Environmental due diligence in real estate and business

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Purchasing commercial real estate or an existing business poses many challenges. The prudent buyer of either will usually allow time to undertake adequate due diligence to determine if the business or property is likely to provide the opportunities the buyer envisions and has any risks that the buyer should consider in determining whether to proceed with the acquisition.
It is likely that the purchase of a business also will involve real estate issues because the business might own or lease real estate. Therefore, for either type of acquisition involving real estate, in addition to other types of due diligence, the buyer should also consider undertaking an environmental investigation.
The buyer’s lender also might require one.

Environmental risks

Unfortunately, the purchaser of real estate or a business also might be purchasing environmental risk. Environmental laws can impose liability, including the costs associated with remediating contamination at a site, not only on those who caused the contamination, but also on the property owner or operator (such as a tenant), even if someone else created the environmental problem.
Although environmental laws generally follow a “polluter pays” principle, if the party creating the problem is no longer around, the current owner or operator of a site might incur the clean-up expenses.
A property also could have contamination which originated from off-site.
Unexpected remediation costs can be very expensive and occasionally exceed the property’s value. For example, a buyer could purchase a restaurant business and its underlying real estate. If it turns out that the property was once a gas station and still contains leaking underground storage tanks, the buyer might have liability associated with remediation of contaminated soil or groundwater because of fuel which leaked from the tanks.
Proper investigation might have disclosed this risk prior to purchase of the property.
Applicable environmental law might provide certain protections for a buyer where the property requires future remediation for unknown but existing conditions. This protection might occur if the buyer conducted an appropriate level of inquiry about the property before purchase and the investigation disclosed no adverse conditions.

The Phase I report

The initial step in the environmental due diligence process might entail the buyer commissioning a Phase I Environmental Site Assessment (ESA) report from an environmental professional.
The Phase I ESA does not typically involve any physical sampling or testing at the property. Instead the environmental professional will interview people with knowledge about the subject property, search environmental databases for information about the property and nearby properties, review historical directories or aerial photographs to determine any past occupants or uses of the site, conduct a visual site inspection, and provide the buyer or others with a questionnaire about the property and its use.
The environmental professional will evaluate the results of this investigation and prepare the Phase I ESA to document any “recognized environmental conditions.” For example, the historic records might show that an adjacent, upgradient property contained a dry cleaning facility which had environmental problems, and this could indicate that contamination might have migrated to the subject property.
The absence of any recognized environmental conditions will help reduce the acquisition risk to the buyer.

Additional investigations

If the Phase I ESA suggests the need for additional environmental investigations because of a recognized environmental condition, the environmental professional might recommend that the buyer obtain a Phase II ESA.
This additional inquiry might involve physical sampling or testing at the site to determine if identified issues are at a level warranting concern. An example might include soil sample testing to determine if any environmental contaminants are present at levels exceeding regulatory criteria.
If the testing does not confirm the suspected contamination, or results show low levels, it might no longer be a recognized environmental condition.

Use of environmental reports

If the environmental reports do not identify any recognized environmental conditions, the buyer might be more willing to undertake the purchase of the property or the business. The buyer could then use the reports as support for an innocent purchaser defense to show that it is a “bona fide prospective purchaser” if it becomes involved in any cleanup liability dispute for any unknown contamination existing at the time of the closing.
If the environmental reports identify areas of concern, the buyer might want to include this risk in the evaluation of whether to acquire the property or business. If the buyer still wants to acquire the property, there might be ways to reduce this risk, such as requiring the seller to remediate any environmental problems prior to closing, having the seller indemnify the buyer for these risks, obtaining environmental insurance or negotiating a reduced purchase price to provide a discount to the buyer for absorbing the environmental risk.

Conclusion

Because remediating an environmental problem can be costly, the buyer of a business or real estate should include an appropriate level of environmental due diligence. This investigation might save the buyer unexpected costs and also give the buyer extra comfort in deciding to undertake the purchase.
Evan Randall is an attorney at Holland & Hart LLP. He can be reached at elrandall@hollandhart.com.