Post-Real Estate Transaction Liability--Beyond ASTM 1527, All Appropriate Inquiry and Innocent Owner Status

In the previous blog we explored the limitations of the ASTM 1527-13 Phase I protocol, and the consequences of the currently trending rigid and commoditized approach to Phase I due diligence.  Today we engage in a reality check about what happens AFTER you get a Phase I report.  The questions discussed below are very common and reflect some key misconceptions which interfere with good decision making.  I offer for each, a short answer and then some commentary:

1.     I did the required ASTM 1527 Phase I and it said there are no RECs (Recognized Environmental Concerns):


(B)  “And if I find something later I don’t have to worry because I have the innocent owner defense—right?” [ YOU MAY HAVE A DEFENSE UNDER FEDERAL LAW BUT THAT IS ONLY A SMALL PIECE OF THE WORRY SPECTRUM]

                      (C) “So now it’s ok to go to closing with an “as-is” provision in the sale agreement    without doing a lot of expensive Phase II sampling?  [ NO—YOU STILL NEED SOME RISK ASSESSMENT INFORMATION—BECAUSE THE DEFENSE WON’T SOLVE YOUR PROBLEM IF RELEASES ARE DISCOVERED AFTER CLOSING AND YOU HAVE TO REMEDIATE TO ALLOW CONSTRUCTION.   


2.     “The report identified several RECs—so should I insist on an indemnity from the Seller? 


1(A)—No RECs means the site is clean? 

 Consider removing the word clean from your vocabulary when discussing environmental issues.  “Clean” is one of those undefined short hand terms that means different things on different days, and gets people into trouble. For example: Soil contamination is measured by a variety of numerical contamination standards which consider site use (residential vs. non-residential) and exposure pathways (human contact, impact to groundwater, or potential vapor intrusion for a nearby building). Groundwater contamination is also measured by residential and non-residential standards, and vapor intrusion screening levels.  So on most days, Clean really means “below all applicable numerical standards based on intended future use”.  Is that reasonably equivalent to a Phase I finding of no RECs?

The problem is that a Phase I is a preliminary qualitative evaluation of property which relies   solely on visual inspection, interviews and review of available public records and on-site documents.  The report categorizes all findings as either REC [ specific evidence of likely release] or De minimis [ evidence of past suspect use but no specific evidence of likely release].  There is no sampling data for comparison to applicable standards unless previous site sampling results are identified and obtained.   Thus, at most sites, the finding of REC or de minimis is reached without any data or with whatever limited historic data can be obtained.  The ASTM definition of de minimis would include a finding of likely historic use by a dry cleaner, gas station, metal plating shop, or all three, if there is no specific evidence of a specific likely release. That is why “De Minimis” does not equal “Clean”.

To be fair, a Phase I report is sometimes able to conclude “no RECs” because there is no evidence of suspect historical uses and there is enough available documentary evidence to give that conclusion reliable credibility. Unfortunately, there are often important gaps in the historic record, or the available evidence in fact suggests the possibility of historic use of solvents or other chemicals—sometimes well before the emergence of environmental regulations in the 1980s.  In these situations, the REC/De minimis pass-fail test may convey a false sense of certainty. 

What if the Phase I reveals that there are documented past releases, for which a government agency has issued a no further action approval based on meeting numerical standards?   Based on ASTM definitions, such a condition would be considered a REC but specifically, a Historic REC (HREC).  However, this can actually be a good thing—and such a site might actually be considered “clean” at least with respect to the location and media addressed previously. [Unless the applicable standards have changed]

Achievement of numerical standards can be difficult at sites where contamination has resulted from long term impact.  Thus we also find sites where agency approvals are granted based on risk assessment, despite residual soil and groundwater contamination above standards.   These sites are not “Clean” but are “Clean Enough” that site development is still feasible so long as one can tolerate protective institutional controls [activity and use limitations, capping of specific areas, perhaps building on a slab instead of excavating a large foundation].   A Phase I report would appropriately label this situation a “Controlled” REC [ CREC]. 

1(B) Phase I with no RECS means I have a defense and don’t have to worry if contamination is found later?

This question illustrates the result of 10 years of media discussion about the importance of ASTM 1527 for qualifying for the CERCLA “innocent purchaser” defense, and readers assuming that it means more than it really does, and then spreading those assumptions to others, in briefing and training sessions. First-- it is easy to forget that CERCLA is not the only or even most common legal basis for resolving site cleanup disputes.  Pennsylvania has two statutes of its own—one of which [ Hazardous Substance Clean up Act—HSCA]  has an innocent owner defense which is worded a little differently and does not provide automatic compliance with the All Appropriate Inquiry (AAI) criterion by completing an  ASTM Phase I report.  There is a second state law, which does not have an innocent owner defense at all [ Clean Streams Law-CSL] and can actually result in strict liability for an innocent buyer.  There are also several commonly invoked common law tort claims, such as negligence, trespass, and nuisance, which are likely unaffected by any statutory defense.  Thus a CERCLA innocent owner defense would not necessarily protect against a PADEP clean up order, a third-party claim by a neighbor seeking property damages or claiming illness, or a HSCA claim 10 years later by a future owner of the property who discovers contamination. 

Another reality is that a CERCLA defense can turn out to have limited value.  For example, EPA does not often go after the owner of a property discovered to have contamination during construction.  The main value of a CERCLA innocent owner defense would be to facilitate a private cost reimbursement claim under CERCLA against a past owner/operator.    Nevertheless, most defendants will resist a reimbursement claim that ostensibly gives them sole responsibility for site costs. In order to level the playing field, it is reasonable to expect an argument that the Phase I report did not meet the requirements of the defense, despite having received a Phase I report which follows the ASTM 1527 scope. Such argument might include the position that   your Phase I report [ the one concluding no RECs] in fact demonstrates you had “reason to know” of likely hazardous substance disposal, because of findings of historic suspect uses which labelled “De minimis”; and therefore you have some liability too.  If suit is filed and the court rules on summary judgment that entitlement to the defense is a legitimate question of fact [ a common result of such motions] trial or settlement may be several years away.  This creates the common situation where assertion of claims or defenses may require substantial unilateral investment of remedial and legal cost resources as well as time, before having a shot at cost recovery.

1(C)--Phase I with no RECs means I can agree to “as-is” terms without having to do Phase II sampling? 

As discussed above, Phase I conclusion of no RECs does not equate to “clean site”.  If the “de minimis” findings of past site use warrant a closer look, then it is a mistake to assume that detailed due diligence can be avoided—especially if the transaction terms are essentially as-is.  As a practical matter, many sale agreements start out with Seller demanding as-is, but the extent of the as-is gets limited in negotiations.  One way to get those limitations is to generate some Phase II site data and insist that Seller retain responsibility for all known conditions. 

(2) –If the report found several RECs do I have to get a Seller Indemnity? 

Just because a Phase I report concludes there are one or more RECs, does not mean there is a serious problem.  A REC could be evidence of a historic underground tank that was not properly closed, evidence of a historic spill which contaminated soil and groundwater and was not fully addressed, a greasy old floor drain, or records of an ancient septic system which was used by an auto body shop, metal fabrication shop and a dry cleaner.  Some of these sound worse than others but the actual impact of any of them cannot be determined unless some Phase II sampling is done along with some evaluation of potential remedial costs.  The Phase I report can only identify and qualitatively describe the RECs—and under the ASTM protocol it does not even have to include recommendations as to follow up sampling. Thus Phase II sampling could become the basis for giving Buyer sufficient comfort to go forward with a deal despite ominous conclusions in a Phase I [ or an informed basis for backing out].   

In many cases, time and resources discourage proper Phase II sampling.  Thus the next best thing may be perceived to be an indemnity covering any and all future environmental liabilities, or at least the specific identified RECs. Sellers are understandably reluctant to give indemnities, but sometimes need to do so in order to close a sale.   Many buyers view an indemnity as an excuse to skip Phase II sampling because the Seller is on the hook for all RECs.  That is a bad idea.  As discussed earlier, the universe of potential environmental liability concerns can be much broader than those labelled as REC. Thus a limited indemnity may not be covering a potentially serious concern. 

 I also think that all indemnities should be considered limited, because they are only as good as the Seller’s assets at the time of a future claim. Over time, sale proceeds and other liquid assets of a LLC, partnership or other small cap-type of business can easily get lost in distributions, other investments, or insolvency—making it difficult to collect on any judgment that might be obtained. 

 It is also a business reality that one can always find a “plausible” defense to a contractual indemnity and force the matter into prolonged litigation. Thus a buyer with an indemnity should be prepared to unilaterally bear the cost of remediation as well as the cost of litigation, pending the outcome of indemnity claims.  The same is true, of course, for any contribution claims against other past owners or operators.     

The take-home point is that contractual indemnities as well as “legal rights” against past owners and operators may require substantial unilateral investment of resources for remediation and for litigation before any recovery can occur, as well as a solvent party from whom to obtain such recovery.   A much better approach [ when possible] is to seek Seller’s covenant to address environmental conditions to the satisfaction of the state agency, within a specified time period. Such covenant can be secured by escrow of sale proceeds.   But in order to be in a position to demand such a covenant, one needs to have enough site data to describe the situation that would be addressed.  Thus due diligence can become the vehicle for resolving liabilities as well as warning of them.


This blog is intended solely as generic commentary and should not be considered as legal advice.  It is also not intended as criticism of any company or individual.