Lenders need to consider the scope and extent of the Phase I Environmental Site Assessment (“Phase I ESA”) they routinely utilize in connection with the acquisition and financing of real estate projects. The Environmental Protection Agency (“EPA”) announced its intent to adopt a new standard expanding the scope of review on May 13, 2022.
The proposed standard would not replace or supersede the existing rule but would create a second set of standards for environmental consultants who are routinely engaged by banks, lending companies, and other institutions in connection with loans used for real estate projects.
EPA approved ASTM International (ASTM) Standard E1527-21 as an additional standard meeting the “all appropriate inquiries” (“AAI”) component for potential liability protections under the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”).
AAI is a process to evaluate the environmental history and condition of real property to assess potential liability for contamination by way of a Phase I ESA. AAI requirements apply to any party, including a lender, who can potentially claim protection from CERCLA liability as an innocent landowner, contiguous property owner or bona fide prospective purchaser.
Lenders that hold mortgages on real property as secured lenders are exempt from CERCLA liability if certain criteria are met. CERCLA Section 101(20) contains a secured creditor exemption that eliminates owner or operator liability for lenders who hold ownership in a CERCLA facility primarily to protect their security interest in that facility, provided they do not “participate in the management of the facility.”
Generally, participation in the management applies if a bank exercises decision-making control over a property’s environmental compliance, or exercises control at a level similar to a manager of the facility or property. Participation in management does not include actions such as conducting property inspections, requiring a response action to address contamination, providing financial advice or renegotiating or restructuring the terms of the security interest.
The secured creditor exemption also provides that foreclosure on a property does not result in liability for a lender, provided the lender takes “reasonable steps” to divest itself of the property “at the earliest practicable, commercially reasonable time, on commercially reasonable terms.” Generally, a bank or other lender can maintain business activities and close down operations at a property as long as the property is listed for sale shortly after the foreclosure date or at the earliest practicable, commercially reasonable time. For now, the standards will co-exist and either standard can be utilized.
Among the most significant differences between the standards:
- Under the new standard, the consultant would be seemingly directed to consider risk factors that the consultant could have ignored under the previous standard, possibly resulting in more conservative conclusions. Phase I ESA conclusions rely on the judgment of the environmental professional, meaning different consultants can, and do, arrive at different classifications after evaluating the same property. A lender should be aware of the different standards and make an inquiry as to which standard is being utilized by its consultant. While the existing standard is still (for the time being) accepted by EPA as satisfying the AAI requirement for liability protection, it is, perhaps, foreseeable that as time goes on, the existing standard may leave lenders vulnerable to claims that a Phase I ESA conducted under that standard was intentionally less searching and is, accordingly, insufficient to shield the lender from underlying conditions giving rise to CERCLA liability. This could potentially spawn litigation seeking to strip lenders of CERCLA liability protection for a Phase I ESA conducted under the existing standard.
- The new standard could be interpreted further to direct an environmental consultant to rely on the environmental professional’s experience regarding the likelihood of certain conditions resulting in releases, instead of discounting the risks associated with such activities based on the lack of current “indications of a release.”
- The new standard would require the Phase I ESA to set forth the environmental professional’s basis for identifying controlled recognized environmental concerns (CRECs), along with copies of the underlying regulatory documentation supporting such conclusion. For the prospective purchaser or lender, this is a positive change because it will permit the user to better understand the risks associated with the property and provide the user with the source documents for any continuing obligations at the property regarding a remedy.
- Under the proposed new standard, the Phase I ESA is valid for 180 days from the date of review of the first of five elements by the environmental professional, such that depending on the length of time needed to complete the review, the “shelf life” of the completed Phase I ESA could be less than six months. Under the existing standard, the 180-day period runs from the date of issuance of the report. In both cases, the Phase I ESA can be extended to one year.
- Certain historical sources must be addressed in the Phase I ESA, including aerial photographs, fire insurance maps, local street directories, topographic maps, building department records, interviews, property tax files, and zoning/land use records, with an explanation if certain material is missing.
- The new standard clarifies that emerging contaminants will become subject to Phase I ESA review once they are classified as hazardous substances under CERCLA. Until such time, lenders may want to discuss the risks and benefits of including certain emerging contaminants under the scope of the Phase I ESA with their environmental consultant and legal counsel.
- Practically speaking, a Phase I ESA may become more costly under the new standard, resulting in additional cost to borrowers and purchasers.
Harris Beach PLLC and its attorneys are available to assist banks and other lenders to better understand the revised standard for a Phase I ESA and to address the implications for lender due diligence and loan documentation.
If you have any questions, please contact the Harris Beach attorney with whom you usually work. Melanie Marotto can be reached at firstname.lastname@example.org or (716) 200-5230, Gene Kelly can be reached at email@example.com or (518) 701-2740, and Frank Pavia can be reached at firstname.lastname@example.org or (585) 419-8709.
This alert is not a substitute for advice of counsel on specific legal issues.
Harris Beach has offices throughout New York state, including Albany, Buffalo, Ithaca, New York City, Rochester, Saratoga Springs, Syracuse, Uniondale and White Plains, as well as Washington D.C., New Haven, Connecticut and Newark, New Jersey.