The Pitfalls of Not Completing Comprehensive Environmental

Feb 01, 2022

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It is good common practice to complete a Phase I Environmental Site Assessment (ESA) when purchasing or refinancing any commercial or industrial property and lenders routinely require that a Phase I ESA be completed prior to closing. Many lending institutions have internal lists of “approved”, reputable consulting firms they have experience with to complete environmental due diligence (EDD), including a Phase I ESA, on behalf of their borrowers. However, some lenders may not have such a list to refer to and others may place the responsibility of choosing an environmental consultant onto their borrowers.

If the lender or the borrower obtain a Phase I ESA from a consultant simply based on turnaround time or cost, there is a risk that such a report may not be fully compliant with the revised ASTM standard (issued in late 2021). Several significant changes and reinterpretations were identified in this revised ASTM standard, ranging from how vapor should be included into a consultant’s findings to what historical information for adjoining properties should be discussed, among many other things. Alternatively, an otherwise fully compliant report may have substantial gaps due to an expedited timeline. These gaps may prevent the consultant from drawing meaningful conclusions and adequately evaluating the risk at the property. The most common example of this occurs with obtaining (or failure to obtain) appropriate agency files. Agency files are a required source of information under the ASTM standard, although the sites files that are requested and the type of files reviewed are up to the discretion of the environmental professional. If the Phase I ESA report is provided without conducting an agency file review or waiting for files to be received in order to meet a faster turn-around time, a consultant may have no choice but to identify a recognized environmental condition (REC) for the potential for contamination to migrate onto the property, as only limited information would be available. However, by waiting for the agency files, it is possible that this REC could be mitigated and the borrower could be issued a “clean” Phase I ESA.

The Risk to the Potential Purchaser

If a fully-compliant Phase I ESA is not completed (which is likely to take longer to complete and cost more following the issuance of the revised standard) prior to purchasing the property, the purchasers liability protections awarded under CERCLA are at risk. Those liability protections assume that the purchaser completed their All-Appropriate Inquiry (AAI), which routinely includes a Phase I ESA, in good faith. Completing comprehensive EDD prior to closing on a property is essential for purchasers. When EDD is rushed or done in a matter to keep costs as low as possible, potential risks associated with the property and/or nearby/ adjoining properties may be missed or improperly evaluated. Uncovering potential (or, in some cases, already documented) environmental issues at a property prior to closing provides better protections to the purchaser (i.e., ability to complete a Baseline Environmental Assessment in Michigan, the ability to negotiate a lower purchase price or seller financing for some of the additional environmental work necessary), compared to discovering those issues later when the property is preparing to sell or be refinanced.

The Risk to the Lender

Historically, there have been situations where completing EDD was waived or otherwise not considered to be necessary prior to lending on a property. This could be based on the loan amount; the known, current use of the property in question; or for a variety of other reasons at the discretion of the lender. In foreclosure, risk is typically evaluated differently. A property that did not have any EDD completed prior to the initial lending, or that had a Phase I ESA completed with significant gaps in its evaluation, may not be sufficient for the lender in those circumstances. It’s possible that a new Phase I ESA may identify previously unknown risks that could have been caught at the time the loan was initiated. For example, there are numerous examples of rural properties where significant environmental contamination was later uncovered due to improper disposal (i.e., dumping) activities which may not be identified without completing a fully-compliant Phase I ESA. In those cases, a new Phase I ESA may be necessary before the lender can sufficiently assess the risk associated with that property. In addition, if the environmental issues identified during the foreclosure process are significant enough, the lender may have considerable expenses related to getting the property in a condition to re-sell and the new price with the environmental issues may be significantly less than what the original loan was for.

Please contact Nichole Mason, EP at BLDI (616) 459-3737 for more information.