Bankruptcy Courts Rules Bank May Not Seek Cost Recovery for Contaminated Site Purchased in Auction Sale

November 27th, 2014

Pete Seeger’s popular song from the 1960s “Where have all the Flowers Gone?” has the haunting recurring lyrics “When will they ever learn”. This song came to mind when we came across another case of a bank taking title to contaminated property without doing any environmental due diligence.

In this case, Suburban Bank and Trust SBT-BB, LLC (SBT”) extended a $4MM loan Boston Blackies Properties IV, LLC (“Boston Blackies”) in October 2006 that was secured by a mortgage on the property located on East Grand Avenue in the Streeterville section of Chicago. Unfortunately, the gourmet hamburger chain embarked on an aggressive expansion plan that was derailed by the Great Recession and had to file for bankruptcy in 2009. (The owners of the chain apparently also had some ethical issues.

SBT foreclosed on the Property in March 2011. SBT did not perform a new phase 1 before taking title and included the October 2006 phase 1 in the Bidder’s Information Package when the property was put up for auction in April 2011. Standard Bank (Standard), the successful bidder also did not conduct a phase 1 report before submitting its bid.

Standard planned to demolish the existing building and construct a new branch office. However, when Standard applied for a building permit, it learned that the property was within the Lindsay Light Streeterville Thorium Monitoring Area (a/k/a as the Moratorium Area) because of the presence of radioactive fill material associated with the former Lindsay Light Chemical Company (“Lindsay Light). Applicants planning to excavate or disturb soils for properties within the Moratorium Area are required to perform soil testing, conduct certain radioactive monitoring and comply with other work practices. Applications for permits which involve work in the Moratorium Area will be held in the City Permit System until the applicant meets with the Department of Public Health (CDPH) and agrees to implement the health and safety work plan that has been established for the Moratorium Area.   Standard performed the required screening and learned the site was contaminated with thorium contamination.

During the early 1900s, Lindsay Light manufactured gas mantles containing radioactive thorium at three locations in an area in downtown Chicago including a location across the street from the restaurant location that Standard purchased. The process of gas mantle manufacturing involves dipping gauze mantle bags into solutions containing thorium nitrate and small amounts of cerium, beryllium and magnesium nitrates. The mesh bags were then placed inside the glass globe of a light fixture.  When heated by the gas flame, the fabric would burn off and the metal mesh would glow.

The thorium processing refining process produced a sand-like waste known as thorium mill tailings, which were used for fill for development projects in the low-lying areas including in utility installations in City-owned street and sidewalk rights-of-way throughout the  Streeterville AreaIn the 1990′s, EPA excavated approximately 40,000 tons of radioactive thorium-contaminated soils that were discovered during property development and utilities installation and maintenance. In 2000, EPA created the Moratorium Area as a form of institutional control in and around Streeterville to impose restrictions and conditions on excavation to limit exposure to the thorium problems created by Lindsay Light plants. 

Six months after learning of the thorium-contaminated soil, Standard retained a law firm to preparing a claim against Tronox, the successor to Lindsay Light. Tronox had itself filed for bankruptcy and a plan for reorganization had that was confirmed in February 2011. The confirmation order established the Tronox Incorporated Tort Claims Trust Agreement (the “Tort Claims Trust”) that assumed the liabilities for all tort claims of Tronox and was to pay holders of allowed tort claims. Because the bar date for filing proofs of claim in the Tronox bankruptcy had been August 12, 2009, Standard filed a motion for leave to file a late claim of approximately $1.5MM. Standard hoped it could be reimbursed by the Tort Claims Trust.

Standard Bank asserted that its failure to file a timely claim was the result of “excusable neglect” because it had no notice from Tronox and acted within a reasonable time. However, in In re: Tronox Incorporated, 2014 Bankr. LEXIS 4678 (Bankr. S.D.N.Y. 11/7/14), the bankruptcy court found that Standard Bank has not introduced admissible evidence as to the notice provided to Boston Blackies or, equally important, that Boston Blackies was aware of the contamination or Tronox’s chapter 11 case. Moreover, the court said there was nothing in the record that suggested that Tronox knew or should have known that Boston Blackies was a potential creditor based on Tronox’s own records.

In denying the motion to file a late claim, the court said that allowing a purchaser of property after the Bar Date would make finality impossible in any bankruptcy case. Instead, the court said a subsequent purchaser of property can protect itself by obtaining representations and warranties from its predecessor and “may also, of course, obtain an environmental report.”

Standard has also filed a complaint against the firm that prepared the October 2006 phase 1 alleging malpractice and breach of contract. Standard Bank and Trust v The English Company, 2014-L-005825 (Cook Cty Circuit Ct. 6/2/14) . This lawsuit appears to be dead on arrival.

First, the phase 1 contained the following passage discussing the review of the CERCLIS database:

“The Lindsay Light Company, 161 E. Grand Avenue, south adjacent property. This building was one of the former gas mantle manufacturing locations for the Lindsay Light Chemical Company, which refined thorium containing ores and made incandescent gas mantels for home and street lighting. This site is listed as a removal only site with no site assessment work needed, but no further information on the status of this site is provided. Based on the close proximity of this site to the subject property, there is the potential that soils have been impacted.”

Had Standard retain an environmental consultant to perform a phase 1, a transaction screen or even review the October 2006 report prior to submitting its bid, Standard would have learned that the property was likely in the Moratorium Area and that its construction plans might be complicated by the presence of thorium-contaminated soil.

In addition, the report was issued to SBT. By the express terms of the phase 1 report, Standard was not entitled to rely on the report. The complaint does not allege that the consultant knew its report would be included in the Bidder’s Information Package or that the consultant consented to allow bidders rely on its five-year old report. 

DEC Announces New Form For Amending Brownfield Cleanup Agreements

October 6th, 2014

When applicants are accepted into the NY Brownfield Cleanup Program (BCP), they enter into a Brownfield Cleanup Agreement (BCA). In addition to establishing the rights and obligations of the applicant, the BCA describes the brownfield site and identifies the parties who will be eligible to claim the BCP tax credits.

If an applicant changes its name or adds a new investor or partner that wants to be able to directly claim the BCP tax credits, the BCA needs to be amended to reflect the name change or new party. DEC recently started using a new BCA amendment form. A BCA amendment is also required if there is a significant change to the BCP site. The new form is available here.

EB-5 Program Can Provide Alternative Source of Funding for Brownfield Projects

September 27th, 2014

In a prior post, we discussed how the EB-5 visa immigrant investor program was becoming an important source of construction funding. Since then, the EB-5 immigrant investor program has continued to undergo explosive growth. The popularity of EB-5 is partially because traditional forms of project financing remains difficult to obtain. However, the EB-5 program is also attractive to developers because it can serve as an alternative source of relatively inexpensive capital or lending with typical interest rates for EB-5 financing is in the low single digits with some projects offering only 1%. Developers are able to offer such low rates of return because the EB-5 investors are primarily more concerned with obtaining green cards. The cheaper equity also allows developers to pursue more projects.

EB-5 capital has been used to fund a wide variety of projects including hotels, mixed use real estate development, nursing and assisted living facilities, hospitals, medical research facilities, manufacturing facilities, large infrastructure and construction projects and even solar energy projects. Some developers use EB-5 funding to acquire development sites those the purchase price cannot be used towards the job creation count. As a result, some developers have entered into purchase agreements with an EB-5 contingency.

Savvy developers are using EB 5 funding in combination with other sources of non-traditional or public-private financing, such as historical tax credits, New Markets Tax Credits (NMTC), and Tax Increment Financing. A number of our clients have used EB-5 funding on complex brownfield projects.

Following is a brief description of the EB-5 program. We then suggest how environmental professionals may play a role in this expanding and important program. Readers interested in learning more detailed information about EB-5 can visit the U.S. Citizenship and Immigration Services (“USCIS”)  website or review the websites of an EB-5 regional center in your geographic areas.  

What is the EB-5 Program?

EB-5 is an employment-based visa program designed to attract foreign capital investments. Foreign nationals that invest in an approved EB-5 qualified project will receive a conditional two-year visa from the USCIS.   If the investment project fulfills the job creation criteria after two years, the investor can apply for permanent resident status, and then seek U.S. citizenship in five years. Thus, the EB-5 program a very attractive means for obtaining green cards.

To qualify for an EB-5 Visa, an investor must invest at least $1MM (or $500K for a project in a “targeted employment area”) in an enterprise that will create at least 10 new full-time jobs for U.S. citizens and legal residents. If the project is an existing business, the 10 new jobs have to be in addition to the existing jobs in the business.

How Does EB-5 Program Work?

EB-5 is usually structured using limited partnerships or limited liability corporation that either extend loans or purchase equity stake in a special purpose entity established for the qualifying real estate or other capital development (i.e., job creating) project that is controlled by the developer. Limited liability partnerships (LLPs) are the preferred investment vehicle because EB-5 regulations require the EB-5 investor to control the business, unless the investor is a limited partner in the business. Each limited partnership generally invests in a single project. Foreign nationals qualify for the conditional visa by purchasing limited partnership interests of the LLP that invests in the qualified project either as a lender or equity participant.

When used as debt, EB-5 funding can be secured by a first lien, second lien, mezzanine pledge, or other collateral, and it may be in the form of recourse or non-recourse debt. The typical term of an EB-5 loan to a developer is five years. After the EB-5 investors obtain their green cards, project sponsors will typical “take out” the EB-5 investors by refinancing or selling the project.  

EB-5 investments may be pooled to raise the funds necessary to finance a project with the total financing dependent on the number of new jobs that are created. Because new jobs have to be created, EB-5 financing is generally used for construction projects such as building new hotels, medical facilities or multi-family projects but have also been used to fund major renovations of old buildings.

EB-5 investments can be made directly to a business or project, or through an approved regional center. In the direct EB-5 investment approach, a business owner raises capital for its business project directly from foreign nationals who will take an equity position directly in a business. Only full-time jobs (i.e., W-2- employees) directly generated by the business or project may be counted for EB-5 funding eligibility. The direct EB-5 model is usually more appropriate for foreign nationals who are interested in buying or starting a business, or want to control their investment and maximize their profits.

In contrast, projects that are sponsored by an approved regional center can include both direct and indirect jobs created within the designated geographic area of the project.  For example, if a shopping center is built with a direct investment of EB-5 financing, only the direct employees of the entity constructing the center may be counted towards calculating the amount of eligible EB-5 funding. However, if the same project received EB-5 financing through a regional center, all of the employees of the tenants in the shopping center could be counted, along with any other employees who provide goods and services to the shopping center. Regional centers usually use economic models to predict the total number of direct and indirect full-time jobs.

Since most EB-5 financings are done through limited partnerships or limited liability companies, EB-5 financings involve the sale of securities that will be subject to Securities and Exchange Commission. The offerings may be exempt from registration under Regulation D (for private offerings of securities) and Regulation S (for offshore offerings of securities outside the U.S.). Counsel for the business owner/developer will prepare the private placement memorandum, limited partnership or limited liability agreement, and subscription agreement for the EB-5 offering. Each EB-5 investor will generally sign a subscription agreement, place the full amount of their investment in escrow, and commence the immigration process by filing an I-526 visa application through a U.S. immigration attorney. Although not required, it is typical that the investor funds will remain in escrow until the investor obtains approval for the I-526 visa application.

For projects with $500K investors, a developer seeking to construct a $20MM hotel would have to generate 400 full-time employees. However, for projects sponsored by an approved regional center, the new jobs count can include direct jobs (hotel employees), indirect jobs (such as jobs at suppliers of goods and services to the hotel) and induced jobs (such as jobs created by other new businesses surrounding the hotel). For every 10 more jobs that can be counted, the developer can raise an additional $500,000 more in EB-5 financing. So, for example, a hotel that will create at least 300 new direct, indirect and induced jobs, could raise $15 million in EB-5 financing.

Not surprisingly, approximately 90% to 95% of all EB-5 visa investments are made through regional centers.  As of June 2014, there were 532 approved regional centers around the country although, many of these regional centers have not yet closed on any EB-5 financings. A number of large developers have established their own regional centers to take advantage of the demand from both investors looking for certified EB-5 projects. Business owners or developers may establish its own regional centers.

With the popularity of the EB5 program, the USCIS processing time for approving visas and regional centers has increase. While the foreign national I-526 petition is pending, the investor’s money is usually held in escrow is approved. Moreover, EB-5 funds cannot be used solely to pay down debt or redeem equity. However, the USCIS allows developers to use bridge financing or interim funding to maintain project feasibility and momentum prior to receipt of EB-5 capital. The bridge loan may be used to fund project costs or early-stage construction costs including demolition, renovation, remodeling can be used. If the project commences based on the bridge financing prior to the receipt of the EB-5 funding and then subsequently takes out the interim facility with EB-5 capital, the project may be able to count the jobs created during the interim financing period towards the required EB-5 job creation. When the EB-5 funding is approved, the EB-5 funds can be used to replace or “take out” the bridge financing. Terms vary widely with interest rates usually ranging from 10% to 14%. EB-5 bridge lenders tend to prefer hotel and senior facility projects in primary markets.  EB-5 funding can also be used for mezzanine financing to bridge the gap between developer equity and the loan-to-cost requirements of many commercial lenders.

Every EB-5 investor will be required to file an I-829 visa application for removal of the conditions within two years of the date that the investor obtained its conditional visa. At that time, the investor will be required to prove that the conditions under which the project was approved as an EB-5 investment have been met. If the business plan was not materially completed for any reason, the investors will lose their conditional visa.

Since obtaining US permanent resident status is generally the principal motivation behind an EB-5 investor, project success (i.e., project completion so permanent jobs are created) is critical to obtaining a permanent resident visa, due diligence has become critical for EB-5 projects. Obvious risks to investors include that the project may not qualify, there be insufficient investors in the project, the investment entity goes bankrupt, and the investor may lose its principal or suffer a delay in return of investment. The developer’s risk can include that investor’s source of funds is not lawful or the investor cannot document the source or path of its funds.

Use for Brownfields and Contaminated Sites

Regional centers and private developers begun turning to the EB-5 program for financing brownfield redevelopment in many US cities. For example, the Empire State EB-5 Regional Center recently closed and funded the first phase of a $220MM multi-use project on a brownfield site in upstate New York.  The America Now–Philadelphia Metro Regional Center, LLC is focused on redeveloping former industrial and brownfield sites. In Pittsburg, the state Department of Community and Economic Development (DCED) helped facilitate EB-5 funding for the Bakery Square project that transformed the former Nabisco property in Pittsburgh’s East Side into a mixed-use complex encompassing retail, office, hotel, dining and entertainment spaces. The Cleveland International Fund has also help fund construction projects on brownfield sites in Cuyahoga and Summit counties. In California, the American Development Center, LLC has provided early stage EB-5 financing for redeveloping former military bases and industrial properties. 

Projects with environmental issues can be a concern to EB-5 investors since the foreign nationals have to make “at-risk” investments. In other words, if the project does not produce the required number of jobs within the two year period, the foreign national’s path to path to permanent residency could be derailed. EB5 investors will need to understand the risks that environmental investigation/remediation process may impact project viability. Environmental issues can increase costs that could make a project infeasible or delay project completion so that the requisite jobs may not be created or may be delayed. Thus, developers seeking EB-5 financing for contaminated property should discuss complications posed by environmental issues in the offering memorandum if the environmental conditions could pose material risks to timely project completion. Foreign nationals will want to retain advisors to help understand the environmental issues as part of their overall project and financial due diligence. Likewise, regional centers promoting redevelopment projects on contaminated sites will need to understand the environmental risks to these projects.  

Cal Appeals Ct Affirms $2MM judgment against foreclosing bank for failure to complete remediation is

September 20th, 2014

The foreclosing lender in Hoang v. California Pacific Bank, 2014 Cal. App. Unpub. LEXIS 5230 (July 23, 2014) made some curious decisions and the result was the bank was ordered to pay damages to the purchaser that exceed the sales price of the property. The irony is that the lender probably complied with the CERCLA and state secured creditor exemption by foreclosing and then quickly selling the property. Unfortunately, the lender incurred contractual liability for the cleanup.

In 2000, California Pacific Bank (CBP) had financed the purchase of a commercial real property that had been contaminated with PCE from a dry cleaning solvent packaging and supply business that had formerly operated at the site. At the time of the loan, the known maximum PCE contamination had been 3,200 parts per million (ppm) in the soil and 82,000 parts per billion (ppb) in the groundwater. The highest PCE concentrations were located in areas where product had been offloaded from railcars and trucks to an aboveground storage tank. 

A consultant retained by the borrower concluded the remediation could be completed within three years at a maximum cost of $250K.  The estimate was based on a limited soil removal and groundwater monitoring. The purchaser/borrower negotiated a reduction in the purchase price from $900K to $850K. In addition, the purchaser agreed to release and indemnity the seller as well as to covenant to obtain a no further action letter from the water board.  An escrow was established equal to the $250K estimate.

Despite the high PCE concentrations, the bank made its first judgment error when it accepted what proved to be a woefully inadequate estimate without retaining its own consultant to independently vet the estimate. The bank then committed its second error when it approved an escrow equal to the estimated cleanup costs. Most lenders will require escrows to be at least 125% and often 150% of the estimated costs to obtain closure.  

After excavating 130 cubic yards of contaminated soil and pumping 5,000 gallons of groundwater, the borrower’s consultant sought regulatory closure form the State Regional Water Quality Control Board (Water Board). In October 2001, though, the Water Board required further groundwater and soil remediation.  

In November 2002,  borrower defaulted on its loan and eventually filed for bankruptcy.  In March 2003, the bank acquired title through a non-judicial foreclosure. In another curious decision, CPB retained the same environmental consultant who had underestimated the cleanup and did so two months AFTER  CPB too title. The consultant reportedly told the bank that he could he could obtain Water Board closure for $45K of additional remediation. However, at trial he testified he had informed the CPB that other environmental consultants probably would have estimated that it would cost over $1 million to obtain Water Board closure. Another lender might have wondered if it was provided with a low-ball bid but CPB appears to have elected to proceed with the environmental equivalent of a “Hail Mary” pass. The Water Board approved the workplan for quarterly monitoring but required submission of a remedial investigation and proposed remedial action by the end of 2003.

CPB then agreed to sell AND finance the acquisition of the property to the plaintiff for $1.14MM. Paragraph 29 of the amended agreement provided that CPB agreed to fund the remedial work up to $45K consisting of additional source removal and installation of additional groundwater wells. If additional remediation was required to obtain an NFA letter, the Bank had the discretion to authorize additional remediation work up to a maximum cost of $100K, with plaintiff paying half of the additional costs. Any costs in excess of $100K were to be the sole responsibility of CPB. The bank covenanted to obtain the NFA letter within three years of the August 6, 2003 closing.

After the closing, the bank’s consultant conducted groundwater monitoring and requested regulatory closure in 2004 and 2005 based on natural degradation of the PCE concentrations but each time the Water Board denied the request.

In 2005, the purchaser/plaintiff refinanced the property for a higher amount ($1.2MM) at 8.25% as opposed to the existing loan of $868K at 5.25%. The refinance allowed the purchaser/plaintiff to recoup its original down payment and pocket an additional $60K. In addition, the purchaser/plaintiff was able to lease the property for approximately $20K a month. By the time the lawsuit was filed, plaintiff had received nearly $290K in rental income.

Meanwhile, a dispute had risen between CPB and the original seller over ownership of the original $250K escrow. The seller demanded the escrow to be released since the original purchaser had failed to obtain the NFA letter. In 2009, the parties settled this lawsuit whereby CPB agreed to remediate the property and obtain an NFA letter by April 2014 (subsequently extended to April 2016) and to pay the seller’s counsel fees of approximately $330K. 

In July 2010, plaintiff filed a breach of contract action asserting CPB had failed to remediate the property within three years from the date of purchase. As a direct result of CPB’s failure to perform, plaintiff claimed it has suffered the loss of use of the property, was unable to enter into a lower interest rate when it refinanced the property , and had lost a sale for a portion of the property that would have netted it $650K.

In August 2010, the Water Board issued another directive requiring additional investigation and requiring submission of remedial alternatives.  The remedial investigation revealed maximum PCE soil samples at 8800 ppm in the soil and 28,000 ppb in groundwater. Maximum TCE concentrations in groundwater were 41,000 ppb, DCE at 61,000 ppb and vinyl chloride at 21,000 ppb. The report also revealed concentrations of PCE and TCE in the soil gas of 8,529,800 ug/m3 and 5,591,070 ug/m3, respectively. As a result, the Water Board also became concerned about vapor intrusion.

A trial was conducted in two phases. First, a bench trial was held to interpret the contract. In April 2012, the trial court found that the agreement did not require the Bank to obtain a NFA letter by any specific date. Instead, the court ruled that the bank had simply promised to complete the tasks set forth in the agreed upon scope of work but did not include a guarantee that the scope of services would result in regulatory closure before the third anniversary after the close of escrow. The plaintiff then filed an amended complaint alleging that CPB’s failure to obtain an NFA letter within a reasonable time constituted a breach of contract for which Plaintiff sought damages of $4.5MM.

In the second phase of trial, a jury awarded plaintiff approximately $2.3MM for the bank’s failure to complete the cleanup in a reasonable time period. The jury based its damage award on expert testimony proffered by the environmental consultants who had conducted the original investigation. These experts had testified based on contaminant levels, it could cost from $1,332,990 to $3,235,770 to achieve the environmental screening levels (ESL) of 0.69 ppm in soils and 5 ppb in groundwater.

On appeal. CPB argued that paragraph 28 of the agreement stating that the bank “shall have no liability to buyer for any known or unknown hazardous contamination on the property” limited plaintiff’s remedy to an indemnity. Since the plaintiff had yet to incur any cleanup costs, CPB asserted that the jury erred when it awarded damages. However, the appeals court noted that CPB had not raise this issue with the trial court prior to or during the trial, did not assert this ground as an affirmative defense and had not objected to the jury instruction on damages until after the jury had returned its verdict. Thus, the court concluded CPB had waived the indemnity issue.

Even if the bank had not waived the indemnity issue, the appeals court went on to say the two contractual provisions do not operate to limit plaintiff’s contractual remedies to indemnity. The court held that Paragraph 28 was an “as is” clause that simply limited the bank’s liability in connection with any representations. This provision, the court continued, could not be reasonably understood to limit plaintiff’s remedies for failing to complete the remediation in a in a reasonable time period as required in Paragraph 29.

Turning to the damage award, CPB contended the evidence was insufficient to support the $2.3MM damage award. The damage claim was based, in part, on plaintiff’s testimony that 1600 tons of contaminated soil would have to be excavated. The bank said the plaintiff’s experts did not explain how they reached the 1600 ton figure. CPB noted that only two of the 15 soil borings relied upon by plaintiff’s experts had PCE concentrations over the ESL, suggesting plaintiff’s expert opinions on the quantity of soil that needed to be removed was unfounded. However, in yet another questionable trial tactic, the court noted that the bank’s counsel did not ask plaintiff’s expert on cross-examination to explain why he would recommend the removal of soil in areas where the borings showed contamination levels below the ESL. Moreover, the court observed, CPB did not offer any expert witness testimony to contradict plaintiff’s expert testimony.

The court found that it was uncontroverted that at least a portion of property contained very high levels of PCE contamination and that while plaintiff’s expert testified that the precise extent of the contamination could not be determined without more testing, his remediation scenarios contemplated excavating soil from the three known hot-spots to resolve the contamination. Moreover, the court said that while it did appear only one or two of the samples were above the ESL, plaintiff’s expert relied on other evidence in forming his opinions. Again, the court highlighted more questionable trial strategy by the bank, noting that CPB did not raise any evidentiary objections to plaintiff’s expert testimony and did not challenge the proffered jury instructions on how to evaluate expert testimony.

The appeals court said while there was uncertainty on the disposal costs of the excavated soil, the evidence was sufficient to support the plaintiff’s estimates on the cost of each element of remediation that would be needed to obtain an NFA letter. Once again, the court noted that the bank did not object before or during the plaintiff’s expert testimony that estimates were based on speculation, either. Since the jury’s award fell within his estimates, the court ruled that the award was not is unduly speculative.

CPB also objected to the amount of the award because it exceeded the purchase price of the property. However, the court noted that the Bank did not argue in advance of the jury’s verdict that there was a ceiling on damages based on the purchase price. The court said the evidence supported the conclusion that plaintiff purchased the property with the understanding that the Bank would remediate the property and obtain an NFA letter would be obtained within a reasonable time. The court said the remediation costs were not awarded based on injury to the property, but to enable plaintiff to be in as good a position as if the bank had remediated his property according to its promise in the contract. Additionally, the court noted that because the state had a firm policy in favor of environmental remediation, it could not say an award of remediation costs was unreasonable just because it exceeds the amount that the present owner paid for the property.

The plaintiff had asserted at trial that he was unable to refinance his property in 2005 at a lower interest rate of 6.75 percent, and instead elected to take a loan at 8.25 percent, allegedly due to the Bank’s breach of the contract in failing to obtain a NFA letter prior to 2005. CPB asserted there was no evidence showing that it breached the contract in 2005 because it had until August 2006 (three years from close of escrow in August 2003) to complete the work. Even if there had been a breach, the Bank argued, any claim for breach would have been barred by the statute of limitations. However, the court ruled that the action involved an executory contract where the plaintiff had fully performed and was waiting for the bank to complete its performance. In such situations, the court said an injured party can wait until the time for complete performance by the other party to bring an action for damages. The court said the party waiting for performance was not required to treat the contract as abandoned on the first breach but could elect to wait for performance, and the statute of limitations will not begin to run until the injured party has made its election. Since the trial court found that the time for the Bank’s performance was not three years, but was instead “reasonable time, there was no error.

CMBS Environmental Due Diligence Needs to Consider B-Piece Buyers

September 12th, 2014

Commercial Mortgage-Backed Securities (CMBS) loans have been playing an increasingly important role in commercial real estate financing and account for around 30% of commercial loan originations. Because of the increasing use of CMBS loans, it is important for consultants to understand the different risk tolerances of the players in a CMBS transaction and how environmental due diligence may differ for CMBS transactions.

When retained to perform a phase 1 for a CMBS loan, consultants tailor their recommendations to the lender’s scope of work since the lender is the consultant’s client. However, in CMBS transactions, there is another big elephant in the  room that Both the originating lender and the consultant need to satisfy– the so-called B piece buyers Recommendations that might make sense if a client was a sophisticated property owner or a portfolio lender might not be acceptable to a B-piece investor.  

CMBS loans are securities created from the cash flows of pooled commercial mortgage that are usually secured by hotels, office buildings, shopping malls, and warehouses. In CMBS transactions, individual loans are originated by a lender (the consultant’s client). After closing on the loan, the originating lender will hold the loan on its books for a short period of time until it has accumulated a sufficient volume of loans and then sell the loans to a CMBS trust which is known as a real estate mortgage investment conduit (REMIC). The loans are sold pursuant to a pooling and servicing agreement (PSA) where the originating lender makes certain representations and warranties about the due diligence it performed for each loan including environmental due diligence.

The CMBS trust pools or bundles the loans and then issues bonds that are secured by the cash flow from the mortgages. Rating agencies assign credit ratings to the various classes of bonds (which are known as tranches) ranging from investment grade (e.g., AAA/Aaa to BBB+) to below investment grade (BB+/ Ba1 through B-/B3). Sometimes the CMBS trust will also have unrated bonds.  Loan payments are distributed to the holders of the lower-risk, lower-interest securities first, and then to the holders of the higher-risk securities. Here is illustration of the CMBS tranches.


After the loans are sold, the trust is administered by Master Servicer will is responsible for servicing all of the loans in the trust, including collecting monthly payments, verifying compliance, and waiving or modifying any mortgage conditions. If an individual loan goes into default, it will be assigned to a Special Servicer.

The critical player in any CMBS transaction are the investors who buy the below investment grade tranches who are called the B-piece buyers. Since holders of class A notes are paid interest and principal payments before the holders of the lower-grade notes, B-note investors will suffer losses before the investment-grade tranches.

Traditionally, B-piece buyers were specialist investors/funds but new players chasing yield have entered this and may now include private equity and public companies. B-piece buyers or a related entity also often serve as special servicer so that they can control the disposition of non-performing assets.

During the credit bubble, B-piece buyers often piggybacked on the environmental diligence performed by the CMBS issuer. Now, though, the due diligence performed by B-piece investors has dramatically increased. B-piece buyers are carefully reviewing properties proposed to be included in new CMBS pools and often force issuers to “kick-out” or drop troublesome properties from the pools.  As a result, the B-piece buyers often drive underwriting standards and serve as a market watchdog. Indeed, it is not unusual for the B-piece buyers to perform desktop reviews or their own Phase I ESA reports. Moreover, environmental consultants and environmental attorneys retained by B-piece buyers are questioning conclusions in Phase I ESA reports and carefully vetting assumptions used to develop environmental loan reserves.

B-piece buyers tend to like cleanups or mitigation to be approved by regulatory agencies. For example, if a consultant identified a former UST that was removed in the past as an HREC but no closure documentation is available, the B-piece buyer might want further sampling investigation. Likewise, if the soil gas at a former shopping center is impacted by a former dry cleaner, a consultant might recommend that the property owner install a sub-slab depressurization system (SSDS) without involving the regulator since this could expand the scope of the investigation and increase the cost of the project. However, the B-piece buyer may insist that the SSDS to be approved by and installed under the supervision of a regulatory agency to keep the property in the CMBS pool.

An indemnity from a credit-worthy entity or environmental insurance can assuage the concerns of B-piece buyers. Fortunately, the environmental insurance market has become very competitive and coverage is not only widely available for unknown conditions but also at attractive pricing. Often times, it may be preferable to obtain a lender policy rather than collect samples from a former dry cleaner space. Borrowers with significant real estate holdings may have their own environmental pollution legal liability (PLL) policies and may want to have the lender added to the existing policy.  However, there are often challenges fitting PLL policies into the particular needs of CMBS transactions so this option may be available.  

OER Launches NYC Affordable Housing Cleanup Fund

August 20th, 2014

The New York City Office of Environmental Remediation (OER) recently announced the creation of the NYC Affordable Housing Cleanup Fund (AHCF) to help remediate and support affordable housing projects in disadvantaged communities. Unlike the OER Brownfield Incentive Grants (BIG) program which are funded from appropriations, OER will be using $1.8MM in EPA Revolving Loan Fund (RLF) to support the AHCF. Thus, the AHCF should not experienced the funding flucuations that have plagued the BIG program.

The creation of the AHCF was made possible after EPA announced a change in its RLF eligibility earlier this year. The policy change allowed OER to award RLF money to a more spectrum of affordable housing projects that were not previously ineligible because of a  financing structure commonly used in New York. We discussed the policy change earlier this year.

The AHCF will award grants of $80K to affordable housing projects that enroll in the OER Voluntary Cleanup Program (VCP) that can be used to cover engineering costs at sites that do not pay prevailing wage. Loans of $150k will also be available for supportive and affordable projects in the VCP that comply with Davis Bacon. The RLF loans can be used at Davis-Bacon sites for asbestos abatement, demolition and any element of an approved remedy. The loan terms will be zero percent interest but repayment can be delayed for 15 years with full repayment by year 30.

In addition to the new funding, OER launched its New York City Clean Soil Bank in December 19, 2013 for sites enrolled in the VCP. The Clean Soil Bank can reduce development costs since VCP applicants can reuse clean native soil excavated at other brownfield properties in the or donate qualified soil to the Clean Soil Bank. OER estimates that brownfield developers could save up to $5 million in soil purchase and disposal costs each year. The clean soil can be used to elevate properties and build protective barriers to protect against storm surges.Affordan

Rep and Warranty Insurance Becoming More Common in M&A Deals

August 13th, 2014

The use of reps and warranties insurance (RWI) is becoming an increasingly popular risk allocation tool in corporate transactions. According to trade press reports, the volume of RWI doubled from 2011 to 2012, with the value of the insurance bound last year exceeding $4 billion.

RWI covers losses related to breaches or inaccuracies in reps and warranties, and can be purchased by either buyers or sellers. An RWI policy can add flexibility to a deal and help parties resolve key transactional issues such as the scope of the reps and warranties, the size of indemnification deductibles and caps, reduce or eliminate the need for escrow as well as extend the survival period. A buyer can use RWI to distinguish its bid in an auction process since the buyer could propose lower or no escrows or indemnification caps. In an odd twist, buyers willing to rely on RWI may actually be able to negotiate longer survival periods and higher indemnification caps since the risk for breaches or inaccuracies would be shifted from the seller to the insurer. RWI is also useful when the buyer has concerns about the seller’s credit such as in distressed asset sales since the RWI can backstop or collateralize the seller’s indemnity

RWI policies are attractive to sellers because they can used as to substitute or supplement a seller indemnity. In this way, an RWI policy can provide certainty to a seller that its exposure will be capped at the amount of a negotiated escrow. The coverage can also help sellers remove contingent liabilities from their balance sheets or avoid establishing new accruals or reserves. The policies can also facilitate a “clean exit” for private equity and “end-of-life” funds to maximize distributions, reduce risk of paybacks and enhance performance metrics. 

The form of the policy and the claims handling procedures will vary, depending if the insured is the buyer or the seller. When purchased by a buyer, the RWI policy is written as first-party coverage. When the buyer learns of a breach or inaccurate rep or warranty, the buyer can simply file a claim directly with the insurer using of proof of loss form and does not have to deal with the seller.   

When purchased by a seller, RWI operates as a “third-party” liability policy. After the seller receives a notice alleging of a breach or inaccuracy in the reps and warranties, the seller will tender the claim to the insurer. Often times the seller will remain obligated under the RWI policy to defend the claim but a seller policies is often able to obtain advancement of defense costs.   

One key difference between a buyer or seller RWI policy is coverage for fraudulent misrepresentations. Seller policies will include an exclusion for fraudulent statements in the reps and warranties while RWI policies issued to a buyer typically would not exclude claims based on seller fraud. Thus, the buyer policy provides broader coverage.

The RWI policies can be structured to cover specific representations and warranties or provide “blanket” coverage for all representations and warranties contained within an agreement that are not otherwise excluded by the insurer. RWI policies generally do not cover known issues, such as issues discovered during due diligence, known to members of the deal teal or described in disclosure schedules. The policies also usually do not cover breaches for covenants or indemnification for specific contingent liabilities. However, a buyer could agree to look to the RWI for breaches of reps and warranties but continue to hold the seller responsible for other indemnification obligations, possibly allowing the parties to reduce any escrow or lower an indemnification cap.  Other standard exclusions may include consequential or damages, fines and penalties and claims for injunctive or other equitable (non-monetary) relief.

Parties should be aware that the RWI underwriters will carefully review the transaction documents and discuss the transaction structure with the deal team. Insurers will particularly focus on the thoroughness of the seller’s disclosure process and the risk management policies of the target company. Underwriters may exclude provisions that they believe are easily breached or perhaps too buyer-friendly.

The pricing for RWI coverage depends on a number of factors including the nature of the risk, the extent of the due diligence performed by the parties and the relative size of the deductible. Coverage limits can be as high as $50MM though higher limits are available by aggregating policies. Premiums have been dropping and now commonly range from 2%-3.5% of the coverage limits. Even at those levels, sellers often prefer the cost of the insurance premium rather than having portions of the sales proceeds tied up in escrow or having to reflect indemnities on their balance sheets.  Self-insured retention (deductible) also varies from deal to deal but often ranges from 1% to 3% of the transaction value.

It is important to know that not all RWI policies will cover environmental reps and warranties—especially if the environmental liabilities are potentially significant.  In such cases, the parties would be better suited obtaining an environmental insurance policy. However, even where a buyer insists on an escrow or indemnity for environmental liability, an RWI policy can still be useful. By covering claims for breaches of other reps and warranties, an RWI policy could enhance the chances that the escrow would not be exhausted by non-environmental claims.

Delaware Extends Statute of Limitations For Contract Claims to 20 Years

August 11th, 2014

The time period for bringing claims for breaches of representations and warranties in corporate transactions (known as “survival” periods) are usually heavily negotiated. General reps and warranties about the condition of the business often have the shortest survival periods (usually 6 months to two years) and often track the length of an escrow period. However, special reps and warranties such as those relating to environmental liability will typically have a longer “survival” period and are frequently are tied to the underlying statute of limitations (SOLs).   If a purchase agreement is silent on survival of reps and warranties, courts tend to default to the state’s contract SOL.

SOLs for claims for breach of contract vary considerably by jurisdiction, usually ranging from 3 to 10 years. The contracting parties will identify the state that will govern the enforcement and interpretation of an agreement. Depending on the state, survival clauses attempting to shorten or extend (or waive) the SOL for breach of contract claims may not be enforceable. States also differ on if a survival clauses tends to operate as a contractual statute of limitation in which a party must file a lawsuit or simply period for an injured party to file a notice of claim.

In states that prohibit extension of the survival period beyond the SOL for breaches of contract, the SOL is essentially also acting as a statute of repose (SOR). Click here  for a prior post on the difference between SOLs and SORs as well as delayed discovery rules that can suspend the running of SOLs.

The SOL will start generally begin to run on the date of the closing though often times survival clauses relating to claims filed by third parties may not be triggered for a period of time after the closing. Because of the variation among state contract SOLs, it is important that the contracting parties understand the SOLs of the state law that govern their agreements.

For example, many transactions will be governed by Delaware law when the companies are Delaware entities. Earlier this summer, the Delaware legislature amended the contract SOL to 20 years for contracts involving at least $100K. The extended SOL became effective on August 1st. However, it is unclear if the change applies to contracts executed after the effective date or if it applies to contracts entered into prior to that date that simply reference. the SOL. If the  SOL amendment is considered  “remedial”  and since it extends a plaintiff’s right to bring suit, it is possible the Delaware courts may  apply the new SOL to contracts entered into prior to its effective date.

McDonald’s Labor Case May Have Environmental Law Implications

July 31st, 2014

Labor rulings have in the past served as precedent for eroding traditional corporate law doctrines and expanding liability of corporations. For example, the doctrine known as either Continuity of Enterprise or Substantial Continuity was used in the 1990s to impose successor liability for environmental contamination originated with a line of labor law cases dating back to the early 1970s (see, e.g.,  William J. Burns International Detective Agency, Inc. v. NLRB, 441 F.2d 911 (2nd Cir. 1971) where a security firm outbid the existing firm providing security services and was required to honor the collective bargaining agreement entered into by the prior firm after hiring most of the former firm’s employees).

Indeed, those of us who were practicing environmental law in the 1980s can recall how the larger corporate law firms initially viewed environmental law as a niche area that was primarily the domain of “tree huggers and critter lovers”-as one cynical corporate once told me. The corporate firms were confident that well-entrenched doctrines of corporate law would shield their clients from significant environmental liability. After the Substantial Continuity test was used override state corporate law and  impose environmental liability on purchasers  of corporate assets, the “white shoe” law firms suddenly  realized they needed environmental lawyers to protect their institutional clients and started scrambling to hire environmental lawyers.

We have taken this path down memory land because of labor ruling earlier this week that may profoundly change corporate relationships. This past Tuesday, the National Relations Labor Board (NRLB) Office of General Counsel issued a decision finding that franchisor McDonalds USA could be liable as a “joint employer” of its approximately 13,000 franchised restaurants in the United States for alleged workplace violations. The employees had asserted that McDonald’s was a “joint employer” with the franchise restaurants  on the grounds that McDonalds required its franchisees to strictly follow its rules on food, cleanliness and employment practices and that McDonald’s often owned the restaurants that franchisees use.

The ruling will now be heard by the five-member NRLB. If the NRLB upholds decision is affirmed and the ruling survives appellate review, it could impact large swaths of the national economy including manufacturers, real estate management firms, hotels, health care, automotive services, and cleaning companies that use temp agencies or subcontractors. It could also possibly impact the environmental consulting firms that heavily relying on independent contractors (“1099s”) to perform phase 1 reports since those individuals might be deemed to be employees that are entitled to benefits.

It should be noted that in the early 1980s, the NLRB ruled that a company could be considered a “joint employer” where two or more employers exerted “significant control” over the same employees. After that ruling was affirmed by an appeals court, though, the NLRB adopted a narrower standard, holding that a company could only be deemed to be a “joint employer” when it directly controlled, for instance, a franchisee’s or a temp agency’s employment practices. The McDonald’s decision suggests that the NLRB may be returning the earlier “significant control” standard.

What are the implications for environmental law? Well, since the inception of state and federal underground storage tank (UST) programs, purchasers of former gas stations and residents with homes impacted by leaking gas station USTs have sought to impose operator liability on Big Oil franchisors because of the control allegedly exercised over their franchisees. The indicia of control frequently asserted by these plaintiffs included that franchisors required the station operators to maintain the premises in a certain manner, keep specific minimum hours and purchase minimum amounts of their products.   Except for a couple of outlier cases where courts found the fuel distributors or “jobbers” essentially acted as agents of the franchisors, these cases have been unsuccessful. The allegations in the McDonald’s case focused on the level of control exerted by the franchisor. It is not a big step from arguing that a company that is liable as a “joint employer” because of the control is exercised over its franchise operations should be liable as an “operator” under state or federal environmental laws.

Likewise, plaintiffs have pursued dry cleaner franchisors and equipment manufacturers under “operator” and arranger” theories. The plaintiffs have asserted that because the manufacturers/franchisors had control over the design of the dry cleaning machines including installing the equipment, chose the locations of the floor drains, physically connecting the discharge piping to the building, inspected the connections to ensure that the waste water was disposed into the sewer system and provided instructions  recommending that the dry cleaners be connected to the sewer system, the manufacturers/franchisors  amounted to either control or actual involvement in decisions about disposal of waste (for example compare Berg v. Popham, 412 F.3d 1122 (9th Cir. 2005) and Vine Street LLC v. Keeling, 361 F. Supp. 2d 600 (E.D. Tex. 2005) with California Department of Toxic Substances Control v. Payless Cleaners, 368 F. Supp. 2d 1069 (E.D. Cal. 2005), Team Enters., LLC v. W. Inv. Real Estate Trust, 2010 U.S. Dist. LEXIS 79912 (9th Cir. 09/09/2010)). One could envision the reasoning in the McDonald’s case being extended to the dry cleaner franchisor/equipment manufacturer cases at least on the “operator” theory of liability.  

The McDonald’s case may not be the first joint employer case to reach the federal appellate courts, though. The NLRB is currently reviewing a request by the Teamsters union to declare Browning-Ferris, Inc (BFI) as a joint employer along with the staffing agency it uses to supply workers at a recycling plant in California because of how closely BFI directs the use of the staffing agency’s workers. 

It is true that following the US Supreme Court decision in United States v. Bestfoods, 524 U.S. 51, 141 L. Ed. 2d 43, 118 S. Ct. 1876 (1998) where the Court ruled that CERCLA did not replace settled rules of state corporation law that several federal appellate courts over the past decade have ruled that the Substantial Continuity test was only applicable to labor law and should not be used to extend liability under CERCLA ( see New York v. Nat’l Servs. Indus., 352 F.3d 682 (2nd Cir. 2005) ruling that the fact that the substantial continuity test is well-established in the context of federal labor law does not indicate that it is extendable to other areas of federal common law, it was  not a part of general federal common law and should not be used to determine whether a corporation takes on CERCLA liability) .  Thus, it is possible that federal courts may decline to apply the reasoning of the “joint employer” cases to CERCLA operator liability. However, the doctrine may be a useful tool for  creative lawyers who will likely be presenting their cases before federal judges appointed over the last eight years-at least on the district court level-  and therefore be more receptive to these arguments.

Major CMBS Lender Requiring EPs to Perform Site Inspections

July 23rd, 2014

We have previously discussed discussed here and in other forums how the All Appropriate Inquiries (AAI) Rule issued by EPA in 2005 is deeply flawed and has directly contributed to a worsening in the quality of phase 1 reports. This is ironic outcome since the reason EPA was instructed in the  2002 amendments to CERCLA  to issue an AAI Rule was to  improve the level of due diligence. This is evidenced by the fact that  Congress added five criteria to the then existing statutory test that property owners needed to  evaluate to satisfy the  CERCLA liability protections.

As we have explained. the principal  weaknesses of the AAI rule was the watered-down definition of Environmental Professional (EP) and not requiring EPs to actually perform any of the AAI tasks. Instead, the AAI rule allows the work to be done by persons who do not even have to have a high school education so long as they under the “supervision” of an EP (who also does not have to have a high school education). Often times, the so-called EP supervision consists solely of the EP stamping its signature on a template  form that has been completed by a field inspector.        

When EPA published a proposed rule to add a reference to the new ASTM E1527-13 to the AAI Rule, several lawyers and environmental consultants urged EPA to use the rulemaking as an opportunity to  revisit the EP definition or at least require EPs perform some of the more important AAI task. However,  the agency declined these requests on the grounds that they were outside the scope of the proposed rulemaking.

Recently, one of the leading  CMBS lenders revised its scope of work to require that EPs must actually perform the site inspections for reports prepared for that bank ( Note that I do not represent that lender but have seen its revised scope of work). The SOW requires that all reports must be performed by EPs (as opposed to under supervision or direction of an EP). In addition, the inspector must have at least five years of experience with that particular property type.

It will be interesting to see if other lenders follow the lead of this major CMBS lender and revise their scopes of work as well. It will also be interesting to see what impact this change will have on the business model of firms that heavily rely on independent contractors (1099s) or part-time employees to perform their phase 1 reports and who do not qualify as EPs.