrictive covenant is enforceable only to the extent that there are both a benefitted property and a burdened property owned by separate parties. Typically, this is not the case with environmental restrictions. As a result, a restriction placed on a property by the owner just to limit the use of the property is presumably not going to run with the land (that is, be binding on subsequent purchasers).

The buyer will want to make clear when the seller needs to complete the remediation, but the seller should be cautious about any remedies for late completion. Environmental remediation projects are notoriously difficult to time. Things tend to take longer than expected, unexpected types or levels of contamination are often found, and groundwater programs seem to always take years longer than planned. The seller should designate any timelines as projections and have no responsibility for delays if the seller is making commercially reasonable efforts to complete the closure on a timely basis.

The buyer will, however, want to be sure that it has remedies if the seller fails to perform in a commercially reasonable manner. Typically, this will include the right to take over the project and receive indemnification from the seller. The buyer may wish to obtain environmental insurance or obtain a deposit or possibly a parent company guaranty to ensure that if it does have to take over the project, it is able to be reimbursed by the seller.

Industrial sellers, especially very large companies, will often want to limit the future use of the property to industrial use or prohibit groundwater use even though there is not specific environmental contamination in excess of residential use standards. This is to prevent future liability of the seller relating to contamination not known at the time of sale, changes in environmental risk-based standards, and groundless lawsuits by residential property owners.

If the parcel is large enough to be subdivided and sold to more than one buyer, then traditional restrictive covenants can be placed on each parcel to benefit the other parcels. Beyond that, a seller will likely have difficulty enforcing the restrictions after the immediate purchaser. Some strategies are to require the restrictions to be placed in future deeds along with a covenant requiring subsequent purchasers to do the same, just filing the restrictions in an effort to chill any purchase by a residential developer, and including a no-challenge clause in the restriction. Including a clause noting that the purpose of the clause is to protect human health and that the seller would not have sold the property absent the restriction might also be helpful in defending a future challenge.

One delicate area for discussion is the role that the purchaser may play in any post-closing remediation or administrative closure. Typically the buyer takes a fairly passive role; however, many sellers have had bad experiences with buyers that have interfered with the process and tried to influence the agency to require more stringent cleanup standards, block efforts to have administrative closures approved, or avoid restrictive covenants. Other times buyers may have just delayed the process and increased costs by planting doubt with the case manager. To avoid problems like this, some sellers provide that they will provide copies of all filings with the buyer but prohibit the buyer from contacting the agency about the project.

Conclusion

Given the interest in redeveloping industrial properties in recent years, most real estate lawyers will need to know how to approach the purchase and sale of affected properties. Although every transaction is different, it is hoped that this discussion provides the reader with a variety of tools to help her client find an acceptable solution to deal with known and not-yet-known environmental issues.

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By George P. Bernhardt

George P. Bernhardt is managing counsel–global real estate at Baker Hughes Company in Houston, Texas and is co-chair of the Section’s In-House Counsel Committee, group vice-chair of the Leasing Group, and a member of the Continuing Legal Education Committee.