BCP Extension Bill Sent to Governor For Signature

December 17th, 2014

Under New York’s unique form of democracy,  bills that are passed by the legislature are held at the Assembly until the Governor calls for the bill.  Once the Governor receives a bill, he has ten days to sign the bill.

As we previously posted, the legislature passed a bill back in June that would have extended the Brownfield Cleanup Program (BCP) tax credits to March 31, 2017. The tax credits are currently set to expire on December 31, 2015. Applicants would need to obtain a Certificate of Completion by that date to qualify for the tax credits if the law is not extended.

We learned today that the Govenor finally called the bill. He has until December 29th to sign the extension

Do Clients Have To Complete Consultant Questionnaires To Comply With AAI?

December 10th, 2014

The short answer is no.

Environmental consultants routinely submit environmental questionnaires to property owners and their clients as part of the phase 1 process. Some consultants tell their clients that they are obligated to complete the questionnaire to be able to comply with EPA’s All Appropriate Inquires (“AAI”) rule. A few go as far as saying they cannot issue a phase 1 report unless the client completes the questionnaire.  However, this is flat out wrong.

EPA’s AAI rule does not require users  to complete the questionnaire. Indeed, the AAI Rule does not even require purchasers, brownfield grantee or lender (collectively the “user”) to provide the results of their “additional inquiries” to the environmental professional much less complete a questionnaire to satisfy with AAI. All the user needs to do is demonstrate that it performed those “additional inquiries” We will now break down the user obligations.

The AAI rule identified what elements of the investigation were the responsibility of the environmental professional and which criteria were the responsibility of the prospective purchaser or brownfield grantee. The information that has to be obtained by the user are known as “additional inquiries” and set forth in 40 C.F.R. 312.22. The “additional inquiries” include: specialized knowledge or experience of the prospective landowner (or grantee); the relationship of the purchase price to the fair market value of the property, if the property was not contaminated; and commonly known or reasonably ascertainable information.

In the preamble summarizing the changes from the proposed rule to the final rule that was published in the November 1, 2005 federal register, EPA stated at page 66076:

“The final rule does not require the prospective landowner (or grantee) to provide the information collected as part of the “additional inquiries” to the environmental professional. Although we expect that most prospective landowners and grantees will furnish available information or knowledge about a property to an environmental professional he or she hired when such information could assist the environmental professional in ascertaining the environmental conditions at a property, we affirm that compliance with the statutory criteria does not require that such information be disclosed. [emphasis added]. 

 Since it ultimately is up to the owner or operator of a property to defend his or herself against any claims to liability, we agree with commenters that asserted that the regulations should not require that prospective landowners (or grantees) provide information collected to comply with the “additional inquiries” provisions to the environmental professional. Should the required information not be provided to the environmental professional, the environmental professional should assess the impact that the lack of such information may have on his or her ability to render an opinion with regard to conditions indicative of releases or threatened releases of hazardous substances on, at, in or to the property. If the lack of information does impact the ability of the environmental professional to render an opinion with regard to the environmental conditions of the property, the environmental professional should note the missing information as a data gap in the written report.” [Emphasis added]

 Beginning on page 66082 of the preamble to the AAI rule in the discussion captioned “H. Who Is Responsible for Conducting the All Appropriate Inquiries?” EPA stated as follows [note we have broken out large block paragraph into smaller paragraphs for ease of reading]:

 “Several commenters asserted that the mandatory nature of the proposed provision requiring the prospective landowner to provide information regarding the four criteria listed above to the environmental professional is problematic. Particularly with regard to the requirement to provide “specialized knowledge or experience of the defendant,” commenters pointed out difficulties in a prospective landowner being able to document such knowledge and experience sufficiently. Also, with regard to the information related to the “relationship of the purchase price to the fair market value of the property, if the property was not contaminated,” many commenters pointed out that prospective landowners may not want to divulge information regarding the price paid for a property. Commenters pointed out that the requirement to consider “commonly known or reasonably ascertainable information” about a property is implicit to all aspects of the all appropriate inquiries requirements. In addition, commenters stated that CERCLA liability lies solely with the owners and operators of a vessel or property. A decision on the part of a prospective landowner to not furnish an environmental professional with certain information related to any of the statutory criteria can only affect the property owner’s ability to claim a liability protection provided under the statute. In addition, the statute does not mandate that information deemed to be the responsibility of the prospective landowner and not part of the “inquiry of the environment professional” be provided to the environmental professional or even be part of the inquiry of the environmental professional. Some of the statutory criteria are inherently the responsibility of the prospective landowner.

We agree with the commenters who asserted that the results and  information related to the criteria identified as being the responsibility of the prospective landowner should not, as a matter of law, have to be provided to the environmental professional. The statute does not mandate that a prospective landowner provide all information to an environmental professional. Given that the burden of potential CERCLA liability ultimately falls upon the property owner or operator, a prospective landowner’s decision not to provide the results of an inquiry or related information to an environmental professional he or she hired to undertake other aspects of the all appropriate inquiries investigation can only affect the liability of the property owner.

In addition, we believe that the environmental professional may be able to develop an opinion with regard to conditions indicative of releases or threatened releases on, at, in, or to a property based upon the results of the criteria identified to be part of the “inquiry of an environmental professional.” Any information not furnished to the environmental professional by the prospective landowner that may affect the environmental professional’s ability to render such an opinion may be identified by the environmental professional as a “data gap.”

The provisions of the final rule (as did the proposed rule) then require that the environmental professional comment on the significance of the data gap or missing information on his or her ability to render such an opinion, in light of all other information collected and all other data sources consulted.

As a result of our consideration of the issues raised by commenters, today’s final rule modifies the requirements of Sec. 312.22 “additional inquiries” by stating (in paragraph (a)) that “persons * * * may provide the information associated with such inquiries [i.e., the information for which the prospective landowner or brownfields grantee is responsible] to the environmental professional * * *.” The proposed rule provided that such information “must be provided” to the environmental professional.” [Emphasis Added]

AAI is a performance-based regulation. Failure to provide the information in 40 CFR 312.22 does not cause a prospective purchaser or party seeking the landowner liability protection to automatically lose its liability protection. The user may lose its ability to claim the protections IF the absence of that information prevents the EP from reaching a conclusion about the presence or absence of RECs or a release.  At the end of the day, the EP has to decide if the failure to respond certain information is a significant data gap that prevents the EP from rendering a conclusion if there is a release (or REC).  

The questionnaire is just the starting point for the due diligence since the environmental consultant will perform its own site inspection and historical records review. It will be a rare occasion when a purchaser or lender will have material information about the property that the consultant will not be able to obtain or that will result in a data gap that will prevent the consultant from determining if there is a recognized environmental condition (REC) on the property. The absence of an uncompleted questionnaire will not be significant in the overwhelming number of transactions where the client is a purchaser or lender. If the consultant still feels obligated to identify failure to prepare the questionnaire as data gap in such a situation, the consultant should be required to indicate that the data gap is not significant and does not alter the conclusions of the report.

50% of BCP Projects Fail to Obtain COCs in 2014

December 10th, 2014

Earlier this year, we reported that the New York State Department of Environmental Conservation (NYSDEC) was expecting to issue a record number of Certificates of Completion (COCs) under the Brownfield Cleanup Program (BCP) in 2014. Based on anticipated project completion dates provided by applicants, NYSDEC projected that it could issue as many as 92 BCP COCs by year end. However, by the start of the summer, the estimated number of COCs had dropped to 80. Now, it appears that the agency will issue less than 40 COCs by year end-a 50% attrition rate.

This is the second consecutive year that there has been a dramatic falloff in projected BCP COCs. In 2013, only one third of the projects were able to obtain COCs. It is unclear if the original COC estimate was based unrealistic or overly aggressive expectations of applicants seeking to secure the tax credits because of the uncertainty over whether the BCP tax credits will be extended, or if the attrition is due to the documentation problems we discussed in a prior postAs we discussed,  BCP applicants really do earn their tax credits because the BCP has robust procedures  that require comprehensive investigations,  high quality cleanups and  significant public participation outreach.  

The projects that were unable to obtain COCs in 2014 will now join the 90 or so projects that were already planning on receiving COCs in 2015.  It looks like NYSDEC is going to be very busy in the coming year.

Does A Phase 1 Have To Be Issued To The Person Seeking To Comply With AAI?

December 10th, 2014

Purchasers who want to be able to assert the CERCLA Bona Fide Prospective Purchaser (BFPP), Innocent Landowner (ILO) or Continuous Property Owner (CPO) landowner liability protections (LLPs) need to conduct a pre-acquisition investigation that complies with EPA’s All Appropriate Inquires (AAI) rule. A question that is surfacing with surprising frequency is if the phase 1 report needs to be issued or assigned to the person seeking to comply with AAI. The short answer is no.

This issue often arises when a local government or local redevelopment agencies conducts a phase 1 using federal or state brownfield funds on property that will be AAIs for a site will be developed by  a private developer. Another example may where a state government agency conducts a phase 1 either for another agency or local government where the local government that does not have access to appropriate staff or capital resources to do the work.

This scenario also occurs in private transactions where an entity that ordered the report is unable to proceed with the transaction. There are many ways this situation can unfold but the more common scenario usually involves the party that originally ordered the phase 1 assigns its rights under a purchase agreement to a related entity (i.e. common principal) who eventually purchases the transaction but failed to ask the consultant to re-issue the report to the purchaser prior to the closing. it failed to obtain a reliance letter from the consultant that prepared the report and is not named in the reliance section of the Phase I report purchaser wants to argue that it satisfied AAI since one of its principals obtained a Phase I pre-purchase, completed the User Questionnaire pre-purchase, and conducted all of the “user” or additional inquires” required by AAI before the purchaser acquired the site. Sometimes the seller ordered the phase 1 to pre-position the property, the deal falls through and the seller provides the phase to a new purchaser. Other times, this situation also occurs because truncated diligence periods or auction sales where purchasers have to rely on materials provided sellers.

Based on the preamble that appeared in the federal register when EPA published the AAI rule, a purchaser may indeed use a report that was not expressly issued to it and does not have a reliance letter from the consultant for purposes of complying with AAI PROVIDED the underlying report satisfies AAI AND the purchaser otherwise complies with the user “additional inquiries”.  We will pull apart these various elements.

In the preamble to the AAI rule, EPA said EPA that:

” all appropriate inquiries investigations may be conducted by or for one party and used by another party. In all cases, the all appropriate inquiries investigation must be updated to include commonly known and reasonably ascertainable information and any relevant specialized knowledge held by the prospective landowner and environmental professional. In addition, the evaluation of the relationship between the purchase price and the fair market value of the property must reflect the current sale of the property. In all other aspects of the investigation, the all appropriate inquiries must be in compliance with the provisions of the final regulation. ” [70 FR 66085 (November 1, 2005)]

The underlying report must also have been complete its environmental site assessment within 180 days prior to the date of acquisition of the property. If the report is older than six months, it must be updated to ensure that the report accurately reflects the current environmental conditions at a property:

  • Interviews with past and present owners, operators, and occupants; 
  • Searches for recorded environmental cleanup liens;
  • Reviews of federal, tribal, state, and local government records; 
  • Visual inspections of the facility and of adjoining properties;  and 
  • The declaration by the environmental professional within one year of taking title to the property.

Finally, EPA cautioned in the preamble that the prospective owner or grantee desiring to use the report prepared for another party cannot wholly adopt the previously conducted AAI but must comply with the following “additional inquiries” that are the responsibility of the user. (70 FR  66084)

  • commonly known and reasonably ascertainable information,
  • relevant specialized knowledge held by the prospective landowner and the environmental professional, and
  • the relationship of the purchase price to the value of the property

To maximize the chances of establish that it complied with AI, the purchaser should document that it complied with the “additional inquiries” in its property file. One way to do this is to complete a questionnaire answering these questions.

Note that the ability to use a report issued for another party for purposes of complying with AAI is a separate and distinct question of whether the party has contractual right to RELY on the report for purposes of breach of contract or malpractice claims.

In general, a contract may be enforced by the parties to the agreement and third parties who are an intended beneficiary of the contract. However, there are often critical non-contracting parties to a transaction such as lenders or landlords who may insist on reviewing the reports. Because most real transactions are financed and the loans are often syndicated or securitized, lenders will often require consultants to extend reliance to broad categories of investors or purchasers of the loans. Those so-called reliance parties would then have standing to bring a breach of contract action subject to the terms and conditions of the underlying agreement. The consultant should identify the parties who may rely on the reports and also place limits on how long those parties may use the information in the reports.

In a professional malpractice action, the question is framed in terms who the consultant owed a duty to and did it breach that duty. This question frequently arises when the consultant is retained by the lender and the borrower/purchaser later wants to file a lawsuit against the consultant for failing to identify contamination. Courts will typically look to contract reliance language in determining who was owed a duty or if it would have been foreseeable to the consultant that such a person who have relied on the phase 1 report.

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.

CMBS

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