In this issue, we are providing you with an alert prepared by members of our Environmental practice group summarizing a rule recently adopted by the U.S. Environmental Protection Agency to clarify the level of due diligence that purchasers of property are now required to perform to guard against potential strict liability for existing contamination.

This release will be of particular interest to acquirers of industrial and manufacturing businesses with environmental concerns and of businesses that invest in brownfields and other contaminated property for redevelopment.

Raising the Bar on Environmental Due Diligence: Changes in “All Appropriate Inquiry” Are In Effect Now

by Gina M. Zawitoski and Paul D. Ackerman

The innocent purchaser, bona fide prospective purchaser, and contiguous property owner defenses to federal Superfund liability for owners of contaminated property require purchasers to conduct all appropriate inquiry (or AAI) into the previous ownership and uses of the property in an effort to identify existing contamination.  For many years, Phase I Environmental Site Assessments (Phase I ESA) have been routinely performed to meet this requirement and to identify environmental risks, but whether a particular Phase I ESA was enough to establish AAI has been uncertain. 

In its final AAI rule (70 Fed. Reg. 66070, codified at 40 C.F.R. Part 312), the U.S. Environmental Protection Agency (EPA) has now clarified that AAI requires a greater level of assessment than traditionally performed. 

Final AAI Rule Establishes New Standards and Practices

The AAI rule establishes new environmental due diligence standards and practices that must be followed in order to qualify for the referenced landowner liability protections.  The rule became effective on November 1, 2006.  It is estimated to affect more than 250,000 commercial real estate transactions nationwide annually.  

EPA also announced that the 2005 update of ASTM E1527 Standard Practice for Phase I Environmental Site Assessments may be used in lieu of the AAI rule to meet the federal due diligence requirements.  Until November 1, AAI could be met by using the new AAI rule or ASTM E1527-05, ASTM E1527-00, ASTM E1527-97.  After November 1, only the new AAI rule and ASTM E1527-05 will constitute compliance with AAI.

Compliance with the new requirements will be critical to limiting the liability of clients engaged in real property transactions.  The AAI rule also establishes important new standards for environmental consultants.  This article briefly summarizes the background of the AAI rule and provides an overview of the new due diligence standards and practices that will take effect in November. 

Background of the AAI Rule

Under the federal Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA or Superfund), owners and operators of contaminated property may be held strictly liable for, among other things, the cost of cleaning up contamination regardless of fault or negligence.  An unintended consequence of this liability scheme is  to deter potential purchasers from investing in the acquisition and redevelopment of historically contaminated properties (sometimes called  brownfields sites) because only innocent purchasers (whose due diligence failed to find contamination) could defend against liability.

In 2002, Congress amended CERCLA to lower the barriers to brownfields redevelopment by, among other things, extending defenses to people who purchase property with knowledge of contamination (“bona fide prospective purchasers”) and to owners of property contaminated by off-site sources (“contiguous property owners”).  It also directed EPA to issue a regulation setting forth the standards and practices for carrying out AAI. 

After negotiating with over 25 organizations representing the real estate and lending service industries, environmental consultants and professionals, state and federal regulators, and public interest groups for more than three years, EPA finalized the AAI rule on November 1, 2005.

The Who, What, and When of AAI

Under the rule, AAI must be conducted by an environmental professional (EP) whose qualifications are spelled out in the rule.  Specifically, the inquiry must include and the EP must take into account all of the following:

• Interviews with past and present owners, operators, and occupants;
• Reviews of historical sources, such as chain of title documents, aerial photographs, building department records, and land use records;
• Searches for recorded environmental cleanup liens;
• Reviews of federal, state, local, and tribal government records, including waste disposal records, underground storage tank records, hazardous waste management records, and spill records;
• Visual inspections of the facility and of adjoining properties;
• Evaluating the purchaser’s specialized knowledge or experience;
• Assessing the relationship of the purchase price to the value of the property, if the property was not contaminated; and
• Commonly known or reasonably ascertainable information about the property. 

A written report must be prepared that includes, among other things, the EP’s opinion about whether conditions indicative of a hazardous substance release have been identified, an evaluation of data gaps, and documentation of the EP’s qualifications, including a prescribed declaration by the environmental professional.  While not mandatory, EPA recommends that the EP provide an opinion about additional appropriate site investigation, if any.

The assessment must be completed within one year prior to the date of acquisition, with updates required for some information collected more than six months before closing. 

What’s Changed?

The most prevalent industry standard for conducting Phase I ESAs is ASTM E1527-00 (which replaced E1527-97 in 2000).  The major differences between E1527-00 (the “old standard”) and the new AAI due diligence standard (the “new standard”) include:

1. Qualifications for environmental professionals are prescribed.  Unlike the old standard, the new standard contains certification, licensing, education, or experience requirements for individuals who are supervising “all appropriate inquiries.”
2. Interviews with the current owner and occupants of the subject property are now mandatory.  Under the old standard, a reasonable attempt to interview a key site manager and a reasonable number of occupants was sufficient.
3. Interviews with past owners and occupants may be required in some circumstances.  The old standard required interviews to inquire about past uses, but did not require the EPs to find and interview past owners and occupants. 
4. Interviews of neighboring property owners or occupants are mandatory if the subject property is abandoned.  Under the old standard, such interviews were discretionary and rarely done. 
5. Responsibility for identifying use limitations and environmental liens may fall to either the EP or the client.  Under the old standard, the user of the Phase I ESA (not the consultant) was responsible for ascertaining whether use limitations (e.g., institutional controls) or environmental liens were present.  Under the new standard, if the user does the search and does not report the results, the EP must identify a data gap in the report. 
6. Federal, state, local, and tribal records must be reviewed.  Under the old standard, local and tribal records were reviewed at the discretion of the EP. 
7. Inspections of adjoining properties from the property line, public rights of way or other locations are required.  The old standard required only that the EP report relevant information about the adjoining property that was actually observed. 
8. Data gaps require more extensive documentation.  The new standard requires the EP to identify data gaps, identify the sources consulted to address data gaps, and comment on the how the data gaps affect the EP’s ability to identify conditions indicative of hazardous substance releases and threatened releases.
9. The Phase I ESA Report has a limited shelf life.  A Phase I ESA must be completed within one year before closing.  If the Phase I investigation occurred more than 180 days before closing, interviews, inspections, historical records review and the environmental lien search must be updated.  Information from older reports can be used, but all of the information must be reviewed and updated in order to complete all appropriate inquiry.

What Else Is Required for CERCLA Landowner Liability Protection?

To be eligible for CERCLA landowner liability protection, a purchaser must do more than conduct AAI.  Eligibility also requires compliance with certain “continuing obligations” spelled out in the 2002 amendments to CERCLA, including:

• Compliance with land use restrictions;
• Not impeding the effectiveness or integrity of institutional controls;
• Taking “reasonable steps” to stop a continuing release, prevent threatened releases of hazardous substances affecting the property, and prevent exposures to released hazardous substances;
• Cooperating with and assisting federal or state regulatory officials or other persons conducting response actions or natural resource restoration at the property;
• Complying with CERCLA information requests and administrative subpoenas; and
• Providing legally required notices.

Standards for satisfying these “continuing obligations” are not defined in the statute or in EPA regulations, although EPA has published interim guidance to provide some assistance to the regulated community.  This guidance and other resources on AAI and related brownfields liability issues can be found on EPA’s web site at http://www.epa.gov/brownfields/liab.htm#liabiss.

A version of this article was recently published as a DLA Piper Environmental Alert.

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DLA Piper in the News

The independent mergers and acquisitions intelligence service mergermarket has placed DLA Piper US LLP among the top M&A law firms in North America for the first half of 2006.  According to mergermarket's half-year report, DLA Piper ranked second for mid-market deals by volume for North American bidders (46 deals) and also ranked fourth for mid-market deals by value ($3 billion). In the technology sector, the firm ranked second for deals by volume (22 deals) for North American bidders. 

DLA Piper is sponsoring the 3rd Annual Buyouts Symposium West, being held at the Stanford Court Hotel in San Francisco on November 6-7, 2006. This event for private equity professionals features a range of high-caliber speakers from both the private equity and corporate worlds. Seattle Partner Matt Adler will be the moderator of the DLA Piper-sponsored panel "Rethinking Asia: Investing, Outsourcing...And When To Avoid Both."

In March, DLA Piper was a lead sponsor of the 18th Annual Buyouts East Symposium in New York City. The event was attended by over 200 professionals in the private equity community. Former Secretary of Defense William Cohen was a keynote speaker, while partner Minh Dang moderated a panel entitled "The Legal & Political Climate For Asian Private Equity." It was a great opportunity to network with all the biggest players in the buyouts community.

For the second year in a row, DLA Piper US LLP ranked as the top trademark law firm in the U.S., based on the number of U.S. trademark registrations issued in 2005 by the U.S. Patent and Trademark Office, according to Intellectual Property Today.

Dr. Wei Liu, a leading PRC and Hong Kong commercial lawyer, has joined the firm as a partner and will be based in the Hong Kong office.  In the last 15 years, Dr. Liu has advised on more than 100 initial public offerings and listings.  He also has served on Hong Kong's Securities and Futures Commission as well as in prominent posts in the PRC government, and has advised on transactions involving fundraising in international capital markets for Chinese business enterprises and foreign investment in PRC.

The National Law Journal has named DLA Piper's Litigation practice to its annual "Defense Hot List."  To compile the list, the NLJ sought nominees with at least one prevailing win in a bench or jury trial which either set significant precedent or included significant financial stakes.  DLA Piper was also praised for its impressive handling of numerous high-stakes disputes for a roster of high-profile clients throughout the U.S. 

 

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