The goal of the Bona Fide Prospective Purchaser Defense,¹ enacted in January 2002, was to lessen the harshness of the Comprehensive Environmental Response, Compensation, and Liability Act's (CERCLA)² strict liability scheme by allowing purchasers of contaminated property to avoid liability provided certain pre-acquisition diligence standards and post-acquisition obligations were met. Ten years later, the defense has not delivered on its promise. As discussed below, many limitations and uncertainties limit the effectiveness of the defense.

Introduction

Passed in 1980, CERCLA was Congress' response to the public health and environmental threats posed by the legacy of over a century of haphazard'and largely unregulated'disposal of hazardous materials at industrial sites and waste disposal facilities. CERCLA addressed this legacy by introducing a radically new liability scheme with respect to the cleanup of contaminated sites. Under CERCLA, with limited exceptions, cleanup liability was imposed on a variety of parties, including current owners and operators, without regard to fault or the legality of the conduct that gave rise to the conditions.

CERCLA presented prospective purchasers of contaminated property with the risk of cleanup liabilities arising from pre-existing conditions. To mitigate this risk, purchasers could often conduct extensive pre-acquisition environmental diligence designed to identify potential contamination conditions. Potential buyers faced with diligence findings revealing actual or potential contamination could then decide to (1) not proceed with the transaction, or (2) proceed with the transaction and either assume the environmental risks or mitigate these risks through contractual protection from the seller or, if available, insurance.

This situation was far from perfect. First, environmental conditions are often hidden beyond the reach of the standard environmental diligence tool, the Phase I site assessment.³ Second, sellers

are not necessarily willing to provide indemnities for pre-closing environmental liabilities, and, even if they are, they may ultimately fail to honor such obligations. These factors also contributed to the existence of "brownfields," or heavily contaminated former industrial properties that were financially impractical to redevelop due to the risk of CERCLA liability.

The defense was enacted in 2002 and provided that a purchaser would be protected against CERCLA liability for pre-closing releases of hazardous substances, whether discovered during pre-acquisition environmental diligence or post-closing, if a purchaser satisfied three basic requirements:

1. All Appropriate Inquiries. The purchaser must conduct an appropriate level environmental diligence prior to the acquisition, referred to as "all appropriate inquiries" (AAI). Pursuant to Environmental Protection Agency regulation, the standards set forth in the ASTM E1527-05 Phase I Environmental Site Assessment Process generally satisfy the statutory requirements for conducting AAI.⁴

2. Continuing Obligations. The purchaser must comply with a number of post-closing obligations, including (1) making legally required notices with respect to the discovery or release of any hazardous substances; (2) taking reasonable steps to stop any continuing release, prevent any threatened future release and prevent or limit human, environmental, or natural resource exposure to any prior release; (3) cooperating with and assisting other parties conducting response actions; (4) complying with any institutional controls implemented in connection with any response actions; and (5) complying with subpoenas or information requests issued pursuant to CERCLA.⁵

3. Purchaser Is Not Otherwise a Liable Party (or Affiliated With One). The defense is not available if the purchaser is "potentially liable" under CERCLA or affiliated with another party who is. However, the contractual relationship between the purchaser and the seller created by the property transaction documents is not considered an impermissible "affiliation" under the defense.⁶

Key Shortcomings

Unfortunately, the defense is fraught with several significant limitations that render it either unavailable in certain contexts or render its utility in a particular transaction uncertain at best.⁷

The Defense Does Not Apply to Stock Acquisitions/Mergers. The defense is not available in stock acquisitions or mergers because the purchaser is not "acquir[ing] ownership of a facility."⁸ This is why the defense is unavailable for many corporate transactions, which are often structured as stock purchases rather than asset purchases.

The Defense Does Not Apply to Most Kinds of Lease Transactions. The defense has limited applicability with respect to leased facilities because a party that becomes a lessee (either by entering a lease or "acquiring" the lease through an assignment) does not "acquire ownership of a facility" (emphasis added), an element of the definition.⁹ As a 2009 EPA guidance noted,¹⁰ lessees are not considered owners under CERCLA unless the lease has sufficient "indicia of ownership."¹¹ If the lease does not meet this standard, a party acquiring or entering the lease cannot claim the defense.

CERCLA's liability scheme in some ways favors lessees over owners. Whereas a lessee's liability under CERCLA depends on whether it is considered an "operator" of the facility, an owner is liable whether or not it is an operator. It is for this reason that prospective purchasers sometimes elect to lease rather than own property with potential contamination; lessees seek to avoid owner status by arguing that their lease agreements do not contain "indicia of ownership" to create CERCLA owner liability. Yet, the defense seems to encourage lessees to make the exact opposite argument.

Environmental Provisions in Transaction Documents May Limit the Availability of the Defense. A recent district court case, Ashley II of Charleston v. PCS Nitrogen¹² (currently on appeal), suggests that environmental provisions in a purchase agreement may preclude the application of the defense. In Ashley II, the owner of a contaminated property, Ashley II of Charleston, LLC, asserted the defense in response to contribution claims by other third parties.¹³ The court concluded that Ashley could not assert the defense because, among other reasons, Ashley agreed to release and indemnify the sellers with respect to environmental liability in the acquisition agreement.¹⁴

Although the reasoning of the court is less than clear, the court appeared to hold that by contractually assuming the sellers' CERCLA liability, Ashley became a "potentially liable" party under §101(40)(h) of CERCLA, which precluded Ashley from asserting the defense.¹⁵ The court also cited Ashley's efforts to persuade EPA not to seek cleanup costs from the sellers, stating (without any citation to legislative history) that this conduct "reveals just the sort of affiliation Congress intended to discourage."¹⁶ The court did not explain why Ashley's efforts to limit its potential indemnification liability by communicating with EPA reveal an impermissible affiliation with the sellers.

The court's holding appears to be contrary to the explicit language of the defense. The provision relied upon by the court' §101(40)(h)'provides that a relationship "that is created by the instruments by which title to the facility is conveyed or financed" is not considered an impermissible relationship for the purposes of the defense.¹⁷ This indicates that environmental provisions in a purchase agreement, such as Ashley's, should not prevent application of the defense.

Following Ashley II, in September 2011, EPA issued a guidance that failed to clarify that Ashley II misapplied the affiliation test.¹⁸ Although EPA stated that it "generally does not intend" to treat indemnities contained in sale agreements as an impermissible affiliation barring application of the defense, EPA noted that it "will analyze the circumstances surrounding the transfer of title and the specifics of the contractual or financial relationships...."¹⁹ EPA also acknowledged the Ashley II court's holding without rejecting or criticizing it and noted the court's reliance on "purchaser's subsequent efforts to dissuade EPA from taking an enforcement action against the seller" as an additional basis for finding an impermissible affiliation.²⁰ The guidance does not explain why this conduct should serve as a basis of a prohibited affiliation under the defense.

Purchasers May Have Liability for Post-Closing Migration or Leaking of Pre-Existing Contamination. A basic limitation on the scope of the defense is that it does not apply to disposal of hazardous substances that occur post-closing. But what constitutes a "disposal"? The term "disposal" has been the subject of decades of CERCLA case law, particularly in determining the liability of former owners and operators. Whereas some courts have held that disposal of hazardous substances requires some sort of active conduct,²¹ other courts have held that mere passive migration of contamination through soil or groundwater constitutes disposal.²² Yet another view distinguishes between passive migration of contamination through soil or groundwater (not disposal), and passive leaking of a substance from a tank or other container (disposal).²³

Ashley II is the only reported decision thus far to interpret the meaning of the term "disposal" in the context of the defense. Following U.S. Court of Appeals for the Fourth Circuit precedent, the court applied the "passive migration" rule to the defense, and concluded that Ashley could not assert the defense because the migration of pre-closing contamination is considered new, post-acquisition disposal.²⁴ This interpretation denies prospective purchasers the very benefit the defense is designed to offer because often the only practical way for a purchaser to assure that pre-closing contamination is not passively migrating is to remediate it. Even under more pro-purchaser interpretations of disposal, purchasers may need to conduct some amount of post-closing investigation or remediation, for example, to confirm whether any former tanks or containers are (or are not) leaking.

Continuing Obligations Under the Defense Could Impose Substantial Obligations on Purchasers. The defense requires purchasers to take "reasonable steps" to prevent the release of hazardous substances post-closing. A 2003 EPA guidance notes that "reasonable steps" will vary by site and will depend on the knowledge of the purchaser and what it learned during the AAI.²⁵ However, if interpreted broadly, this obligation can be read to impose investigation or remediation obligations on the purchaser with respect to pre-existing conditions identified by the purchaser in its AAI or after the acquisition. The court in Ashley II adopted such an interpretation, holding that the defense required Ashley to address the recommendations in its pre-acquisition Phase I site assessment. Although Ashley addressed certain Phase I recommendations, the court concluded that Ashley's actions fell short of the statutory standard and led to exacerbation of pre-existing conditions.²⁶

In contrast, at least one court has interpreted the "reasonable steps" requirement more narrowly. In 3000 E. Imperial, LLC v. Robertshaw Controls Co., the district court found that the manner in which the purchaser addressed a number of leaking underground storage tanks (including leaving in place a number of USTs presumed to be empty) constituted "appropriate care" in dealing with the release of hazardous substances."²⁷

Conclusion

The bona fide prospective purchaser defense is often irrelevant; the defense offers no protection in stock acquisitions or mergers and many kinds of lease transactions. But has the defense succeeded with respect to the kinds of transactions or liabilities it was designed to address? The answer thus far appears to be "no." Ambiguities in the statutory text, the 2011 EPA Guidance, as well as Ashley II's narrow reading of the defense have created uncertainties regarding the defense's scope. Although further development in the case law may clarify some of these issues, many of the uncertainties identified above are inherent in the way the self-executing defense is designed to operate.

A purchaser seeking to qualify for the defense is guided only by vague and general statutory directives such as the "reasonable steps" requirement, which provide little certainty in specific situations. Thus, a purchaser assessing what, if any, post-closing investigation or remediation is necessary to meet the standard must proceed at its own peril without any assurance that the defense will be available or accepted.

The upshot of the failures of the defense to provide clear and sensible guidance is that parties to transactions will continue to conduct environmental due diligence, negotiate transactions and allocate environmental risk based on what makes commercial sense rather than attempting to shoehorn the deal into the uncertain contours of the defense. While it will often be prudent to conduct AAI and comply with the defense's post-closing obligations, a purchaser should not take these steps on the assumption that protection against CERCLA liability will be available should contamination issues arise.

Footnotes

1. Pub. L. No. 107-118, 115 stat. 2356.

2. 42 U.S.C. §§9601-9675 (2006).

3. Note that CERCLA was amended in 1986 to provide a limited defense to buyers with respect to unknown contamination conditions. See 42 U.S.C. §9607(b)(3) and §9601(35)(A)(i).

4. 40 C.F.R. §312.11 (2008).

5. 42 USC §9601(40)(D)-(E).

6. 42 USC §9601(40)(H).

7. It should be noted that the defense protects against CERCLA liability only and not state law.

8. §9601(40).

9. §9601(40).

10. Memorandum from the Environmental Protection Agency: Enforcement Discretion Guidance Regarding the Applicability of the Bona Fide Prospective Purchaser Definition in CERCLA §101(40) to Tenants (Jan. 14, 2009) ("2009 EPA Guidance") at 3-4.

11. 2009 EPA Guidance at 3-4. See, e.g., Commander Oil v. Barlo Equip. Corp., 215 F.3d 321 (2d Cir. 2000).

12. 791 F.Supp.2d. 431 (D.S.C. 2011), appeal docketed, No. 11- 1662 (4th Cir. 2011).

13. 791 F.Supp.2d. at 498-502.

14. 791 F.Supp.2d. at 502.

15. 791 F.Supp.2d. at 502.

16. 791 F.Supp.2d. at 502.

17. 42 U.S.C. §9601(40)(h).

18. Memorandum from the Environmental Protection Agency: Enforcement Discretion Guidance Regarding the Affiliation Language of CERCLA's Bona Fide Prospective Purchaser and Contiguous Property Owner Liability Protections (Sept. 21, 2011) ("2011 EPA Guidance").

19. 2011 EPA Guidance at 10.

20. 2011 EPA Guidance at 10.

21. United States v. CDMG Realty, 96 F.3d 706, 722 (3d Cir. 1996); Bob's Beverage, Inc. v. Acme, Inc., 264 F.3d 692 (6th Cir. 2001); United States v. 150 Acres of Land, 204 F.3d 698, 706 (6th Cir. 2000).

22. Nurad, Inc. v. William E. Hooper & Sons, 966 F.2d 837 (4th Cir. 1992).

23. Joslyn Mfg. Co. v. Koppers Co., 40 F.3d 750 (5th Cir. 1994).

24. Ashley II, 791 F.Supp.2d. 431, 501.

25. Memorandum from the Environmental Protection Agency: Interim Guidance Regarding Criteria Landowners Must Meet in Order to Qualify for Bona Fide Prospective Purchaser, Contiguous Property Owner, or Innocent Landowner Limitations on CERCLA Liability (March 6, 2003).

26. 791 F.Supp.2d. at 501.

27. 2010 WL 307706 (C.D. Cal. 2010).

Previously published by New York Law Journal on August 7, 2012.

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