NYC OER Issuing Comfort Letters To Facilitate Real Estate Transactions

EPA and some state environmental agencies may occasionally issue “comfort letters” to facilitate a particular brownfield project to assuage concerns of developers or lenders about their potential liability. However, regulators have made it clear that they do not have the resources to review conclusions in phase 1 or phase 2 reports generated during routine real estate or financing transactions.

As a result, property owners and lenders are forced to evaluate recommendations or conclusions about environmental conditions identified during due diligence based on their own risk tolerance. The definition of a “Recognized Environmental Condition” (REC), which is used in phase 1 reports that conform to the ASTM E1527 phase 1 standard, involves a certain level of professional judgment and it is not unusual for a property owner or its counsel to disagree with an environmental consultant if a certain condition rises to the level of a REC. Moreover, environmental consultants often tailor their recommendations to the risk profile of their clients or the structure of a particular transaction. For example, a consultant may recommend additional sampling for one lender who will retain the loan on their books and where the loan is highly-leverage. On the other hand, another lender with a recourse loan that has guaranty from a high net worth individual or well-capitalized entity may not feel it necessary to further define the potential liability associated with the environmental condition.

This subjective approach to environmental risk often causes borrowers to misperceive the risks associated with a property. As we have previously written, borrowers typically believe that a site is “clean” if a bank determines that a Phase 1 or phase 2 is acceptable. However, what many borrowers 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. Because of the secured creditor exemption under CERCLA and most state superfund laws, lenders will not be liable for remediation unless the borrower encounters financial difficulties and the bank either takes over the borrower’s operations or forecloses on the property. As a result, the bank’s liability for environmental conditions is generally limited to the value of the loan.

In contrast, a borrower/property owner will be first in line for any enforcement actions that may result if the land turns out to be contaminated. Indeed, there have been a number of recent cases where borrowers relied on a Phase 1 that was acceptable to its lender only to find out after the borrower acquired title that the site was contaminated

To help reduce this uncertainty and to facilitate redevelopment of contaminated properties, the New York City Office of Environmental Remediation (OER) has the authority and ability to issue two types of letters that can help facilitate real estate transactions or enable lenders to become comfortable with the environmental conditions at a property.

The first type of letter is known as an “acceptance letter”.  This type of letter is particularly useful when a phase 2 identifies contaminants above the standards established by the New York State Department of Environmental Conservation (NYSDEC) but there are not any completed pathways because of the existence of a building foundation, paved surfaces, etc. OER will review phase 2 reports and if it agrees that no further action is required, OER will issue a letter indicating it accepts or agrees with the conclusions of the report.

The second letter is known as a pre-enrollment “comfort letter.” Frequently, when a consultant recommends further sampling or cleanup, lenders may require a borrower to enroll in a voluntary cleanup program prior to the closing and require borrower to covenant to obtain a no further action letter from the appropriate regulatory agency. Unlike other remedial programs, the OER voluntary cleanup program does not accept applicants until after a site has been characterized and documented in a remedial investigation report. Thus, a borrower may not be able to actually enroll in the NYC VCP until after the closing. To provide assurance to a lender, OER will issue a pre-enrollment letter indicating that the borrower is making progress towards acceptance into the OER VCP. OER interprets this sentence very broadly and will write letters to satisfy concern of lenders.