Don't Let These Three Due Diligence Tricks Haunt Your Next Real Estate Deal

Performing diligence to support your real estate acquisition can feel daunting—especially during "spooky season." But there are steps companies can take to navigate the more unsettling environmental aspects with practical guidance.

Here are three environmental "tricks" that could impact your acquisition—and the tips that can help you tackle them.

Trick #1 – Real estate due diligence only requires a Phase I Environmental Site Assessment (ESA). Once completed—regardless of timing—the project can proceed.

The Phase I ESA may only be one part of the environmental assessment process to determine potential contamination at the property, and it is important that the Phase I meet all requirements.

The Phase I ESA is a crucial first step in the diligence process. The American Society for Testing and Materials (ASTM) has established international standard E1527-21, which sets out the requirements that the Phase I must meet to qualify for environmental liability defenses under CERCLA. Amongst other requirements, the Phase I must include:

• Review of historical property records and previous land uses
• Examination of regulatory databases and environmental compliance history
• Visual inspection of the site and surroundings
• Interviews with current and prior owners and occupants

Importantly, certain elements of the Phase I must be completed within 180 days of the acquisition of the property, regardless of when the Phase I report is dated. There are also a number of "user responsibilities" that the purchaser must consider independent of the consultant's work (including whether there are liens or activity use limitations on the property, whether the purchase price reflects market value, etc.).

If the Phase I identifies "recognized environmental conditions," (RECs) a more invasive Phase II ESA may be recommended. Although not legally required, in these situations, a Phase II is often necessary to qualify for the bona fide prospective purchaser defense under CERCLA. Phase II assessments may include soil, groundwater and/or soil gas sampling and analysis and indoor air assessment.

If the Phase II identifies contamination in environmental media above applicable state or federal screening standards, further action may be necessary or recommended. Whether further action is required may depend on factors like where the property is located, the environmental media impacted, and the levels of contamination identified. It is important that the purchaser understand what reporting and other requirements might be triggered by sampling resultsbeforeperforming the Phase II.

Trick #2 – ESAs can fully resolve uncertainty regarding the presence of contamination at the property through the identification of RECs.

ESAs are intended to reduce—not eliminate—uncertainty regarding potential contamination at a subject property.

RECs include:

• Confirmed presence of hazardous substances or petroleum products due to a release
• Likely presence of hazardous substances or petroleum products due to a known or suspected release
• Conditions that pose a material risk of future risk

Although the identification of RECs is an effective way to quantify environmental liability risk, it necessarily has limitations since it does not include sampling of the property. It is always possible that the document review and site visit may not uncover lurking environmental conditions. Sometimes, the Phase I report will identify "business environmental risks" that may pose some risk to the property, but that do not rise to the level of an REC. In these situations, the purchaser must consider the likelihood of an actual environmental problem and its tolerance for risk, keeping in mind the proposed use of the property.

Even if your Phase I identifies RECs, it isn't necessarily a deal breaker. Historic or controlled RECs may not pose much risk of liability and may not require any further investigation. The risk of RECs may also depend on how severe the issues appear to be and the intended use of the property. These can often be managed through contractual means. Work with a trusted environmental consultant or lawyer who can interpret the Phase I report and any RECs and determine whether a Phase II ESA is advisable.

Trick #3 – The risk of contamination is the only environmental concern in an acquisition.

When acquiring a property, there are a number of "non-scope" items that may not be considered by the Phase I report, but that may nevertheless pose some risk of liability or otherwise interfere with development plans. Additionally, the Phase I report will not typically consider whether the facility is in compliance with applicable permitting and other regulatory requirements.

Phase I reports will not typically assess some common environmental and health and safety issues such as:

• The presence of asbestos-containing material (ACM), lead-based paint, mold or radon
• The presence of regulated wetlands
• Whether environmental liens or activity use limitations are in place
• The presence or release of "emerging contaminants" such as PFAS (with limited exceptions)

Depending on the location and type of the property, the age of the structures and the intended use (including whether new structures are planned), these issues can pose significant risks to the prospective purchaser. The purchaser should consider whether these factors weigh in favor of engaging a consultant to perform additional diligence work, which might include an asbestos survey, a wetlands delineation, etc.

The prospective purchaser should also consider whether it is beneficial to assess the property or facility's compliance with applicable permitting and regulatory requirements. This will not typically be covered by a standard Phase I report. If the purchaser is acquiring a regulated or permitted facility with the intent to keep operations going, it may make sense to perform a self-audit to determine whether the facility is in compliance to avoid any post-closing regulatory headaches or liability issues. Many states now offer liability protections for violations identified through a self-audit, so long as the violations are corrected in a timely fashion.

Finally, in addition to state and federal regulations, local governments may also enforce their own environmental requirements. These can include property transfer disclosures, permitting and zoning restrictions, and ordinances protecting waterways and wetlands, and remediation standards tailored to state-specific environmental risks. Prospective purchasers should work with their consultants and environmental counsel to determine whether there are any local issues that may pose an obstacle to the planned use of the property.

Managing environmental risks in real estate acquisitions can seem a little scary at times, but with appropriate technical and legal advice, a purchaser can rest easy knowing there are no skeletons in the property's closet. Please reach out to David Topping, Semaj Fielding or any member of the Phelps Environmental team with questions or for compliance advice.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.