Overview
Whenever commercial or industrial property is sold, leased or financed, the checklist of due diligence items includes a Phase I environmental site assessment (Phase I). Phase Is are performed both for possible defenses to liability as well as for broader due diligence purposes. A Phase I includes four basic components: (1) historical review of the property usage back to the first developed use, (2) agency record review for indications of use or release of possible contaminants, (3) site visit to assess the site for evidence of releases of contaminants, and (4) interviews with individuals with knowledge of the current and past use of the property. The area of the property is also included in the review although surrounding properties are only assessed from the property line. If "recognized environmental conditions," or RECs, are identified in the Phase I, then sampling of soil, groundwater, surface water, soil gas or indoor air may be necessary to confirm whether there has been a release of hazardous substances or petroleum products. Such sampling reports are known as a Phase II environmental site assessment (Phase II). This article explores what Phase Is are and why we do them.
CERCLA
The fundamental reason for performing a Phase I began in 1980 with the passage of the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), which imposed liability for hazardous substance release cleanup on owners and operators of real property, among other parties. As CERCLA is not fault-based, purchasers for the first time faced incurring remediation costs that could be many times the value of the property purchased. CERCLA included a defense to liability where the contamination was caused by an act or omission of a third party, but such defense was not available to purchasers.
In 1986, Congress passed the Superfund Amendment and Reauthorization Act (SARA) amending CERCLA to create the "innocent purchaser" defense for those purchasers who conducted "all appropriate inquiries" into the past use of property prior to acquisition. If a purchaser performed all appropriate inquiry and did not find a concern for a release of hazardous substances, then such purchaser had a defense to liability if the historic release was found after the purchase was completed. "All appropriate inquiries," was not defined, however, so the environmental consulting industry responded by developing the Phase I environmental site assessment. The first Phase I assessments appeared on the scene around 1987 and covered just a few pages.
While the Phase I is rooted in CERCLA and was meant to cover hazardous substances, it evolved very quickly to also consider petroleum products, as the U.S. Environmental Protection Agency passed its underground storage tank regulations in 1988 and many states followed suit over the next decade. The environmental consultants quickly began noting concerns for potential releases of petroleum in Phase Is.
In 1993, the American Society for Testing and Materials (ASTM) developed its first standard for use in performing Phase Is, titled Standard Practice for Performance of Phase I Environmental Site Assessments, with the number E1527-93. The scope of Phase Is had evolved over the eight years since the passage of SARA, so the ASTM standard was able to gain some, but not widespread, traction in the real estate industry. ASTM amended the standard in 1997 and 2000, creating E1527-97 and E1527-00, which experienced broader usage.
Brownfields Act
EPA was required to create its own "all appropriate inquiries," or AAI, standard with the enactment of the Small Business Liability Relief and Brownfields Revitalization Act (Brownfields Act) further amending CERCLA in 2002. In the interim before EPA developed its own standard, AAI could be met by following the 1997 or 2000 ASTM Standard. On Nov. 1, 2005, EPA published its AAI rule. The most important aspect of the AAI rule was that it specifically provided that a then-new version of the ASTM "Phase I Site Assessment Process Standard" E 1527-05 (2005 ASTM Standard) could be used to meet AAI. Since the AAI rule went into effect, most Phase Is have followed the 2005 ASTM Standard.
Recently, EPA completed a rulemaking to add an updated version of the standard E 1527-13 (2013 ASTM Standard) as approved for meeting AAI and a subsequent proposed rule to eliminate the use of the 2005 Standard in the future. The 2013 ASTM Standard requires more extensive agency records review and additional focus on potential sources of vapor intrusion, among other changes. The agency records review requirement generally means that a proper Phase I will take three to four weeks to complete. As with the 2005 ASTM Standard, the new standard includes requirements regarding the professionals who may complete the work, required certifications, and limitations on how long Phase I components are viable before closing.
Bona Fide Prospective Purchasers (BFPPs)
While the innocent purchaser defense helped protect purchasers from the harshness of CERCLA, if contamination or potential contamination from hazardous substances was found on the property, the purchaser would not have a defense to liability. The Brownfields Act was a big game change as it created the bona fide prospective purchaser (BFPP) defense. The creation of the BFPP defense allowed contamination or potential contamination from hazardous substances to be identified in a Phase I and the purchaser to still purchase the property and avoid liability as an owner or operator. It is not as simple, though, as just performing a Phase I. The purchaser also must meet certain obligations even post-closing to maintain BFPP status.
A BFPP is defined as "a person (or a tenant of a person)" who acquires ownership of a facility after the release of the hazardous substances and after Jan. 11, 2002, and who meets a number of criteria both before and after the purchase. Although a purchaser must meet all of the requirements, two stand out:
- Conduct "all appropriate inquiries" into the previous ownership and uses of the property. Exercise appropriate care with respect to the hazardous substances found – stop continuing release, prevent threatened future release, and prevent exposure (Continuing Obligations).
Many purchasers complete a Phase I, purchase the property, and then forget about the Phase I. However, if any "recognized environmental conditions," or RECs (the term of art coined by ASTM as issues), are identified, then the purchaser may need to complete a Phase II to further assess the concerns. Purchasers also have to consider the Continuing Obligations to maintain the defense or run the risk of incurring liability to EPA, the state or third parties for a hazardous substance cleanup.
There are a few cases where the Continuing Obligations have been considered by courts in determining if a purchaser has maintained the BFPP defense post-closing. In 3000 E. Imperial, LLC v. Robertshaw Controls Co. (C.D. CA 2010), the court determined that since the purchaser removed the contents of the tanks shortly after learning that they were leaking hazardous substances after closing, that it had exercised appropriate care and was a BFPP.
In PCS Nitrogen, Inc. v. Ashley II of Charleston, LLC v. (4th Cir. 2013), the Fourth Circuit Court of Appeals affirmed the district court's decision that a purchaser did not qualify as a BFPP. In Ashley II the court held that a number of the purchaser's post-closing actions did not meet the Continuing Obligations requirement, including removing roofs exposing cracked sumps with hazardous substances, which allowed them to be exposed to rainwater and leakage, and failing to keep gates locked, which allowed dumping to occur.
Finally, in Votggenhenthaler v. Maryland Square (9th Cir. 2013), the court found that a purchaser who demolished a building after closing and thereby exposed contaminated soil to the elements, but who took no action to remove the soil or prevent the spread of the contamination thereafter, failed to meet the Continuing Obligations requirement. The court further found that the purchaser did not show that it met the AAI requirements as it simply provided an affidavit about its due diligence and not a Phase I.
Tenants as BFPPs
While the CERCLA defenses to liability are available primarily to purchasers, a tenant can obtain some protection by completing a Phase I and following the BFPP requirements. The definition of BFPP under CERCLA includes a tenant of the BFPP, so if the landlord satisfied the AAI requirement and has maintained the Continuing Obligations and other compoents, the tenant would have a derived defense. Also, in the case of Commander Oil v. Barlo Equip. Corp. (2nd Cir. 2010), the court found that the tenant had acquired enough of the proverbial bundle of sticks to constitute a fee simple purchase, such that it should be considered a purchaser. EPA also issued guidance in 2012 that it would exercise enforcement discretion under CERCLA with respect to a tenant who completes AAI and maintains the Continuing Obligations as a BFPP, as though the tenant had purchased the property. Such guidance also noted the Commander Oil case as criteria where a tenant may be considered a purchaser.
Phase I as a Component of Due Diligence
In addition to the liability protection provided under CERCLA, the Phase I has become a basic due diligence tool in the financing, purchasing and leasing of commercial and industrial property. As noted earlier, Phase Is also focus on the storage or release of petroleum. The historical review may pick up concerns for solid waste disposal, and the regulatory search may identify possible enforcement actions as well.
Phase Is, however, do not necessarily provide everything a lender, purchaser or tenant needs to know regarding the environmental condition of the property. Sampling for asbestos, lead-based paint and PCBs in building materials is not a standard component of Phase Is but rather an added service that may be necessary for the parties to understand the costs that may be incurred when renovating a building. Phase Is also do not assess the possibility of wetlands, endangered species or historic resources that may be encountered in land development. These are specialized services that may be needed, depending on the property and its intended use. Additionally, a Phase I does not assess compliance with environmental, health and safety laws or the required permitting that may apply to industrial facilities, so a separate environmental, health and safety audit will need to be considered.
CONCLUSIONS
Phase I environmental site assessments are used not only for liability defense purposes but also as a broader due diligence tool. Purchasers, proposed tenants and lenders of commercial and industrial property should consider completing a Phase I meeting the ASTM E 1527-13 standard and allow three to four weeks to properly complete the components prior to the purchase. The ASTM standard includes requirements regarding the professionals who may complete the work, required certifications, and limitations on how long Phase I components are viable before closing. Purchasers and tenants also must consider their Continuing Obligations post-closing to maintain the BFPP defense.
OTHER RESOURCES
New Requirements for Phase I Environmental Site Assessments Effective November 1, 2006, McGuireWoods LLP (2006)
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