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Lenders need to consider the scope and extent of the
Phase I Environmental Site Assessment (“Phase I
ESA”) they routinely utilize in connection with the
acquisition and financing of real estate projects. The
Environmental Protection Agency (“EPA”) announced its
intent to adopt a new standard expanding the scope of review on May
13, 2022.
The proposed standard would not replace or supersede the
existing rule but would create a second set of standards for
environmental consultants who are routinely engaged by banks,
lending companies, and other institutions in connection with loans
used for real estate projects.
EPA approved ASTM International (ASTM) Standard
E1527-21 as an additional standard meeting the
“all appropriate inquiries”
(“AAI”) component for potential liability
protections under the Comprehensive Environmental Response,
Compensation, and Liability Act (“CERCLA”).
AAI is a process to evaluate the environmental history and
condition of real property to assess potential liability for
contamination by way of a Phase I ESA. AAI requirements apply to
any party, including a lender, who can potentially
claim protection from CERCLA liability as an innocent landowner,
contiguous property owner or bona fide prospective purchaser.
Lenders that hold mortgages on real property as secured lenders
are exempt from CERCLA liability if certain criteria are met.
CERCLA Section 101(20) contains a secured creditor exemption that
eliminates owner or operator liability for lenders who hold
ownership in a CERCLA facility primarily to protect their security
interest in that facility, provided they do not “participate
in the management of the facility.”
Generally, participation in the management applies if a bank
exercises decision-making control over a property’s
environmental compliance, or exercises control at a level similar
to a manager of the facility or property. Participation in
management does not include actions such as
conducting property inspections, requiring a response action to
address contamination, providing financial advice or renegotiating
or restructuring the terms of the security interest.
The secured creditor exemption also provides that foreclosure on
a property does not result in liability for a lender, provided the
lender takes “reasonable steps” to divest itself of the
property “at the earliest practicable, commercially reasonable
time, on commercially reasonable terms.” Generally, a bank or
other lender can maintain business activities and close down
operations at a property as long as the property is listed for sale
shortly after the foreclosure date or at the earliest practicable,
commercially reasonable time. For now, the standards will
co-exist and either standard can be utilized.
Among the most significant differences between the
standards:
- Under the new standard, the consultant would be seemingly
directed to consider risk factors that the consultant could have
ignored under the previous standard, possibly resulting in more
conservative conclusions. Phase I ESA conclusions rely on the
judgment of the environmental professional, meaning different
consultants can, and do, arrive at different classifications after
evaluating the same property. A lender should be aware of the
different standards and make an inquiry as to which standard is
being utilized by its consultant. While the existing standard is
still (for the time being) accepted by EPA as satisfying the AAI
requirement for liability protection, it is, perhaps, foreseeable
that as time goes on, the existing standard may leave lenders
vulnerable to claims that a Phase I ESA conducted under that
standard was intentionally less searching and is, accordingly,
insufficient to shield the lender from underlying conditions giving
rise to CERCLA liability. This could potentially spawn litigation
seeking to strip lenders of CERCLA liability protection for a Phase
I ESA conducted under the existing standard.
- The new standard could be interpreted further to direct an
environmental consultant to rely on the environmental
professional’s experience regarding the likelihood of certain
conditions resulting in releases, instead of discounting the risks
associated with such activities based on the lack of current
“indications of a release.”
- The new standard would require the Phase I ESA to set forth the
environmental professional’s basis for identifying controlled
recognized environmental concerns (CRECs), along with copies of the
underlying regulatory documentation supporting such conclusion. For
the prospective purchaser or lender, this is a positive change
because it will permit the user to better understand the risks
associated with the property and provide the user with the source
documents for any continuing obligations at the property regarding
a remedy.
- Under the proposed new standard, the Phase I ESA is valid for
180 days from the date of review of the first of five
elements by the environmental professional, such that
depending on the length of time needed to complete the review, the
“shelf life” of the completed Phase I ESA could be less
than six months. Under the existing standard, the 180-day period
runs from the date of issuance of the report. In both cases, the
Phase I ESA can be extended to one year.
- Certain historical sources must be addressed in the Phase I
ESA, including aerial photographs, fire insurance maps, local
street directories, topographic maps, building department records,
interviews, property tax files, and zoning/land use records, with
an explanation if certain material is missing.
- The new standard clarifies that emerging contaminants will
become subject to Phase I ESA review once they are classified as
hazardous substances under CERCLA. Until such time, lenders may
want to discuss the risks and benefits of including certain
emerging contaminants under the scope of the Phase I ESA with their
environmental consultant and legal counsel.
- Practically speaking, a Phase I ESA may become more costly
under the new standard, resulting in additional cost to borrowers
and purchasers.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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