Today everyone recognizes that the owner or operator of a property/facility can, under appropriate circumstances, be held liable for the historical environmental conditions existing on that property. When acquiring real property, an ownership interest or leasehold interest in real property, or even a general business interest, the most effective way to manage the risk of environmental liability is to understand the property’s pre-existing environmental conditions prior to the intended acquisition. The only way to obtain the necessary level of understanding is through the environmental due diligence process. Keep in mind that managing environmental risk is more than simply identifying environmental conditions. Risk identification allows the parties to place a realistic value on the subject property and to negotiate risk allocation provisions including but not limited to: purchase price adjustments, indemnities, and pre- and post-closing obligations. The first step in the due diligence process is assembling your due diligence team and retaining an environmental consultant. This short article will focus on the most common issues that arise when retaining an environmental consultant.
Unfortunately, many purchasers treat environmental consultants as fungible. Some purchasers have become quite cavalier with the environmental due diligence process and their selection of environmental consultants. For those purchasers, obtaining an environmental assessment has become a “check the box” exercise. Keep in mind that the role of the environmental consultant is to ascertain the facts necessary for their client and his/her counsel to make informed decisions concerning identified or “recognized” environmental conditions. In order to achieve this objective, the consultant must have specialized environmental knowledge and expertise. This will necessarily include knowledge of the rules and regulations applicable to the environmental concerns presented by the property or transaction in question. It is therefore necessary to hire a qualified individual (maybe one, or more depending on the issues), not the firm. Make sure the consultant has some familiarity with the type of property or business interest that is the focal point of the transaction. If you are not familiar with the individual, check their references and arrange to meet with them to discuss your project. Make sure they are capable of working effectively as a member of the due diligence team.
Once you have identified a qualified environmental consultant to conduct your due diligence inquiry, you should pay particular attention to certain provisions contained in the consulting contract. The following contractual provisions are of particular importance: (1) the Scope of Work; (2) limitation of liability clauses; (3) insurance: (4) ownership of the work product; and (5) confidentiality.
The Scope of Work
CERCLA (a.k.a. Superfund) includes certain specific defenses for those who conduct environmental due diligence. These defenses are predicated on the purchaser conducting an appropriate inquiry into the environmental condition of the property. For most buyers, the appropriate inquiry translates into the performance of a Phase I Environmental Site Assessment (“Phase I”) under the standards set forth by The American Society for Testing and Materials (“ASTM”). However, it is important to keep in mind that the ASTM Phase I is primarily focused on the presence of contamination resulting from hazardous substances and does not necessarily address other environmental concerns that could impact site use, occupancy and/or development, including the presence of endangered species, wetlands, asbestos, lead based paint, and mold. Furthermore, the ASTM Phase I does not address compliance with environmental laws which could be of significant concern if the transaction includes operating properties. The Scope of Work should be tailored to fit the specific needs of the transaction.
In developing the Scope of Work make sure the consultant is given sufficient information about the target property, including information about your intended use and the nature of the transaction. If you have access to a data room, make sure your consultant can access the data room as well. If the data room is no longer available, meet with the consultant to discuss the files reviewed in the data room and seek their input on further data room inquiries.
In most acquisitions, timing is critically important. Often the transaction timelines get compressed leaving barely enough time to complete a Phase I. If timing is critical and the information available on the target property warrants sampling and data collection, it should be included in the initial Scope of Work. Keep in mind that you may not have sufficient time to conduct further inquiries prior to closing. With some additional data you may be able to extend the due diligence period and/or negotiate favorable risk allocation provisions.
Deliverables and timing should also be included in the Scope of Work. At a minimum, the consultant should be required to make an oral report of their findings prior to drafting a written report. After the oral report the consultant should be required to prepare a draft report for review by the transaction team. The transaction team must be given ample time to review the draft report in detail. All too often we find executive summaries that give comfort to the purchaser while the body of the report contains statements and information that would lead a reasonable purchaser to conclude that further inquiry is warranted. Each of these deliverables should be included the Scope of Work with hard deadlines dictated by the timing of the transaction.
Limitation of Liability Clauses
It is not uncommon to see an attempt to limit the consultant’s liability to the cost of the services rendered under the contract. This makes little sense given the size of most commercial real estate acquisitions. At a minimum, the limit of liability should be equal to the amount of insurance coverage held by the consultant. Most environmental consultants carry insurance, including environmental liability insurance in excess of $1 million.
You should also look for clauses that disclaim liability for hazardous substances, wastes and materials. Consider modifying these clauses to include a negligence standard. Exclude from the clause any conditions caused by the activities of the environmental consultant, including the exacerbation of an existing condition.
Consider requiring additional insurance coverage based on the nature of the transaction and the Scope of Work. Always obtain a Certificate of Insurance along with appropriate assurances that there are no pollution exclusions in the consultant’s coverage. Depending on the nature and size of the transaction, you may want to consider reviewing the policies in detail and, if appropriate, ask to be named as an additional insured.
Ownership of the Work Product
Make sure that you are the owner of the consultant’s work product and there are no restrictions or limitations on its use or distribution.
Make sure the confidentiality provision requires the consultant to hold all information developed or obtained through the course of the project in the strictest confidence. Premature disclosure of confidential information could place you at a competitive disadvantage and impact perceptions concerning future site use and development. Furthermore, not all evidence of contamination triggers a reporting obligation, and most environmental reporting obligations fall on the current owner or operator, not the prospective purchaser. It is important to note that some jurisdictions place additional reporting and disclosure obligations on licensed professionals (e.g. engineers, geologists, etc.). The purpose of the confidentiality provision is to prevent the premature dissemination of the environmental data by giving the transaction team the ability to evaluate the legal basis for any proposed disclosure.
Keep these simple points in mind when retaining a consultant to conduct an environmental due diligence assessment.