Advance due-diligence activities benefit contaminated real estate transactions.

Brownfields have been defined by the Environmental Protection Agency as: abandoned, idled or underused industrial and commercial facilities where expansion or redevelopment is complicated by real or perceived environmental contamination. (1) The number of brownfields in the United States has been estimated to be between 400,000 and 600,000 sites. (2)

Investing in, owning, developing, or making a loan on contaminated real estate entails risks which can be difficult to quantify and evaluate. Much of the excess risk facing brownfield investors and lenders stems from federal and state statutes and rules. Federal legislation passed in 1980 known as the Comprehensive Environmental Compensation and Liability Act (CERCLA), also called the "superfund" law, cast a broad net which covered many potentially "responsible parties" for brownfields related liability. (3)

The CERCLA legislation has had some unfortunate and unintended consequences. Fear of becoming a "responsible party", under CERCLA, has caused investors and developers to ignore brownfield sites and build in outlying "greenfield" locations causing sprawl, decentralization of employment and reduction of property tax base. Some owners of contaminated property tried to avoid the "strict liability" doctrine of CERCLA by hiding information and not publicly reporting environmental financial exposures in their financial statements. (4) Lenders have resisted financing brownfield projects fearing that they may eventually become owners through foreclosure. In addition, some municipalities have refused to take possession of tax delinquent contaminated properties because of the potential environmental liabilities. The fear of becoming a potentially "responsible party" under CERCLA has precluded many attempts to remediate, redevelop, or to sell brownfield sites.

The many uncertainties involved in selling contaminated real estate often make the transactions expensive, lengthy, and at high risk of not being completed. Uncertainties such as: the cost of environmental due-diligence, the cost of cleanup, the likelihood of obtaining approvals of closure from regulatory agencies, and the risk of acquiring or retaining the environmental legal liability often make selling a brownfield site a low percentage real estate transaction. Sellers of contaminated real estate often become discouraged as buyers are reluctant to make offers to purchase due to the potentially high cost of environmental investigation, cleanup, and other risks. In addition, lengthy time delays resulting from false starts and a series of failed transactions add to the frustration and cost of selling contaminated real estate.

Beginning in the 1990s, a new focus on combating urban sprawl and a backlash against perceived unrealistic cleanup standards encouraged federal and state regulators to remove some of the impediments to brownfield redevelopment. The effort included: lender and buyer liability reform, widespread adoption of "risk-based" cleanup standards, and new approaches to site closure. At the same time, technical advances in site investigation and remediation technology, and the maturation of the environmental engineering market, have helped reduce or moderate the costs of environmental due-diligence and cleanup. Environmental insurance companies responded to regulatory reform and moderating remediation costs by creating several new insurance products to manage and transfer environmental risks.

The recent changes in brownfield regulation, technology, and environmental liability insurance have ameliorated risk and uncertainty and created new opportunities to sell properties that would have been unsalable in the past. However, access to these brownfield tools, whether regulatory, technical, or financial, requires an understanding of site conditions that few sellers obtain prior to their entry into the marketplace. As a result, sellers experience a greater risk of offers failing to close and of higher transaction costs.

PURPOSE

This article illustrates the benefits, from the seller's perspective, of performing some of the critical duediligence activities prior to, and in preparation for, marketing real estate. The sellers advance due-diligence will be shown to be a prudent and reasonable method of overcoming buyers reluctance to submit offers to purchase as well as providing the seller with a more solid basis upon which to value the property, quantify the environmental risk and evaluate the offers which are made. Through the use of advance due-diligence, it will be argued and illustrated that sellers may be better able to evaluate and select the "best" offer and reduce time delays and transactional costs.

METHODOLOGY

A transactional review will be made of a recent sale of a manufacturing Brownfield site located in a medium-sized midwestern city. The seller was a company involved in federal bankruptcy proceedings and was highly motivated to make a timely sale at a price and terms that were acceptable to the creditors committee. Since time was of the essence, and local investors were aware of perceived environmental problems at the site, the seller decided to perform many of the due-diligence activities in advance of soliciting offers to purchase.

The effect of performing sellers advance due-diligence will be evaluated and reviewed within the context of the eight offers to purchase which were received on the property. All of the eight offers were drafted by attorneys skilled in real estate environmental law and were received during the submittal periods established by the bankruptcy court. By tabulating the important issues of the offers to purchase, it will be possible to see how, from the seller's perspective, the advance due-diligence expedited the evaluation and negotiation of the offers, and ultimately the closing of the transaction.

THE BROWNFIELD PROPERTY

The subject property is located close to the downtown business district in a rapidly growing Midwestern city. The site borders an area of light manufacturing, utility, and industrial service businesses and is surrounded by a transitional residential neighborhood.

To prepare the property for sale, the owners commissioned Phase 1, Phase 2, and Supplemental Phase 2 environmental site assessments (ESAs). Phase 1 ESAs are generally the starting point in the environmental due-diligence process. A principal goal of a Phase 1 report is to identify if past environmental management practices have created the presence of Recognized Environmental Conditions (RECs). RECs refer to the presence or likely presence of hazardous substances or petroleum under conditions that might indicate a release into the ground, groundwater or surface water. (5) For many sites with long histories of commercial or industrial use, RECs are commonly identified, and follow-up investigation is needed to determine if the potential releases have actually occurred. At the subject property, RECs were found. They included: potential soil and groundwater contamination from underground petroleum storage tanks, historical use of solvents, and releases at nearby properties.

Based on the phase 1 results, the seller elected to perform a Phase 2 investigation to assess concerns identified by the Phase 1 report. The Phase 2 investigation included more detailed reviews of environmental files for several off-site releases on neighboring properties to learn if they might be contaminating the seller's property. Several RECs on the subject property were also investigated. In particular, a magnetometer survey was performed on areas where underground storage tanks were suspected and 10 borings were made to collect soil and groundwater samples near the current and suspected historic underground tanks and a bordering rail corridor.

To prepare the property for sale and remove as much uncertainty as possible, three underground tanks were removed and some contaminated soil from each tank basin was excavated. The Phase 2 report concluded that limited soil contamination remained at one former tank location, and that shallow groundwater was contaminated in excess of state standards at two former tank locations. The groundwater impacts were thought not to have migrated off the property. In addition, an area with solvent contamination was identified, but the source was thought to be coming from off-site.

The Phase 2 report concluded that two areas could be submitted to state regulatory authorities for closure, and one area was likely eligible for reimbursement under a state fund that pays for cleanup of releases from petroleum tanks. However, additional borings and four groundwater monitoring wells were recommended to identify the extent of soil and groundwater contamination. Without the additional data, it would be difficult to present closure requests to regulators or remediation cost estimates to potential buyers and environmental liability insurance underwriters.

The seller agreed with the consultant's recommendations for additional site investigation to remove or reduce uncertainty regarding remediation costs and to get regulatory approval to close as many areas on the site as possible. In addition, the consultant was asked to perform supplementary historical research to identify the possible location of two fuel oil tanks identified in an older report and potentially still present on the site.