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Lenders should consider the scope and extent of the
Phase I Environmental Site Assessment (“Phase I ESA”) that they commonly use in the context of the acquisition and financing of real estate projects. The Environmental Protection Agency (“EPA”) announced its intention to adopt a new standard expanding the scope of the review on May 13, 2022.
The proposed standard would not supersede or supersede the existing rule, but would create a second set of standards for environmental consultants who are regularly engaged by banks, loan companies and other institutions on loans used for projects real estate.
EPA approved ASTM International Standard (ASTM) E1527-21 as an additional standard meeting the “all appropriate requests” (“AAI”) component for potential liability protections under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”).
AAI is a process for assessing the environmental history and condition of real property to assess potential liability for contamination through a Phase I ESA. AAI requirements apply to any party, including a lenderwho may potentially claim liability protection from CERCLA as innocent owner, contiguous owner, or bona fide prospective purchaser.
Lenders who hold mortgages on real estate as secured lenders are exempt from CERCLA liability if certain criteria are met. Section 101(20) of CERCLA contains a secured creditor exemption that eliminates owner or operator liability for lenders who hold ownership of a CERCLA facility primarily to protect their security interest in that facility, provided that they do not “participate in the management of the installation”.
Generally, management participation applies if a bank has decision-making control over a property’s environmental compliance or has control at a level similar to that of a facility or property manager. Participation in management not included actions such as carrying out inspections of the property, requiring intervention action to remedy contamination, providing financial advice or renegotiating or restructuring the terms of the security.
The secured creditor’s exemption also provides that seizure of property does not make a lender liable, provided that the lender takes “reasonable steps” to dispose of the property “as soon as possible, at a commercially reasonable time, on commercially reasonable terms”. Generally, a bank or other lender may maintain business operations and close operations in a property as long as the property is offered for sale shortly after the foreclosure date or as soon as commercially reasonable. For now, the standards will co-exist and either standard can be used.
Among the most significant differences between the standards:
- Under the new standard, the consultant would apparently be required to consider risk factors that they might have overlooked under the previous standard, which could lead to more conservative conclusions. The conclusions of the Phase I SEA are based on the judgment of the environmental professional, which means that different consultants can and do arrive at different classifications after assessing the same property. A lender should be aware of the different standards and find out which standard is used by their consultant. Although the existing standard is still (for now) accepted by the EPA as satisfying the IAA’s requirement for liability protection, it is perhaps foreseeable that over time the existing standard may leave lenders vulnerable to claims that a Phase I ESA performed under this standard was intentionally less onerous and is, therefore, insufficient to protect the lender from the underlying conditions giving rise to CERCLA’s liability . This could potentially lead to litigation aimed at stripping lenders of CERCLA liability protection for a Phase I ESA conducted under the existing standard.
- The new standard could be interpreted more to direct an environmental consultant to rely on the experience of the environmental professional regarding the likelihood of certain conditions causing releases, rather than dismissing the risks associated with such activities on the basis of the absence of “current indications of a release”. “
- The new standard would require the Phase I ESA to set out the environmental professional’s basis for identifying Recognized Controlled Environmental Concerns (CRECs), along with copies of the underlying regulatory documentation to support that conclusion. . For the potential buyer or lender, this is a positive change as it will allow the user to better understand the risks associated with ownership and provide the user with source documents for any ongoing obligations to 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 the five elements by the environmental professional, so depending on the time required to complete the review, the “retention period” of the completed Phase I ESA could be less than six months. According to the current standard, the period of 180 days runs from the date of issue of the report. In both cases, the ESA Phase I can be extended to one year.
- Certain historical sources should be addressed in the Phase I ESA, including aerial photographs, fire insurance maps, local street directories, topographic maps, building department records, interviews, records property tax and zoning/land use records, with an explanation if any documents are missing.
- The new standard specifies that emerging contaminants will undergo a Phase I ESA review once they are classified as hazardous substances under CERCLA. In the meantime, lenders may wish to discuss the risks and benefits of including certain emerging contaminants within the scope of the Phase I ESA with their environmental consultant and legal counsel.
- In practice, a Phase I ESA may become more expensive under the new standard, resulting in additional costs for borrowers and buyers.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
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