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The following discussion thread excerpt is from a recently completed law.com online seminar, “Addressing Environmental Concerns in Real Estate Transactions,” moderated by Michael B. Gerrard of Arnold & Porter. For information on this program and other law.com seminar offerings, please visit http://www.law.com/seminars. MICHAEL B. GERRARD, ARNOLD & PORTER, NEW YORK, N.Y. Yesterday’s discussion focused on why due diligence should be performed. Today I suggest we deal more with the how than the why. (Of course, anyone remains free throughout this seminar to add new posts on prior days’ topics.) These are some questions: What should a Phase I report encompass? Is the ASTM standard an appropriate starting point, ending point, or neither? Are there better guidelines? What specifically should trigger a Phase II study? Should the decision on whether to prepare a Phase II be made by the lawyer, the client, or the consultant? What kinds of dealings with federal, state and local authorities are appropriate in preparing Phase I and Phase II reports? To what extent should counsel be concerned that inquiring of regulators may invite unwanted inquiries? How can one best prepare site assessments when working under severe time constraints? Can the work be phased? When hiring site assessors, what is the relationship among cost, quality and speed? BRUCE KLAFTER, DIRECTOR OF ENVIRONMENTAL, HEALTH AND SAFETY LEGAL AFFAIRS, APPLIED MATERIALS, SANTA CLARA, CALIF. I have generally asked consultants to perform an ASTM Phase 1+. Where my clients were funding a loan for multi- family properties, we would always sample for lead paint, asbestos (depending upon the age of the structure) and radon gas. That scope was dictated by FNMA and other standards. In instances where the site is remote and we already have some idea the Phase 1 will identify RECs, we have included a limited Phase II right off the bat. That way the client can save some mobilization and other costs. In terms of triggering a Phase II, that decision should always be made collaboratively. I believe the lawyer and his/her client are best prepared to make the judgments about risk, i.e., is there a need to do a Phase II and what are the objectives. The consultant is usually not very adept at making that sort of call, but does play an important role in resolving technical questions. An open issue sometimes may be designated an REC, but upon further discussion or investigation can be resolved somehow. I’ve dealt with numerous cases where dry cleaners were identified through address records, and further poking around enabled us to determine it was drop-off only. You certainly don’t want to perform a Phase II in such a case. I am a believer in contacting regulatory authorities where the possibility exists of settling an ambiguous situation with a comfort letter, phone advice, etc. In today’s environment, you won’t find too many instances where the authorities are completely unaware of a highly contaminated site and (on the flip side) they often take a relaxed view of sites with lesser problems. From the buyer or lender’s perspective, of course, there’s usually little to lose in making such an inquiry. The argument you make to the seller is that the issue (if there is a genuine one) will have to be confronted in some transaction and at some point. “If not now, then we might just walk away.” I’ve found authorities in many states (California unfortunately being an exception) very ready to help clarify that an old tank, small concentrations of petroleum, or other facts do not require further action. One last thought on consultants — Phase 1s are a commodity today. Some consultants churn them out by the reams and the quality varies remarkably (contrary to the expectations of some clients). The worst failings in my opinion are the following: 1) the failure to “close out” an issue, i.e., to gather evidence until a conclusion can be reached. I’ve seen countless instances where a consultant finds something obvious like a prior cleanup and then simply fails to obtain closure records or other evidence the issue is resolved; 2) The other common failing is the consultant’s failure to interpret the evidence reasonably and draw some useful conclusions. You’ve paid for some recommendations and all you receive is a collation of various records. A typical case arises in interpreting the database search. If there is a nearby leak site, you need the consultant to state whether or not it’s close enough and serious enough to pose an issue of cross-contamination. It is usually the case that there is no problem, but the consultant needs to say that and justify the conclusion. I recommend asking for sample reports if you haven’t worked with the consultant (or a particular office of a consultant) before. Phase 1s are not “rocket science” by any means, but a good number of consultants still produce some poor work. The price may not be great, but the headaches in terms of lost time, phone calls, etc., can be huge. GAIL PORT, PROSKAUER ROSE, NEW YORK, N.Y. As we noted in yesterday’s discussions, corporate due diligence has been around for many decades. Environmental concerns, and thus, environmental due diligence, including environmental assessments, however, became a common component in transactions primarily in response to liability concerns that arose under CERCLA’s joint, several and retroactive liability scheme that place broad liability on four categories of potentially responsible parties (PRPs). Moreover, judicial decisions in the late 1980s to early 1990s sent shockwaves through the lending community because they held that, under certain circumstances, lenders could fall within the PRP categories and become responsible for the environmental cleanup if, for example, they foreclosed on contaminated property or participated in the management of the borrower’s business (or even if they merely had the capacity to control the management of the business.) The lenders’ concerns have largely been addressed by the enactment of the Asset Conservation Lender Liability and Deposit Insurance Protection Act of 1996 in the waning days of the 104th Congress. However, lenders remain concerned with, among other things, the ability (financial and otherwise) of their borrower to address environmental concerns associated with their business or properties. How one conducts an environmental assessment is very much like the Stonecutters Parable that you may have heard me refer to in other programs at which I have spoken on this topic. A man comes upon three stonecutters. He approaches the first and says, “Sir, may I ask, what are you doing?” The stonecutter replies: “I am earning a living — it pays the bills.” The man approaches a second stonecutter and asks the same question. The second stonecutter responds, “I’m cutting the perfect stone. Each facet is cut at just the right angle.” The man moves onto a third stonecutter and asks again the same question. The third stonecutter replies, “I’m building a cathedral.” It is critically important in determining how much and what scope of an environmental assessment to perform to understand the underlying transaction. Is your client trying to build a cathedral or just earning a living? What are they trying to accomplish? What are your client’s short- and long-term needs? What type of and amount of information does your client need to know to make his/her business decisions? How risk-adverse is your client? If he/she is a risk taker, how can you protect him/her from him- or herself. What are the environmental risks inherent in the deal and, most importantly, how real are those risks? These are but some of the questions you should be asking in determining the scope of the environmental assessment to conduct. The environmental assessment is typically, but not necessarily, done in sequential phases known as a Phase I and a Phase II. The Phase I is designed primarily to identify sources of potential on-site contamination. However, under appropriate circumstances, such as if you are involved in a stock transaction or your client is considering the acquisition of all or substantially all the assets of an ongoing business, you may want to include in the work scope of the Phase I an identification of off-site liability and a permit audit or review to ascertain that the facility has all required environmental permits and is in compliance therewith. In my experience, particularly where I represent a seller, a Phase II should only be conducted when the Phase I raises significant suspicions [and] identifies potential environmental problems (known as “recognized environmental concerns” under the ASTM protocols). Some examples would include sampling and analyzing soil suspected of being contaminated, but only for those constituents of concern associated with the suspected contamination, installing and sampling of groundwater wells (again, the laboratory sampling should be limited to the methods associated with the constituents of concern and should be no broader), tank tightness testing, sampling of suspect asbestos containing materials or lead based paint, waste stream characterizations, etc. There is no end to what some consultants may propose be done as a Phase II, so lawyers, particularly those representing sellers of property, are cautioned to consider and evaluate the potential risks of and timing involved in conducting a Phase II. As noted by one of the earlier panelists, a critical consideration in determining the scope of a Phase II investigation is what you expect or hope to accomplish with that investigation. It may not be helpful in facilitating a transaction merely to identify that contamination exists in the soil or groundwater above regulatory thresholds. The more useful questions are: How much will it cost to clean it up, how long will it take to clean it up, how intrusive will the cleanup activities be, and can the property/plant/facility still be used to conduct the business while the remediation is ongoing. You will need to work closely with the environmental consultant to design a Phase II investigation that will enable you and your consultant to answer those questions which your client is bound to ask. Sometimes a Phase III investigation needs to be conducted. A Phase III is generally a more extensive and/or focused site investigation to enable the consultant to design and implement a remedial system. Sometimes you don’t have the luxury of time that this phased approach requires. So you have to do a bit of a balancing act in working out the scope of the Phase II investigation, always keeping in mind that you want to get it done quickly and cost-effectively, but you want to generate enough information to enable your client to understand the nature and scope of the environmental issues, to come up with (and be able to estimate a cost for implementing) a plan to deal with them and to enable you or him/her to negotiate the deal. As you probably have already figured out, the conduct of environmental due diligence is an interdisciplinary endeavor with the attorney and consultant working closely together as a team. The attorney’s role, among other things, is to scope out, manage and interpret the legal implications of the consultant’s work product. Accordingly, it is critically important that the consultant and the attorney be able to work closely together. When I am looking to retain a consultant on behalf of a client, I consider the following: your personal experiences with the consultant or the recommendations of others whose judgments you trust; the consultant’s expertise/experience in the particular industry to be assessed; the writing skills of the consultant (watch out for consultants who use “red flag” words or are afraid to render professional conclusions); the consultant’s billing rates and, even more important, their ability to stick to the budget and schedule for the completion of the work; the accessibility, responsiveness and availability of the consultant and the ability of the consultant to staff a multi-site environmental assessment project; the relationship of the consultant with governmental agencies from whom they may need to get information quickly (and without having to take the time to make a Freedom of Information Request); the acceptability of the consultant to the other parties in the transaction, including known or potential lenders (even if they are not yet identified). LAWRENCE SCHNAPF, SCHNAPF AND ASSOCIATES, NEW YORK, N.Y. The revised ASTM is a good starting point for determining the scope of the Phase I. It should be noted that the revised version imposes new responsibilities on users (clients) to provide information to the consultant on the purpose of the project. The new standard also addresses what are called HRECs, which are historical recognized environmental conditions. These may be contaminated areas that have been addressed in the past but may, for example, be subject to institutional controls. Determining what is an HREC is really a legal as well as technical exercise. The revised standards also allows users to request that the consultant consider “business risks” and not just focus on the CERCLA innocent purchaser’s defense. The new standard also specifically requires consultants to look for institutional controls. Generally, a buyer does not have an obligation to disclose the results of a Phase II report to government regulators. However, the USTs regulations of a number of states provide that “any person” who has knowledge of a release from a UST must report the release to the state. Indeed, in 1999, an administrative action was filed by the N.Y. DEC against a consultant hired by a bank for failing to report contamination observed during a tank pull performed by the borrower. It is advisable for the parties to address confidentiality of information generated during due diligence in the contract prior to doing the work. Language should also be inserted in the consultant’s contract as well. Generally, these provisions provide that the other party will not disclose unless they reasonably believe they are obligated under law and then only after they consult with the other party. JAMES RIGANO, MCMILLAN, RATHER, BENNETT & RIGANO, MELVILLE, N.Y. In response to the questions posed on Day 2, I wanted to offer the following thoughts. ASTM is a very useful guideline, but it is typically necessary to broaden the scope of ASTM to include other items. Asbestos should be addressed. At a minimum, the consultant should be directed to review a property visually for friable asbestos-containing material. If appropriate, testing for asbestos may be appropriate. If building renovation or demolition is being considered, then an asbestos testing survey should be performed and should include non-friable asbestos, such as floor tile material. If demolition is planned, the non-friable asbestos, in addition to the friable asbestos, should be removed before demolition. ASTM guidelines do not address regulatory compliance issues. As a result, compliance issues should possibly be considered as part of a Phase I report. Most importantly, issues under RCRA (the Resource Conservation and Recovery Act) should be considered with the focus on an overview of manifests produced for the generation of hazardous waste and how hazardous wastes are handled at a facility both currently but, more importantly historically, to the time when operations first commenced at the facility. RCRA was first implemented in the early 1980s. As a result, hazardous waste handling before that time should be evaluated carefully. The consultant should also be careful to perform local municipal searches and obtain aerial photographs. These items can often reveal potential problems that may otherwise be overlooked. The second question posed was what should trigger a Phase II study. Any suspicion presented in a Phase I should probably trigger a Phase II. A purchaser should carefully review a suggestion to not perform a Phase II, while a seller should carefully review a recommendation to perform a Phase II. The recommendation on whether a Phase II should be performed should be made by the consultant but should be carefully reviewed by an attorney and a client. The reasons for the Phase II, and more importantly the exact scope of the Phase II, should be reviewed in detail. For example, the chemicals that will be sampled and the laboratory method proposed by a consultant should be carefully evaluated. Very often, a consultant will propose sampling of too many chemicals or too few chemicals. Under the third question, dealings with governmental authorities in the Phase I and Phase II process, direct interaction with regulatory agencies is typically not performed, with the exception of obtaining basic historical information regarding the site. Typically, after a Phase II, a purchaser, or perhaps a new lender on the property, will request that the seller or the consultant attempt to obtain a sign-off from a governmental agency with regard to the property. While such a sign-off is very desirable, it is usually very difficult to obtain. As a result, a purchaser’s counsel and their consultant may have to make judgments regarding the results of the Phase II and whether those results present acceptable risks to a purchaser without the benefit of a sign-off from a governmental agency. The fourth question addressed is the preparation of a site assessment when working under severe time constraints. It is typically best to first perform a Phase I followed by a Phase II. Sampling locations are typically identified through the Phase I process. Nevertheless, where time is critical, the Phase I and Phase II can be performed together with the sampling locations being identified after a walk-through at the premises. Under the fifth question, when hiring site assessors, what is the relationship between cost, quality and speed, typically the only increased cost associated with a quick site assessment is rapid laboratory turnaround time. However, a consultant typically will not sacrifice quality in performance of a quick Phase I or Phase II. The one aspect of a quick site assessment that cannot be completed on a quick basis is obtaining Freedom of Information Act responses from governmental bodies. This process typically takes six to eight weeks.

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