Tackling Envrionmental Issues In Real Estate Agreements - Addressing the Potential Issues

Lauren Beetle and Amy M. Trojecki
September 2, 2008 — 1,593 views  

Addressing environmental issues has emerged as one of the most significant concerns in commercial real estate transactions today. The strict liability nature of environmental laws has resulted in a heightened awareness of environmental issues in real estate transactions for decades now. Dealing with environmental concerns, however, has become increasingly important in recent years, due to rigid state and federal environmental requirements and the fact that many New Jersey developers, investors and property owners are now acquiring existing and/or redeveloping abandoned or underutilized sites. Because environmental law has become a specialty practice area, provisions in real estate deals regarding environmental matters seem to be managed either so intensely that the environmental concerns smother the transaction, or are virtually ignored. While it is not practical to include provisions in an agreement that address every potential environmental issue that may arise, it is crucial that parties to a real estate transaction understand the representations and warranties that are made and the due diligence that is performed regarding environmental issues, along with the fiscal and legal implications of such information.

Environmental Due Diligence

From a buyer’s perspective, assuring that you are entitled to perform envi¬ronmental testing, including a Phase I Environmental Site Assessment (“Phase I”) and/or Preliminary Assessment (“PA”) and, if necessary, a Phase II Environmental Site Assessment (“Phase II”) or Site Investigation (“SI”) is critical to any agreement. Sellers may be reluctant, however, to permit such testing because of the legal obligations that arise from learning that owned property is contaminated, and due to the intrusive nature of the testing. Traditionally, prospective purchasers have relied on general due diligence provisions affording them the right to investigate the real property as a source for permitting environmental testing. Because of the growing implications of environmental due diligence, however, it is now necessary to determine and provide for what testing may be performed and by who, how it is performed, how results are handled, and how the costs of such testing is allocated.

In most instances, it is in the both the buyer’s and seller’s best interests for the buyer to conduct adequate environmental due diligence. The buyer needs to be able to conduct sufficient investigation to determine whether there are environmental risks associated with the property and perhaps, more importantly, to satisfy the requirements of the innocent landowner defense under the New Jersey Spill Compensation and Control Act, and CERCLA. Sellers benefit from allowing prospective purchasers to conduct appropriate environmental due diligence because many times such investigation serves as a basis for the seller to limit its representations and warranties to the buyer. Sellers should include protections in the agreement of sale, including requiring evidence of liability insurance covering liability arising from any due diligence work performed by or on behalf of buyer and an indemnification from buyer for any loss, damage to the property, or death or injury as a result of buyer’s due diligence. Sellers should also consider provisions in the agreement requiring written consent by seller before buyer may perform any invasive or intrusive testing on the property, restricting testing so that it does not interfere with ongoing operations at the property, allowing for the right to be present at the time of environmental testing and split samples.

Moreover, sellers should consider provisions restricting the distribution of investigation results. It is important that information be kept confidential and limited to the parties to the transaction and their professionals, unless required to be disclosed by law.

While traditionally the costs in connection with such environmental testing have been a buyer’s due diligence expense, where the property in question is known or suspected to have environmental issues or ISRA applies to the transaction, it may be appropriate for the parties to share a portion of those costs. Although a purchaser must ultimately decide whether a property is in acceptable condition, sellers may find that reimbursing buyers for a portion of their environmental costs, where the property is a known contaminated site or a suspected site for which little past environmental information is available, is a powerful incentive to finalizing a deal.

To Represent or Not To Represent

Determining what representations and warranties are reasonable is always difficult, but especially so in the environmental context. Typical seller representations include: (a) to the seller’s knowledge, the property is in compliance with applicable environmental laws; (b) to the seller’s knowledge, there are no conditions that give right to liability or imposition of a statutory lien or require remediation under applicable environmental laws; (c) seller has not received notice of any violations, claims, demands, actions or proceedings against the property or the seller, by any governmental agency or otherwise, or any claim relating to damage, loss or injury resulting from hazardous materials; (d) seller is not aware of any release on the property; and (e) the presence or lack of underground storage tanks. In transactions involving large commercial properties used for retail or industrial purposes, for which PAs and/or SIs are routinely performed, a representation about the delivery of any existing reports as the true, correct and complete environmental history for the property is common. Sellers should subject any representations and warranties they deliver to the results of such environmental reports. Moreover, sellers should be clear in any knowledge qualification and limit their representations to occupancies, events, deliveries and performances which they directly and personally control.

Because of the growing sophistication of environmental matters and the fact that many property owners may be in the chain of title for only a limited duration, sellers are increasingly hesitant to make significant, substantive representations and instead are asking buyers to rely on existing environmental reports, or new testing performed as part of the buyer’s due diligence. With renewed interest in existing or previously developed sites that have potential environmental baggage, this trend is likely to continue. Attorneys representing buyers should push for adequate, traditional representations that are within a seller’s knowledge and control, but should be aware of this shift. One can expect additional changes and the development of new representations as the field grows and practices, such as the issuance of LNAs, change.

ISRA Application and the Discontinuance of LNAs

Probably the most significant difference between residential and commercial real estate transactions from an environmental perspective is the applicability of the New Jersey Industrial Site Recovery Act. N.J.S.A. 13:1K et. seq. and N.J.A.C. 7:26B et. seq. Stated simply, ISRA is an environmental law that imposes certain preconditions on the sale, transfer or closure of certain types of businesses (those qualifying as an “industrial establishment”). Primarily, industrial establishments are defined by reference to an owner’s or operator’s North American Industry Classification System code. Unless they qualify for an exemption or waiver under ISRA, owners and operators of industrial establishments planning to close or transfer ownership or operations must obtain a No Further Action letter for the property, which, at a minimum, requires the completion of a PA.

ISRA regulations provide a mechanism for owners and operators to obtain a determination from the New Jersey Department of Environmental Protection concerning the applicability of ISRA to a specific place of business or transaction. Traditionally, buyers have required sellers to secure a Letter of Non-Applicability from the NJDEP to confirm that ISRA does not apply to a sale transaction. LNAs have provided buyers and lenders with a level of comfort that an impending transaction would not trigger the ISRA filing requirements — the idea being that buyer would not be subject to ISRA at the time that it sells the property to a subsequent owner. Over the last several years, however, the NJDEP reduced those properties and transactions for which the service is available.

Effective April 30, NJDEP will no longer issue LNAs. This means that parties will now need to independently make a determination of ISRA applicability. While this change is so recent that its exact implications on real estate agreements is unclear, buyers will likely look to address the uncertainty by requiring new, additional seller representations. This will mean additional costs to and professional services being required by sellers who may need to retain environmental consultants and attorneys in order to provide ISRA analysis in connection with such representations and warranties. Buyers may also specifically request ISRA applicability determinations from their consultants performing environmental due diligence. The time required for completing due diligence and in drafting and making environmental representations will likely increase since reliance on an LNA is no longer available. Furthermore, because the responsibility of confirming the nonapplicability of ISRA historically resided with the seller, there may be a call by some buyers to shift a portion of the expenses for environmental due diligence to the seller to cover this change in NJDEP policy. The change will certainly present new issues for documenting and negotiating environmental transfer requirements, and further illustrates the careful and thoughtful consideration that must be implored with respect to the environmental component of any real estate transaction.

Beetle is an attorney in the Real Estate Department and Trojecki is an attorney in the Environmental Practice Group of Ballard Spahr Andrews & Ingersoll in Voorhees.

Reprinted with permission from the July 21, 2008 edition of the New Jersey Law Journal. © 2008 ALM Properties, Inc. All rights reserved. Further duplication without permission is prohibited. For information, call 973.854.2923 or [email protected]. ALM is now Incisive Media, www.incisivemedia.com <http://www.incisivemedia.com/>

Lauren Beetle and Amy M. Trojecki

Ballard Spahr Andrews & Ingersoll, LLP