Archive for the ‘Lender Liability’ Category

JP Morgan Chase Actually Acquired “Toxic” Assets During the Great Recession

Sunday, March 4th, 2018

During the Great Recessions, the term “toxic assets” became a cliché. It was used to describe loans and other financial instruments that had fallen significantly and for which there is no longer a functioning market. The presence of these so-called toxic assets on their balance sheets caused many banks to fail.

As it turned out, JPMC actually acquired some toxic assets in the more traditional sense when it purchased the acquired the insolvent Washington Mutual Bank (WMB). As a result of this transaction, the bank eventually entered into a series of consent orders with United States and the California Department of Toxic Substances Control (DTSC) to resolve the liability of WMB and various predecessors involving the former BKK Sanitary Landfill Site  in West Covina, California. Under the consent order JPMC agreed to pay $27 million to the DTSC for its past response costs and remaining $58 million to the PRP steering committee. In addition, JPMC paid DTSC $1 million for attorney fees and other costs incurred related to the Consent Decree. In the federal consent agreement, JPMC agreed t pay to EPA  $1MM for past response costs.

The story began back in 1959 when Home Savings of America FSB (“Home Savings”) purchased land in West Covina, California. In 1963, Home Savings leased a portion of the landfill to BKK Corp., which developed and operated the a landfill that accepted both solid waste and hazardous wastes. Around 1973, Home Savings transferred title to the BKK Facility to a subsidiary, Oxford Investment Corp. (“Oxford”) which held title until approximately 1977 when BKK Corp. exercised a lease option to acquire title to the facility.

In 1995, Oxford became a direct subsidiary of H.F. Ahmanson & Company, the parent corporation of Home Savings. Oxford was subsequently renamed Ahmanson Developments Inc.  In 1998, H.F. Ahmanson &c Company merged into Washington Mutual Inc (WMI), which was the parent corporation of WMB. As part of that transaction, Home Savings merged into WMB, and Ahmanson Developments Inc., became a direct subsidiary of WMI.

In 2004, NAMCO Securities Corp., a subsidiary of WMB, loaned BKK Corp. money to assist BKK Corp. with maintaining its post-foreclosure financial assurance. However, BKK Corp. notified DTSC later that year that it could no longer perform its post-closure obligations for the closed hazardous waste landfill or operate the Leachate Treatment Plant.

DTSC was forced to retain a contractor to conduct emergency response activities at the BKK Facility. The agency then issued an Imminent and Substantial Endangerment Determination and Order and Remedial Action Order (ISE Order) to BKK Corp. and approximately fifty (50) other parties including WMB.

DTSC subsequently entered into a series of administrative settlement agreements with some of the PRPs named in the ISE Order. WMB was one of the settling respondents. DTSC later filed an action for cost recovery against 25 PRPs including WMB which resulted in a consent order that required the settling defendants to undertake various actions regarding the BKK site and to reimburse DTSC for certain costs it had incurred or would incur in the future related to the Subject Property.

After the Office of Thrift Supervision closed WMB and appointed FDIC as the receiver, WMI and WMI Investment Corp. commenced a chapter 11 petition. DTSC, the PRP steering committee and certain of its members filed proofs of claim in the WMB Receivership alleging that WMB and its subsidiaries or affiliates were liable for response costs and other damages associated with the BKK Facility. These claims were disallowed.

In 2012, the Bankruptcy Court approved a settlement agreement whereby the settling parties agreed, among other things, that JPMC would fund the obligations of the WMI Entities for Response Costs associated with the BKK Facility and act as their agent for certain insurance policies. Interestingly, the settlement agreement provided that the automatic stay would be lifted to the limited extent required to determine WMI’s liability for response costs related to the BKK Facility.

The Schnapf Environmental Journal that was published from 1998 to 2008 and is available from the newsletter page of this website discussed a number of instances where lenders incurred environmental liability as a result of acquisitions. For example, the 2002 September issue discussed Citibank’s liability for the Shattuck Chemical Company. The December 2004  issue covered the listing of a bank branch office to the federal superfund list.

Remedial Program Reform Proposals for EPA Administrator Pruitt

Tuesday, February 28th, 2017

Regulatory reform is at the centerpiece of the Trump Administration’s plan to stimulate economic growth. During the presidential campaign, candidate Trump vowed to rollback a variety of Obama Administration Climate Change Initiatives but said little about EPA remedial programs such as the federal Comprehensive Environmental Response, Compensation and Liability Act (CERCLA or superfund). Based on his testimony and follow-up written response to Congress, it appears that EPA Administrator Scott Pruitt recognizes the value of brownfield programs and the need to remediate contaminated sites. There also seems to be strong bipartisan support for the brownfield program in the House committee responsible for the EPA budget.

As a result, I have shared the following recommendations to Administrator Pruitt for reforming EPA’s remedial programs. These suggestions could improve the efficiency of the remedial programs without weakening environmental protections. Some of the changes could be achieved through legislative amendments but could be administratively implemented if Congress does not have the time to address environmental issues during the current term. The proposals are not in any order of importance

  1. CERCLA Continuing Obligations Guidance– The 2002 amendments to CERCLA added the Bona Fide Prospective Purchaser (BFPP) and Contiguous Property Owner defenses. These defenses (in particular the BFPP defense) were enacted to help incentivize purchasers to acquire and remediate contaminated properties so they can be put back into productive use. While EPA promulgated an all appropriate inquiries (AAI) rule to help define the pre-acquisition obligations necessary to be able to assert these defenses, there is little guidance from EPA on how property owners or operators may satisfy their “appropriate care” or “continuing obligations” so they can maintain their liability protection after taking title or possession of property. The 2003 “Common Elements Guidance” is inadequate. The lack of guidance and recent caselaw have created uncertainty for developers and undermined the value of these defenses. EPA should issue detailed guidance on what constitutes appropriate care. Developers and property owners should not have to rely on ASTM to provide guidance on how to comply with their legal obligations.

2. Revise “Enforcement Discretion Guidance Regarding the Affiliation Language of CERCLA’s Bona Fide Prospective Purchaser and Contiguous Property Owner Liability Protections” – This memo did not sufficiently address concerns raised by the Ashley decision that purchasers of contaminated property could lose their eligibility for the BFPP by agreeing to indemnify sellers. 

3. More Robust Use of PPAs and CPO “Assurance Letters”- With the passage of the 2002 CERCLA amendments, EPA announced in guidance that it would issue PPAs or CPO assurance letters only in rare instances because the landowner liability protections were self-implementing. However, these agreements can be incredibly valuable. EPA should urge its regional offices to issue such documents where they can facilitate redevelopment such as in urban superfund sites (e.g., GowanusCanal, Newtown Creek) and where municipal governments are willing to foreclose on contaminated properties and then convey title to redevelopers. 

4. Clarify Scope of Municipal Liability Protections Under CERCLA to Encourage Taking Title of Vacant Properties and Facilitate Reuse- There is considerable uncertainty among local government community if municipalities can invoke the protections of 42 U.S.C. 9601(20)(D) and (9601(35)(A)(ii) where they take title in lieu of formal tax foreclosure proceeding since this may not be “involuntary”. Local governments might be more willing to take title and assemble vacant properties so they would become more attractive to redevelopment if they could obtain clarity on the scope of this protection. Presumably, a purchaser from a municipality would then be able to assert the BFPP or third party defense. A related problem is that the BFPP defense would not apply to local governments who took title prior to January 11, 2002.

5. Reform EPA Remedial Programs Into a Single Unified Cleanup Program- Our nation’s remedial programs were created as we became aware of new concerns. This has resulted in different cleanup standards and procedures. We have separate staffs for CERCLA, RCRA, TSCA (PCBs), USTs, etc. We now have three decades of experience remediating sites. I think we should strongly consider combining these discrete offices into one streamlined remedial office that will provide consistent regulatory approach and reduce unnecessary staff. 

6. Clarify Lender Obligations Following Foreclosure- The original EPA lender liability rule contained a “bright-line” test for lenders to follow so they can be deemed to have taken commercially reasonable steps to sell property following foreclosure, thereby staying within the safe harbor created by the secured creditor exemption. Unfortunately, when the rule was vacated and the 1996 lender liability amendments were added to CERCLA, the “bright line” test was omitted. So lenders have no guidance on how to proceed during what is the worst economic downturn since the Great Depression. Can they reject an offer that is equal to artificially depressed price? How long can they hold onto property without losing protection? Some states allow for two years while others allow up to five years to sell the property. Greater clarity will help lenders move these properties.If control of Congress changes, this can be legislative proposal.  

7. Encourage States to Adopt Licensed Professional Programs– States are facing severe staffing constraints which are creating backlogs in site remediation.  EPA could use its authority under section 128 of CERCLA (approval of state response programs) as well as its RCRA delegation authority to have states adopt licensed site professional programs like MA, NJ and CT so that states could devote their limited resources to the sites that pose the greatest risk to human health and the environment. EPA could establish a national licensing program for consultants that sets forth minimum professional requirements and states could adopt these programs as part of their remedial programs. One way to accomplish this could be by amending the All Appropriate Inquiries (AAI) Rule to revise the definition of Environmental Professional. This could avoid having to promulgate a new regulation.  

8. Revise NCP- revising the NCP. It was last revised in 1990. Since then we’ve learned a lot about cleanup and have lots of informal guidance to help streamline the process and make it more cost-effective. Doesn’t make sense to continue to follow the RI/FS lockstep process. Why review five alternatives? The NY brownfield program requires applicants tp propose remedy and an unrestricted cleanup alternative, and this approach has been able to generate robust cleanups. The NCP could be revised to incorporate streamlined provisions for brownfield sites that will produce faster and more cost-effective cleanups while preserving right of contribution. Right now, firms are incentivized to follow the lock-step approach to preserve their ability to pursue cost recovery. 

9. Revise CERCLA Disclosure Requirements With Amnesty Program To Incentivize Accelerated Cleanups- Property owners are not currently required to disclose historic contamination. As a result, many sites remain unremediated until the owner is ready to sell the property. To help accelerate cleanups, I think EPA could announce it was going to change its disclosure rules from reportable quantity approach to contaminant concentrations and at the same time provide current property owners a one year amnesty period to voluntarily disclose contamination. Much like the EPA audit policy, owners who disclose the existence of contamination that they are not responsible for would be afforded BFPP status. They would have to exercise “appropriate care” but not full cleanup. The SARA Title III program resulted in substantial reductions in pollution. It seems worth the try to experiment with an amnesty period for contaminated sites. 

10. Seek Cost Recovery from Responsible Parties When Brownfield Grants Are Awarded – According to a 2004 EPA study, there may be 300,000 contaminated sites in the nation that may cost over $200 billion (not adjusted for inflation) to remediate.  Many brownfield sites were created when corporations closed plants and either relocated elsewhere in the country or exported the jobs overseas yet remains financially viable. EPA has been granting brownfield grants to local governments without considering if there is a responsible party.  Before EPA gives away public money, it should make a determination that there are no responsible parties. If responsible parties are available, RPA should give the responsible party an opportunity to conduct an investigation and remediation of the contaminated property is has left behind. If the responsible party declines to participate int he cleanup, EPA could then award the Brownfield grant and seek cost recovery. In this way, the brownfield funding program would not have to rely entirely on Congressional appropriations.

11. Move Away from Brownfield Grants/Loans and To Tax Credits- The brownfield financial incentives are becoming like public works projects. The funding often takes too long for private development. Rather than giving funds to local government to investigate and reuse planning, EPA could incentivize the private market to do this work by expanding and extending brownfield tax credits. The New York Brownfield tax credit program has resulted in an estimated $7.5B in investment in the state at a cost of $750MM. Tax credits put the upfront risk on the developer instead of the taxpayers. 

12.Adopt National Environmental “WARN” Obligations Under RCRA- to prevent future brownfields, companies closing operations should be required to notify relevant permitting authority at least 90 days in advance of closing to ensure that appropriate closure occurs so that public money does not have to be used to address cleanup or local government seeks brownfield funds.

13. Require States To Use Parceling To Encourage RCRA Brownfields- EPA RCRA Brownfield Reforms urged states to allow owners or operators of TSDF to sell off clean parcels of their facilities (e.g., portions never used for any waste management) while the HWMUs or SWMUs were undergoing corrective action. EPA should more forcefully use its delegation authority to allow this much needed reform.  

14. Clarify RCRA liability for Generator-only sites- There is much confusion if closure obligations for a generator site run with the land. In other words, a site may have been owner or operated by a defunct generator. A prospective purchaser is interested in redevelopment but is concerned it will become subject to closure obligations for the areas where wastes were managed. Presumably, generator sites could be treated as any brownfield site without the need to undergo formal RCRA closure.  

15. Add Landowner Liability Protections to TSCA for PCB Cleanups- Purchasers often take steps to qualify for CERCLA BFPP only to learn after taking title that the property has been impacted with PCBs and they are subject to TSCA cleanup. This might require Congressional action but I do not see any reason why TSCA should not have a BFPP defense. Congress added AAI and BFPP to OPA in 2004 with little controversy.

16. TSCA PCB Reform- The PCB cleanup and disposal rules are a bit RCRA-like, a bit CERCLA-like and not well integrated. The cleanup should also not depend on the original spill concentration but on current concentrations and media. I’d like to see the entire Subpart D to 40 CFR 761 repealed, and disposal of PCB-containing material handled entirely within RCRA via the listed-waste and LDR route. 

17. Adopt Restatement (Third) of Torts Approach to Joint Liability– When CERCLA was enacted, Congress said that liability should be premised on evolving concepts of common law. At the time of its enactment, the Second Restatement was in effect which favored use of joint liability for indivisible harm. However, this was before states began adopting comparative negligence statutes. The Third Restatement states that the law has shifted dramatically from the use of joint liability and that courts should try to find a basis for apportioning liability where there is a reasonable basis. Despite the publication of the Third Restatement in 2000, federal courts continue to cling to the doctrine espoused by the Second Restatement. Recently  an appeals court declined to adopt the suggestion of an amicus brief submitted by The American Tort Reform Association to use the Third Restatement to apportion liability for the Fox River cleanup. My post on this case is at: . The Administration might want to have Congress clarify that CERCLA liability should be based on the Third Restatement or  EPA could issue interpretative guidance that it now considers the Third Restatement to be the governing law for CERCLA liability. This  would reflect the Congressional intent to follow the evolving common law and confirm the direction where the law has moved.

Lender that Sold Contaminated Property Agrees to $1.4MM Settlement

Wednesday, May 6th, 2015

We have previously reported on instances where banks have incurred cleanup costs in connection with properties they have sold.  For some examples, click here, here, here, here and here

The latest installment of this saga involves Bank of America (BOA) which agreed to pay $1.4MM as part of a settlement involving a dry cleaner property that a BOA predecessor owned decades ago. A federal district court approved the settlement in Whitehurst v. Heinl, 2015 U.S. Dist. LEXIS 49147 (N.D.Ca. 4/14/15).

In this case, Charlotte A. Heinl (“Heinl”) operated a Norge Cleaners in Oakland, California from approximately 1965 to 1987. Bank of America, National Trust & Savings Association (“NTSA”) owned the property from approximately 1969 to 1987 and had leased it to Heinl. Bank of America became the successor to NT&SA when BankAmerica Corp. merged with NationsBank in 1998. As part of that merger, Bank of America, NTSA, was renamed Bank of America, NA (BOA).

NTSA sold the property to Richard and Lorraine Whitehurst (“Plaintiffs”) in 1987 for $265,000 pursuant to an “as is” agreement. The Plaintiffs had also been provided with a opportunity to investigate the property prior to the closing and had obtained a 120-day extension. The Property had been part of a larger parcel of real property that NTSA subdivided shortly before it sold the property to the Plaintiffs. The remainder of the parcel is still owned by Bank of America, NA and is potentially impacted by the former dry cleaner.

Sampling conducted September 2007 revealed elevated levels of PCE and its breakdown products in the groundwater. After the California Regional Water Quality Control Board, San Francisco Bay Region (“RWQCB”) sent an information request to the Plaintiffs, they filed a complaint against the Heinl and BOA asserting the defendants were liable under RCRA 7002,  CERCLA and various state common laws claims. The plaintiffs sought an order compelling the defendants to remediate the contamination and sought damages because they had been unable to lease or sell the property due to the presence of the contamination. The bank subsequently filed claims against both Whitehurst and Heinl alleging they were responsible for the contamination.

After several court-sponsored mediations failed to achieve a settlement, the parties reached an agreement on the eve of trial. Under the settlement, the parties agreed to establish a $2MM remediation fund. BOA agreed to contribute $1.4K with $200,000 of that amount representing a contribution from the Plaintiffs Whitehurst in the form of an interest free loan. The plaintiffs will be required to repay the loan within 6 months of receipt of a NFA letter from the RWQCB.  The Fireman’s Fund agreed to tender $600K on behalf of Heinl who passed away during the course of the litigation.

The plaintiffs and BOA entered into Fixed Price Remediation Agreement  with a consultant to implement remedial actions required by the RWQCB. BOA is required under the agreement to designate a Project Manager to supervise the cleanup and handle various administrative tasks associated with the cleanup.

A copy of the order approving the settlement is available from Google Scholar here 


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

Wednesday, 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.

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

Thursday, 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. 

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

Saturday, 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.

Major CMBS Lender Requiring EPs to Perform Site Inspections

Wednesday, 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.  

Problems Emerge with New CREC Definition

Wednesday, June 4th, 2014

After a little more than six months after ASTM issued its new E1527-13 Phase 1 standard practice, problems are emerging over the new definition Controlled Recognized Environmental Condition (CREC) definition. The difficulties are related to the definition itself and differences among state environmental programs.

Before discussing the CREC problems, a little background might be helpful for readers. Prior to 2000, there were only two types of conditions that had to be evaluated in an ASTM Phase 1 report by an environmental consultant: a Recognized Environmental Condition (REC) or a de minimis condition. The term REC does not appear in CERCLA but was developed by ASTM to help consultants distinguish minor spills from those conditions that would be required to be investigated or remediated. If a consultant identified minor spills or releases that did not pose a risk to human health or the environment, and that would not result in enforcement actions if brought to the attention of regulators could be classified as a de minimis condition.

The 2000 revisions to E1527 added the term Historical Recognized Environmental Conditions (HREC) which was intended to be used for sites where contamination was remediated to applicable standards. Instead of labeling the former contamination as a REC, consultants could now identify the former spill as an HREC, confirming that it has been remediated and no longer poses a risk to human health of the environment. The HREC concept was a useful tool since it prevents property from continuing to be stigmatized by the existence of a former release in state or federal databases.

Unfortunately, consultants did not consistently apply the HREC term so that similar situations were classified as HRECs, RECs or de minimis conditions. Some made HREC determinations without verifying the cleanup standard used in the past was still valid and that the remedy (i.e., engineering or institutional controls) was still protective and functioning as designed.  Other consultants identified the continuing presence of residual contamination a REC notwithstanding regulatory approval. This was a significant concern since most cleanups now employ risk-based approaches where some remnant of contamination is allowed to remain so long as institutional or engineering controls are used to prevent unreasonable exposure to the residual contamination.

To promote more consistency in how these remediated RECs were described and presented in phase 1 reports, the ASTM E1527 task group revised the HREC definition and added the new CREC designation. The HREC term was intended to apply to cleanups that had achieved unrestricted residential cleanup standard while the CREC term for cleanups where residual contamination remained and the site was subject to institutional or engineering controls (known as Activity and Use Limitations or “AULs” in ASTM parlance).  As a result, there are now four types of conditions that may be identified in an ASTM E1527 phase 1 report: REC, HREC, CREC, and de minimis conditions.

The task group hoped that creating the CREC term would help alert purchasers if there were controls on future use of the property as well as develop plans for complying with the controls that are in place so that they can satisfy their post-acquisition “continuing obligations” and maintain their liability protections. A CREC will not require further action so long as the “controlled” conditions remain in effect.

As originally drafted, the CREC term would have been limited to circumstances where ECs/ICs were actually created or recorded against the property and the environmental professional would be required to verify that the EC/ICs were properly maintained/recorded. However, the environmental consultant representatives on the task force pushed back on these requirements, arguing they should not be put in the position to determine if a particular control was “enforceable.”  As a result, the final CREC definition selected by the task force group did not require consultants to actually verify that the controls are in place or are properly working. The final definition adopted by ASTM provides that a CREC is:

 “ a recognized environmental condition resulting from a past release of  hazardous substances or petroleum products that has been addressed to the satisfaction of the applicable regulatory authority (for example, as evidenced by the issuance of a no further action letter or equivalent, or meeting risk-based criteria established by regulatory authority), with hazardous substances or petroleum products allowed to remain in place subject to the implementation of required controls (for example, property use restrictions, activity and use limitations, institutional controls, or engineering controls).”  

Many of the lawyers on the legal subcommittee were opposed to the CREC definition. Several well-known and respected lawyers submitted negative comments during the balloting process, asserting that the CREC term added a needless level of complexity and was unnecessary because conditions that had been addressed to the satisfaction of regulators should be considered a “de minimis condition.”  One particularly prescient negative comment stated that the CREC term was inconsistent with the common understanding of the word “control” or “controlled” and was misleading because it implied that residual contamination was under “control” when it fact consultants were not required confirm that controls were actually in place and effective. The task group was also cautioned that term would be problematic in a number of states because of their approach to cleanups.  Despite these warnings, the ASTM task force found these negative comments “non-persuasive.”  

Because ASTM did not limit CRECs to those conditions where formal AULS have been implemented and did not require the consultant to verify if the “control” has been properly implemented and remains effective, the usefulness of CREC and the extent that an owner, lender or their counsel can rely on the designation will depend on the type of CRECs that exists for the property. At one end of the CREC continuum are those sites where enforceable AULs have been recorded against the property such as a deed restriction and the specific cleanup standards has been memorialized in the NFA letter. In such circumstances, then owner, its lender and counsel will be able to determine if “control” has in fact been implemented, can assess if it remains protective and if it continues to be in compliance with current cleanup standards.

At the other end of the spectrum are cleanups that were done without any oversight by the regulator (commonly known as “self-directed” or “at-risk” cleanups) where the developer or property owner implemented a cleanup on its own to avoid regulatory delays. Because the cleanup would not have been completed “the satisfaction of the applicable Regulatory Authority”, this cleanup would not qualify as a CREC and probably have to be identified as a REC subject to post-remedial confirmatory sampling. An exception would be if the cleanup was supervised by a licensed environmental professional in a state with a licensed environmental professional program such as Massachusetts, Connecticut or New Jersey and the licensed professional opines that the cleanup met “risk-based criteria established by regulatory authority”  

The more challenging CRECs will be those within the murky middle of the continuum where a regulator may have signed off on a cleanup without referencing a formal control. Many state regulators have signed off on risk-based cleanups without referencing any AULs, particularly with petroleum-contaminated sites where many state programs rely on natural degradation of petroleum and only require removal of grossly contaminated soils/source materials. There is still petroleum contamination in the ground but no actual “control” in place.  The contamination has been addressed to the satisfaction of the regulator but often times the records are archived or destroyed so the consultant cannot verify the actual levels that were left in the ground.  In such an instance, the note to the CREC definition advises consultants that they can look to the data and infer an implied a control!

In other words, the consultant can assume that if the site was a gas station or a commercial property with a UST, the cleanup was approved by the state on the condition that the property would continue to be used only for commercial purposes. Indeed, ASTM trainers are emphasizing to consultants that AULs are just one indication of a past of a past or present release but not the only evidence that a property may not be used for unrestricted use.  Consultants are also being instructed that if there are no formal AULs, they should look at the data and ask if the “dirt is eatable and the water drinkable”.  How this assumption is helpful to property owners and their lenders remains unclear.

Then there are the situations where regulatory controls may be implemented but human exposures remain because of the potential for vapor intrusion. Some states allow local governments to adopt groundwater ordinances that prohibit the use of groundwater to facilitate cleanups. The groundwater ordinance serves as a “control” that could qualify as a CREC. However, many states do not take into account potential human exposures from vapor intrusion. In such a situation, while the groundwater “control” is in place but human exposure is not controlled. This is particular so in states with dry cleaner trust funds. Most state programs rank sites for funding based solely on impacts to drinking water. If the groundwater is not used, the site will receive a low priority ranking for cleanup. While the property owner waits years for the dry cleaner fund to get around to funding the cleanup, the groundwater plume could be migrating off-site and posing a risk of vapor intrusion to nearby residences.  

For example, there was recent loan transaction involving a shopping center where a plume from a dry cleaner had migrated off-site and was within proximity to single-family residences.  Because the local government had passed a groundwater ordinance, the state issued an NFA letter. However, the soil gas near the residential community was 20 times the EPA residential screening level. In a different state where vapor intrusion is evaluated as part of a cleanup, closure would not have been granted, the dry cleaner plume would have been identified as a REC and the owner additional investigation would have been required to assess the extent of the REC. However, in this state which allowed for pathway elimination by ordinance, closure was granted and the dry cleaner contamination was identified as a CREC with no further investigation recommended even though there was a strong likelihood that human exposures were not “controlled”. In other words, the same condition in a different state would have a different designation even though in both situations human exposures were not controlled. 

In essence, because of the regulatory program of this state, what might have been a REC in another state was transformed into a Business Environmental Risk in the form of a potential toxic tort claim. Fortunately, counsel for both the lender and property owner recognized the potential liability and a pollution legal liability policy was obtained to protect against potential third party claims for bodily injury or property damage. 

Since the  ASTM Task Group declined to follow the prescient warnings of several seasoned environmental transactional attorneys and approved a flawed CREC definition, what are property owners, lenders or counsel to do? E1527-13 does require that CRECs be listed in the findings and conclusions section of a phase 1 report, and consultants are also required to explain their reasoning related to the impact of the CREC on the property. So users of phase 1 reports, particularly purchasers who will need to take comply with their continuing obligations to maintain liability protections (i.e., take reasonable steps to stop continuing releases and prevent exposure to existing releases), should carefully review the discussion of any CREC and be prepared to ask the consultants the following questions:

  • did they review the NFA letter or decision document by the licensed professional concluding that the cleanup met state standards;
  • identify what the cleanup standard was and if it remains in effect or has been changed since the NFA letter or its equivalent was issued;
  • identify the “controls” that it has identified as the basis for concluding the condition is a CREC;
  • have the consultant verify if the “control” has in fact been properly implemented (e.g., recorded in the land records, sub-slab depressurization is properly working, engineering control is properly maintained, etc) and remains protective of human health;
  • if the consultant is inferring a control, provide justification for concluding the control is applicable to the site; and
  • ask the consultant to determine if human exposures such as vapor intrusion are under “control”

If the environmental consultant cannot verify what cleanup standard was used or that it remains the correct standard, this could be viewed as a significant data gap that would have to be verified to be in compliance with AAI. If the consultant believes in its professional judgment that the condition is continuing to pose a risk of human exposure, the condition should be a REC and not a CREC even if regulatory closure has been granted-especially where the consultant is representing a purchaser. Appropriately identifying the condition as a REC early enough in the transaction will enable the parties to further evaluate the issue or negotiate some risk allocation mechanism for the condition.   

Until ASTM takes another look at the definition, owners and possessors of property should be prepared to ask hard questions of the environmental professionals to make sure that they are not lulled into a false sense of comfort only to inadvertently forfeit their liability protections because they failed to comply with “controls” they did not anticipate after they taking title or possession of the property.  

As we discussed in an article, lenders are positioned differently than property owners from a liability standpoint and therefore may have risk tolerances that are different from those who take title to potentially contaminated property.  Since understanding a CREC will likely be vital to maintaining liability protections, purchasers should not simply rely on consultants retained by their lenders but be prepared to retain their own professionals to independently verify the CRECs and their underlying controls.

Finally, do not forget that a CREC only applies to regulatory “controls” (i.e., institutional and engineering controls) and not human exposures. Purchasers should not assume that a CREC means human exposures are safely controlled. The purchaser who fails to have their consultant verify that if human exposures are under control may later learn that they have bought themselves into a toxic tort lawsuit.   

CMBS Special Servicer May Not Recover VI Test Costs Under Environmental Indemnity

Thursday, November 14th, 2013

Earlier this year, we discussed   the federal district ruling in Orix Capital Markets, LLC v Cadlerocks Centennial Drive, LLC, 2013 U.S. Dist. LEXIS 48424 (D. Mass. 4/2/13) where a special servicer was allowed to pursue a guarantor despite the presence of an environmental insurance policy and was awarded over $100K in environmental investigation costs.

This week, a three judge panel of the federal Court of Appeals for the First Circuit reversed the district court ruling on the environmental investigation costs and remanded the award of attorneys fees back to the district court. VFC v. Cadlerocks Centennial Drive, 2013 U.S. App. LEXIS 22816 (1st Cir. 11/12/13). This case should be particularly important to lenders and borrowers in the Commercial Mortgage-Back Security (CMBS) market since the decision interprets the scope of the free-standing environmental indemnity agreements commonly used in those transactions.

As more fully discussed in our prior post, Cadlerocks decided to obtain an environmental insurance policy naming the original Lender as the insured after a phase 1 ordered by the original lender reveal The original Lender conducted a Phase I Environmental Site Assessment (“1999 Phase I”) prior to the closing of the Loan revealed the potential presence of tetrachloroethylene (“PCE”) at the property from a tenant that pre-dated Cadlerocks acquisition of the site.

As part of the loan documentation, Cadlerocks entered into an Indemnity Agreement which provided, inter alia, that Cadle and Cadlerocks (the “Indemnitors”) would indemnify the Lender and its assignees and successors (“Indemnitees”) from:

all . . . costs, . . . demands, . . . expenses” and other liabilities “of any kind or nature whatsoever . . . sought from or asserted against Indemnitees in connection with, in whole or in part, directly or indirectly, . . . the presence, suspected presence,  release, suspected release, or threat of release of any Hazardous Material” on or around the Property.

The Indemnity Agreement further stated that applied to seven particular categories of liability including:  “the cost required to take necessary precautions to protect against the release of any Hazardous Materials in, on, or under the Property, the air, any ground water, waterway or body of water, any public domain or any surrounding areas to the Property.”

The original lender assigned the loan to a securitization trust in August 2000. Cadlerocks was unable to make the balloon payment when the loan matured in January 2010. Orix Capital Markets, LLC (“Orix”) as special servicer issued a Notice of Default to Cadlerocks who acknowledged the default and entered into a Pre-Negotiation Letter. Cadlerocks continued to make monthly principal and interest payments until August 2010 while the parties discussed the possibility of a loan modification. When these talks proved unsuccessful, Cadlerocks ceased making further payments. Orix then filed a notice of a foreclosure sale.

Cadle offered a “deed-in-lieu” in settlement of the Trust’s claims prior to foreclosure. As part of its routine due diligence during these negotiations, Orix retained an environmental consultant to conduct a new Phase I test (the “2010 Phase I”) which revealed the possible presence of PCE on the Property.  Based on the results of the test, Orix rejected the offer of the deed-in-lieu, postponed the foreclosure sale, and sought the appointment of a receiver. Cadlerocks did not oppose the appointment motion and the district court appointed a Receiver for the Property in December 2010.

Meanwhile, Orix ordered a Phase II, consisting of an integrity test of an underground storage tank on the Property and a soil vapor investigation of the exterior of the warehouse. The tank passed the integrity test but the soil vapor investigation identified the presence of PCE in the soil outside of the building. The phase 2 recommended indoor air sampling of the warehouse. The sampling was conducted in March 2011 and detected PCE in concentrations of 1.65 micrograms per cubic meter (μg/m³) in the portion of the building occupied by the daycare center.

After Orix notified the Receiver of the results, Receiver immediately authorized a second round of indoor air sampling which revealed PCE in concentrations of 1.16 μg/m³. The Receiver provided the results of the sampling to daycare center along with an analysis by a licensed environmental professional retained by the Receiver which indicated that the PCE concentration were two to five orders of magnitude below available short-term guidelines and did not represent an acute (short-term) risk. The LEP did go on to say that to evaluate the risk of chronic risk, a more thorough investigation was required. The LEP then collected eight-hour samples in June 2011 and twenty-four-hour samples on July 2011. None of the tests showed concentrations of PCE at hazardous levels.

The Receiver sought reimbursement from Cadlerocks for the costs of the 2011 investigation. When Cadlerocks did not respond, the Receiver requested payment from Orix who agreed that the Receiver could draw down on income and sales proceeds generated from the Property that otherwise would have been applied to pay down the debt.

In the fall of 2012, the Receiver authorized an additional round of indoor air sampling as well as soil and groundwater sampling to facilitate a possible sale of the property. However, the purchaser declined to pursue the sale.

The federal district court partially granted a motion for summary judgment by Orix. The ruled that Orix was entitled to recover the $102,536 under the Indemnity Agreement for its environmental investigation costs, finding that  the costs were reasonable and necessary since the Receivers needed to ensure that conditions were safe for the occupants of the day care facility on the premises. However, the court did not allow Orix to recover the costs of the 2010 phase 1 because Orix ordered phase 1 reports in connection with its standard pre-foreclosure due diligence situations and not in response to suspected environmental conditions. In a separate order, the court awarded Orix $50,000 in attorney’s fees and $5,609.75 in costs.

Cadle and Cadlerocks appealed the award of expenses related to the environmental testing. During the appeal, Orix assigned the Loan and Judgment to VFC. However, we continue to refer to Orix since because Orix was the loan servicer during the relevant time period.

The appeals court said that the district court interpreted the Indemnity Agreement too broadly when it ruled the environmental costs were covered as “reasonable and necessary” expenses conducted in response to suspected environmental hazards.

Orix had argued that because the Receiver demanded Orix to pay the costs and expenses related to the environmental investigation, these expenses fell within the Indemnity Agreement.  The appeals court first noted that the Indemnity Agreement only covered liabilities “sought from or asserted against” the Indemnitees. Thus, only those costs Receiver sought to recover from Orix after March 23, 2011 were potentially covered by the Indemnity Agreement.

The appeals court went on to find that the second sentence of paragraph four (beginning “Such Liabilities shall include . . .”) functioned as a limitation on the much broader preceding sentence. In addition, subclause (iv) of the second sentence limited the indemnity obligation to “the cost required to take necessary precautions to protect against the release of any Hazardous Materials” in or around the Property. The court said it must determine if the Receiver’s expenses fall within the enumerated categories of liability listed in the second sentence.

The Indemnitors argued that the environmental tests were not necessary, because “there was never a recognized immediate threat to public health at the Property.” Orix asserted that Cadlerocks and Cadle should be liable long as the tests were at least indirectly related to the suspected presence of a hazardous material. The court noted found that the test results that Orix gave to the Receiver on March 23, 2011 indicated a detectible presence of PCE already in the air but at a level unlikely to pose a health threat to the building’s occupants and that the PCE levels declined slightly in the second round of sampling. Because there was no evidence that a hazardous level of PCE was likely to be released into the air, the court found that the Receiver costs were not incurred to take steps to prevent such a release.  Instead, the court found that the testimony and exhibits all indicated that the purpose of the Receiver’s additional testing was to confirm that the known presence of PCE in the air was at concentrations that were safe for the daycare center and to facilitate the foreclosure sale.

The court there was no doubt that the Receiver acted reasonably and that the tests were undoubtedly necessary for Orix and the Receiver to ensure that the Property was free from harmful contaminants before selling it. However, the court concluded that Indemnity Agreement allocated liability for costs “necessary precautions to protect against the release of any Hazardous Materials”  and not for tests to confirm the safety of tenants or attracting buyers in a foreclosure sale. Accordingly, the court held that the Receiver’s environmental testing costs fell outside of the scope of the Agreement.

More Prominent Role for Environmental Risk Management in Revised OCC Handbook

Tuesday, September 3rd, 2013

The Office of the Comptroller of the Currency (OCC) has been updating its Comptroller’s Handbook to reflect changes to supervisory policy as well as to implement the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010. The Comptroller’s Handbook is a collection of booklets divided into five handbook series that contain OCC procedures for the examination of national banks, federal savings associations, and federal branches and agencies of foreign banks.

In August, the OCC  issued a revised “Commercial Real Estate Lending” (CREL) Handbook booklet which  replaces the “Commercial Real Estate and Construction Lending” booklet issued in 1995 and the OCC Advisory Letter 2003-7 “Guidelines for Real Estate Lending Policies” (August 8, 2003). The CREL booklet is located in the “Assets Quality” tab of the “Safety and Soundness” handbook series.

Banks are required to comply with the “Real Estate Lending Standards” set forth in subpart D of 12 CFR 34 (national banks) or 12 CFR 160.101 (federal savings associations). This rule requires banks to adopt written real estate lending policies that are consistent with safe and sound banking practices. It applies to all extensions of credit that are secured by liens on or interests in real estate. It also includes loans made for the purpose of financing the construction of a building or other improvements whether or not secured by real estate. Examiners will review the bank policies and practices to determine if the bank’s real estate lending program satisfies with the rule, is consistent with safe and sound banking practices, and reflects an appropriate consideration of the “Interagency Guidelines for Real Estate Lending Policies” contained in appendix A to subpart D of part 34 (national banks) and the appendix to 12 CFR 160.101 (federal savings associations).

Loans guaranteed or insured by the federal government, its agencies or backed by the full faith and credit of a state government are exempt from the rule provided that the amount of the guaranty or insurance is at least equal to the portion of the loan that exceeds the applicable LTV limit. Also exempt are loans that are to be sold promptly after origination, without recourse, to a financially responsible third party.

A bank’s real estate lending policies should be appropriate for the bank’s size, the nature and scope of its operations, and should reflect the level of risk that is acceptable to its board of directors. The board of directors must review and approve the bank’s real estate lending policy at least annually.

The 1995 Commercial Real Estate and Construction Lending contained a general statement encompassing a half-page of the Compliance Risk section that banks should have policies or procedures to protect the bank from liability for any environmental hazards associated with real estate that it holds as collateral. The 1995 booklet handbook recommended that a bank should identify environmental risks before funding a loan or offering any type of commitment to lend. If the bank discovered that it held contaminated property as collateral, the 1995 booklet said the bank should monitor the situation for any adverse effects on credit risk as well as take steps to minimize any potential liability to the bank. Finally, the handbook suggested that a bank seek the advice of environmental risk experts if it believes the environmental problems are serious particularly when deciding whether to foreclose on a contaminated property and to help preserve its “innocent landowner” defenses

Environmental risk has been elevated to a more prominent position in the 2013 CREL booklet. The CREL booklet identifies environmental liability as one of five credit risks that effect ability of the borrower to repay its loan. The booklet states that “contamination may decrease the collateral’s value or render the collateral worthless. Furthermore, the cost that may be imposed on a responsible borrower for the remediation of a contaminated property may severely impair the borrower’s ability to repay the loan.

Moreover, the CREL now has a separate environmental risk management topic that extends for three pages. It begins by stating that a bank’s loan policy should establish a program for assessing the potential adverse effect of environmental contamination and ensure appropriate controls to limit the bank’s exposure to environmental liability associated with real estate taken as collateral. For these reasons, the CREL says, a bank should evaluate a borrower’s or tenant’s business activities and any property taken as collateral before funding a loan and before taking title in satisfaction of debt. The CREL further states this evaluation should be commensurate with the risk of loss that collateral contamination or borrower liability poses to the bank.

The section then goes on to explain the scope of the secured creditor exemption but cautions that while exemptions may limit a lender’s direct liability for cleanup, it does not protect the lender from the decline in value due to contamination nor protect a borrower from liability for cleanup that could severely impair its ability to repay the loan. The CREL also states that banks do not need to comply with the AAI rule to qualify for the secured creditor exemption during loan origination, it suggests that an AAI-compliant investigation can be useful in assessing of a property’s environmental condition, the potential liability for a borrower, and disposition strategies upon foreclosure.

OCC says an appropriate environmental risk management program should reflect the level and nature of the bank’s real estate lending activities, its risk profile, and consideration of applicable environmental laws. The program should be reviewed and approved with its lending policies annually by the bank’s board of directors or a designated committee of the board.

The CREL then describes specific components that should be contained in an effective environmental risk management program. To satisfy the CREL standards, a bank should:

  • develop policies and procedures that reflect potential environmental risks associated with lending in markets and to industries served by the bank. The procedures should clearly specify the bank’s requirements for determining potential environmental concerns. For example, procedures should include guidelines that the lending staff should follow in conducting an initial analysis of potential environmental impact and when a more detailed environmental assessment should be conducted by a qualified professional.
  • provide environmental risk assessment reports be reviewed before a bank issues its final loan commitment.
  • establish procedures for assessing environmental concerns associated with assets before acquisition by the bank in workout or foreclosures as well as the bank’s investment in real estate assets for its own use.
  • ensure that qualified persons evaluate the environmental risk possess and specify selection criteria to evaluate and monitor the performance of third-party professionals, such as environmental experts or legal counsel, who may be consulted to assess environmental risk.
  • provide guidelines that the lending staff should follow for monitoring potential environmental concerns for the duration of loans held in the bank’s loan portfolio. These guidelines should focus on changes in business activities that might result in an increased risk of environmental contamination associated with the property, thus adversely affecting the value of the collateral.
  • maintain guidelines for loan documentation to protect the bank from  environmental liability such as ensuring rights of access to perform AAI-compliant investigations.
  • The bank’s policies and procedures should reflect adequate consideration of the EPA’s AAI rule.

OCC stats that the environmental risk management should incorporate certain key elements, including;

  • an analysis of current environmental laws and due diligence requirements for borrowers and the bank.
  • a level of due diligence internally required in all real estate loan transactions.
  • risk thresholds based on property type, use and loan amount for determining when and what type of due diligence is required.
  • varying due diligence methods depending on the type of loan, the amount of the loan and the risk category, including borrower questionnaire or screening, site visit, government records review, historical records review, testing or inspections using qualified professionals.
  • the potential for significant impact resulting from the presence of hazardous building material such as asbestos and lead-based paint.
  • appraisal requirements for disclosing and taking into consideration any environmental risk factors.
  • criteria for evaluating environmental risk factors and costs in the loan approval process.
  • criteria for determining the circumstances in which the bank would normally decline loan requests based on environmental factors.
  • collateral monitoring and periodic inspection requirements throughout the loan term for properties with higher environmental risk.
  • procedures of evaluating potential environmental liability risk and environmental factors that could impact the ability to recover loan funds in the event of a foreclosure.
  • guidelines for maintaining the secured creditor exemptions and for qualifying for CERCLA defenses including the landowner liability protections if the bank acquires ownership of the property.

OCC also states that loan documentation should contain certain environmental provisions. For example, commitment letters should set forth the extent of due diligence required, borrower costs, approval contingencies, reporting obligations, documentation requirements, etc. The loan documents should contain representations and warranties, inspection requirements, reporting requirements, lien covenants, indemnification provisions, and provisions allowing for the acceleration of the loan, refusal to extend funds under a line of credit, or exercise other remedies in the event of foreclosure.

For the most part, the 2013 CREL booklet reflects the core elements of the environmental risk policies that have been adopted by the more sophisticated financial institutions. Perhaps the most notable provision is that the risk management policy should provide that real estate appraisals take into account impacts from contamination. This requirement may require a change in the instructions that banks provide to appraisers when making valuation assignments.

Under its Guide Note 6 “Consideration of Hazardous Substances in the Appraisal Process” to the Uniform Standards of Professional Appraisal Practice (USPAP), the Appraisal Institute recommends that appraisers should issue a disclaimer or limiting condition to the effect that the appraisal is predicated on the assumption that hazardous substances do not exist when there are no known or suspected hazardous substances associated with the property.

However, where the appraiser discovers reason to believe there may be hazardous substances associated with the property, USPAP recommends that the appraiser should immediately notify the client to address the situation. According to the Guide Note 6, the appraiser may develop a value opinion for the property that excludes the consideration of known hazardous substances. Such an appraisal would be based on a hypothetical condition that the property is not impacted by known hazardous substances (“as if” unimpaired).

Finally, the USPAP Guide Note cautions that when the appraiser is asked to develop a valuation based the presence of contamination, the value of a property impacted by hazardous substances may not be measurable simply by deducting the typical remediation cost, or discovery cost from the total value, as if “clean.” The possibility of other changes affecting value, such as a change in highest and best use, marketability, and stigma, should be considered.  the appraiser must correctly employ those recognized methods and techniques that are necessary to produce a credible appraisal

It should be noted that the USPAP Guide Note 6 also indicated that if the appraiser is provided with a Phase I, Phase II, or Phase III report that indicates the possibility of contamination, the appraiser should note this information with the amount of further investigation that is required by customary business practice as well as necessary to establish the “innocent purchaser” defense.

Advisory Opinion 9 “The Appraisal of Real Property That May Be Impacted by Environmental Contamination (AO-9) issued by The Appraisal Standards Board (ASB) of the Appraisal Foundation states that an appraisal that includes the effects of environmental contamination on its value usually requires data that is not typically used in an appraisal of an otherwise similar but uncontaminated property or an appraisal of a potentially impacted property using either a hypothetical condition or an extraordinary assumption that it is uncontaminated. AO-9 states that relevant factors that might have to be considered would be if the contamination discharge was accidental or permitted, regulatory compliance status of the property, the remediation lifecycle stage when the appraisal is conducted, the type of contamination constituents (petroleum hydrocarbons, chlorinated solvents, etc), the media impacted, if the property is the source of the contamination, the cost and timing of any remediation, potential limitations on the property use based on the approved remedy and potential or actual off-site impacts. In developing a valuation, the ASB states that the appraiser consult with environmental experts as well as appropriate regulatory authorities to confirm the presence or absence of contamination.

AO-9 states that in some assignments, the appraiser may be asked to appraise a property known to be contaminated under the hypothetical condition that the real estate is free of contamination. In other situations, AO-9 states the appraiser may be asked to appraise a property believed to be free of contamination or when the environmental status is uncertain due to the lack of information or conflicting information. For these assignments, AO-0 states that the property may be appraised under the extraordinary assumption concerning assumed factual information about its environmental condition and status.

It appears that use of an “as if” valuation based on a “hypothetical condition” or “extraordinary assumption” would not comply with 2013 CREL. Thus, banks may need to provide copies of phase 1 and other environmental report to their appraisers to ensure that the valuation will be based on the “as -is” condition of the property with full consideration of the effects of environmental contamination.