Appropriate Inquiries in Commercial Real Estate Due Diligence: What You Need to Know
What are All Appropriate Inquiries?
On November 1, 2006, the US Environmental Protection Agency (EPA) adopted an “all appropriate inquiries” (AAI) rule. AAI is the process of evaluating a property’s environmental conditions and assessing potential liability for contamination. This AAI rule codifies new requirements for conducting environmental due diligence inquiries in all transactions that involve commercial real estate. The AAI rule establishes good commercial and customary practices for environmental site assessments of commercial real estate within the scope of the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA). Sellers or buyers of commercial property must comply with these requirements or risk losing the innocent purchaser defense and others.
Reasons for Conducting All Appropriate Inquiries:
Under CERCLA, persons may be held strictly liable for cleaning up hazardous substances at properties that they either currently own or operate, or owned or operated in the past. Strict liability under CERCLA means that liability for environmental contamination may be assigned based solely on property ownership.
Persons Subject to the All Appropriate Inquiries Requirements
Commercial and government entities purchasing property, and all individuals purchasing property for non-residential use, who may, after purchasing a property, seek protection from CERCLA liability for releases or threatened releases of hazardous substances.
Who Can Perform All Appropriate Inquiries?
Many AAI-required activities must be conducted by, or under the supervision or responsible charge of, an individual who meets the definition of an “environmental professional.”
When Must All Appropriate Inquiries Be Conducted?
AAI must be conducted or updated within one year before the date of acquisition of a property.
Components of All Appropriate Inquiries Include, Among Other Things:
- Interviews with past and present owners, operators, and occupants. The AAI rule requires these interviews, when necessary, to collect information on past uses and ownerships of the property and to identify potential conditions that may indicate the presence of releases or threatened releases of hazardous substances at the property.
- Review of historical sources of information. The AAI rule provides that historical sources should be reviewed back to the time that the property first contained structures or was used for residential, agricultural, commercial, industrial, or governmental purposes.
- Searches for recorded environmental cleanup liens. The AAI rule requires that the environmental site assessment include searches for cleanup liens that are filed or recorded against the property. Either the prospective property owner or the environmental professional may conduct the search. If the environmental professional is not instructed to conduct a cleanup lien search, the person seeking the liability protection is required to perform the search.
- Reviews of federal, state, tribal, and local government records. The AAI rule requires that the environmental site assessments include a review of federal and state government records and specifies the minimum search distance for each record.
To Comply or Not to Comply?
AAI will increase the costs and the time to complete environmental due diligence. The EPA estimated that the costs and delays would be minimal, but several industry studies have indicated that the expense of performing AAI-compliant reports could increase significantly.
Many developers facing tight construction schedules and rising building costs are already implementing so-called at-risk or self-directed cleanups in which they investigate and remediate contamination encountered during construction without notifying state authorities because of concern over delays associated with reviews by understaffed environmental agencies. Purchasers and developers are not likely to incur the delays and costs associated with AAI, unless they feel they are getting a significant benefit from following AAI or their lender mandates implementing AAI.
During the past few years, purchasers and lenders have been increasingly accepting what are commonly referred to as “commodity style” environmental site assessments that have barely satisfied the AAI requirements. The significantly expanded pool of persons who can now serve as an environmental professional virtually assures that underqualified people will issue substandard environmental site assessments. Prospective purchasers and their lenders should do more than just take the consultant’s word that an environmental site assessment complies with E1527 (Phase I Environmental Site Assessment Process). Instead, prospective purchasers should have their own procedures in place for verifying the information and making sure that all of the appropriate inquiries have really been made.
- Relying on “Commodity-Style” Reports – These assessments generally consist of a desktop records review and a hasty inspection of the premises, usually by an employee who may not be familiar with industrial operations. These assessments may be unreliable. Users should tailor the Phase I ESAs to their particular needs such as taking advantage of the new defenses added to CERCLA, opportunities to reduce cleanup costs under state brownfield programs, and understanding how site conditions will impact future development or business plans.
- Over-Reliance on Representations and Warranties – Purchasers should avoid relying on representations and warranties received from the seller in lieu of due diligence to save the investigation costs. Representations and warranties should be viewed as a starting point for helping purchasers identify possible environmental issues and get a sense of management’s attitude towards environmental compliance.
- Insufficient Time – Environmental due diligence can often be viewed as a necessary evil or cost item that must be incurred to satisfy a bank. Individuals often fail to provide enough time to perform due diligence. Even where individuals may allow enough time to physically perform the ESA, they often have already negotiated the major deal points and cannot effectively use the information to re-price or restructure the deal. If performed early enough in the transaction, the information generated by an ESA can bring value to the transaction by helping the parties restructure a transaction, negotiate mechanisms to address cleanups, change site plans to minimize cleanup costs, and take advantage of new self-disclosure rules that reduce liability for past violations.
- Former Facilities – Individuals should resist focusing just on the facilities that they currently own or operate. Courts are increasingly willing to impose liability on successor or parent corporations and on former property owners. Thus, consider possible environmental liabilities for how those past assets may have been contractually allocated.
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