February 2004

By now, developers and investors in real property are aware of the potential risks and costs that environmental liabilities pose to a transaction. Investigation of potential environmental concerns is now a standard part of the due diligence process for prospective purchasers of all but the most pristine tracts. The most widely recognized guideline for conducting such an investigation is the so-called "ASTM Standard," set forth by the American Society for Testing and Materials ("ASTM") in the "Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process, E 1527-97." Phase I reports adhering to the ASTM Standard are routinely relied upon by developers and lenders involved in real estate transactions.

Despite the general acceptance of the ASTM Standard, new due diligence guidelines are being developed in response to recent federal legislation and rulemaking. The intent of these laws and regulations is to spur redevelopment of contaminated properties by providing purchasers with greater certainty regarding appropriate due diligence standards. However, the proposed standards have already raised a number of questions and objections from interested parties and commentators. As the draft standards continue to evolve, it remains to be seen whether these potential conflicts can be worked out in a manner that encourages redevelopment of contaminated properties.

One of the chief impediments to redevelopment of real property is the federal Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA," also known as "Superfund"). By imposing strict liability on owners of contaminated property, CERCLA poses a major roadblock to any developer contemplating the purchase of land on which hazardous substances may have been used or disposed. Moreover, the uncertain definitions of the few statutory defenses to liability provide little security to prospective purchasers of potentially contaminated land.

In an effort to alleviate these uncertainties and reduce the risks of redevelopment, Congress amended CERCLA to clarify certain defenses, including those for innocent landowners, bona fide prospective purchasers and contiguous property owners. To take advantage of any of these defenses, a property owner must demonstrate that he or she "had no reason to know of" the contamination after conducting "all appropriate inquiries . . . into the previous ownership and uses of the facility in accordance with generally accepted good commercial and customary standards and practices." To date, no federal statute or regulation defines the critical term "all appropriate inquiries."

The federal legislature attempted to resolve this omission in the "Small Business Liability Relief and Brownfields Revitalization Act," signed into law on January 11, 2002. This Act sets forth general guidance on the definition of "all appropriate inquiries." Further, the Act requires the United States Environmental Protection Agency ("USEPA") to promulgate regulations establishing standards for what constitutes "all appropriate inquiry." Until the new regulations are enacted, the Act establishes the ASTM Standard as the interim guideline.

TIn response to the 2002 legislation, USEPA convened the "All Appropriate Inquiry Negotiating Rulemaking Committee." Composed of interested stakeholders, the Committee was charged with drafting language for the proposed regulations. In December 2003, the Committee issued the negotiated proposed regulations in a "Final Consensus Document." USEPA is in the process of completing administrative review of the Consensus Document. After the review is completed, USEPA is expected to publish the proposed regulations for public comments sometime around June 2004.

The Consensus Document generally takes a similar approach to the ASTM Standard; however, there are certain differences that have already raised concern from the environmental community. In some instances, the Consensus Document has a stricter standard or requires more research than the ASTM Standard; on other points, it is more permissive. For example, the Consensus Document is more specific than the ASTM Standard in establishing the qualifications of an "environmental professional" authorized to conduct an "all appropriate inquiry" investigation. On the flip side, the draft regulation requires only that an environmental professional supervise many aspects of the investigation, allowing the inquiry to be conducted largely by non-professional staff. This provision and other inconsistencies have led to critics arguing that the proposed standards are both unnecessarily restrictive and too lenient.

Another major concern is that the Consensus Document does not cover petroleum products. Although this omission is consistent with the scope of CERCLA, which excludes petroleum products, it creates a major inconsistency with the ASTM Standard. In fact, petroleum contamination is the most commonly encountered environmental hazard, and can present major risks and liabilities in spite of its exclusion from CERCLA. The proposed federal standard therefore appears to have a massive gap in its scope of what constitutes reasonable due diligence. Environmental organizations are concerned that this omission and other ambiguous language in the Consensus Document will lead to environmental investigations that are less reliable and less protective of environmental resources than the ASTM Standard.

The Consensus Document continues to be scrutinized by the USEPA and stakeholders seeking to correct these weaknesses before the agency promulgates the final regulations. Among other interested parties, ASTM is reviewing the Consensus Document against its own standards to determine if they can be harmonized. The public comment process will provide a further opportunity for ASTM and other leading experts in the field of environmental assessment to influence the federal due diligence guidelines.

Despite the broad consensus approach taken by USEPA's negotiating committee, significant criticisms have already been leveled against the proposed "all appropriate inquiry" standards. It is likely that the draft standards will be modified to respond to those concerns as they evolve into final regulations. Given the sheer number of real property transactions potentially impacted by these guidelines, it is critical that the USEPA ultimately adopt due diligence standards, which can be relied upon confidently by real estate professionals, environmental consultants and lenders. If the agency succeeds, the new "all appropriate inquiry" regulations will finally give some teeth to CERCLA's statutory defenses. The increased strength and availability of these defenses should in turn create new and better opportunities for redevelopment of contaminated properties.

If you have any questions regarding this bulletin, please contact Barry MacNaughton, Esq., at 310.281.6342 or bmacnaughton@ecjlaw.com. If you would like to be a part of the Real Estate Reporter mailing list or if you would like to receive copies electronically, please contact Cynthia S. Kaiser at 310.281.6328 or ckaiser@ecjlaw.com.

Real Estate Reporter

New Due Diligence: Developing Federal Regulations Will Establish New Standards For Avoiding Cercla Liability