Conducting Cost-Effective Due Diligence:
Top Ten Due Diligence Mistakes

By 

Lawrence P.  Schnapf, Esq. 

Schnapf & Associates

55 E.87th Street #8B
New York, New York 10128
212-996-5395 (phone)
503-213-9314 (fax)
LSchnapf@environmental-law.net (e-mail)
www.environmental-law.net (website)

		Environmental due diligence is playing an increasingly important role in corporate and real estate transactions. Unfortunately, contracting parties often fail to do sufficient environmental due diligence or do not complete it early enough to use the information in the transaction effectively. As a result, parties to a transaction may find themselves saddled with unexpected liabilities. This article will discuss how to tailor a due diligence program to the particular needs of a transaction and how to use the information developed during environmental due diligence in a way that will bring maximum value to the transaction. 

Why Is Environmental Due Diligence Necessary?

	Federal and state environmental laws enacted during the past two decades can impose substantial liabilities on a wide range of entities. For example, under the federal Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA” or “Superfund”) current and former owners or operators of facilities (“owners or operators”) may be held strictly liable for the cleanup of hazardous substances. Cleanup liability can be imposed on owners or operators even when they were not responsible for the contamination. In addition, companies who arranged for the disposal of hazardous substances (“generators”) as well as those entities that transported the wastes (“transporters”) may also be liable for the cleanup of contamination at disposal facilities where the waste was sent. (42 U.S.C. 9607(a)(1)-(4)). These four types of liable parties are known as potentially responsible parties (“PRPs”).   

	CERCLA imposes joint liability on PRPs, which means that a PRP may be held responsible for the entire cost of the cleanup even though there may be other PRPs for a site. Moreover, because CERCLA provides for strict liability an entity may be found responsible for the cleanup of the contamination even when its actions were lawful at the time. 

	Federal courts have broadly construed CERCLA and have expanded the liability of parent corporations and purchasers of corporate assets. Traditionally, state law has governed liability of corporations. A basic tenet of corporate law has been that a corporation is a separate entity from its shareholders who are protected from the liabilities of the corporation by a corporate veil. In order to hold a shareholder liable, plaintiffs have to pierce this corporate veil. To hold a parent liable for the liabilities of its subsidiary, a plaintiff usually had to show that the parent dominated the subsidiary to the point that it had no separate identity and that honoring the corporate form would result in injustice. In order to ensure uniform enforcement of this federal statute, courts have adopted a more liberal federal common law test. However, in United States V. Bestfoods, 118 S. Ct. 1876 (1998), the United States Supreme Court ruled that a parent corporation may be considered a CERCLA  “operator” of a subsidiary’s facility only if the parent exercises actual control over that facility. The focus for “operator” liability is not on the relationship of the parent to the subsidiary but on the relationship between the parent corporation and the individual facility. A parent may also be held liable as an “owner” of the facility under a “piercing the corporate veil” analysis.

	Likewise, the liability for purchasers of corporate assets has been expanded. The traditional rule has been that a purchaser of stock assumes all of the liabilities associated with a corporation but an asset purchaser does not incur liability unless the purchaser assumed those liabilities, the transaction constitutes a defacto merger, the new corporation is a continuation of the old corporation, or there is fraud. Because plaintiffs have had problems imposing liability on successor corporations under these four exceptions, federal courts have established a new test for imposing liability under CERCLA. Under this doctrine known as the Continuity of Enterprise theory, an asset purchaser may be liable for the liabilities of its predecessor if the purchaser merely continues the same business operations. Among the factors courts will examine to determine if a purchaser should be considered a successor corporation will be if the new business retains the same officers, uses the same facilities, makes the same products, and retains most of the workforce. (United States v. Mexico Feed and Seed Co., Inc, 980 F.2d 478 (8th Cir. 1992))  
    
	There are only three statutory defenses to CERCLA liability: Act of War, Act of God, and the Third Party Defense. (42 U.S.C. 9607(b)) The most commonly asserted defense is the third party defense. Under this defense, a defendant must show that the release of hazardous substances must have been SOLELY caused by a third party who was not in a contractual relationship with the defendant. (42 U.S.C. 9607(b)(3). This defense is generally unavailable to purchasers when the seller caused the contamination since the sales agreement would qualify as a contractual relationship. Likewise, landlords have been unable to assert the defense when a tenant caused the contamination since the lease constitutes a “contractual relationship”. Even if a defendant can get past the “contractual relationship” barrier, there are two additional hurdles it must satisfy before it could assert a third party defense. The owner would also have to show that it took reasonable precautions against the acts or omissions of third parties and that it exercised due care regarding the hazardous substances at the property. In other words, the purchaser cannot allow previously deposited drums to deteriorate or allow groundwater contamination to continue to migrate if it wants to be able to assert this defense.

 	Because the third party defense was unavailable to new landowners who did not cause the contamination at a site, Congress enacted the innocent landowner’s defense in 1986. This defense provides that a purchaser will not be considered to be in a “contractual relationship” and thus be able to assert the defense if the purchaser could establish that it did not know or had no reason to know about the contamination. (42 U.S.C. 9601(35)(A)). To establish that it had no reason to know, the purchaser would have to show that it undertook a reasonably appropriate inquiry into the past uses and practices of the property that was consistent with good commercial and customary practices. In reality, this defense has been largely unavailable because most courts have ruled that if the purchaser did not discover the contamination prior to the transaction, it probably did not conduct a sufficient inquiry. 
	Despite their importance, there are no uniform federal due diligence standards. CERCLA provides only that purchasers use "appropriate inquiry into the previous ownership and uses of the property consistent with good commercial or customary practice." In determining whether "all appropriate inquiry" was made, a court is required to examine "any specialized knowledge or experience on the part of the defendant, the relationship of the purchase price to the value of the property in an uncontaminated state, commonly known or reasonably ascertainable information about the property, the obviousness of the presence or likely presence of contamination at the property, and the ability to detect such contamination by appropriate inspection." (42 U.S.C. 9601(35)(B)).

While parties to a transaction usually perform environmental due diligence to preserve the innocent purchaser defense, there are other reasons why companies should perform environmental due diligence. If done properly and early enough in a transaction, environmental due diligence can be used to achieve a wide range of business objectives and bring value to the process.  Properly designed and implemented due diligence can more than pay for itself in terms of liabilities avoided and costs saved. Some of the reasons for performing environmental due diligence include:  

•	A purchaser who wants to assert the third party defense must show it exercised due care regarding hazardous substances at a facility. Unless a purchaser thoroughly examines a site, it may not become aware of contamination and thus may not take the steps necessary to assert the defense successfully. 

•	A purchaser can use the information to “draw a white line” around the facility to show what conditions existed prior to the closing. In this way, the purchaser could not only demonstrate in any future litigation what contamination it knew about but also what contamination was not attributable to its operations.

•	If environmental due diligence is performed early enough in a transaction, the parties can use information to allocate liabilities identified during the investigation, draft indemnities, or perhaps re-price the deal. The information may also be used to obtain environmental insurance that may be used to help allocate environmental liability. 

•	Some states have financial assistance programs that can help pay for contamination associated with underground storage tanks (“USTs”) or dry cleaners. Parties that are aware of these sources of contamination can determine the availability of funding sources and use this information in the contractual allocation of these liabilities.

•	Nearly 70% of corporate acquisitions fail to achieve the business objectives that were anticipated when the purchaser agreed to enter into the transaction. One of the principal reasons for the poor performance is post-acquisition integration. The environmental practices of a seller often differ from those of the purchaser. Pre-acquisition due diligence will help the purchaser identify the probable environmental costs of these changes and plan operational changes that may be necessary. If the business was operated in violation of environmental laws and those violations continue to take place after the purchaser takes over the business, the purchaser may become liable for those violations that take place after the closing. 

•	A purchaser must evaluate the various facilities to be acquired in an effort to understand how the new business will fit into its current structure. The purchaser may find itself with excess production capacity and obsolete plants and will have to develop a plan for streamlining or restructuring operations and closing obsolete plants. Comprehensive pre-acquisition environmental due diligence will help the purchaser understand the environmental implications of these choices and help it avoid or minimize unnecessary environmental costs.

•	EPA and nearly two-dozen states have implemented self-reporting auditing policies under which companies that voluntarily disclose violations discovered during due diligence or an audit can obtain significant reductions in penalties. (See “Incentives for Self-Policing; Discovery, Disclosure, Correction and Prevention of Violations,” 65 F.R. 19618, April 11, 2000)  If a purchaser uncovers violations during its due diligence, it may be able to take advantage of these policies. However, if the EPA or state agencies perform a site inspection after the purchaser takes control of the business and discover violations, the purchaser of the business will no longer be able to take advantage of the penalty reduction policies. One note of caution, however. If environmental site assessments do identify violations and the purchaser does nothing about them, the existence of the violations in the reports can be used by government regulators to allege that the purchaser knowingly violated the law and therefore could be criminally liable. 

•	Similarly, the federal Securities and Exchange Commission (“SEC”) has begun to insist on more comprehensive disclosures of environmental liabilities in the disclosure statements that publicly-traded companies are periodically required to file. A purchaser who conducts comprehensive environmental due diligence can also use this information to assess its SEC disclosure obligations without having to conduct another expensive environmental compliance audit after the acquisition.

•	Partly because SEC rules may require sellers to reflect indemnities on their balance sheets, sellers are increasingly reluctant to provide purchasers with environmental indemnities. Accordingly, it is important that the purchaser understand the liabilities associated with the business so that those risks are adequately reflected in the purchase price or other consideration given in the transaction.  

•	There has been an increase in bodily injury and property damage claims for persons and property exposed to hazardous substances. The parties to a transaction should be aware of the possibility of groundwater contamination migrating off-site or air emissions that could lead to such liability.

•	Environmental audits may also be used by lenders to evaluate the likelihood that a heavily leveraged borrower may be required to fund a cleanup that could render it insolvent. Finally, lenders or purchasers can use environmental audits to screen or exclude properties from the transaction or to identify properties that can be foreclosed.

Mechanics of Performing Environmental Due Diligence

Neither CERCLA nor the EPA's guidance documents interpreting the scope of the innocent purchaser’s defense precisely describes what constitutes an “appropriate” inquiry (See “Announcement and Publication of Final Policy Toward Owners of Property Containing Contaminated Aquifers,” 60 F.R. 34790 (July 3, 1995); Announcement and Publication of Guidance on Agreements With Prospective Purchasers of Contaminated Property and Model Prospective Purchaser Agreement,” 60 F.R. 34792 (July 3, 1995); “Guidance on Landowner Liability Under Section 107(a)(1) of CERCLA, De Minimis Settlements under Section 122(g)(1)(B) of CERCLA, and Settlements with Prospective Purchasers of Contaminated Property,” 54 F.R. 34235 (August 18, 1989)). As a result, this determination is made on a case-by-case basis. The few courts that have addressed the issue have not consistently interpreted the meaning of that phrase and EPA has often taken the position that if an audit failed to detect contamination, it was not an appropriate inquiry. Some of the 40 states that have enacted their own versions of CERCLA have established criteria that must be followed for environmental due diligence but for the most part, parties must develop a program that is tailored to the particular circumstances of the transaction. 

The American Society for Testing and Materials (“ASTM”) published two standards (discussed below) for conducting environmental assessments on commercial real estate that are intended to establish what constitutes "good commercial and customary practice" under CERCLA. The ASTM standards are only designed to satisfy the requirements of the CERCLA innocent purchaser defense though recently adopted changes to the ASTM standards for Phase I Environmental Site Assessments will expand the scope to include “business risks.” The ASTM standards do not address requirements of other federal or state environmental laws. Furthermore, non-CERCLA liability issues such as asbestos-containing materials, lead-based paints, lead in drinking water supplies, or wetlands are not normally covered.

The first step after deciding to perform environmental due diligence should be to assemble and review the existing information on the facilities or properties involved in the transaction as well as any existing reports evaluating environmental conditions. There are also a number of databases that may be used to determine if any of the facilities have been subject to enforcement actions or have been listed on the list of Superfund sites, known as the National Priorities List (“NPL”)(40 C.F.R.300). During this review, the number and location of current and formerly owned and leased facilities and the kind of operations involved at each facility should be evaluated.

After gathering this information, a company should establish the scope of the environmental due diligence. The scope and detail of environmental due diligence will vary significantly from deal to deal because no two transactions are alike. There are a number of factors that can influence the scope of environmental due diligence, and the attorney will have to identify these constraints in determining the scope of the investigation. Factors that must be considered will include:

•	The number and type of facilities to be investigated;
•	The value of the transaction;
•	The time allotted for performing the investigation;
•	The funds available for performing the investigation; and
•	The level of risk that the parties are willing to accept in developing remediation or liability estimates.

Although it is preferable to conduct environmental due diligence on each parcel that will be part of the transaction, parties in multi-parcel transactions may choose to restrict the investigations to a limited number of properties because of cost or time constraints. The sites that are selected will usually be those that are likely to have the worst problems, that have operations within certain SIC numbers, or that represent the most valuable properties. The size of the transaction is also a key factor. Larger deals can absorb greater environmental liability. For example, a $1 million cleanup for a $50 million transaction may not be considered a material liability but a $100,000 liability might prove to be a deal killer for a one million dollar transaction. Because each site may pose its own unique environmental problems depending on its site history and because management practices may vary from plant to plant, extreme caution should be used during the site screening process. 

One way of screening the sites in a multi-parcel transaction is for the purchaser’s attorney or in-house environmental staff to prepare an environmental due diligence questionnaire that will be completed by an engineer or the plant manager of each facility. This document will seek answers to general questions about the environmental practices and operating conditions of each of the facilities. This information gathered from the questionnaire will help to more narrowly focus the scope of work that will be prepared by the environmental consultant hired to perform the environmental due diligence and also help to cut down on some of the work that the consultant may have to do. However, because of time constraints and disclosure issues, this approach is rarely used now. The ASTM Transaction Screen (discussed below) may also be used to identify the properties that should be investigated. 

Another critical aspect of due diligence examinations is gaining access to the site and obtaining information from the facility personnel. Such cooperation will not be forthcoming in a "hostile" takeover. In a "friendly" takeover, the seller, target company, or borrower may be reluctant to share information that may cause a party to back out of a deal or renegotiate the price or that may make government aware of previously unknown operating conditions. This may be particularly so if the operator was engaged in negotiations with the government since the agency may use the pending transaction as leverage for additional concessions.

Another reason why operators may resist divulging information is that if the transaction collapses, the operator may nevertheless be required to report the presence of contamination uncovered during the due diligence investigation. This resistance to divulging information can be softened, though, if the parties enter into a confidentiality agreement that outlines what information will be divulged and how it will be handled.

Retaining the Environmental Consultant

After the scope of the investigation has been determined, the purchaser must determine if the environmental due diligence is to be performed internally or if an outside environmental consultant will be hired. If the decision is made to use an outside environmental consultant, a request for proposal (RFP) may be prepared and sent to a number of consulting firms, inviting them to bid on the project. If the transaction involves a limited number of facilities or the purchaser has had significant experience performing environmental due diligence, a Scope of Work (SOW) may be prepared and forwarded to the bidders in lieu of an RFP.

The RFP will describe the objectives and limitations of the work to be performed and request that bids be submitted by a specific date. If there is inadequate time to solicit bids, the attorney or client may select consultants based on prior experience. If a national environmental consulting firm is being considered, it is important to remember that the level of competence may vary between offices and individuals within offices. Thus, if a consulting firm is being retained because of a previous work association, it is advisable to request the same individuals who worked on the prior transaction. The consultant should not be directly hired by the client but, instead, retained by an attorney so that the opinions or conclusions contained in the consultant's report might be able to be cloaked under a legal privilege. 

Reviewing Environmental Consulting Agreements

Many consulting firms use standard contracts that should be carefully reviewed by the attorney prior to retention of the consultant. In addition to the standard contract terms, the contract should contain a description of the work to be performed, a cost estimate for the project, and a project schedule. 

One of the more important issues involves ownership of all materials that are generated by the consultant. The consulting agreement should provide that all materials, including drafts, drawings, photographs, and field notes, are the property of the client and that the consultant will not release any information obtained in the investigation to any third party without the express written consent of the client. Furthermore, the consultant should agree to destroy any draft reports and field notes at the conclusion of the project.

Consulting agreements frequently request that the client indemnify the consultant for any injuries or losses resulting from site conditions. Since the client will usually not be the party that is in control of the site, the client should not agree to such a provision.

Clients are also often asked to be responsible for obtaining permits or to be responsible for disposal of any hazardous residues generated from laboratory analysis. The consultant should be responsible for obtaining permits, complying with the conditions of such permits, and disposing of any sampling residues.

Another important issue is insurance. It is recommended that the consultant should be required to maintain GCL, professional liability, automobile, workers' compensation, and employer's liability insurance and to add the client as an additional insured under the GCL polity.

Many consulting agreements provide for accrual of interest after 30 days. If the client is a large corporation that cannot generate payments rapidly, it is advisable to request a longer accrual period of 60 to 90 days. The client should also seek the right to terminate the contract for any reason and have the consultant agree not to incur any further charges upon receipt of the termination notice. Many agreements normally provide that the consultant may finish the particular phase of the work following receipt of the termination notice. 

Preparation and Review of the Scope of Work

Before commencing the project, the environmental consultant should prepare a scope of work (SOW) unless the SOW was previously prepared by the client as part of the bid package. This document is probably the most critical document in the due diligence process because it determines how the investigation will be performed. The scope of work will be developed using the information that is already available from the existing company or regulatory records as well as the responses to the questionnaire or transaction screen. 

The scope of work will describe the specific tasks to be performed, the schedule for each task, and a cost estimate for the project. Specifically, this document will indicate the number of facilities to be visited, the priority of the site inspections, the extent and nature of any sampling to be performed, the kinds of substances that will be analyzed, off-site disposal practices, and the kind of regulatory information that will be collected. 

Once the scope of work is approved, the consultant will have to determine its staffing needs. Generally, each site inspection could require two person-days and an additional two person-days will probably be needed for collection of regulatory information. Another couple of days will be required to prepare a draft report, and oversight by management will add another person-day to the project. As a result, a site inspection will typically cost between $5,000 and $7,000 per industrial facility without soil or groundwater sampling. If sampling is required, this could add $10,000 to $20,000 to the cost of each site depending on the number and depth of the wells that have to be installed, the number of soil samples, the kinds of parameters to be analyzed, and the time that the laboratory has to analyze the samples.

Phase I Environmental Site Assessments

	Environmental due diligence is customarily performed in phases since this will be the most cost-effective methodology. Under this approach, each investigative phase is based on the information gathered in the preceding phase. Thus, it is extremely important that each phase be performed as thoroughly as possible. 

The Phase I Environmental Site Assessment (“ESA”) is designed to identify areas of potential soil or groundwater contamination. The Phase I ESA consists of a site inspection and a review of public and private records to ascertain the present and past regulatory and operational history of the site. 

This ESA should include the following:

•	Title Search- Records should be reviewed to reconstruct the chain of title as far back as possible to determine if the property was previously used for on-site generation, storage, or disposal of hazardous materials. This information can be obtained from title abstracts, tax records, subdivision maps, building or land use permits, and interviews with local officials. However, if the owner was not the operator of the site, this process may not reveal prior operating history or uses of the site.

•	Historical Facility Records- Manufacturing or chemical facilities that have been in existence for a long time have probably significantly changed their environmental practices. Areas of a facility that may not appear to pose any current environmental risk may have been used in the past as lagoons, landfills, or disposal areas. If there are areas at a site where hazardous materials were handled or disposed, corrective action may be required in the future. Thus, it is important for the purchaser to review site plans, plats, engineering surveys, blueprints, and aerial or historical photographs which may locate structures, underground storage tanks, PCB transformers or capacitors, floor drains, sewer lines, lagoons, settling ponds, trenches, railroad tracks, areas of hazardous waste storage, and the presence of asbestos. Former employees who may have knowledge about past practices should also be interviewed if they can be located.

•	Regulatory Compliance Records- Businesses subject to environmental regulation are required to maintain a variety of records on the site and are obligated to file reports with state and federal environmental agencies. These will include environmental permits and applications, hazardous waste manifests and notifications, monitoring and discharge reports, spill reports, underground storage tanks registrations, environmental consultant reports and correspondence, notices of violations, consent decrees, financial reports indicating expenditures for pollution control equipment or reserves for environmental liability, insurance policies, records and procedures for compliance with right-to-know, training, and other health and safety requirements of OSHA. When reviewing permits, the examiner should confirm that the transferee is the permit holder and that the permit has not expired. Contacts with regulatory agencies must be handled with extreme care to avoid triggering reporting obligations.

•	Neighboring Properties-Because nearby properties can be a source of contamination and may also be impacted by contamination migrating from a facility, the consultant should observe properties within a one-mile radius and review state and federal database filings within the geographic range.

•	Off-site Disposal Facilities- When purchasing a business it is important to identify the disposal facilities where the company sends and has sent its hazardous wastes to ascertain if it faces any potential CERCLA generator liability.  

When the Phase I report is completed, the consultant should orally review the results of the investigation with the client and the attorney. If time is short, more frequent oral debriefings may take place at set intervals or after the investigation at certain key facilities has been completed.

	Following the oral report, the consultant should prepare a draft report for review by the attorney. One of the most important tasks of the attorney is to make sure that the report is limited as much as possible to factual observations. Conclusions or opinions regarding status of regulatory compliance or speculations on the sources of potential contamination should be deleted. The reason for this is that many clients will not be prepared to address all of the noncompliance issues that may be raised in a report and the existence of such findings in a report could be used by a government agency in any subsequent civil or criminal enforcement action as evidence of willful or deliberate noncompliance with environmental laws. If the attorney makes substantive changes to the draft Phase I report, a revised draft should be forwarded to the attorney and a final Phase I report should not be issued until the attorney approves the revised draft. The final Phase I report should be issued to the attorney.

Phase II Investigation

If the Phase I ESA reveals areas of environmental concern, it is then customary to perform a Phase II ESA, which is a more extensive investigation involving soil sampling, groundwater, and surface water monitoring, and stack emission sampling. The purpose of the Phase II site investigation is to further investigate the areas of potential environmental concern identified in the Phase I ESA. Many times when heavy industrial properties are involved, the parties to a transaction automatically perform a Phase II site investigation.

A second scope of work will be prepared that will generally provide for preliminary subsurface investigation that may include soil or groundwater sampling in areas of suspected contamination. Because many sources of contamination cannot be visually observed, the Phase II subsurface investigation may begin by using noninvasive screening methods such as metal detectors to identify buried metal structures, like storage tanks, as well as a volatile organic analyzer that can "sniff" gases evaporating through the soil from buried storage facilities or plumes of contamination.

If groundwater contamination is suspected, one or more groundwater monitoring wells may be installed. The construction of the wells will depend on the kind of suspected contaminants. If the wells are to be sampled for gasoline or other lighter-than-water liquids, the wells should be built with screens placed at the top of the water table so that the floating contaminants may be collected. However, if the contaminants are believed to be chlorinated solvents or other "sinkers" that settle at the bottom of an aquifer, the wells must be designed to allow sampling from the lower portion of the aquifer.

If groundwater contamination is confirmed, additional wells will have to be installed to define the extent of the contamination and to determine the direction of groundwater flow. The groundwater flow can be particularly important because it may turn out that the contamination is flowing onto the site from an adjacent property.

As with the Phase I report, the environmental consultant should first communicate the results of the investigation orally and then prepare a draft report for review by the attorney.

	Delineating the extent of soil and groundwater contamination can be extremely costly, especially for transactions in the $1 to $10 million range. The sampling and analysis that may have to be performed to understand the material liabilities may make some deals economically unviable. However, performing the work in stages and understanding the regulatory requirements can control the costs of a Phase II investigation. 

American Society for Testing and Materials Standards for Due Diligence

The two ASTM standards for conducting environmental site assessments essentially split the traditional Phase I approach into two separate tasks. The first standard is known as a Transaction Screen (E 1528), which is a limited review that is based on the results of a questionnaire completed by an owner operator of a facility, a cursory site visit based on the responses provided in the questionnaire, and a limited review of government records. The second standard, the Phase I Environmental Site Assessment (E 1527), is a more extensive examination that is similar to the Phase I approach discussed earlier. The Transaction Screen may be a useful device for deciding which sites to investigate in a multi-parcel transaction, but it is at best an issue-identifying device and should not be used in lieu of a full-fledged Phase I investigation.

While the ASTM standards are useful to the extent that they provide the regulated community with consistent definitions, for a number of reasons the standards fail to achieve their objective of creating uniform procedures for performing environmental due diligence.

Perhaps the major flaw of the ASTM standards is that they still determine "appropriate inquiry" on a case-by-case basis. This is because the ASTM attempted to balance the need for obtaining information about commercial properties against the cost and time involved in obtaining this data. As a result, the level of "appropriate inquiry" varies depending on the nature of the transaction and the kinds of properties involved in the transaction.

Furthermore, the ASTM practices continue to give parties to a transaction too much discretion in developing the scope of due diligence. For example, a seller who is not concerned about qualifying as an innocent purchaser may be willing to perform an ESA that will fall below that standard established for "an appropriate inquiry." Accordingly, purchasers should not blindly rely on environmental audits based on the ASTM standards. Instead, these parties should independently review the scope of work to determine if the investigation was adequately designed to assess conditions at a particular site. Undoubtedly, users will want to consider scopes of work that go beyond the ASTM requirements. One of the important changes to the ASTM 1528 standard is the requirement that the Phase I report provide sufficient documentation to allow an independent third party to recreate the process and arrive at the same conclusions. This could eliminate the need to perform duplicative site assessments for Phase I ESAs that are less than a year old. 

Furthermore, both the Transaction Screen and the ESA are only required to identify "recognized environmental conditions." While the definition of this term includes the presence of hazardous substances indicating that a release has or may have occurred in the past, it is not intended to include de minimis conditions that do not present a material risk of harm to public health or the environment and that generally would not result in any enforcement action if brought to the attention of governmental agencies. This definition may not necessarily comport with requirements of various state cleanup and reporting laws. In addition, it is difficult to predict if a particular level of contamination may set off an enforcement action. De minimis concentrations of hazardous substances might trigger enforcement actions if there are environmentally sensitive areas, local drinking water wells, or if the site is located in a residential community. It would be preferable to tie the condition to state cleanup levels.

Another major weakness is the kind of information that owners or operators of facilities are required to disclose. The person answering the Transaction Screen is only required to provide information in their actual possession. Respondents are not required to locate information not in their possession. Likewise, the investigator is not required to conduct an exhaustive search of company records, but simply to review information that is "reasonably ascertainable" or "practically reviewable." Reasonably ascertainable information is data that may be obtained "within reasonable time and cost constraints" while information that is practically reviewable refers to information that does not require extraordinary analysis. The ASTM suggested that records that are sorted or filed according to limited geographic areas would be considered "practically reviewable" while large data bases that are not organized by zip code or other geographic designation would not be considered practically reviewable.

Another illustration of the limited nature of the ASTM standards is that the only source of physical information about the site that the investigator is required to examine is the USGS topographic map. The ASTM leaves other sources that describe groundwater, soils, and geology to the discretion of the investigator.

For past uses of the property, the investigator is only required to describe past uses or conditions that are visually or physically observable during the site reconnaissance or that are identified from reasonably ascertainable records. This leaves a lot of "wiggle" room to parties who are not interested in uncovering information about prior practices at a site.

The recent trend towards selling corporate assets through a bidding process has only heightened the importance of environmental due diligence. Sellers usually provide bidders with a form contract with little or no contractual protection for environmental liabilities, and bidders generally do not have much leverage to negotiate acceptable environmental representations and warranties or indemnities. Under such circumstances, it is imperative that purchasers fully investigate the environmental liabilities associated with the assets and take those liabilities into account when preparing their bid offer.  

On the other hand, sophisticated purchasers may be able to use the due diligence process to their advantage in the bidding process. In the past, most environmental agencies developed cleanup standards based on the assumption that the property would be used for residential uses even if the property was an industrial or commercial site. Now, though, many states have adopted risk-based approaches to cleanups where the cleanup standard is based on the actual use of the property. Under this approach, states may allow higher levels of contamination to remain at a site or not require treatment of groundwater if it is not used for drinking water purposes. This could result in less expensive cleanups. If purchasers develop sufficient information during their due diligence, they may be able to use environmental cost accounting techniques to develop a range of costs estimates with probability analysis and use a discounted cash flow approach instead of estimating reserves. By using a sophisticated environmental cost accounting approach, a bidder may determine that the environmental liabilities may not be as high as anticipated and use the cost savings to increase the bid offer. 

Top Ten Mistakes Committed When Performing Environmental Due Diligence for Corporate Transactions

•	Beware of “Commodity-Style” Reports- The environmental consulting business has become very competitive and many firms are bidding on projects with offers in the $1,500 to $2,000 per site range. Prospective purchasers should be wary of these so-called “commodity-style” site assessments. They generally consist of a desktop records review and a cursory inspection of the premises usually by an inexperienced employee who may not be familiar with industrial operations. The reports may appear to be comprehensive because of thick appendices containing database searches but do not be fooled. The reports are sketchy on substance and highly unreliable. They are also often poorly written and inform the reader only about what the consultant found, not what the consultant failed to consider. Thus, it is difficult to determine if a site investigation was sufficiently comprehensive. Indeed, a recent government study suggested that over 70% of these “commodity-style” Phase I reports failed to discover site contamination.

•	Over-Reliance on Representations and Warranties- Purchasers should not give into the temptation of relying on representations and warranties in lieu of due diligence to save the investigation costs. Representations or warranties should be viewed as a starting point for helping purchasers identify possible environmental issues and shape the due diligence. The nature of the representations and warranties that a seller is willing to give may also provide the purchaser with a sense of management’s attitude towards environmental compliance. 

•	Insufficient Time- Do not expect that environmental due diligence can be performed the day before the closing. Purchasers should give themselves at least a month to adequately investigate the environmental issues associated with a business and more time may be needed for multi-site transactions involving a manufacturing operation. While a Phase I ESA can generally be conducted in two weeks, a Phase II ESA usually takes a month because samples have to be sent to a laboratory for analysis. If a deal is time-pressured, consultants can use field equipment that provides real time data for screening purposes and can request expedited laboratory analysis. However, expedited laboratory turn-around will substantially add to the analytical costs. Purchasers should also try to do as much investigation work as possible when the equipment is available rather than limiting the amount of sampling because of concern over initial sampling costs. If the team and equipment have to return to a site, the re-mobilization costs can be significant. 

•	Historical Information- “Commodity-style” reports often skimp time-consuming and labor-intensive historical investigations since they involve reviewing local records and interviewing local government officials. However, historical information is extremely important for older facilities since they change considerably over time and evidence of past improper disposal may no longer be obvious. 

•	Former Facilities- Do not simply focus on the facilities that the company currently owns or operates. Because courts are increasingly willing to impose liability on successor corporations, it is important to determine what facilities a company may have operated or owned in the past.  It is possible the seller may have contractually assumed environmental liabilities associated with those previous assets, agreed to indemnify prior owners or operators, or may have incurred those liabilities by operation of law. It is not uncommon for courts to rule that contracts executed prior to the enactment of CERCLA nevertheless allocated CERCLA liability. Thus, it is important also to review former contracts transferring the assets or properties in the past.

•	Disposal Facilities- It is also important to identify facilities that the company presently uses to dispose its wastes as well as facilities that may have been used in the past, including those that may have been used by discontinued units or by operations that were sold. Once these facilities have been identified, a data base search should be done to determine if any CERCLA cleanups are likely to be required at those facilities. 

•	Old Audits- Do not rely on audits older than six months since conditions may have changed and the audits may not have been comprehensive. To save costs, a purchaser could consider ordering a rundown from the same consultant to determine if anything at the facility as changed. If so, another audit would be advisable. 

•	Seller’s Audits- For the same reason, it is not advisable to rely on audits provided by a seller. Reliance on due diligence performed by another party is not considered an “appropriate inquiry.” Nevertheless, if a buyer is going to rely on environmental due diligence provided by a seller, the scope of work should be reviewed to make sure that the investigation will cover all of the areas that the buyer wants to be examined. Without reviewing the SOW, it may be hard to determine if a particular environmental issue was not discussed in a report because it was not examined.

•	Estimating Liabilities- Estimate environmental liabilities using actual cleanup standards allowed by the state environmental agency to make sure that they are not over- or under-inflated. When a cleanup escrow is established, the buyer has incentive to make sure that the escrow is used up so a seller should make sure that the most cost-effective cleanup allowable by the state is used. For example, if a state allows residual contamination to remain at a site provided a deed restriction is placed on the property, the cleanup estimate should not be based on the cost of excavating and disposing contaminated soil at an off-site facility.  

•	Bid Data Rooms - Many sellers offering assets in bids want to limit a buyer’s due diligence to the documentation provided in the data room. Buyers should review all documents in the actual or constructive possession of the seller relating to environmental issues, request access to environmental managers, and schedule inspections of the seller’s facilities.

* Larry Schnapf is a New York City-based environmental lawyer whose practice concentrates on environmental issues associated with business and real estate transactions. He is also an adjunct professor at New York Law School where he teaches “Environmental Problems in Business Transactions.” He is also the author of “Environmental Liability: Managing Environmental Risk in Corporate/Real Estate Transactions and Brownfield Redevelopment”. He has an environmental law website at www.environmental-law.net.