Property Acquisition Environmental Due Diligence Procedures

As companies grow, they may acquire other companies, or purchase properties for expansion or to start new operations. In addition, public institutions such as non-profit organizations, colleges, universities, and hospitals may also be given property through donations and bequethments. Acquisition of new property brings the potential for environmental risk. A parking lot may have been part of a former industrial site or the adjacent farmland, or undeveloped land may have been used in the past as an illegal dump. Thorough due diligence can help minimize these environmental liabilities prior to purchasing or accepting property.

Background

The federal Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) of 1980 addressed responsibility for the cleanup of sites contaminated with hazardous substances. Under CERCLA, any party that purchases a property with unknown environmental impacts or concerns is responsible, through strict, joint and several liability, to remediate the site even if they did not create the impacts.

CERCLA also includes an innocent landowner defense for any environmental liabilities associated with a property that existed prior to the purchaser’s ownership or involvement with the property. Successful use of this defense requires the purchaser to make “all appropriate inquiries into the previous ownership and uses of the property consistent with good commercial or customary practice” so they can be exempted from liability. The level of appropriate inquiry varies according to the purchaser, lending institution requirements, and type of property.

Environmental Site Assessments

Properties that will be purchased or donated to a company should be evaluated for their environmental condition. A company may also want to evaluate the environmental condition of any property they are going to lease. This should be done so an environmental baseline can be established to prevent the property owner from holding the leasee responsible for any past environmental liabilities. This effort should complement pollution liability indemnification language incorporated into the lease agreement.

Due diligence typically involves conducting an environmental site assessment (ESA), also known as a Phase I Environmental Site Assessment, on the property. ESAs are detailed investigations of a property or facility to identify any past, current, or potential environmental liabilities. ESAs can take various forms. The American Society of Testing and Materials (ASTM) has published protocols for conducting Phase I Environmental Site Assessments (ASTM E-1527). Other associations, lending institutions, and state regulatory agencies (i.e. NJDEP’s ISRA program) may have their own protocol for environmental site assessments. The correct format should be verified prior to performing the ESA.

The Phase I ESA should address the following information: historical/records review; site description and inspection; historical use; surrounding property uses; current operations and practices; conclusions; and recommendations/opinions. It is important to use a qualified consultant to conduct the assessment as your future environmental liability may depend on it.

A Phase I ESA may be too comprehensive depending on the type of property. For residential or commercial properties, where the environmental liabilities may be less severe, ASTM has developed the Transaction Screening Process, (ASTM E-1528) that contains similar information as ASTM E 1527, but in a checklist format.

Conversely, a Phase I ESA may not be comprehensive enough for an industrial property, which may require a Phase II ESA. The Phase II ESA can also be utilized to more adequately satisfy the innocent purchaser defense under CERCLA. The purpose of the Phase II Environmental Site Assessment is to determine the presence or absence of an uncertain liability or to quantify a known liability or recognized environmental condition, which were identified in the Phase I ESA or transaction screen. Phase II ESAs typically involve investigation that can include geophysical and intrusive efforts to collect and analyze soil and groundwater samples. ASTM has also developed standards for Phase II ESA (ASTM E-1903). The results of the Phase II ESA will either eliminate or confirm any recognized environmental conditions associated with the property. With any recognized environmental conditions confirmed, the prospective property owner will have to decide whether to address the condition through additional investigation, remediation, or contract language or decide not to purchase or accept the property.

A company that is purchasing an active industrial or commercial property may also choose to conduct an environmental compliance audit on site activities as part of the due diligence process. A compliance audit focuses more on current operations and can help identify concerns with permit and regulations compliance; pollution and spill control; chemical and waste handling, storage and disposal; and safety issues. A compliance audit will identify deficiencies, which may require time and expense to correct or address. The audit will also determine if the company to be purchased is subject to any regulatory consent orders or outstanding violations for which the purchasing company may be liable.

Due Diligence Procedures/Policy

A designated person should be assigned to review the ESA report. Consideration should be given to using a third party to review and provide comments on the report if the company does not maintain in-house environmental expertise. Third party review can provide a legal perspective or a detailed look at the ESA from persons well experienced in these reports. The person reviewing the report is also responsible for addressing the recommendations presented in the report and determining if a Phase II ESA should be conducted.

The results of the Phase I/Phase II ESA should be reviewed by staff within the company who are responsible for purchasing or accepting properties and also have an understanding of environmental issues. A decision must then be made on whether to purchase or accept the parcel. For properties to be purchased, environmental concerns can be addressed through sales agreement conditions such as incorporating environmental indemnification language, adjusting the sale price, or creating an escrow account to cover any investigative or remediation activities.

It is a good practice for companies to develop a written due diligence policy for distribution to key personnel within the organization. The policy should:

• State the company’s policy on property acquisitions/acceptance.
• Designate personnel involved in the property acquisition or acceptance process.
• Outline the procedures used for having Environmental Site Assessments and compliance audits completed, reviewed, and approved.
• Develop procedures for approving or rejecting the purchase/acceptance of a property based on report findings.
• Establish responsibilities for addressing the recommendations.

XL Environmental • Risk Control Division • 520 Eagleview Boulevard, PO Box 636, Exton, PA 19341 • Phone: 800-327-1414 • Fax: 610-458-7285 • xlenvironmental.com

XL Environmental is a division of XL Specialty Insurance Company.