Environmental Due Diligence and Commercial Real Estate

Hardly a day goes by where I don’t find myself discussing the latest commercial real estate news with clients and friends. And, I have an increasing amount of clients who are entering this field. However, there’s a general lack of knowledge about the risks imposed on owners by a variety of environmental laws.

           Imagine you’ve bought your first piece of income producing property. After several months, you discover that the prior owner dumped contaminants out the back door and now the EPA wants you to clean up the property. It may sound farfetched, but this is a routine occurrence throughout Illinois.

            Federal and State laws, generally speaking, impose liability for environmental remediation costs on current and prior landowners.  Yes, that’s right -- anyone in the chain of title can be forced to pay one hundred percent of the cleanup costs.

         There is, however, one way to escape such liability.  Both Federal and State law provide the "innocent purchaser" of land with immunity from that liability.  If this standard is met, the property owner cannot be held liable for past contamination, only for "new contamination."  How, then, does one go about establishing him or herself as an "innocent purchaser?"

  The usual way is to employ an environmental consultant to conduct what is known as a "Phase I."  Under Illinois law, a Phase I assessment that indicates property is “clean” is sufficient to establish the innocent purchaser defense.  Federal law, although not stating it in so many words, essentially says the same thing.

  A Phase I provides a historical review and reconnaissance of a particular property to identify recognized environmental conditions.  Those conditions may be past or present history and may be located on the property or adjacent to it.  The recognized environmental conditions are then evaluated with regard to potential environmental impact to the property.  A Phase I seeks to balance the cost of a site assessment with the objective of reducing uncertainty.  Phase I assessments typically include a review of various public records, a site "reconnaissance" and various personal interviews.  They can only be performed and prepared by qualified environmental consultants and can cost around $1,500 and up.

  Phase I assessments are not guaranties that the land is clean.  Rather, they are designed to satisfy the innocent purchaser defense and to reduce potential uncertainties.  Of course, if any red flags are raised in a Phase I, more investigation is required in order to satisfy the innocent purchaser standard.

  This further investigation usually involves the "Phase II" inspection.  A Phase II, building on a Phase I, includes actual tests of soil and groundwater for the presence of contaminants.  A clean bill of health from a Phase II usually establishes the innocent purchase defense again.  But what if contamination is found on the property you are considering purchasing?

  Beyond establishing the innocent purchaser defense to liability, there are additional reasons to incur the time and expense of environmental due diligence.  The smart property purchaser includes an "escape clause" in the sales contract so that he or she can walk away from the deal if contamination is found.  Absent such a clause, the law may well require the buyer to close irrespective of the contamination.

  There are other reasons to go through this environmental due diligence.  Assuming you are financing your purchase, your bank will ask about the environmental status of the proposed property.  Banks are generally excluded from liability if they ever have to take title to property from a delinquent borrower.  The real issue, however, is that a bank will have a difficult, if not impossible, time selling environmentally contaminated land to recoup its debt.  Accordingly, most banks require at least a Phase I before making a mortgage loan on any significant purchase.

  Moreover, even if no remediation is required and the contaminants do not affect your proposed use of the property, the very presence of contamination might "stigmatize" the property in the eyes of any future purchasers, thereby reducing the property’s potential sales price.  Perhaps that is a risk you are willing to take, but environmental due diligence can let you intelligently assess the risk.

  And, if you think that you can ignore environmental issues and rely on your insurance to protect you, you best think again.  Virtually without exception, your insurance will not provide coverage.  Most all insurance now includes the so-called "absolute pollution exclusion."  Due to this provision, interpreted by Illinois Courts in the insurance companies’ favor, and for many other reasons, the chance of collecting on any insurance policy is so small as to be non-existent.

  Given the enormous potential liabilities associated with environmental contamination, as well as the uncertainty associated with the costs of environmental remediation, proper environmental due diligence should become an integral part of every transaction. As with so many other situations, forewarned is truly forearmed.