Common Shortcuts in Environmental Due Diligence

People all too often take shortcuts in Environmental Due Diligence (EDD) because they often want or feel they need to close deals as fast as possible and are therefore commonly only interested in meeting a lender’s minimum requirements. To accomplish the goal of quickly closing the transaction, stakeholders often try to guide EDD to their predetermined outcome of minimizing or incompletely defining environmental conditions.

The problem is… simply meeting a lender’s minimum EDD requirements does NOT ensure protection from federal and state environmental cleanup liability. We have observed that a great number of property owners who fail to conduct full EDD consequently have significant issues when subsequently selling their property. Consider that future purchasers of the property will likely conduct their own EDD and may find contamination, if it exits, that was not detected previously. In such cases, conducting the minimum EDD will have a significant negative impact on the future sale price or sale terms for the property or business. Further, discovering such issues may commonly delay or negate other business opportunities or the retirement plans of the seller.

These are some of the common shortcuts we see taken:

• Not conducting any EDD and using seller financing
• Skipping one or more of the steps in the EPA’s mandated due diligence process, most notably not addressing RECs
• Using a consultant who prejudices the outcome toward a “clean” Phase I ESA
• Completing a Transaction Screen instead of a Phase I ESA
• Using a Phase I ESA that is more than 1 year old

Each step in the EDD process dictates or guides what, if any, further steps may be required to obtain liability protection or lending approval. If all steps are required, the full EDD process consists of a Phase I ESA, a Phase II ESA (sampling), a Baseline Environmental Assessment (BEA) and a Due Care Plan. If no recognized environmental conditions (RECs) are identified in the Phase I ESA, no further investigation is required. For more detail on the EDD process flow, call or email us for a copy of BLDI’s EDD Q&A and flowchart.

Understanding the Risks & Complications

1 - Purchaser’s risk of over-paying for a risky asset.

When you take shortcuts in, or ignore the EDD process, the purchaser is at risk of over-paying for an asset that may present a liability due to contaminated soil or groundwater. Knowledge of the presence of contaminated soil or groundwater is especially important for properties that use groundwater for drinking, production use or for property development whereby soil must be moved.

2 - Seller’s risk of under-valuing their property.

The seller needs to be assured that their asset is not discounted based upon limited information and fear of a possible environmental liability. The seller may have a perception, or fear, of the worst case. The fact is that although some properties in industrial areas may be impacted by a contaminant, the impact feared by the seller may not have any relationship to their property or operation.

3 - Purchaser’s risk of NOT being able to sell the property in the future.

The purchaser many times does not consider that deal structure, including skipping the full EDD process, may impact future property transactions. The purchaser should consider that the structure of a particular transaction will actually dictate, to a great degree, the value of their property or business in a future transaction. Unless the purchaser conducts full EDD, how can he know where this property fits in the continuum of environmentally distressed properties?

In today’s more stringent lending environment, it is more likely that not only will the full EDD be required by a lender, but that “high quality” EDD documentation will also be required and will likely be reviewed by an outside party, e.g., an attorney for the lender or the bank’s environmental risk management staff. One should also consider that although the lender may not require the completion of a full, complete EDD process, a future lender, or the same lender upon a loan renewal, may require further EDD. An incomplete EDD can delay needed business funding (e.g. short-term cash) or decisions due to inadequate information and fear. Remember, that the outcome of each step in the EDD process can affect both the current and future transaction. This means that if issues e.g. recognized environmental conditions (RECs) are identified, cost sharing for the remaining steps in the EDD process may often be negotiated. Further, it is not uncommon that the outcome of the EDD process can affect the final sale terms or price of the property or business.

4 - Purchaser’s risk of NOT getting liability protection.

Remember, you must complete all of the steps in the EDD process when you purchase the property; otherwise there is NO liability protection at the federal or state level. Do NOT assume someone else’s liability just because it financially may be a “good” purchase. However, with sufficient information to understand the cost of assuming this liability, one can make an “informed” business decision provided the purchaser does not need to borrow funds.

Real World Example:

A lender client retained BLDI to conduct EDD on a parcel they planned to purchase and develop. The parcel was listed on a State environmental list of contaminated sites (Part 201). The client did not wish to conduct “all that stuff” (EDD) as the seller said it was not necessary. Discussions with the client, their legal counsel, and BLDI laid out a scope of work which utilized historical investigation data as well as new data developed by BLDI. Due to the overall risk aversion of the client, at least after understanding all of the risks as explained by their attorney, they chose to have both the Baseline Environmental Assessment (BEA) and Section 7a (Due Care Plan) submitted for determination by MDEQ. BLDI met with the contractor for the new building several times to incorporate their construction program into the BEA and Due Care (Section 7a) documents being submitted to MDEQ. MDEQ affirmed both the BEA and Section 7a.

Fast forward four years and this client (a lender) is now being purchased by another lender. The full EDD package developed by BLDI was simply handed to the purchasing bank who indicated that this package made their EDD review very simple and straight forward to approve and move the transaction forward. If this full EDD process, including the affirmed BEA and Section 7a, had not been completed, the purchaser indicated that the transaction would likely have been delayed, if not rejected, to the detriment of all parties. Skipping the new Phase II ESA step by the buyer, as recommended by the seller, would not have resulted in the MDEQ affirming the BEA or Section 7a, and possibly having an EDD of questionable value. Conducting the complete EDD at the time of purchase likely saved thousands in legal fees simply to assess and determine the site status relative to EDD upon the sale of the business.

Takeaway Point

Don’t take shortcuts when it comes to Environmental Due Diligence. A complete and thorough job will ensure liability protection to avoid problems in future transactions and help assure that environmental conditions are properly valued in the transaction.

More Information

Request a copy of BLDI’s EDD Q&A and Flowchart. It provides an illustration of EDD flow and explains the general content of each step of the EDD process.