June 21, 2023
By Daniel Moser
Risk Consulting Associate, AXA XL
Commercial real estate can be a lucrative investment. Performing careful environmental due diligence is an important step in ensuring that it remains that way. Assessments like a quality Phase I Environmental Site Assessment helps buyers assure that the property they are buying is free of potential contamination, or undiscovered pollution conditions that could later impact its value or planned use.
It seems like a no-brainer. Afterall, buyers and sellers would never consider skipping a formal property appraisal to determine an appropriate sale value. However, the location, current use, proposed future use, or speed of a business deal can often cloud judgement and diminish the perceived need for a Phase I ESA, or prompt short cuts either by the buyers or hired consultants, in the process. At 色多多视频 we review hundreds of draft & final Phase I ESAs every year and experience tells us that some will be lower quality and less reliable than others.
Cautionary tales
It’s surprising that buyers still consider skipping Phase I ESAs when there are plenty of costly examples that demonstrate what could happen. Consider the infamous .
The Kiddie Kollege Daycare opened its doors in 2004. NJ Department of Environmental Protection (NJDEP) began investigating mercury exposures in the daycare’s children and staff in 2006. The property had been previously owned by a manufacturer of mercury thermometers. When the company ceased operations, it failed to comply with the Industrial Site Recovery Act (ISRA) which requires certain industrial establishments that are transferred or closed to undergo environmental investigation and remediation if required. The property was acquired without having a Phase I ESA performed or meeting NJDEP requirements for a Preliminary Assessment by a real estate investor who renovated the building and then leased it to the daycare center.
A trial court found that the property owner could have learned of the potential presence of mercury contamination by researching the historical records or if they followed their attorney’s advice and engaged an environmental professional to perform a preliminary assessment before proceeding to foreclose the tax sale certificates.
In 2010, the property owner and daycare operators settled a class action lawsuit brought by parents for USD $1M. Another judge subsequently awarded $1.6M in attorneys’ fees to plaintiffs’ lawyers. Meanwhile, the building was demolished in 2010 with the debris hauled away to an Indiana hazardous waste site. More recently, in 2016, New Jersey trial court ordered the current property owner who leased the contaminated building to the daycare center to reimburse the NJDEP $2.05M and awarded treble damages of $6.1M against the former owner of the thermometer manufacturer.
Taking short cuts also has repercussions. That’s a lesson one bank learned when it procured a Phase I ESA to support a refinance of a commercial property in NY. The contracted environmental consultant, however, failed to perform adequate historical review and missed radioactive contamination from historic uranium sludge processing onsite. Regulatory files dating back to the 1970s had references to the historic conditions so this information should have been readily available if the proper historic review was performed. In the end, the borrower defaulted on the loan leaving the bank a property with a value that dropped from $3M to $0. The cost to clean up the property was estimated to be between $4M and 30M.
Critical business decisions essential to the success of a real estate transaction can rest on these reports.
Equipped to make critical business decisions
Why is the content and quality of a Phase I Environmental Site Assessment important to customers and other stakeholders that rely upon its findings and conclusions? Because a lot of critical business decisions essential to the success of a real estate transaction can rest on these reports.
Whether a site issue is identified as a Recognized Environmental Condition, a Business Environmental Risk, or some other creative classification developed by the report’s author, a variety of stakeholders often depend on the Phase I ESA scope and quality. These reports, which must follow prescribed industry and regulatory standards, should help clarify whether there is a potential material threat to the environment or human health. Far too often a poor Phase I ESA can hinder stakeholder decision making. These considerations can impact transaction profitability and future site use plans.
Attorneys may need to decide if additional indemnification language is necessary in a purchase & sale agreement (PSA), environmental regulators may need to decide if additional site investigation is necessary, lenders may need to determine if an environmental issue could potentially cause a loan default, and insurance underwriters may need to decide if known pollution conditions can be covered or excluded.
Information-backed decision making
Ultimately, it is the buyer or seller retaining the Phase I ESA consultant that must make the final decision on whether to proceed with a transaction. The structure of the deal will be impacted by the decisions other stakeholders make, as well as the risk management mechanisms employed. Seldom is sale price alone the only consideration. A myriad of options may need to be explored such as further investigation of RECs, establishing pollution condition discovery periods, performing corrective actions, funding remediation escrow accounts, finalizing regulatory agency agreements, and modifications to draft PSA language.
Phase I ESAs that utilize non-standard terminology, lack required information or fail to provide a solid rationale for RECs, HRECs, CRECs, BERs, potential or actual environmental conditions, or other report recommendations can create confusion. This often results in differences in professional opinion and conflicts during stakeholder decision making. Stakeholders should also be mindful of relying on Phase I ESA conclusions from consultants that incorporate risk tolerances or financial materiality factors at the request of their client without clearly defining these considerations in the report. Suffice to say, it can be difficult to develop an appropriate transactional path forward without a Phase I ESA that stakeholders agree presents sound conclusions.
Ensuring that adequate environmental due diligence has been performed to identify the potential for existing or future pollution conditions is essential. Retaining an experienced environmental consultant to complete a quality Phase I ESA that will improve decision making is an important step. Engaging the appropriate resources and collaborating with business partners to assist with decision making is also prudent.
To learn more about Phase I Environmental Site Assessments and what needs to be considered when performing one, download our latest Environmental Risk Bulletin: Property Transactions and Environmental Due Diligence.
About the Author
Daniel Moser is a Risk Consulting Associate with AXA XL’s Environmental insurance business. He can be reached at daniel.moser@axaxl.com.
