ENVIRONMENTAL ISSUES
IN REAL ESTATE DEVELOPMENT:
ASSESSING AND ADDRESSING THE RISKS


Frank L. Hearne
Mechanik Nuccio Bentley Williams & Hearne, P.A.
Tampa, Florida
June 2001
Telephone ( 813) 909-7400 or visit us at The Synergistic Café
on the World Wide Web at www.hgn.com

If you are active today in developing real estate sites for businesses, you know that many otherwise attractive sites often have environmental issues. We have put together this information to help answer the following questions:

Why are sites with environmental issues a risk?
What types of sites might have environmental issues?
How can we protect ourselves?
What are some common mistakes in Environmental Site Investigations?
Can a site be developed even though there are environmental risks?

As we will see below, the answer to the last question is yes. However, in developing a site, one must carefully assess the risks that may be involved and work logically and creatively toward a resolution if there is to be a transaction. In all cases, the investment may not be worth the risk. On the other hand, many properties can be resolved favorably.

We've prepared this paper in response to the needs of our clients who are active in the acquisition of real estate sites as a part of their business. Experience has taught us that such businesses must have a procedure in place for reviewing properties and for working through a reasoned decision on whether a particular problem can be addressed within the company's tolerance of risk or whether the property should be avoided altogether. Obviously, this decision is best made as early as possible in the review of the site. As you know, no one can be sure that any set of procedures will be foolproof and there must be room in each case for judgment and flexibility. As we have seen many times, management goals must be factored into the overall effort being put into the investigation. Keeping those factors in mind, we would like to offer some information and some suggestions that should be helpful.


Why are sites with environmental issues a risk?

A Dozen Principles:

Here are some facts of life in dealing with environmental risks under present environmental laws and regulations:

The "owner" and "operator" of contaminated real property are subject to narrow defenses, liable to the government for cleanup costs in many cases even if the conditions were caused by another, for example, the former owner or a tenant. Fault is not necessary for liability, although, at least under federal law, it can be considered in some cases in dividing costs between parties.

2. Even if the property is leased, building on contaminated property or being a tenant can involve complications. Issues include worker exposure during construction and business interruption if site work is required later.

3. The cost of the problem can often be unrelated to the value of the property or the size of the transaction. Because the cleanup of soil and groundwater is so expensive, a small parcel can have a big price ticket. In addition there can be cases where a relatively small source affects a big area, such as when gasoline leaks reach an underground utility line and spread over a large area.

4. Many environmental issues are hidden and require special technical investigations to detect. As we will discuss below, a site doesn't have to be a factory or even an old gasoline station to have issues.

5. Environmental laws cover a broad range of commonly used materials, including fairly common fuels, cleaners, alcohols, acids and solvents, just to name a few.


6. Use of many regulated materials involves some degree of release to the surroundings or exposure to people, e.g., use of solvents in cleaning engine parts or use of acids in etching, therefore use resulted in contamination.

7. Generally, known environmental risks are difficult to insure against, however, coverage for unknown risks is now becoming available where there has been an adequate assessment of the site.

8. The environmental issues may interfere with the occupant or tenant's ability to continue normal business operations during a cleanup. An example would be the disruption of business resulting from the removal of soil from a parking area or driveway.

9. In the case of successive tenants or owners using the same or similar regulated materials, it may be difficult or impossible to separate the effects of one tenant or owner from the other.

10. In the case of nearby owners or tenants using the same or similar regulated materials, it may be difficult or impossible to separate the effects of the nearby owners or tenants.

11. In some cases, there are state sponsored programs which limit the risk of certain types of contamination.

12. Despite the risks, there are ways to manage the issues and sites with contamination are increasingly involved in transactions.

What types of sites might have environmental issues?

The truth is just about any type of site can have an environmental risk. As we will explain below, the practice in the real estate business today is to check out the history and condition of the all property thoroughly as early as possible in the negotiation. More on that later. For now, let's focus on what types of sites frequently pop up as problems.

Probably the most frequent type of site is the former gasoline station, which can have petroleum in the underground soil and groundwater from leakage associated with underground tanks. However, gas stations can also have contamination from waste lubricating oil, solvents from the cleaning of engines or parts, metals and acids from batteries, tanks related to hydraulic lifts and other issues.
Different contaminants may have different regulatory consequences. On the other hand, there are many other types of sites which may have had underground tanks. To name a few:

Rental Car sites
Bus Depots
Taxi businesses
Trucking companies
Airports
Farms
Plant Nurseries
City Municipal facilities for vehicle repair
Residential sites with heating oil

Another common type of site is one involving an old drycleaner or laundry. Such establishments used a chemical for cleaning instead of (or in addition to) using water. Thus the name "dry cleaner." These solvents have found their way into the environment in a number of different ways and the resulting situation is relatively difficult to fix. Many other types of business used a similar product for cleaning. Some of them are:

Auto repair shops
Small engine repair
Businesses doing molds to cast plastic
Car Washes and Detail shops
Painting
Welding and metals shops.

In addition, many types of businesses have other environmental issues. Here are some examples of other types of property and the associated environmental risks we have encountered in our practice:

Farmland : Pesticide usage including organics and metals like arsenic.
Under ground or above ground tanks for farm equipment
Tires

Orchards: Metallic fungicides
Tanks for equipment use
Solvents form equipment repair

Funeral Homes: Embalming fluids

Vacant Land: Past usage
Landfilled materials

Plant Nursery: Tanks for equipment
Metals from fertilizers and pesticides

Hat Manufacturing: Mercury from felt

Plating: Acids and metals

Sausage Making: Lubricating oils from grinding equipment.

Consequently, those in businesses which seek sites for development are wise to implement procedures which will identify environmental risks and address them early in the process of a transaction. This procedure should be applied to every property under consideration. Many lenders, borrowers, tenants and other businesses have already set up such procedures. This paper will set forth some basic points which could be a part of that procedure.

How can we protect ourselves?

Planning Environmental Reviews of Transactions:


One note: Anytime a purchaser is considering a transaction, both environmental liability and compliance issues should be addressed. Here, we have focused mainly on "liability" issues. Such issues include, for example, a risk of having to pay remedial costs after the transaction by becoming responsible for cleanup costs. Closely related would be the risk of interference with business or possible liability to third parties on or off the site. On the other hand, "compliance" risks would be those involving permits or licenses to operate. For example, there could be a wetlands permit requirement at a site that could prevent operation or make operation difficult or expensive. Site developers are usually more familiar with these permits and approvals but some may be complicated by contamination on the site as well. These issues must be addressed as well, but are not the focus of this presentation.

While the particular real estate interests being taken are very important factors in the liability risk of a particular deal, there can be real risks even where real properties are not being purchased. In some cases, liability issues may arise when the property is leased or where there is a purchase option. Each case requires an independent analyses.

One way of assessing risk is a stepwise approach, staring with a fairly general review and progressing to more complex investigation. Of course, the process is more complex than a simple step process. Where site issues are obvious, Phase 11 testing may be addressed early in the process. However, no step should be skipped.

Step 1: Transactional Screening

With advance planning, you can establish an approach that will, to the extent practical, list the information that will be needed about each site or business to evaluate it as a candidate for company acquisition. Since 1993, a national standard has been available to use in addressing the possibility of site issues early in site review. These were developed by the prestigious "American Society for Testing and Materials" or ASTM. ASTM sets technical standards for all sorts of equipment and procedures in America. The ASTM Standard for "Transactional Screening" can be used, with some fine tuning, early in the process to identify issues for the types of sites that a business would be pursuing. This approach is a structured review of the target property aimed at assessing whether environmental issues are likely.

With training, we have found that many businesses have successfully used internal staff to do some of the threshold work early in the evaluation of a site. Examples would include collection of information from certain agency records and from companies which provide records by address. Some are now available on the Internet. Again, this should only be done in conjunction with proper training for in-house staff. Staff must have an overall understanding of the issues in any case. This effort could also be coordinated with development of a form for initial review which, while targeted to the particular business, could be used as guidance for preliminary evaluations (although, in our experience, such forms should never be slavishly applied).

Step 2: Environmental Site Assessments


It the Transactional Screening indicates that there may be issues, the investigation becomes more intense. At that point, environmental consultants would need to become involved in the process and to address specific concerns. The company might develop guidance for when the consultants should become involved based on the outcome of the Transactional Screen. Consultants should be pre-qualified and under specific contract, including all required terms. They should be obligated to provide site work in keeping with industry standards. The company should attempt to avail itself of the possible protections in using another ASTM standard "Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process," to the extent possible. This form sets the fundamentals for review of sites in a "Phase I" environmental review, now more frequently referred to as an Environmental Site Assessment or "ESA". It is however, not intended to be exhaustive and should be fine-tuned for particular sites and risks. Using the standard outline form from the standard helps in reviewing reports on many sites for completeness.

Step 3: "Phase II" or Additional Studies

Depending on the results of the ESA, additional site investigations may be necessary. These types of studies need to be developed with the assistance of a qualified environmental professional clearly representing the buyer's interest. Each will be very specific to the particular site when investigations of soil and groundwater became necessary. The site investigation at this point has entered what is often called "Phase 2". Although there is also an ASTM standard ( Phase II Environmental Site Assessments"), this term has little standard meaning since it is by definition site specific and can vary greatly in extent, time and cost. In many cases, Phase II work begins almost immediately to address known issues.

Step 4: Assessing Remediation Costs

When it becomes necessary to evaluate how the site might be remediated (or cleaned up), the investment becomes larger. The required work is totally dependent on the circumstances at the site. Obviously, it may be more efficient to conduct a single study, if possible, to accomplish an assessment of cleanup costs at the time of the "Phase II." However, this may not be possible. In the long run, the needs and resources of the buyer and the circumstances of each site and the contract or lease, especially what solutions might be available, must dictate the design of the investigation.

The bottom line is that the company must conduct the studies needed to accurately assess the risks or reach a solution. In some cases, in may be apparent that the costs of the studies alone or the time to conduct them is a significant barrier to proceeding. In other cases, it may be that a particular site can be purchased and developed with acceptable risks and a prime location becomes available.

What are some common mistakes in Environmental Site Investigations?

Wishful thinking:

Examples:

"My site is just vacant land."
Risk: Vacant land may have once held an operation with significant risks.

"The owner says it has all been addressed"
Risk: The owner may not understand or remember what the issues were or may be misleading in his or her assurances.

Poor consultant selection:

Examples:

Using the Seller's or Landlord's consultant
Risk: The seller's or landlord's consultant, even though they are familiar with the site, is not a prudent choice of advisor for the buyer or tenant. Similarly, any company affiliated with the seller or landlord, in most cases is not an acceptable consultant for the buyer. You need independent advice from a consultant with no conflict of interest.

Using inexperienced consultants
Risk: The consultant may fail to properly address all site issues or give an uninformed opinion of the risk. Note that you may receive bad advice either way. That is, you may be told a site which is viable is to risky if the consultant incorrectly thinks more stringent standards apply.

Bad Consultant Contracts
Risk: By accepting without review the consultants form contract, the site manager accepts terms which severely limit or eliminates the consultant's responsibility for her work.

Contracting Errors

Examples:

Failure to build in enough time for environmental due diligence.
Risk: Running out of time and endangering the deal if more work is needed.

Failure to draft contract to take environmental issues into account.
Risk: Loss of deal or litigation when issues arise.


Given all this, can a site be developed even though there are environmental risks?

Yes, in many cases, it is possible to satisfactorily address environmental issues at a site prior to closing. In fact, we and other environmental attorneys nationwide are finding a trend for the parties to confront and address environmental issues on a site and complete the transaction. A "tool kit" of options to address these types of sites has been developed and the options expand everyday.

Here are few possibilities which can facilitate deals:

Remediation and release of the site by the agency: Experienced environmental counsel and consultants in some cases can accelerate the review of a site by the agency or can advance legal and technical options for concluding work at a site which simply have not been addressed by prior consultants on a project.

Contract Terms allocating liability: Various optional approaches in contract terms might provide flexibility to manage the risk during the investigation period before closing on a site and the payment for costs after closing. Possibilities include an indemnity from the Seller or landlord with guarantees from solvent parties and/or an escrow amount calculated to cover some or all of the expected costs. Obviously, these are dependent upon the negotiation and bargaining strength of the parties.

Environmental Insurance: Increasingly, we are seeing environmental insurance becoming available and allowing deals to close. Examples would be insuring against an unknown risk or providing coverage for contractors who will be working on the site after closing. Costs of such coverage has become manageable in the context of most real estate deals.

State Programs: A number of states have programs which greatly assist in addressing contaminated sites. You must seek advice from knowledgeable lawyers and consultant in your state.

"Brownfields Programs": State and federal programs exist to encourage development on sites which have been out of commerce as a result of environmental problems. Grants, tax benefits and reduced cleanup requirements may be available.

Agency "Comfort Letters": In some cases where the site is affected by nearby property or other circumstances exist, the agency may be able to provide to a prospective buyer some written assurance that they will not be liable for cleanup or other costs.

These approaches and others can be tailored to address a broad variety of sites and manage the risk to a point which is acceptable to the business goals. A successful project may be accomplished.

Summary:

Environmental risks are a fact of life in site development. Present laws and regulations place a heavy penalty on misjudging the risk of a particular property. Any property may have an environmental risk. Businesses are addressing this risk by a structured review procedure to determine the history and condition of the property. When the risk has been assessed, there are a variety of methods available to manage the risk in the context of a transaction. While in some cases the cost of addressing the risk may be unacceptable, there are many cases where the transaction can move forward.

We hope these suggestions are useful to you and that they are taken in the spirit offered which is to save time and money in evaluating sites for development. As always, we are available to assist in helping your company implement its plans to evaluate potential purchases.

Enjoy and keep in touch.

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