Archive for August, 2011

Lessons Learned – Post Due Diligence Scenarios in Real Estate Transactions

August 7th, 2011

Sometimes, the “exciting” aspects of the environmental drama can occur long after the initial due diligence is over.  Good environmental due diligence should prepare an owner or lender for events which might happen months or even years after a particular real estate transaction has been concluded.  This is particularly true if restrictions or deal constraints were imposed during the original due diligence.

Recently, two clients had post-due diligence experiences which arose after the due diligence period had concluded.   In the first instance, pursuant to a Phase I assessment, the purchaser had identified that the subject restaurant property was located between a former gas station with known petroleum releases, and a dry cleaning facility with identified solvent impacts.  However, the seller did not allow buyer to undertake any phase II or subsurface investigations, as seller was concerned that if impacts were discovered, and buyer chose not to proceed with the transaction, then seller would be aware of such impacts and would be responsible for addressing same.

Since buyer planned to raze and rebuild the restaurant in the near to intermediate term, buyer knew that she would be intruding into the subsurface of the site at some point, possibly aggravating existing impacts.  Therefore, buyer negotiated that seller would pay up front at closing for a seven year $2.0 Million environmental insurance policy against the discovery of impacts at the site associated with the adjacent facilities’ issues (note: the policy would pay for government mandated cleanup and third party claims, but not for any initial investigations).  Buyer was not able to secure lender financing for the transaction because of the uncertainty of the environmental status of the site, so it was to be a cash transaction.

Three years later, buyer proceeded to raze and redevelop the restaurant.  In order to determine whether such activities would exacerbate any existing impacts, buyer initially undertook the Phase II sampling activities (at her own expense) which she had not been able to do prior to site acquisition.   Buyer’s consultant sampled for both petroleum and solvent impacts in soil and groundwater; while such impacts were detected, none were about regulatory action levels.  Buyer was now free not only to rebuild without concern for environmental issues, but was also able to secure lender financing to pay for the redevelopment.   The environmental insurance policy remains in place until year 7, in case of further developments from the adjacent sites.

Sometimes, however, circumstances are less benign. Recently, a lender took control of a property with known soil impacts under a parking lot area (encapsulated, with deed restriction).  Lender had identified a new buyer for the property.  Lender had also secured certain funds ($75,000) from the prior borrower pursuant to the loan guarantees to address such impacts as had been identified in a prior phase II assessment, which funds were allocated to the cleanup as part of the new transaction.   However, after the transaction occurred and the cleanup began, the new borrower discovered that the soil impacts were about twice as extensive as had previously been understood, and that the funds available from the prior borrower were insufficient.  In this instance, the true level of impacts was only ascertained once removal activities had begun, and the borrower is now required to cover the difference (an additional $69,000).  While the new borrower has the ability to manage this additional expense due to the borrower’s relatively healthy balance sheets, however, this was an unwelcome development for both borrower and lender.

As illustrated above, environmental impacts, whether from on-site or adjacent activities, continue to have the potential to cause concern, for both lenders and borrowers.   It is important to understand that due diligence is not an exact and absolute science, but only a measure of reasonably ascertainable information at a specific time.  What due diligence does allow the participants to do is make contingency plans, including for example, environmental insurance policies or cash reserves, in case circumstances turn out worse than expected later on.  Due diligence remains an appropriate mechanism for reducing and managing transactional risk associated with commercial real estate transactions.

Lessons Learned –Environmental Issues Still Arise in Real Estate Transactions

August 7th, 2011

As you may recall from the 2010 end-of-year Lessons Learned survey of due diligence activity, lenders were less active in 2010 than in the prior years; however, we are still seeing environmental issues arising associated with lender activity, which reminds us that the issues are still out there, even if the activity which would give rise to such an encounter has decreased.  Two recent situations in the last 12 months, brought to our attention by colleagues at EDR and LinkedIN, illustrate the problems which may arise if adequate environmental due diligence is not undertaken: 

(1) Foreclosure Leads Bank to Sue Dry Cleaner, Friday, June 25, 2010 by Cassie Anderson, from the June 2010 EDR Insider.

An Illinois-based lender filed an environmental lawsuit after foreclosing on a seemingly benign property that was later found to be contaminated. In 2009, the bank foreclosed on a two-family home. Subsequently, the bank discovered that a nearby dry cleaner had allegedly contaminated the foreclosed property, along with the surrounding area. As a result, the bank is now suing the dry cleaning company, its owner and its lender. The plaintiff is seeking $10,800 for environmental testing and an additional $300,000 for nuisance, negligence and trespassing.  The residence is located on a block targeted for purchase and redevelopment by the city. According to local reports, the PCE plume allegedly caused by the dry cleaner is delaying this project. The bank has tried for months to resell the foreclosed home unsuccessfully, and claims that the presence of contamination has stigmatized the site and ruined its marketability, even given the proposed redevelopment for the area. With the projected coming wave of foreclosures by banks on both residential and commercial properties, this story demonstrates the importance of conducting environmental due diligence upfront. Even properties that are not associated with high-risk operations and are in high-demand neighborhoods can have associated environmental issues that need to be addressed prior to property resale.

(2) Court Says Purchaser Failed to Exercise Due Care, reported by Attorney Larry Schnapf, Principal at Schnapf LLC  and an Adjunct Professor at New York Law School, on LinkedIN.

The Kentucky Federal District Court recently held that plaintiff’s had (1) unreasonably relied on a cursory environmental audit [instead of an ASTM Phase I assessment] when it purchased the property, (2) The audit informed plaintiff that hazardous materials had been handled on the site and that there was at least one hazardous substance, chromium, on the property, (3) Plaintiff unwisely relied on its auditor, did nothing further to investigate, and claimed it had no knowledge of any spills, (4) Plaintiff took no precautions when demolishing buildings in the area of former electroplating and waste water treatment operations, (5) when preparing to sell the property, it learned from the potential buyer’s auditor that there was contamination found in samples taken from the area where it had removed concrete floors and did not disclose to the state. 500 Associates v Vermont American Corp, 2011 U.S. Dist LEXIS 11724 (W.D.Ky 2/4/11)

As illustrated above, environmental impacts, whether from on-site or adjacent activities, continue to have the potential to cause concern, whether for lenders or their clients.   Therefore, pre-loan and pre-purchase assessment remains an appropriate and cost effective mechanism for reducing and managing transactional risk associated with both commercial and, in certain circumstances, residential real estate transactions.