When expanding an existing business or starting a new one, it is rare to locate on a property that did not have a previous use. In most areas of the country, it is also not uncommon for the property to have environmental issues that can create liability for both prior and current owners.
Although in the vast majority of circumstances these environmental risks are not so severe as to prevent someone from purchasing the property, it is critical that all owners conduct proper due diligence prior to acquiring a new location. Within the field of environmental risk management, this is referred to as conducting All Appropriate Inquiry (AAI).
AAI is not only a prudent risk management tool to manage a business and the financial risk associated with a transaction, but it is also critical to minimize regulatory risk and establish defense protection against potential lawsuits.
This due diligence should go beyond an understanding of the historical environmental conditions at the site and also consider any risks that may be imposed via contract or regulatory/governmental mandate.
Look Closely at What You Buy
Take for example a former metal stamping facility with over two million square feet of building space situated on 266 acres that operated continually from the mid 50’s to 2010 when to facility was closed. The property is located close to major highway and is viewed as one of the top road infrastructures in the nation.
Various environmental conditions have been indentified at the site through past investigations. Based upon these investigations, a restrictive covenant to limit future use to industrial/commercial and to prohibit onsite groundwater use may be required and $3 million has been set aside for future investigations and potential cleanup.
In order to achieve a No Further Action (NFA) letter from the state, it was necessary to conduct a soil investigation in one area outside of the building; however the area beneath the main building has not been investigated.
Within the real estate community these distressed assets are often referred to as “upside-down properties” since the perceived or actual environmental risk exceeds the commercial value of the property.
This property is just one of 89 former General Motors properties located in 14 states that the Revitalizing Auto Communities Environmental Response Trust (RACER) has been mandated to sell following the GM bankruptcy and $50 billion taxpayer bailout.
The trust is tasked not only in selling over 44 million square feet of industrial space it has a broader mission of creating jobs and increasing tax revenue in communities where the plants were located while addressing and remediating the historical environmental liabilities.
For commercial organizations, these RACER properties represent a tremendous opportunity to acquire property in desirable locations to support expansion activities. However based upon past activities, these properties will present environmental risk exposures that must be addressed and managed as part of the real estate transaction.
What are the Environmental Risks?
To assess the environmental risk, the buyer must conduct environmental due diligence (AAI) which will include, at a minimum, a Phase I Site Assessment that is performed in accordance with ASTM standards.
The Phase I will include an inventory of Recognized Environmental Conditions (RECs) and any Engineering or Institutional controls which are defined as follows:
- Recognized Environmental Conditions (RECs) -- means the presence or likely presence of any hazardous substances or petroleum products on a property under conditions that indicate an existing release, a past release, or a material threat of a release of any hazardous substance or petroleum products into structures on the property or into the ground, groundwater, or surface water of the property.
- Institutional or Engineering Controls -- legal or administrative tools (institutional controls) or physical controls (engineering controls) that are taken to reduce the potential for exposure to hazardous substances.
Based upon the findings of the Phase I assessment, it is possible that a Phase II assessment will be recommended which can consist of collecting soil samples, groundwater and surface water for contamination.
These assessments help quantify the risks to help determine if acquisition of this property is within an organizations’ risk threshold. It also becomes an important tool in qualifying for environmental liability insurance. Recognized Environmental Conditions (RECs) are known issues and it is often difficult to obtain on-site clean up insurance coverage associated with these conditions until remediation has been conducted and a regulator has provided a No Further Action (NFA) letter.
In order to turn these upside down properties into redevelopment opportunities, these recognized environmental conditions are not completely removed. Remediation is conducted in accordance to a risk-based cleanup in which remediation goals are achieved by limiting exposure to hazardous substances instead of removing them or decreasing their toxicity.
The devices used to limit exposure to hazardous substances left in the ground are institutional or engineering controls and are referred to as Continuing Obligations.
In our property example, the area beneath the main building has not been investigated and the use of this property is restricted to industrial/commercial use. The building serves as an engineering control to cap any potential contamination under the property and any future use or renovation of this property must be accomplished without breaching this control.
If the new owner of the property maintains these Continuing Obligations, it is possible to obtain landowner liability protection from CERCLA liability. However this protection only applies to federal lawsuits and it is important for the property owner to determine the extent that these efforts will protect them from state or local liability.
How Can These Risks Be Managed?
Now that we have conducted All Appropriate Inquiry and understand the environmental history and risks at this site, would you be willing to purchase the site?
For some organizations, any environmental risk is beyond their threshold and they would avoid purchasing this site. However based upon the past remediation/investigation efforts and regulator approval, through the issuance of a No Further Action letter, the environmental risks appear to be sufficiently addressed. The Continuing Obligations in the form of the restrictive covenant and groundwater use prohibition must be managed creating additional risk concerns for the new property owner, which can be addressed with a continuing obligations monitoring plan.
To further protect the owner against risk, this property would likely qualify for environmental insurance that can address the historical issues, a breach of an institutional or engineering control along with any new conditions arising from their new commercial operations.
Addressing environmental risks can be a complex process and no commercial property should be purchased in an “as=is” condition unless the buyer is willing to take on substantial risk. Performing proper due diligence requires the purchaser to rely on a team of legal, financial and environmental professionals to guide them through the process. However, with the increased risk comes the reward of locating commercial properties that can support a growing business at a very reasonable price.
John Beauchamp is Environmental Product Head at Beazley, a specialist insurer.