Presenting a live 90-minute webinar with interactive Q&A Environmental Due Diligence for Real Estate Buyers, Sellers and Lenders Identifying and Mitigating Risks and Liabilities in Real Estate Transactions TUESDAY, MAY 19, 2015 1pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Derek Ezovski, President, Outsourced Risk Management Solutions, West Hartford, Conn. Cindy Karlson, Founder, Law Offices of Cindy J. Karlson, East Hampton, Conn. Rachel Rosen, Department Manager, Burns & McDonnell, Wallingford, Conn. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.
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Agenda Introduction - Environmental Due Diligence Site Assessment Lenders/CMBS Perspectives Drafting Environmental Provisions for Contracts Questions 5
Framework for Environmental Due Diligence Compliance with Environmental Laws Common Law Issues Statutory Obligations Evaluate Potential for Liability under Regulatory Regimes CERCLA, RCRA, Clean Air Act, Clean Water Act, state analogs CERCLA Issues Site nexus will be established with transaction Assess Liabilities and possible defenses Defenses very limited Innocent landowner defense Bona fide prospective purchaser defense Contiguous landowner defense 6
Transactional Considerations Lease & Finance Agreements Stock & Asset Acquisition Company transitioning unchanged - Corporate liabilities of company unchanged by transition Liabilities arise only as related to the assets transitioning Contamination present, contamination originating from, and current compliance status of the asset(s) 7
Due Diligence Strategy Considerations All Appropriate Inquiry Primary function Support CERCLA defenses Evolved into de facto commercial standard ASTM 1527-05 Specific elements required Still responsible for any new conditions on the Site Specific State Considerations Connecticut Transfer Act New Jersey Industrial Site Recovery Act Common Law Compliance Contractually required disclosures SEC disclosure review 8
Environmental Due Diligence Considerations Rachel M. Rosen, LEP May 19, 2015
Buyer s Due Diligence Strategy & Tips AAI Standard ASTM Standard Vapor Encroachment The Findings Related Topics & Considerations 10
Strategy: Selecting Consultants & Counsel Evaluate consultant and/or attorney s experience and credibility Evaluate the business acumen and negotiation skills of the key individuals Scrutinize the scope of work Carefully review the consultant s terms and conditions to the contract 11
Strategy: Tips For Due Diligence What is necessary vs. recommended All Appropriate Inquiry & ASTM E1527-05 What is included? What is not included? Vapor Encroachment ASTM E2600-10 Potable water, mold, asbestos, wetlands, lead-based paint and indoor air quality Appreciate the factors that guide various lenders and your own liability tolerance 12
What s Needed? Developing A Due Diligence Strategy Transactional Factors Size of the deal vs. nature and extent of Buyer s due diligence efforts Buyer s risk tolerance Financing conditions Commercial lender, private equity issues Schedule constraints Buyer does not have to compromise on due diligence even under tight timeframes (i.e., e-due diligence rooms can be accessed 24/7) Budget limitations Corporate Governance Fiduciary duties 13
All Appropriate Inquiry and Liability Protection For Buyers 2002 SARA and the Small Business Liability Relief & Revitalization Act (Brownfield Amendment) Innocent landowner defense Bona fide purchaser defense Contiguous landowner defense What work is required to qualify for liability protections All Appropriate Inquiry 42 U.S.C. 9601(35)(B) 40 C.F.R. 312 (2005) 14
All Appropriate Inquiry Regulatory Considerations - All Appropriate Inquiries Eligible persons for liability protection under CERCLA Innocent landowners, contiguous property owners Bona fide prospective purchasers State or local government that acquire ownership/control involuntarily through bankruptcy, tax delinquency or abandonment Conditions to satisfy AAI: Must perform due diligence in accordance with 40 CFR Part 312 AAI timelines prior to acquiring ownership of property: Within 1 year prior to acquisition, perform or update AAI Within 180 days prior to acquisition, perform interviews of current and past owners; review government records; on-site visual inspection and search for environmental cleanup liens 15
All Appropriate Inquiry (Cont.) AAI alone does not guarantee CERCLA protection, the following conditions must also be met: Comply with Continuing Obligations after acquiring the property Provide all legally required notices with regard to discovery of releases of hazardous substances Comply with land use restrictions, fully cooperate with persons conducting response actions and information requests; use due care with respect to hazardous substances Buyer must not be affiliated with any liable party through family, contractual, corporate or financial relationship (other than the property conveyance instrument) 16
ASTM 1527-13 The Findings: Recognized Environmental Conditions ( RECs ) The presence or likely presence of any hazardous substance or petroleum products in, on, or at a property: (1) due to any release to the environment; (2) under conditions indicative of a release to the environment; or (3) under conditions that pose a material threat of a future release to the environment. The term includes hazardous substances or petroleum products even under conditions in compliance with laws. The term is not intended to include de minimis conditions that generally do not present a material risk of harm to public health or the environment and that generally would not be the subject of an enforcement action if brought to the attention of appropriate governmental agencies. 17
The Findings: Historical Recognized Environmental Conditions ( HRECs ) A past release of any hazardous substances or petroleum products that has occurred in connection with the property and has been addressed to the satisfaction of the applicable regulatory authority or meeting unrestricted residential use established by a regulatory authority, without subjecting the property to any required controls (e.g. property use restrictions, AULs, institutional controls, or engineering controls). Before calling the past release an HREC, the environmental professional must determine whether the past release is a REC at the time the Phase I ESA is conducted 18
The Findings: Controlled Recognized Environmental Conditions ( CRECs ) A REC resulting from a past release of hazardous substances or petroleum products that has been addressed to the satisfaction of the applicable regulatory authority (e.g. as evidenced by the issuance of a no further action letter or equivalent, or meeting risk based criteria established by regulatory authority), with hazardous substances or petroleum products allowed to remain in place subject to the implementation of required controls (e.g. property use restrictions, AULs, institutional controls, or engineering controls). 19
The Findings: Read Between the Lines Varying interpretations Read Your Report! Does the Story Make Sense? No RECs = Clean Site 20
The Findings: Read Between the Lines Know Why Due Diligence was Performed Real Estate Transfer? Funding/Insurance? Regulatory Program? Identify potential risks related to adjacent properties 21
The Findings: Read Between The Lines Potential buried risks in due diligence findings: Scrutinize waste disposal practices no matter how small the quantity of waste Understand implications of water use/availability for your site and development plans Evaluate status of regulatory permits (any permit transfers necessary?) Identify potential risks related to adjacent properties 22
Vapor Encroachment Standard ASTM E1527-13 requires Assess potential for hazardous vapors to migrate onto or within the target property How to comply? 23
Encroachment Standard per ASTM E1527-13 Definition Encroachment = movement of hazardous substances or petroleum products Solid, liquid, vapor Surface and subsurface Requires Analysis of surrounding property uses Data-base record review No other guidance, but refers to ASTM E2600-10 24
Vapor Encroachment What is It? Encroachment of volatile chemicals from the subsurface into buildings vapor Encroachment now gets as much attention as groundwater Encroachment from a risk evaluation perspective Potential liability exposure Tenant and third party claims The CERCLA definition of release includes vapor Encroachment Continuing obligations at site 25
Goal of ASTM E 2600 (Vapor Encroachment Screening) Identify a Vapor Encroachment Condition (VEC) VEC = Presence or likely presence of [chemicals of concern] vapors in the sub-surface of the target property Caused by the release of vapors from contaminated soil or groundwater On or near the target property Tier 1 or Tier 2 procedures 26
Tier 1 - Vapor Encroachment Screen Resources Historical records Historical uses Federal, state, local and tribal governmental records Physical setting information User-specialized knowledge 27
Tier 1 Vapor Encroachment Screen Search Distances Minimum search distances Potential petroleum releases within 1/10 of a mile Up to 1/3 of a mile for hazardous material releases 28
Tier 2 - Vapor Encroachment Screen Resources Unless a Tier 1 screen can rules out a VEC, may want to do: Additional regulatory file reviews and/or Soil, soil gas or groundwater 29
Conclusions Re Vapor Encroachment Screening Process similar to the Phase I ESA Process Research Goes hand in hand with Phase I ESA research Can order with the Phase I ESA Moderate additional cost 30
Conclusions Re: Vapor Encroachment Screening ASTM E1527-13 Caveat: nothing in this practice should be construed to require application of the Guide E2600 standard to achieve compliance with all appropriate inquiries. However, using E2600 to fulfil the ASTM E1527-13 vapor encroachment assessment is relatively easy 31
Related Topics & Considerations Potable water Indoor air PCB in caulk Property Condition Assessments (ASTM Standard E 2018 ) Building Energy Performance Assessments (BEPA) Reliance Letters Continuing Obligations (ASTM Standard E2790-11) 32
Building Energy Performance Assessments New ASTM standard: Standard Practice for Building Involved in a Real Estate Transaction It is a tool to calculate a building s energy consumption and cost different from an energy audit Can be used for disclosure to an interested party Intended to supplement ASTM E 2018 and E 1527 environmental site assessments Consultant may offer bundle pricing for ESA, PCA and BEPA 33
Reliance Letters Not A Given Not a Guarantee of Buyer Protection Text Varies Widely Tied to Other Contracts Conflicting Obligations 34
Contact Information Rachel M. Rosen, LEP Burns & McDonnell (Direct) 203-294-2357 (Cell) 203-464-3573 rmrosen@burnsmcd.com 35
Drafting Environmental Provisions For Real Estate Contracts Cindy J. Karlson, Esq.
Discussion Points Structuring the deal to manage potential/actual environmental risk Contract provision options and tools Key negotiated definitions Strategy practice pointers 37
Structuring the Deal Purchase and Sale Agreement - Environmental liability risk allocation - Walk away after due diligence - Representations, warranties and covenants - Remedies - Indemnities - Guarantees - Releases and waivers - Post-closing considerations 38
Structuring the Deal Modifying the Agreement After Due Diligence Period - Purchase price reduction - Environmental side agreement - Site access terms and conditions - Separate indemnity - Pre-closing conditions - Escrow agreement - Environmental insurance 39
As-Is provisions Contract Provisions Boiler-plate language is a good starting point - The devil is in the details - Drafting with due diligence goals in mind Strategy on how you define terms is key - Whether to use broad or very specific definitions and terms depends on the deal context 40
The Basics: Definitions What is a Liability for purposes of the contract? - As broad as violation and/or any noncompliance with any environmental law Environmental Laws - applicable federal, state, and local laws, including statutes, regulations, codes, judicial or administrative orders, and ordinances, relating to the protection of public health and welfare and the environment, including without limitation, those relating to the storage, handling and use of chemicals, or regulated substances to the generation, processing, treatment, storage, transport, disposal, investigation, remediation or other management of waste materials of any kind, and for the protection of environmental sensitive areas or threatened or endangered species. - Options : - common law - OSHA, health and safety considerations - Define Environment separately 41
The Basics: Definitions Hazardous substance any and all substances or wastes that have been defined or classified as hazardous, toxic, or harmful pursuant to any environmental laws or that are regulated pursuant to such environmental laws, including petroleum and each of its chemical constituents and by-products, PCBs, and asbestos in any form. - Options include mold, lead-based paint, urea formaldehyde foam insulation Release - depositing, spilling, leaking, pumping, pouring, emitting, emptying, discharging, injecting, escaping, leaching, dumping or disposing into the environment, whether intentional or unintentional. - Keep in mind your indemnity when you determine the scope of these definitions 42
Definitions: Vague or Specific? If too vague: -Potential arguments over what is and is not included If too specific: -You could be cutting yourself off at the knees in the future depending on site developments Deal strategy will effect the drafting of the definitions Is simple better in some cases? Pick your battles. 43
Due Diligence Provisions Materiality - Pros and cons of defining Material Adverse Effect Set the playing rules Communications with regulators (file reviews) - Scope of allowed investigation (who is present and when) Confidentiality - How can you handle existing and potential sample results 44
Due Diligence Provisions Site access requirements - Notice, insurance, approved individuals Limitations - Time periods; sampling Potential ramifications disclosures and reporting (liability, contract breach, insurance issues) 45
Reps and Warranties What issues are typically covered: 1. Compliance with environmental laws; 2. Compliance with environmental permits; 3. Release of hazardous materials on- and off-site; and 4. Pending and threatened environmental claims from governmental authorities and/or third parties. Limits/carve-outs: 1. Materiality - Material Adverse Effect 2. Knowledge 3. Disclosure schedules 46
Reps and Warranties Practice pointers -Bring down provision and post-closing survival - Third party consent obtained if required - Buyer s satisfaction with due diligence results - Connecticut Transfer Act - New Jersey Industrial Site Recovery Act - Link to indemnification for breach of reps and warranties - Trigger termination provision 47
Scope what to include? Indemnification - Breach of environmental reps and warranties - Pre-closing environmental conditions - Undisclosed liabilities - Reciprocal indemnity Who is covered? - Any successor or assign - Directors, officers, shareholders, partners, agents 48
Setting limits Indemnification - Monetary basket and ceiling - Time duration - At conclusion of environmental work - Tied to approval by a consultant or a government entity - Regulatory audit periods after remediation work - Sunset provisions - Breach of environmental reps and warranties - Specific pre-closing environmental conditions - Undisclosed liabilities 49
Escrow Determining the amount of the escrow - Consultants and lender input What costs will be covered by the escrow Who has rights to approve payment from the escrow Potential hidden costs Time and money involved with objections to escrow payment requests Potential litigation Lender s role 50
Survival of the Fittest Practice Pointers Successors and assigns The indemnity obligations of Seller shall continue until Seller s obligations under this agreement have been met and compliance achieved as set forth in Section X below. Buyer s Remorse Buyer shall indemnify, defend and hold harmless Seller from any loss, cost, damage, or expense (including attorneys fees) actually incurred or sustained by Seller in connection with the release or disposal of Hazardous Substances on the Property by Buyer, its agents, tenants, employees and contractors. 51
Contact Information: Cindy J. Karlson, Esq. Law Offices of Cindy J. Karlson, LLC (860) 365-5167 (860) 614-0184 (cell) Cindy@karlsonlawfirm.com 52
Environmental Due Diligence in Real Estate Transactions Environmental Trends in Lending and Commercial Real Estate Derek Ezovski 53
Current Trends in Lending/Financing of Commercial Real Estate Pressure from regulators Newer ASTM Standard for Phase I s OCC Updated their Environmental Guidelines SBA Lending Lenders updating environmental/appraisal policies More levels/forms of due diligence than ever before on more loans Seems to be a big push in the CRE market again 54
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CRE Lending While increasing bank leniency and improved fundamentals have helped revive the CRE market, the high level of maturing debt remains a significant concern. - excerpt from Deloitte CRE Study 56
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Issues Important to Lenders Collateral Devaluation Direct Liability - Loan origination to foreclosure Reputational Risk (Brand and Image) Operational & Enterprise Risk Credit & Trust Risk but at the end of the day, the primary issue for lenders is Business Risk 64
How Did AAI Affect Lenders For the first time, there was a federal statutory authority saying what is needed for a Phase I environmental site assessment Biggest impact of AAI on lenders were the changes to regulatory and government agencies specifically FDIC guidelines and the SBA 65
New FDIC Guidance FDIC updated its Guidelines in November 2006. NCUA updated their guidelines and issued guidance in May 2008. FDIC s guidance set the standard; FDIC is regarded as a leader in terms of environmental requirements. FFIEC implemented environmental policy training/education for examiners across all agencies (October 2007, May and June 2008) A majority of lenders have reconsidered and revised their environmental policies. 66
OCC Updates Develop policies and procedures that reflect potential environmental risks associated with lending Provide for receipt and evaluation of environmental reports prior to making final commitment. Ensure that persons responsible for evaluating environmental risk possess relevant knowledge, skill and competence. A bank s policy should reflect the EPA s AAI rule. 67
NCUA Environmental Guidance 68
Small Business Administration Update SBA updated its Environmental Policy Effective August 1, 2008 and updated six times since (most recently in January 2014). Went from 1000 pages to 400 pages. Especially important for institutions with preferred status who do SBA underwriting. 7A and 504 lenders must adhere to this policy. Has become default policy for many lenders. 69
SBA Environmental Due Diligence Policy 2 levels of Environmental Due Diligence for SBA 1. Phase I for high risk properties If property type/use matches the list of NAICS codes for Environmentally Sensitive Conditions 2. Records Search with Risk Assessment low risk properties Includes a search of the government databases (compliant with AAI); A search of historical use records, and; A risk assessment by an environmental professional determining whether the site is High, Elevated or Low risk New Gas Station/Dry Cleaner Requirements 70
Impact of Lender Size/Resources Regional & National Lenders Resources in place to understand environmental issues on the property Screen for lower-risk loans Have staff/internal resources to manage environmental risk Credit Unions/Community Banks No on-staff environmental expertise (typically) Not as sophisticated with regard to environmental issues or due diligence options available Often rely only on environmental questionnaires and/or proceed without accurate knowledge of environmental condition of property Rely on external guidance to dictate their practices 71
Trends from EBA Survey of National Banks Less Command and Control by ERM departments More flexible than in the past; More time going into reviewing reports provided by the borrowers vs. bank commissioned reports. Slow adoption of sustainability and green programs High default rates/foreclosures might be contributing Very consistent with past practices Continue to outpace credit unions/community banks in risk management 72
Environmental Due Diligence Options Environmental questionnaire (EQ) Desktop due diligence Transaction Screen Assessment (TSA) Phase I Environmental Site Assessments Phase II, III, Remediation, etc. Environmental insurance Storm water Issues Sustainability/Green Issues Environmental Insurance Others 73
Common Commercial Issues USTs Fuel Oil Tanks Spills Storage/disposal of Hazardous Waste Vapor Intrusion Gas Stations Dry Cleaners Mold, lead, asbestos, radon, etc. Storm water Runoff Superfund 74
Examples of Environmental Concerns for Lenders Originations Foreclosures Boring property that used to be auto shop Retail that used to be Gas Station Removal of waste from a property by lender triggers possible action 75
Summary Lenders have unique processes and reasons for conducting due diligence. Market pressures have reinforced long-term trend to increased due diligence. Regulators enforcing risk management due to a perceived over-concentration of risk regarding commercial real estate. Risk Management (Credit, Collateral, Environmental, etc.) is as critical as ever to lenders. Environmental and appraisals are both pieces of the puzzle that are being revised under the current environment. 76
It s Risk Management 77
Contact Info: Derek Ezovski 860.838.5388 dezovski@orms.com 78