Buyer Relies on Seller/Lender Phase 1 To Detriment

We have previously discussed why borrowers and purchasers should independently evaluate environmental conditions at their properties and simply rely on phase 1 reports prepared by their lenders or sellers.  Click Here. Borrowers typically believe that a site is “clean” if a bank determines that a Phase 1 is acceptable. However, what many purchasers or do not realize is that 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. In addition, unsophisticated property owners or potential purchasers often mistakenly believe that a phase 1 is a comprehensive environmental compliance audit and do not understand the limited scope of the standard E1527-05 phase 1 environmental site assessment.

Lack of due diligence or reliance on pre-existing is a frequent problem in smaller transactions. This was illustrated in C.V. Company, LLC v Ben Realty Corp et al, 2009 Misc. LEXIS 3091 (Sup. Ct.-Nassau Cty 11/9/09) where the defendants agreed to purchase a commercial property located in Bay Shore, Long Island In 2003 for $375K. The “as is” contract provided that the defendants had inspected the property, they did not rely on any representations not set forth in the contract, and that they could not rely upon representations made by the seller. After the defendants were unable to obtain financing to purchase the property, the seller/plaintiff agreed to take took back a five-year $ 375K interest-only mortgage. The principals of the purchaser also executed a personal guaranty in favor of the seller.

The defendants did not perform their own due diligence but instead relied on a Phase I Environmental Site Assessment provided by the broker that had been prepared for Greenpoint Savings Bank in connection with the plaintiff’s purchase of the property in 2000. The October 2000 Phase 1 indicated that a gas station had operated at the property from 1968 until the early 1980’s and that a 6,000-gallon UST had been removed in June of 1981. The report concluded that “no additional testing of the property was necessary or even advisable.” The report went on to state that “the subsurface area of and in the immediate vicinity of the subject property contains a highly developed infrastructure which makes the penetration of contaminated ground water or soil  stemming from sites other than those immediately adjacent to the subject properties difficult and, therefore, unlikely. It is therefore the opinion of this Environmental consultant that there is little risk of subsurface soil and/or ground water contamination at this property and that the cost of on-site sampling and analysis to ascertain subsurface soil and groundwater quality are not justified at this time.”

In 2008, the defendants faced an impending balloon payment from the expiring seller mortgage. They tried to refinance but a phase 2 required by a potential lender revealed that the property was contaminated. The defendants failed to tender the balloon payment and the seller/mortgagee filed a lawsuit seeking to recover the balance due under the mortgage note and to enforce the personal guaranty executed by the principals of the company they formed to take title to the property. The defendants filed counterclaims alleging the plaintiff fraudulently sold them a contaminated property.

On the plaintiff’s motion for summary judgment, the court dismissed all of the defendants’ counterclaims and affirmative defenses. On the defendants’ estoppel defense, the court said that even assuming that the plaintiff knew of the contamination and concealed it and even misled the defendants via oral representations, the Phase I clearly alerted the defendants to the possibility of contamination. Therefore, any reliance by the defendants on such alleged representations to the contrary was not justified

On the defendants’ negligent misrepresentation counterclaim, the court noted that phase 1 contained a disclaimer that the report was “limited in budget and scope” and further stated that it “is not and should not be considered a warranty or guarantee about the presence or absence of environmental contaminants which might affect the subject property” Moreover, the court pointed out that the report stated that “The nature of subsurface soil and ground water at the subject property cannot be confirmed, given the limited budget and scope of this Phase I Environmental Survey.”

On the negligent misrepresentation claim, the court ruled that because of the disclaimer language in the Phase I, the fact that the property’s questionable history was openly disclosed in the Phase I and because the Phase I was inconclusive about the property’s condition, the defendants could not have reasonably or justifiably relied on any representations alleged to be made the plaintiff to the contrary.

The court observed that the fact that contamination was detected when samples were collected five years later showed the condition of the property was readily ascertained. Thus, the court said the cause of the defendants’ damages was their failure to fully investigate the property. In the absence of any allegations that the plaintiff thwarted their efforts to conduct their own due diligence, the court dismissed the defendants’ fraud claim.

The court also dismissed the defendants Navigation Law, holding that defendants simply alleged that the plaintiff knew about the contamination but had not asserted that the plaintiff caused or contributed to the petroleum discharge.

The defendants initially appealed the grant of summary judgement and dismissal of their claims. However, the parties subsequently settled the matter and the appeal was withdrawn.

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