Published October 2008 – By Joseph W. Berlin, PE, CFE

Takeaway Point:

Given the tight credit market, seller financing is becoming the primary means for gas station sales. And in seller-financed deals, it is common for environmental conditions – such as contamination and unresolved releases – to be ignored. This can come back to haunt the purchaser and the seller as it can complicate the current and future transactions.

Contents of this BLDI Briefing:

• The trend towards seller-financed gas station transactions.
• How incomplete Environmental Due Diligence affects deals.
• How to achieve a positive financial outcome. Our top insights and recommendations.
• Real World Case Study.

The trend towards seller-financed gas station transactions:

As of Spring 2008, the Small Business Administration (SBA) has stopped lending on gas stations and most other lenders have followed suit. In fact, a recent BLDI survey of nine Michigan-based lenders found that none of these lenders would lend on any older gas station. Only one lender was receptive to lending, but only for relatively new stations built within the last two to three years.

The lack of active commercial lending for gas station/C-stores is driving seller financing to become the primary means for gas station sales. This briefing offers insights on environmental due diligence as it relates to seller-financed gas station deals.

How incomplete Environmental Due Diligence (EDD) affects seller-financed gas station deals:

Incomplete Environmental Due Diligence (EDD) may not only complicate the current transaction, but also future transactions. Further, the implications of incomplete EDD on gas stations can dictate whether the transaction has a positive financial outcome.

It is common for environmental conditions – such as contamination and unresolved releases – to be ignored in seller-financed deals. This can come back to haunt the purchaser and the seller as it can complicate both the current transaction as well as future transactions.

• It is common that the value of the business is negatively affected by up to 50% for detrimental environmental conditions.
• If the purchaser does not perform complete EDD, any environmental problems on the property become a liability to the purchaser.
• At payoff of the land contract, bank financing will most likely be difficult because the lender will require a more complete environmental assessment.

How to achieve a positive financial outcome. Our top insights and recommendations for gas station buyers and sellers.

1.) Follow the standard linear due diligence process for all seller-financed deals.

EDD on gas stations can dictate whether buy/sell transaction(s) has a positive financial outcome. For every gas station transaction, one should follow a standard linear process including a Phase I Environmental Site Assessment (Phase I ESA), a Phase II Environmental Site Assessment (Phase II ESA), and a Baseline Environmental Assessment (BEA), if necessary.

Phase I Environmental Site Assessment (ESA):

• The Phase I ESA will almost always identify underground storage tanks (USTs) as a Recognized Environmental Condition (REC) to be further investigated.
• To resolve RECs, additional investigation in the form of a Phase II ESA is conducted.

Phase II Environmental Site Assessment (ESA):

• The Phase II ESA will involve the use of drilling methods to collect soil and groundwater samples. The samples are submitted to a laboratory for analysis to identify if the soil or groundwater has been impacted by petroleum constituents.
• Phase II ESAs for gas stations tend to focus on areas of current system operations, including USTs, fill piping and dispensers, or past UST system locations.
• We cannot stress enough that only experienced professionals should be allowed to drill near USTs and underground piping. We have seen inexperienced professionals damage UST components, make inappropriate agency, lender or insurer contacts, and cause seller/purchaser stress great enough to make the deal collapse.
• The Phase II ESA tends to be much more rigorous on gas station sites. Often releases are discovered and require a notification be issued to the Michigan Department of Environmental Quality (MDEQ) within 24 hours.

2.) Ensure liability protection with a Baseline Environmental Assessment (BEA).

For a lender, a key to financing a gas station is full EDD and liability protection for both the purchaser and lender. Since it is common that the Phase II ESA will document contamination requiring cleanup, the ability to conduct a BEA for liability protection is very important, especially from the lender perspective. Since the new purchaser will utilize the same chemicals as were released to the environment, a Category “S” BEA (same chemical use) is required. However, conducting a Category “S” BEA for a site with a single-walled UST system is not consistent with current MDEQ guidance. Although MDEQ guidance does provide the ability to conduct adequate site characterization to segregate old versus new contamination, the means to conduct such work is very complex and expensive with no guarantee of MDEQ concurrence. That reason is why so many sites with older, single-walled UST systems try to utilize seller financing.

Alternately, EDD on gas stations with double-walled UST systems can be relatively simple. If the UST system is entirely double-walled, the concrete is in good condition, the UST system monitors are in good operation and the system has been adequately maintained, the EDD can be relatively minor. It is possible that only a tank and line tightness test would be needed. In this case, even if contamination is found, the system component(s) can be identified and repaired, the system brought back into service, and a BEA conducted to provide liability protection for the purchaser.

3.) Use insurance products to mitigate risk.

The use of insurance products can help mitigate purchaser environmental risk and help seller financing. For the best financial results for the seller and purchaser, the EDD needs to be completed in support of the sales agreement developed by an attorney very familiar with these types of deals. In such cases, the environmental risk is quantified and allocated.

4.) Retain a team of experts that have specific experience dealing with gas station acquisitions and environmental issues.

The right team for these types of deals is one that is knowledgeable and experienced in gas station deals. We recommend that the right team for the EDD process consist of:

• Legal Counsel: Good environmental counsel will develop a sales agreement that incorporates, and likely unwinds, past transaction requirements. The new agreement will need to assess the seller/buyer relationship and risk mitigation.
• Engineer/Consultant: Good environmental engineering firms will integrate their knowledge, site conditions, and EDD processes to support not only liability protection, but also the sales process and agreement.
• Lender: Even in the best of times there are a limited number of lenders willing to lend on gas stations. However, experienced lenders can lend on all manner of gas stations so long as the team works together.
• Seller/Buyer: Both parties need to acknowledge the complexities, especially environmental, and be flexible in deal structure and timing.

Real-World Case Study:

In 2007, one of BLDI’s clients wanted to sell their gas station. They had purchased the station in 2002 on a land contract deal and because there was not an outside lender involved, EDD had not been completed, although the client did complete a Phase I ESA.

The new purchaser wanted bank financing for the purchase but the banks required full EDD including a Phase I and II ESA and a BEA. During the initial EDD soil sampling, contamination was found to be present. It was also determined that the existing 40 year-old, single-walled underground storage tank (UST) systems had to be removed because it was also documented that the contamination was from the USTs.

As a result of these findings, the seller (client) had to drop the sale price and terms had to be renegotiated. The client lost 40% of the price he originally paid for the station in 2002. BLDI and the environmental attorney were able to minimize the losses by helping the client get a successful claim on the UST insurance policy, which covered much of the cost of the required cleanup.

This case study underscores the point that one cannot ignore the EDD process in any gas station transaction. It will likely come back to haunt you in the future. In this case, our client would have been able to negotiate a much higher price if they had conducted proper EDD when they first purchased the station.

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