Risk and Reward: Environmental Issues in Real Estate Development
Throughout 2021 and the first half of 2022, the commercial real estate market in the Southeast has been remarkably active. Despite rising interest rates and economic uncertainty, analysts expect this trend of high activity to continue. As a result of the historically high demand for commercial real estate, buyers and developers are acquiring properties they may not have considered even a few years ago—including properties with environmental conditions.
Environmental conditions may impact real property in a number of ways, including:
- present risks and costs associated with assessment and remediation of existing conditions;
- future risks and costs associated with potential changes to regulatory requirements and assertion of third-party claims;
- limitations on property use whether through institutional controls, regulatory requirements, or practical limitations; and
- potential impacts on future property value and marketability, whether due to actual un-remediated environmental conditions or due to stigma associated with past contamination that has been remediated.
To help assess and address these potential risks and costs, buyers and developers should consider taking the following steps before taking title to any property.
All Appropriate Inquiries
Performing “All Appropriate Inquires” (AAI) into the potential environmental risks on the property has become a routine step to reduce environmental risks. Conducting AAI may provide federal liability protections for certain landowners and potential property owners who did not cause or contribute to contamination of the subject property. Effectively, such innocent parties show through AAI that they did their due diligence to understand potential environmental hazards. AAI conducted in compliance with the standards approved by the federal Environmental Protection Agency (EPA) may be used as a basis to obtain protection from potential liability under the federal Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) as an innocent landowner, a contiguous property owner, or a bona fide prospective purchaser.
The standards for AAI were first established by the EPA in 2002 and require a variety of specific activities, including:
- interviews with past and present operators and occupants;
- review of historical sources;
- review of federal, state, tribal and local records;
- visual inspection of the property and adjoining properties;
- review of commonly known or reasonable ascertainable information;
- assessment of the degree of likeliness for contaminants on the property; and
- searches for environmental cleanup liens.
The AAI review must be done by an environmental professional who meets specific requirements outlined by the EPA.
The EPA has recognized that a site assessment conducted using the standards promulgated by the American Society for Testing and Materials (ASTM) for a Phase I Environmental Site Assessment (ESA) will comply with the AAI standard. The goal of the ASTM Phase I ESA is to identify the confirmed presence or likely presence of hazardous substances or petroleum products on the property, which are also known as “Recognized Environmental Conditions” and commonly referred to by the shorthand RECs (pronounced “wrecks”).
The most recent EPA-approved ASTM standards are ASTM E1527-13 (for previously developed properties) and ASTM E2247-16 (for forestland or other rural properties). ASTM recently adopted new standards for developed properties, ASTM E1527-21, which is intended to replace ASTM E1527-13. The new standard makes significant modifications to the existing standard. Among other things, ASTM E1527-21 includes a new definition of a REC, imposes additional requirements for environmental consultants to consult historical records, and provides guidance regarding the consideration of emerging contaminants, including per- and polyfluoroalkyl substances (PFAS). However, the EPA recently withdrew a final rule to adopt the ASTM E1527-21 standard in response to adverse comments. As a result, the new standard has not yet been recognized by the EPA as meeting the AAI requirement. Nevertheless, potential buyers and their environmental consultants should consider compliance with ASTM E1527-13 and ASTM E1527-21 in order to take advantage of liability protections under CERCLA as well as assess potential business and environmental risks.
Notably, compliance with all applicable AAI requirements is necessary in order to obtain CERCLA liability protections. For example, report dates can be critical as some aspects of AAI must be conducted or updated within one year of the date of acquisition, while others must be completed no more than 180 days before. The details matter, and noncompliance may result in unintended—and very much unwelcome—exposure to liability.
Once the AAI has been completed, it is important to closely review the report(s) generated and ask questions of consultants to determine the full costs, as well as the legal risks, of any RECs, including potential further assessment, remediation, regulatory actions or third-party claims. Thorough analysis of reports and discussions with consultants allows the buyer or developer to understand and assess business risks associated with environmental conditions for the site.
Limiting the Risks and Costs of Environmental Concerns
In addition to AAI, there are several actions potential buyers and developers can take to limit their risks when evaluating a property with environmental issues.
- Remediation of RECs or de minimis environmental conditions prior to closing should be considered to further limit potential liability for the purchaser. If the cost of cleanup is relatively small, future concerns can be eliminated by simply remediating the REC.
- Where RECs may be ruled out through further assessment, buyers should consider conducting limited soil and ground water sampling in order to do so and limit potential liability associated with that REC. Of course, discovering significant contamination can have an adverse impact on the current landowner/seller.
- Where significant and widespread RECs are identified, field sampling may be used as a screening tool to determine if the expense of further assessment or remediation is merited within the prospective buyer’s decision-making framework.
- A prospective buyer may also consider non-AAI scope assessment, such as locating any wetlands or streams on the property and assessing potential impacts those features may have on permitting planned development.
- To help minimize the risk associated with RECs, prospective developers in North Carolina may want to consider participating in the North Carolina Brownfields Program. Under the program, a prospective developer may enter into an agreement with the state’s Department of Environmental Quality whereby the developer agrees to undertake certain assessments and potentially limited remediation efforts and/or land use restrictions. In exchange, the state agrees not to hold the developer liable for further remediation to more stringent regulatory standards. In essence, this economic development program is intended to incentivize redevelopment of contaminated properties by allowing the developer to enter into a contract with the state to undertake limited, risk-based remediation, and receive liability protections and tax incentives in return.
- Potential purchasers should also consider other North Carolina programs that may help reduce the burden of remediating and developing contaminated properties. For example, the Underground Storage Tank Fund provides reimbursement for eligible costs incurred during the cleanup of soil and groundwater contamination resulting from a release of petroleum from a commercial underground storage tank. The Dry-Cleaning Solvent Cleanup Act also established a fund to assess and remediate dry-cleaning solvent contamination at eligible facilities.
Contractual Allocation of Risk and Liability
Many of the risks and associated liabilities related to the purchase and development of a contaminated property can be negotiated among the parties.
Prospective buyers should almost always secure the right to access the property to conduct a thorough environmental investigation and due diligence of any potential risks and liabilities. In addition, prospective buyers may consider negotiating a “walk away” provision that would allow them to rescind the offer if significant contamination is discovered.
Parties negotiating a purchase agreement should also pay close attention to the seller’s representations and warranties related to the environmental condition(s) of the property. The scope of any indemnification of the buyer for claims arising after the property is sold should also be considered, as well as any limitations to their liability. In addition, escrows may be used if there are significant environmental condition(s) and concerns about the seller’s future ability to actually fund its obligation to indemnify.
Parties may also negotiate who pays the cost for an environmental assessment and other due diligence, any necessary cleanup, and the cost of entering into a Brownfields Agreement, if applicable.
Environmental insurance may also be considered, and could be a valuable means of limiting risk, depending upon the circumstances, the costs of premiums, and the risks covered and excluded from coverage.
The remarkably brisk purchase and redevelopment of contaminated properties will likely continue in North Carolina and throughout the Southeast. Environmental issues must be strategically assessed and navigated, along with the more traditional business factors involved in potential real estate acquisition and development. Those who are able to successfully do so may reap significant rewards.
Alex Elkan provides strategic counsel on all manner of environmental, natural resources and land use matters, and represents clients in permitting and transactional matters as well as litigation before state and federal administrative tribunals, and trial and appellate courts. He often represents companies in the mining, real estate development, manufacturing and waste management industries, as well as municipal governments and individuals.
Cordon Smart focuses his practice on business litigation and environmental law. He represents clients in a variety of civil and environmental matters before state and federal courts, as well as administrative and regulatory bodies.