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Buying & Selling Contaminated Properties:
Equations For Success


By Gerald L. Pouncey, Jr., Esquire
Morris, Manning & Martin, LLP
glp@mmmlaw.com
404.504.7738
&
George E. Hibbs, Esquire
Morris, Manning & Martin, LLP
geh@mmmlaw.com
404.504.7761

I. Introduction

The proliferation of environmental laws, rules and regulations at all levels of government has created in the minds of most property owners and potential purchasers what may best be described as environmental paranoia. Costs of environmental assessments and reassessments, fees for attorneys, fines for violations, potential liability to third parties and the general unpredictability and uncertainty by regulators imposing new and untested provisions all contribute substantially to this perception. Minor levels of contamination which pose no genuine threat to human health or the environment may nonetheless spell the death knell for a multi-million dollar transaction.

The financial drain and difficulties imposed upon commercial real estate practices over the past decade as a result of these environmental provisions is undeniable. Equally undeniable, however, is that significant opportunities exist for thoughtful sophisticated investors to capitalize on this paranoia by acquiring valuable income producing properties at a price substantially below market.

The key to successfully seizing these opportunities lies in accurately quantifying the risk created by the environmental concern, then determining if and to what extent that concern impacts the income generating and future sale prospects of the property. Once that due diligence is complete, the prospective purchaser may then engage in appropriate risk allocation in order to maximize the benefit of the transaction while minimizing potential exposure created by acquiring the proposed acquisition. These risk allocation methods include reduction in purchase price, agreements regarding responsibility for remediation of the property, execution of indemnities by the seller and other potentially liable third parties and establishment of escrow funds to satisfy remediation costs and potential third party claims. When appropriate due diligence and use of risk allocation is effectively combined, the net result often is acquisition of a valuable and ultimately marketable commercial property at a dramatically reduced price with no substantive additional risk.

II. Overview of Legal Framework

In order to accurately assess whether a particular contaminated property presents a genuine opportunity, one must have a basic working knowledge of the impact of applicable environmental laws and regulations. The framework of environmental laws is undeniably complex, extensive and seemingly ever-changing. Beginning at the federal level with CERCLA and RCRA and the rather intricate interplay between their scope of coverage, then working down through the state and local variations which have followed, the network of potentially applicable requirements can justifiably seem daunting. This is particularly true for the business investor whose primary goal is often achieving maximum levels of predictability with respect to a transaction.

The principal feature of CERCLA and most of the state replicas is the imposition of strict liability upon the owner of a contaminated property. In other words, the owner of property contaminated by "hazardous substances" (as that term is defined in CERCLA) is potentially liable for all cleanup costs associated with that property. This liability exists whether or not the owner caused the contamination and whether or not the contamination occurred prior to the time the owner acquired the property. Understandably, this potential liability acts as a tremendous disincentive for prospective purchasers of properties contaminated by hazardous substances. The potential liability to federal and state regulators and third parties, as well as the uncertainty created thereby, dramatically narrows the universe of purchasers willing to consider purchasing the site and lenders willing to loan on the property. The resulting impact of this depressed demand is an effective market value significantly below what an investor would typically pay for the property based upon the income stream associated with that property.

Many state counterparts to CERCLA contain additional provisions which impact property values on an even more direct basis. The authors' experience with Georgia's recently adopted version of CERCLA, the Hazardous Site Response Act ("HSRA"), is illustrative. Under HSRA, state environmental authorities are required to publish a list or "inventory" of all properties where regulated substances have been released or disposed of in "reportable quantities." This list is to be updated on a periodic basis, at least annually, and sent to local court clerks throughout the state, where the list is kept with the county deed records. A significant percentage of the properties listed in the initial inventory published earlier this year are commercial sites. Many other states have similar provisions for published inventories of contaminated properties.

Georgia's HSRA also requires that any instrument transferring an interest in property (i.e., deeds, leases, etc.) upon which environmental corrective action is required must contain within that document a notice provision stating that the property "has been listed on the state's hazardous site inventory and has been designated as needing corrective action due to presence of hazardous waste, hazardous constituents or hazardous substances regulated under state law." Such a notation becomes a permanent part of the chain of title for that property. A number of other states also have statutes which impose "transaction triggered" obligations, including requirements that a certain level of cleanup be accomplished on contaminated property before transfer of that property may occur. In acquiring contaminated properties, the potential purchaser must be sensitive to such transaction-based obligations which may accompany acquisition of a contaminated property.

Another issue of importance related to the legal framework of environmental laws is the distinction which has been carved out for petroleum based contamination. Due in part to extensive and effective lobbying by the oil industry, contamination originating from petroleum based releases (gasoline, diesel fuel, etc.) is specifically excluded from the CERCLA regulatory framework. Regulation of these contaminants is generally confined to the RCRA section dealing with underground storage tanks and the various state statutes and regulations corresponding to that section. These provisions generally impose cleanup obligations on the "owners or operators of the underground storage tank system" from which the contamination occurred. In many instances, the applicable cleanup standards are less stringent than those required under statutes dealing with other hazardous substances. The "petroleum products" distinction also is significant where a potential purchaser is concerned with the transaction imposed obligations described above. Since petroleum products are excluded from CERCLA and most of the parallel programs, these transaction based obligations (such as the deed notice, the hazardous sites inventory, etc.) do not apply.

Finally, the potential purchaser of contaminated property must be aware of possible liability, under general state law principles, to neighboring landowners or other third parties who claim an adverse impact from the contamination at the subject property. This may include potential exposure to claims ranging from property damage, on the one hand, to personal injuries and illness resulting from exposure to the site contamination.

Some positive response has been forthcoming at the federal level in an effort to reduce the uncertainty associated with the environmental regulatory framework. One example is the effort of the EPA, involving a cooperative undertaking among attorneys, accountants and financial institutions, to develop a lender liability rule which details with specificity the activities a lender may undertake without being liable for contamination discovered on its borrower's collateral. This effort, a response to a United States Court of Appeals decision which suggested a wide ranging set of circumstances in which a lender could be held liable for contamination on its borrower's property, unfortunately has recently been struck down.

A second effort at the federal level to respond to this uncertainty is the "prospective purchaser agreement." These agreements represent the product of negotiations between the EPA and a potential purchaser of contaminated property whereby the EPA fixes, in advance of the purchaser acquiring the property, the purchaser's exposure to the EPA related to the existing contamination. This practice, in its early stages of implementation by the EPA, allows a purchaser at least to quantify its potential liability vis-à-vis the EPA.

III. Prepurchase Due Diligence

With the legal environmental framework described above as a backdrop, the first step in acquiring a environmentally contaminated property is to conduct the necessary prepurchase due diligence. That due diligence consists of the following steps:
  1. Environmental due diligence;
  2. Legal due diligence;
  3. Market value assessment/use impact.

1. Environmental Due Diligence

The initial step in any acquisition of a contaminated or potentially contaminated property is the environmental site assessment. This is the case whether the prospective purchaser has specifically identified environmentally contaminated properties as its target or whether the prospective purchaser learned after site selection that the particular property he seeks to acquire is in fact contaminated.

For the last several years, the principal objective in conducting an environmental site assessment of commercial properties frequently was to accomplish the minimum necessary due diligence necessary to qualify the purchaser for the "innocent purchaser" defense. As long as he felt he had performed the minimal due diligence necessary to attain innocent purchaser status, the potential purchaser would prefer not to discover contamination existing on the property, since it might "kill the deal," particularly, the financing associated with the transaction. While the merit of this approach could be debated, it nonetheless represented the prevailing attitude for an extended period.

As environmental laws have developed and matured, this approach, whatever is previous merit, is now clearly obsolete. With the advent of various transaction restrictions which exist without regard to innocent purchaser status, and the practical and legal difficulty in qualifying as an "innocent purchaser" the focus of an environmental assessment should now be solely to determine whether contamination exists on the property.

In this regard, the environmental engineer should engage in a comprehensive review of the property. Decision regarding location and extent of testing should occur in close consultation with the purchaser's environmental legal counsel and should take into account site conditions and regulatory issues within that jurisdiction. The assessment should consist of both subsurface (soil and groundwater) and surface investigation.

One arrangement recommended for the commercial real estate investor and developer is the retention of an experienced, knowledgeable, environmental consultant, separate and apart from the engineer performing the site assessment, to perform peer review services of the work proposed by and performed by the engineer. Though the use of generally acknowledged standards (such as those adopted by the American Society of Testing and Materials, or "ASTM Standards") on a widespread basis has now become quite common, the quality of services performed by environmental engineers can very significantly. Having a separate single environmental consultant involved from the initial stages of evaluation in order to review, supervise and, under the purchaser's authority, direct the engineer's activities can prove invaluable. Though admittedly this involves some degree of duplication of effort and expenses, in the long run, overall expenses are likely to be reduced and results enhanced. Thoughtful selection of strategic soil boring and groundwater well locations at a site versus the unfortunate but common "swiss cheese" assessment approach is a prime example of the benefits derived from this type of arrangement. Since the vast majority of environmental assessment costs are devoted to drilling, sampling, laboratory analysis and report preparation activities, the small additional investment in the hourly services of a peer review consultant to oversee these services almost universally results in a savings which exceeds the investment. Moreover, the additional review maximizes the likelihood that contamination, if it exists, will be discovered, properly assessed and delineated.

If contamination is discovered during the course of the environmental assessment, the engineer's next responsibility is to identify all types of contaminants involved and to delineate, both vertically and horizontally, the scope of the contaminant plume. The engineer should also determine the source of the contaminant. Identification of the source and type of contaminant may have a dramatic impact upon overall liability and cleanup obligations and costs. If the contaminant discovered is lighter than water (for example, gasoline) and thus floats on top of the underground water table, it may allow for easier and less expensive remediation than "sinkers," such as drycleaning solvents which are heavier than water and sink through the underground water table downward toward bedrock. Similarly, the determination that the contaminant source originates offsite likely will result in a completely different analysis regarding potential legal exposure than a determination that the contamination originated from an onsite source. Correspondingly, a determination that the contaminant originates from an underground storage tank system or is the result of a petroleum based release likewise may dramatically alter which cleanup standards apply.

Once the type and extent of contamination is identified, as well as the potential source, the environmental engineer should next propose various preliminary options for remediation. Dramatic advances have occurred in techniques of remediation. Relatively new processes such as dual vacuum extraction and air sparging may allow for effective remediation of the soil and groundwater on the property without interference with the income generating operations of the property. The remediation options proposed by the environmental engineer should cover a range of alternatives, addressing not only overall costs, but also timetable for completion of the remediation and the level of cleanup to be attained. Frequently, a potential purchaser may discover that a more extended cleanup results in significantly lower remediation costs yet has no overall financial impact on the property since it does not interfere with operations. It is here that the services of the peer review environmental consultant again may prove invaluable. The consultant can review and comment upon the various remediation options and their respective viability.

One other issue should not be overlooked. Frequently unnoticed are the terms of the potential purchaser's relationship with the environmental engineer conducting the site assessment. These conditions are usually attached to the end of the proposal and are incorporated by reference. Often, these terms set forth a maximum exposure by the engineer from losses that occur as a result of the engineer's negligence (such as failure to discover contamination) in conducting the assessment. In some instances, the exposure is limited to the amount paid for the assessment, which may only be several thousand dollars. It is important to negotiate such limitations out of the consultant's contract, or at the very least negotiate larger limits of liability, when investigating potentially contaminated properties.

2. Legal Due Diligence

Once the type, extent and level of contamination has been determined by the environmental engineers and consultants, the next step should be an analysis of the legal consequences of that contamination. This will involve a number of considerations, including:
  1. The regulatory obligations imposed on the type of contamination discovered;
  2. Whether the contamination exceeds federal or state cleanup standards and whether the property would be subject to cleanup directive from a state or federal agency;
  3. Whether the contamination has migrated offsite and creates potential exposure to third parties; and
  4. Whether the type and level of contamination may result in public "inventory" issues or other restrictions on transfer or marketability.

In dealing with the above issues, it is frequently important to engage in prepurchase communications and negotiations with the appropriate regulators (whether state or federal). Such dialogue may provide a clear understanding regarding the likelihood and anticipated extent of enforcement action related to the property or remaining regulatory requirements. Also, the opportunity may exist for some form of prepurchase agreement or other arrangement with regulators whereby the liability of the potential purchaser is fixed. Discussions will frequently provide a clearer understanding of the remaining regulatory requirements. In the event an enforcement action may otherwise be treated as confidential, a specific waiver of these confidentiality provisions by the seller in order to permit direct dialogue with regulators is advised. To the extent that a potential purchaser may wish to participate, even as an observer, in ongoing negotiations between the site owner and regulators, the information gleaned from such participation will be very important in understanding the specific expectations of state regulators required to be fulfilled by the purchaser after closing. Participation in this negotiation process should also provide substantial assistance in quantifying the required procedures, timetable and, most importantly, costs involved. If the purchaser will be potentially liable for any of these long term costs, it is essential to factor this information into any price reduction negotiations. If third parties are impacted by contamination originating on the subject property, counsel for the prospective purchaser may wish to engage in a dialogue with these third parties and, through undertakings such as remediation agreements, similarly fix its potential liability as to these third parties.

Perhaps the most overlooked aspect of acquiring a contaminated property is the availability of legal recourse against the party causing the contamination. Take for example a situation where contamination has migrated onto the subject property from an offsite source. Claims exist against the party causing the contamination in favor of the owner of the subject property at the time the contamination occurred. The prospective purchaser should assess the value of these claims and the potential for recovery against the responsible party. As part of the acquisition of the property, the potential purchaser should ensure he acquires legal rights to all claims the seller has related to contamination on the property. Once armed with that assignment of claims, the purchaser may then bring an action against the party responsible for the contamination seeking to recover the damage caused to the property, including its impact both on cleanup and market value. One must be acutely aware in this context of potential statute of limitations issues. Frequently, such statutes of limitations bar otherwise valid claims for damage which have occurred more than a given number of years (often four or less) prior to assertion of the claim. Claims may be barred even if the damage (such as subsurface contamination) was not discovered until well within the limitations period. A purchaser must factor this consideration into the equation when evaluating how the viability of such claims affects the validity of the transaction.

The converse situation also should be considered. As with the party who acquires rights to a claim for contamination originating from an offsite source, the potential purchaser may also acquire liabilities if contamination originating on his property is impacting neighboring properties. These potential liabilities should be assessed, quantified and allocated as part of the risk allocation process. Obviously, indemnities may serve to reallocate this responsibility to some extent, assuming the indemnifying party is solvent and abides by the indemnity obligation if and when a claim is asserted.

3. Market Value Assessment/Use Impact

Once the prospective purchaser has completed the environmental and legal due diligence, he then is in a position to assess intelligently the legitimate impact of the contamination on the value of the property to him. The prospective purchaser must recognize this determination is still somewhat subjective. Historically, the mere existence of some form of environmental contamination creates a stigma for the property owner, particularly in the context of commercial property. In truth, most environmental laws were and still are intended to address significant industrial contamination. Unfortunately, an automatic but erroneous association with toxic dump sites and other industrial problems often accompanies the discovery of minor or moderate levels of contamination on commercial tracts.

Separating this "stigma" from the tangible impact on value is possible. If the required remediation system does not interfere with operations on the property, the impact on cash flow for an operating property should be negligible or non-existent. Obviously, this income stream is the principal asset the purchaser is acquiring. The purchaser also should assess the relationship between the contamination discovered and the use of the property. For example, a minor amount of petroleum based contamination on a facility which will be used as a gasoline station/convenience store has considerably less "stigma" associated with the contamination than significant solvent contamination discovered at a high end office complex. In this regard, the prospective purchaser should determine whether any permanent deed notations may be required or whether the property is or may soon be listed on an "inventory." If the answer is yes, then once again the overall impact on value will in part be determined by the type of commercial property involved.

An obvious factor in assessing the impact on market value is ascertaining the cost and scope of remediation. At a minimum, this involves the comprehensive site assessment described earlier, with some subsurface investigation. This is also the point in time to consider various alternatives for remediation and whether remediation options exist which would allow continued use of the property during the course of remediation.

It is also vital to identify ground water conditions at the site and whether significant potential for off-site migration exists. Where such off-site impact has occurred or is likely to occur, consideration must be given to potential for claims and litigation to be made against the prospective purchaser after acquisition of the site. Additionally, the costs associated with long term monitoring can be substantial and also impact the available future uses of the site. Such closure and post closure care under RCRA can last for as long as 30 years and accurate projection of these types of costs must be given careful consideration as a part of the overall financial impact of the contamination.

Whether the surrounding properties are similarly contaminated also impacts the market value. Detailed records database searches must also be a part of the investigative process. Often, valuable information concerning the site can be obtained from "hands on" records searches of regulatory files as well as interviews of surrounding property owners and employees.

The final variable in this equation is providing the necessary comfort to the lender so as to allow the transaction to proceed. Over the last several years, lenders have become much more sophisticated regarding contaminated properties and many no longer take a complete "hands-off" approach. On the other hand, any transaction involving contaminated properties will likely involve additional financing costs. Moreover, opinion letters may be required from prospective purchaser's counsel along with various indemnities from the prospective purchaser. It will be incumbent upon the prospective purchaser to educate the lender that the contamination does not pose any significant threat to the collateral or to the lender and to factor the resulting additional costs associated with the loan into the reduction in purchase price.

IV. Risk Allocation

The final element with regard to purchase of a contaminated property is allocation of risk and future liability associated with that property. That risk allocation may consist of one or more of several forms:
  1. Remediation agreement;
  2. Price reduction;
  3. Escrow agreements ; and
  4. Indemnity agreements.

This article will briefly address significant features of each of these risk allocation vehicles.

1. Remediation Agreements

Once the potential purchaser has completed its due diligence, that purchaser must then determine the type of remediation which will be accomplished (if remediation is deemed necessary) and allocate responsibility for that remediation. In most instances, the purchaser's interests are best served by allocating responsibility for the remediation to the seller. This shifts to the seller the risk associated with attaining the required level of cleanup, as well as responsibility for disposal of the contaminants removed from the site. This latter issue is not insignificant. Frequently, offsite disposal of byproducts of the remediation (including the contaminants removed from the property) involves waste manifests and other documentation which inserts the party arranging for disposal within an accountability framework at the disposal facility. For example, if hazardous substances disposed of at a permitted landfill subsequently leak into the environment, the party on that disposal manifest may be liable for a portion of the cleanup costs associated with that landfill. Moreover, if some accident should occur during transportation of the hazardous substance to the disposal facility, the "owner" of the contaminant similarly may be held liable for damages caused by the release of the contaminants.

Attachment A to this article is a sample of a comprehensive remediation agreement. In this agreement, the seller assumes ownership and possession of the property subject to the seller's continuing obligation to remediate the property. In this instance, remediation is expected to extend over several years. The attachment illustrates several important issues which should be addressed in any remediation agreement. The authors wish to caution the reader, however, that this sample agreement, and the others attached to this presentation are for illustrative purposes only and the reader is cautioned not to rely upon either these attached sample documents or the content of this text concerning actual substantive legal issues. Consultation with counsel of choice is recommended for individual advice on such specific issues.

The attached agreement sets forth a specific milestone schedule for undertaking and accomplishing the remediation activities at the site. Language such as a "reasonable period" should be avoided. Similarly, specific cleanup standards should be established (i.e., levels of benzene in groundwater should not exceed 71 parts per billion benzene, etc.) Such language as "such other standards as may be set by federal and/or state regulation" create patent ambiguities as to the specific cleanup requirements which are to be achieved by the remediating seller. The seller also should be obligated to obtain a "clean closure" letter or other certification from appropriate regulatory officials that cleanup acceptable to the appropriate regulatory body has been accomplished at the site.

As an incentive for prompt cleanup, it is prudent to insert a liquidated damages provision providing specified monetary penalties, such as lost rental value, for any significant delays in the remediation schedule. The purchaser should also receive periodic reports and test data regarding the progress of cleanup and copies of any reports submitted to environmental authorities. Provisions for enhancing cleanup activities should be imposed upon the seller so that such enhanced activities must take place if during remediation it becomes apparent cleanup is not progressing in accordance with the milestone schedule.

A clear understanding of the operational aspects of the remediation system should be reached and incorporated into the agreement. Obviously, defined operating schedules which avoid interference with business activities to be conducted at the site by the purchaser are important. Requirements for notice to and permission by the purchaser for the installation of additional remediation equipment and/or borings is also advisable and should be specifically set forth in the agreement. Restoration of the property to specified standards, including closure of all monitor wells, as directed by the purchaser, should be included. In some cases, the purchaser may wish to retain certain monitoring wells as an easy means to provide continued information concerning the environmental condition of the site. This may be particularly significant if and when the purchaser wishes to sell or refinance the property, as information regarding the environmental condition of the property at that time certainly will be required by the lender or new prospective purchaser.

Prepurchase agreements where the seller and purchaser jointly share responsibility and costs for environmental assessment and remediation are also common. Attached as Attachment B is one example of such an agreement involving the purchase of a light manufacturing facility. Pursuant to this agreement, the responsibility to select and pay the costs of initial assessment and, if necessary, subsequent assessments, is jointly allocated. On a theory that initial environmental costs are typically a buyer's responsibility, the provision in the attached agreement weights the costs of that phase more heavily in favor of the purchaser, with responsibility for the costs of subsequent assessments shifting to the seller as more investigation is required. This can be justified during negotiation on the grounds that the need to further assess and remediate any detected contamination is attributed to spills or releases caused during the seller's operations at the site. It is only logical that the seller assume responsibility for any additional assessment and remediation costs for contamination site it has caused during the past operations. Based on this reasoning, costs of any corrective action are to be 100% the seller's responsibility.

Large oil or chemical companies regularly involved in the purchase and sale of contaminated properties often employ standard form agreements which they attempt to impose upon compliant purchasers on a "take it or leave it" basis. One example of such a standard form agreement for the sale by a major oil company of a contaminated former service station site is attached as Attachment C. Requirements for the seller to conduct only such additional assessments as "seller deems necessary" or to avoid "to the extent practicable" interference with purchaser's business activities are just two illustrations of the many one-sided provisions which should be renegotiated by the purchaser out of the agreement.

Federal or state trust funds may provide an avenue for recovery of remediation costs. As noted earlier, most states have enacted some form of underground storage tank (UST) regulatory scheme. A common feature in this scheme includes creation of some form of trust fund to provide for reimbursement of costs to remediate petroleum based contamination resulting from UST releases. Funded typically by various fees on the petroleum industry itself, these various trust state funds provide some measure of financial resources to the owners of gas stations and adjacent facilities affected by underground petroleum releases to soils and groundwater. Prospective purchasers may acquire the right to make a claim against such funds for covered properties or reach an agreement with the seller that he will accomplish the cleanup using monies obtained from the fund. These trust funds typically work in one of two ways: (i) reimbursement of approved remediation activities or (ii) cleanup by state selected contractors paid from the fund. While inadequate staffing, bureaucratic problems and strained trust fund resources often make complete reliance on this remedy unsatisfactory, it does provide one source of funding for remediation activities.

States have begun to apply this trust fund framework to industries in addition to gasoline stations. A prime example is the drycleaning industry, which has through nationwide efforts begun and, in some cases, succeeded with attempts to pass state based legislation providing trust funds for cleanup of the solvent based contamination associated with drycleaning operations.

2. Price Reduction

Price reduction is obviously the simplest mechanism for the allocation of legal and financial risks associated with the purchase of an environmentally contaminated site. The amount of reduction functions as the "fund" available for use by the purchaser for remediation and to satisfy claims by third parties and/or accounts for the impact on market value created by the environmental stigma. The purchaser assumes the risk that cleanup can be accomplished for less than the amount of the reduction of the purchase. If that is the case, and no claims are asserted by third parties, the prospective purchaser has obtained a windfall. If the prospective purchaser is dealing from a position of greater knowledge, and is comfortable that cleanup can be accomplished for much less than the reduction the seller is willing to accept in the purchase price, then this is an attractive alternative. This is also a preferable alternative where establishment of a formal escrow arrangement with a seller is, for various reasons, not practical.

It is at this point that purchaser should take full advantage of market value "stigma." A seller unsophisticated in this area, concluding that the impact on market value and exposure to third parties is overwhelming, may attempt to dispose of the property via a fire sale. The purchaser is in a position to point to limited financing options, the reduced universe of purchasers and the potential liability associated with acquiring the property in an effort to further drive the price down.

One additional factor involves the financing of the proposed transaction. It is desirable to use a lender experienced not just with the type of property involved, but one who also has a comfort level with the type of environmental contamination at issue. It would obviously be unwise to invest considerable time and resources into the evaluation of a potential purchase only to discover that the proposed lender on the transaction, through inexperience or ignorance of the impact of the particular environmental problem, determines that it will not go forward with the transaction. Moreover, as noted earlier, the contamination may result in increased effective financing costs (whether through higher rates, reduced term, requirement of other additional collateral, etc.). These factors must be considered in the price reduction.

By way of illustration of this technique, several fast food chains on a regular basis purchase abandoned or closed gasoline stations and convert them into fast food restaurants. These fast food operations are frequently able to negotiate price reductions in the range of 25% to 40% below market value while at the same time obtaining parcels at high traffic intersections which act as a tremendous complement to their intended use of the property. Since the contamination is subsurface, it does not affect the operations to be conducted on the property. Assuming the cleanup can be accomplished at a relatively minor cost (which frequently the seller will bear), the fast food operation has acquired the property at an attractive price yet with little or no adverse impact from the contamination on the purchaser's economic interest.

3. Escrow Agreements

Like price reductions, escrow agreements involve efforts to specifically quantify the cost of environmental assessment and clean-up. The advantage of escrow agreements lies in the predictability that a specific sum of money has already been reserved and will theoretically be readily available to cover costs or liability associated with the contamination. Presumably, the seller will be willing to escrow a sum larger than he would accept via a price reduction, since the possibility exists that some of the escrowed funds may not be used and thus will be returned. Funding by the seller of an environmental escrow agreement also permits the prospective purchaser to have a measure of control and security with respect to the required post acquisition environmental activities at the site. An example of an escrow agreement the authors have previously negotiated is attached hereto as Attachment D.

The attached agreement provides for a seller funded escrow account to remediate contamination suspected to be originating from a nearby, but unidentified offsite source and migrating onto the acquired site. Coverage from the fund is also to include costs for assessment, quantification, remediation and monitoring of the detected contamination at the acquired site, including the necessity to conduct related communications and negotiations with regulatory officials. Also included in the coverage of the escrow fund are any potential costs to the purchaser resulting from civil claims which may be brought within 2 years of the acquisition by downgradient property owners affected by continued migration of the contaminate plume from across the acquired site. The duration of any such agreement should be tied to the applicable statute of limitations within that jurisdiction. Disbursement procedures for escrow funds are tailored to specific circumstances. The purchaser should limit as much as possible the notice and objection provisions which allow the seller to contest disputed requests for disbursement.

4. Indemnity Agreements

Probably the most common forms of risk allocation in any transaction is the indemnity. A copy of an indemnity agreement used in connection with purchase of a contaminated site is attached hereto as Attachment E.

The obvious advantage of an indemnity agreement from the purchaser's perspective is that the seller's liability is not limited. In a reduction of purchase price or an escrow agreement, the seller's liability is capped, such that if costs or claims associated with the contamination exceed the discounted purchase price or the escrowed amount, the purchaser then bears the remaining loss. With an indemnity, that risk is avoided. Another advantage is that frequently an indemnity from a solvent and substantial seller will provide some level of comfort to a lender, particularly if that indemnity also runs in favor of the lender. Therefore, the existence of such indemnities frequently allows for financing of transactions which might otherwise fail.

There are several disadvantages. First, the purchaser loses the ability to obtain a windfall based upon superior knowledge. As noted earlier, the purchaser may have determined through his expertise in the area and the advice of his consultants that he has no effective liability to third parties and that he can accomplish cleanup for $100,000. At the same time, based on the contamination, he has been able to negotiate a reduction of the purchase price of $200,000. As a result of his superior knowledge, he therefore has obtained a windfall of $100,000. The indemnity precludes that opportunity. The second disadvantage of the indemnity is that, since it is based on the resources of the indemnifying party, it is only as good as the net worth of that indemnifying party, which may change dramatically during the term of the indemnity. A third disadvantage is that the indemnity is like any other contract. If the party chooses not to honor that indemnity, the only way to obtain satisfaction is through judicial efforts to enforce the indemnity. Moreover, disputes frequently arise as to whether the loss for which recovery is sought qualifies as an indemnified event. For example, the indemnifying party may subsequently raise as a defense that the loss suffered was the result of contamination occurring after the sale, etc. Moreover, the indemnified party may not have the financial resources to sustain the loss suffered until recovery can be obtained from the indemnifying party.

All of these issues factor into the equation of whether to accept an indemnity in lieu of some of the other risk allocation methods described above. Should an indemnity be negotiated as part of the transaction, whether in lieu of or in addition to other risk allocation procedures, there are several important issues to include. Initially, the indemnification should be as broad as possible and apply to all contaminants on the property to be purchased. Limiting indemnification only to contamination which occurred during the seller's occupancy of the property may ultimately result in a dispute over whether the loss or damage occurred as result of contamination preexisting the seller's occupancy. Similarly, the indemnity should not be limited to losses or claims related only to contaminants which were discovered during the pre-purchase investigation phase. Any contaminants subsequently discovered which predated the indemnity should be covered by the indemnification. All reasonably anticipated costs should be included as "indemnified matters," including costs related to additional assessments, remediation and disposal, legal and consultant costs, lost market value, investigative costs as well as all potential claims to which the purchaser is subjected. Additionally, the agreement should provide for prompt arbitration of any disputes arising out of the indemnification agreement with costs and fees to be awarded to the prevailing party. If a time limit to the indemnity obligation is demanded by the seller, the purchaser should extend the length of coverage of the agreement for as long as possible and in any event beyond the expiration of any potentially applicable statute of limitations.

On occasions, the tables may be reversed. In some circumstances an indemnification of the seller may be demanded by the seller as a condition to transfer of the property. This frequently occurs when the property is owned by a lender which acquired the property through foreclosure or where the property is part of a portfolio held by government regulatory bodies, such as the FDIC. These agreements are generally required in exchange for a significant reduction of the purchase price for the site. An example of such an agreement is attached hereto as Attachment F.

V. Conclusion

Significant opportunities continue to exist in today's commercial real estate market for the purchase of environmentally contaminated properties at a price substantially below the real impact of the contamination on the property's value. The key aspect to taking advantage of the opportunities presented by environmentally contaminated properties is conducting the appropriate due diligence in order to quantify the risks and impediments associated with the contamination. Once that due diligence is complete, the purchaser is able to use a combination of the risk allocation devices described above to reduce or eliminate the risks associated with the contamination while obtaining the property at a reduced price.

 

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