New EPA Rule Requires Buyers, Tenants to Broaden Environmental Investigation

As a result of a new U.S. Environmental Protection Agency (EPA) rule, buyers, lenders, tenants, and other parties must conduct more comprehensive investigations of buildings and centers to protect themselves from certain environmental liabilities. The new rule, called Standards and Practices for All Appropriate Inquiries, took effect Nov. 1, 2006. It requires environmental “due diligence” in certain commercial real estate transactions. And as an owner, you'll be asked to provide information during these environmental investigations.

CLLI, with the help of Los Angeles attorney Sedina L. Banks and Sacramento, Calif., attorney Jennifer Hartman King, will explain the rule's key requirements and when they apply. And we'll explain your role in the environmental investigations.

Reason for EPA's Rule

The EPA's rule relates to the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA). CERCLA imposes liability on past and present owners and operators (among others) of a property at which hazardous substances have been released or are in danger of being released, regardless of who caused the contamination, says Banks. For example, CERCLA can make a buyer responsible for cleaning up all of the contamination at a building or center, even if the buyer did not cause the contamination.

To avoid that unfair cleanup responsibility, prospective buyers, lenders, and tenants can qualify for certain legal defenses to CERCLA liability. The first—but not the only—step toward preserving these defenses is to conduct an “all appropriate inquiry” (AAI) investigation that complies with the EPA's new rule before acquiring an interest in potentially contaminated property, Banks says.

The EPA's rule, which applies to real estate transactions closing on or after Nov. 1, 2006, sets forth regulatory requirements for meeting the new AAI standard, says Hartman King. The rule also stresses the importance of conducting comprehensive environmental investigations during commercial property transactions, adds Banks.

Rule's Key Requirements

The EPA's rule includes the following key requirements for carrying out the AAI investigation, say Banks and Hartman King. Before the rule went into effect, some of these requirements were merely discretionary, but the rule now makes them mandatory to qualify for certain key CERCLA defenses:

Environmental professional. The prospective buyer must use a qualified environmental professional to conduct or supervise the AAI investigation. This is an individual who meets certain minimum education, licensing, and experience qualifications, says Hartman King.

Phase I investigation. The environmental professional must conduct a comprehensive, nonintrusive environmental site assessment (or Phase I) of the building or center. The rule broadens the scope of Phase I investigations and will very likely increase their cost as well, says Banks. The increased cost, however, should be counterbalanced by the improved quality and usefulness of the investigation in establishing a baseline for existing conditions, which is critical in protecting your interests, says Hartman King. The environmental professional must do the following:

• Conduct interviews. The environmental professional must interview you, as a present owner, and any operators (such as your building's or center's property manager), and occupants (such as tenants and subtenants), and consider whatever specialized knowledge the prospective buyer may have about the building or center—such as information regarding contamination or potential releases of contamination at the building or center.

  The environmental professional should also interview past owners, operators, and building or center occupants if it is necessary to determine the building's or center's potential for contamination, says Banks. If the building or center is abandoned, the environmental professional must interview the owner of a neighboring property.

  These interviews can occur by telephone or in person, says Banks. The rule does not specify what questions the environmental professional must ask. But interviewees should expect questions about how the building or center and the underlying land is and has been used, as well as about the building's or center's physical characteristics, she says. The environmental professional will most likely need to interview representatives of the building's or center's major tenants, adds Banks.

• Review history, records. The environmental professional must review historical sources of environmental information about the building or center; search for recorded environmental cleanup liens; review government records concerning contamination at the building or center; and visually inspect the building or center and the adjoining properties for possible sources or areas of contamination, says Banks.

• Issue written report. The professional must issue a written report that includes his opinion about whether there are hazardous substances at the building or center. The report must also document any gaps and uncertainties in the data—such as that the professional was unable to interview the building's or center's major tenants, says Hartman King.

Timing. The AAI investigation must be completed within one year of the building's or center's sale date, says Hartman King. But certain aspects, such as interviews, historical record review, on-site visual inspection, and the search for environmental liens, must be updated if they are conducted more than 180 days before the sale date.

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Practical Pointer: You may decide to carry out your own AAI investigation complying with the EPA's rule to establish a baseline for conditions at your building or center before an impending sale. You can give your environmental professional's report (and/or past reports) to the prospective buyer. The buyer then can use this as a starting point in meeting its own AAI obligations.

But prospective buyers must conduct their own, independent AAI investigation to preserve the statutory defenses to CERCLA liability, says Hartman King. All AAI investigations intended to preserve those defenses must meet the rule's timing requirements, she adds.

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Your Role in AAI Investigation

The environmental professional will need to interview you, as the building's or center's owner, say Banks and Hartman King. You can help facilitate the AAI investigation by:

• Giving the environmental professional access to the building or center so it can carry out the AAI investigation;

• Cooperating fully with the AAI investigation, and requiring your property manager and tenants to cooperate, too;

• Making yourself available for an AAI interview;

• Making your property manager and other occupants, such as major tenants, available for AAI interviews; and

• Giving the environmental professional enough time before the building's or center's sale date to conduct any additional investigations if the Phase I investigation results show that the building or center may be contaminated.

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Practical Pointer: The EPA's rule does not require environmental sampling at the building or center, but that step may become necessary if the AAI inquiry indicates likely contamination, says Hartman King. In that event, you should discuss potential options and strategies with your environmental attorney and environmental professional, she cautions.

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Other Scenarios for AAI Investigations

AAI investigations may be needed in situations that do not involve the sale of your building or center. For example, they could arise in any of these other scenarios, says Hartman King:

Refinancing mortgage. If you are refinancing the mortgage on your building or center, the lender may require an AAI investigation to preserve certain defenses to CERCLA liability, including a statutory exemption directly applicable to lenders, notes Hartman King. Savvy lenders will require an investigation, recognizing that they could end up owning the building or center through a foreclosure.

Protecting tenants. New tenants planning to occupy potentially contaminated commercial space could conduct AAI investigations, Hartman King says. Tenants risk becoming ensnared by CERCLA's harsh liability provisions as “operators” of contaminated property, she notes. To safeguard their ability to assert certain CERCLA defenses successfully, incoming tenants could conduct their own AAI investigations before signing the lease, she explains. The environmental professional's report enables the tenant to assess potential contamination at the space and establish a baseline of existing conditions, says Banks.

Also, a sophisticated tenant with an existing long-term lease may decide to comply with the AAI requirement in some situations—such as when it wants to expand its space or when it gets new information that triggers the need to update a previously performed Phase I, says Hartman King. The information gathered will be useful in the CERCLA context and in uncovering issues that must be addressed to avoid other types of liabilities, such as health and safety violations that could affect employees, she explains.

Taking out insurance. If you are trying to get environmental insurance for the building or center, the insurer may demand an AAI investigation to assess environmental risks at and around the property before issuing coverage.

Buying another property. If you decide to buy another property, you must comply with the EPA's new rule and conduct an AAI investigation before closing on that property.

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Practical Pointer: The EPA has endorsed the American Society for Testing and Materials (ASTM) International Standard E1527-05 (Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process) as “consistent with” the EPA's new rule and “compliant with the statutory criteria for AAIs,” notes Banks. ASTM E1527-05, already in effect and broader in scope than the EPA's rule, is the guidance document that environmental professionals will most likely adhere to when complying with the EPA's rule, she explains.

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Comply with Other Environmental Laws, Too

CERCLA is not the only law that applies to potentially contaminated properties, warns Banks. Many other federal and state environmental laws also potentially apply, notes Hartman King. Therefore, you should hire an environmental attorney and environmental professional with expertise on the federal and state laws that apply to the property to get guidance on complying with those laws, say Banks and Hartman King.

• Comprehensive Environmental Response, Compensation, and Liability Act: 42 USC §9601 et seq.

• Standards and Practices for All Appropriate Inquiries: Fed. Reg. Vol. 70, No. 210, p. 66070 et seq. (11/1/05).

CLLI Sources

Sedina L. Banks, Esq.: Greenberg Glusker, 1900 Ave. of the Stars, 21st Floor, Los Angeles, CA 90067; (310) 201-7436; sbanks@ggfirm.com.

Jennifer Hartman King, Esq.: Downey Brand LLP, 555 Capitol Mall, 10th Fl., Sacramento, CA 95814; (916) 444-1000; jhking@downeybrand.com.