GET A BETTER UNDERSTANDING OF THE ENVIRONMENTAL DUE DILIGENCE PROCESS AS IT RELATES SPECIFICALLY TO BUYING OR SELLING A DRYCLEANER
BY: DRU SHIELDS
The sale of a commercial property oftentimes requires a Phase I Environmental Site Assessment (ESA) in order to account for potential liability that may be taken on by the buyer and lender during the transaction. This process is extremely important in buying or selling a drycleaning property due to the historical likelihood of contamination. And, for many drycleaners the prospect of contamination being discovered during due diligence puts artificial restraints on plans of selling their property or passing it down to the next generation.
In this blog post, we will address when you’ll need environmental due diligence, what to expect during a Phase I Environmental Site Assessment and what might determine the need for a Phase II, how to use the results of a Phase I and Phase II in a real estate transaction, and how to use old insurance policies to offset the cost of environmental liability.
WHEN YOU NEED ENVIRONMENTAL DUE DILIGENCE
There are several reasons for a Phase I Environmental Site Assessment to take place such as if you or someone near you is:
- Buying or selling a property;
- Refinancing a loan;
- Having road work done;
- Has received a letter from a Regulatory agency; or
- One of your neighbors is conducting a Phase I ESA
WHAT TO EXPECT DURING A PHASE I
A Phase I ESA is a study conducted on a property by a Qualified Environmental Professional (EP) to evaluate the likelihood of environmental contamination, which must follow the American Society for Testing and Materials Engineers (ASTM). When performed correctly, a Phase I ESA will satisfy the All-Appropriate Inquiry (AAI) requirement, which was established by the U.S. EPA to allow buyers of property to avoid taking on environmental liability accidentally. In other words, if you look at a property and actually try to find contamination and you don’t, then you can buy the property and not be responsible for a previous owner’s issue if discovered later.
WHAT HAPPENS IF RECs ARE IDENTIFIED?
If a Recognized Environmental Condition (REC) is identified, the All-Appropriate Inquiry (AAI) process mandates that a Phase II ESA be performed, which includes actual sample collection in the areas of concern. Keeping in mind that to qualify for the liability exemption, you actually have to try and find the contamination. During a Phase II, the EP investigates those areas where they believe there could be a problem and collect soil, groundwater, and/or vapor samples for laboratory analysis. They will most likely only look for the chemicals that they have cause to be concerned about. If the property is a dry cleaner, this usually means that they will need to make a hole in the floor next to current and past drycleaning machines. Other common locations are out the back door, near the current and past dumpster locations, and along the sanitary sewer corridor. If these all come back clean, you can again feel pretty good about things.
WHY ARE ENVIRONMENTAL SITE ASSESSMENTS VALUABLE?
The All Appropriate Inquiry (AAI) is defined and recognized by ASTM and EPA through the federal Superfund Law CERCLA. Essentially, it refers to the method of assessing the environmental conditions in association with a property, as well as liability for potential contamination.
If the buyer is using a bank loan to finance the deal, the bank will require a Phase I ESA so that the property can be used as collateral. They want to make sure that they don’t accidentally acquire a contaminated property if the buyer defaults on the loan. For that reason, any time an owner refinances a loan where the property is already used as collateral, the bank will require a fresh Phase I ESA.
By having the coveted AAI, it means buyers will be confident proceeding in the real estate transaction. If buying or selling, make sure that your environmental consultant knows exactly what they are doing and exactly how to use the ASTM standard to help you avoid liability.
ITEMS WITHIN PHASE I/II ESAs THAT CAN BE NEGOTIATED THROUGH LEGAL COUNSEL DURING A REAL ESTATE TRANSACTION
The first thing to understand about how to use the Phase I ESA in the buying and selling of a drycleaner is the levels of risk and liability that can be up for negotiating during the real estate transaction. The first level of risk is Operator Liability. Operator Liability is related to the managed use of drycleaning chemicals and their proper disposal. The second level of risk is Owner Liability. Property owners can be held liable for contamination even if they weren’t responsible for a spill. This is why an operator who rents their property may have additional environmental conditions in their leasing agreement that need to be met. All of this, of course can be discussed during the negotiation of the contract purchase and sale agreement.
A common variable in real estate transactions is the involvement of a third party bank or lender. The lender will typically have their own environmental requirements relating to the condition of the property. In many instances, the lender may require that certain steps be taken by the buyer on the property to address environmental problems. And, oftentimes, the bank or lender will bring their own environmental consultant in to do their due diligence. From the buyer’s perspective, it’s very important to coordinate these efforts so there isn’t any confusion or duplication of work between the consultants. Some legal counsel will even recommend using the same consultant for both the buyer and the lender, to avoid the duplication issue.
It’s important to be mindful of the various state requirements. A drycleaner will want to make sure their due diligence efforts address both state and federal regulations. For instance, some states will require a buyer to report an environmental impact discovered during due diligence, other states don’t have that requirement because the buyer isn’t technically an owner or operator yet. Some states place restrictions on the type of consultants that are allowed on a property during the sales process. A good rule of thumb is to have legal counsel look into both state and federal requirements and communicate those requirements to the environmental consultant to increase the likelihood of satisfying the AAI requirement.
HOW TO USE OLD INSURANCE TO OFFSET ENVIRONMENTAL COSTS
If there are environmental impacts found during the due diligence process, finding old insurance coverage through insurance archeology can be one way to prevent a deal from falling through. Old policies, or even just evidence of insurance coverage can provide a defense against a claim or suit. In some states, that can be either a letter from the regulatory agency or a neighboring property owner demanding a response to the identified environmental contamination.
Once a Commercial General Liability (CGL) policy is triggered, it can be used to cover legal fees, defense against claims, site investigation, remediation/cleanup, interim remedial measures, building a legal case, potentially responsible parties (PRP) search, interfacing with agencies, and cost recovery for prior remediation measures.
Learn more about Commercial General Liability policies and how they can be used to pay for environmental cleanup
NEXT STEPS FOR DRYCLEANERS PLANNING ON BUYING OR SELLING
Now that some of the Phase I Environmental Site Assessment process has been demystified, and you’re ready to kick off a real estate transaction, we recommend following these four steps:
1. Look into insurance archeology to locate your old coverage
If you’ve sat in on any of our webinars or presentations, you’ve probably heard us preach that looking into your old insurance policies should be the first thing you do. Period. Finding out how much money you have available to you from a source other than your own bank account will help lay the groundwork for how to address contamination should it be found at your site.
2. Find an environmental consultant that has experience with drycleaners
It’s important when choosing an environmental consultant to make sure that the consultant you choose to work with has extensive experience with investigating and remediating chlorinated solvent contamination. Truly understanding historic drycleaning operational history as well as experience with investigating dry cleaner sites is needed to be able to locate true source areas..
3. Find an environmental attorney who understands real estate law, environmental law, and how to use insurance
It’s also important when hiring legal counsel that you look for an attorney who not only understands environmental law, but who also understands the nuances of using insurance. Every state’s case law is different in how they apply real estate laws, environmental laws and statutes, and also in how they interpret key insurance coverage points as they relate to using old insurance policies to help cover cleanup costs, and having legal counsel to help you navigate all of this will be key.
4. Carefully prepare for the transaction
It’s important to carefully prepare for your transaction – both as a buyer and as a seller – consult an attorney, consult your environmental consultant, make sure your team is coordinating, and make sure you cover all of your bases so surprises don’t derail your deal.
Dru Shields, Director of Dry Cleaner Accounts
For over 10 years, Dru has helped numerous business and property owners facing regulatory action, navigate and manage their environmental liability. Dru has vast experience in assisting dry cleaners in securing funding for their environmental cleanups through historical insurance policies. Dru is a member of numerous drycleaning associations in addition to serving on the Midwest Drycleaning and Laundry Institute (MWDLI) advisory council and on the Drycleaning & Laundry Institute Board (DLI) as an Allied Trade District Committee Member.