NY Case Illustrates Dangers of Completing Environmental Questionnaires

The decision in Revell v Guido, 956 N.Y.S.2d 343 (App. Div-3rd Dept. 2012) is another example of the limits of “as is” contracts when it comes to environmental issues. The doctrine of caveat emptor is still valid in commercial transactions but may not insulate sellers from liability when they make misstatements in environmental questionnaires or engage in activity that courts perceive amount to active concealment.

In this case, the plaintiff was a licensed real estate broker purchased commercial property that contained nine rental homes from the defendant Real Property Solutions, LLC (RPS) in 2005.  The property information sheet prepared by the seller’s real estate stated, “Septic system totally new leach field totally replaced — new 5000 gallon holding tank.” The information sheet also contained a general qualification that “all information deemed reliable but not guaranteed.” The purchase agreement provided that the buildings on the premises were sold “as is”. The agreement also contained a “Septic System Contingency” which stated that the agreement was contingent on a timely test of the septic system. The plaintiff elected not to test the septic system inspected, thus waiving the contingency.

As it turned out, the defendants were notified of code violations associated with the septic system and was advised that that the defective septic system had to be replaced. Defendants retained a certified by a licensed engineer to install a new septic system which essentially amounted to an upgrade of the existing system by adding two 2,000 gallon septic tanks. In June 2004, the defendants were advised that the upgraded system was not functioning properly and that there were pools of sewage on the ground surface.

The defendants then entered into a consent order with the NYSDEC where they paid a fine and were required to submit a design to NYSDEC for approval. The proposed modified system- designed by the same engineer- incorporated the two septic tanks installed in 2003 but added a raised bed leach field. NYSDEC also required the use of infiltrators instead of pipe and stone. While the system was installed, the engineer never certified the modified 2004 system.

In connection with the 2005 transaction, the plaintiff’s bank required the completion of an environmental questionnaire. Defendant Joseph Guido on behalf of RPS indicated he had no knowledge of any past violations of environmental laws, that there were no prior environmental site assessment that revealed contamination or the need for further assessment. While the contract was pending, the engineer who designed the septic system sent a letter to the Guido discussing concerns about the septic system but Guido did not respond to the engineer or inform the purchasers of any issues. Within a month of the closing, the septic system failed again, requiring plaintiff to remedy the problems at their own expense.

The plaintiff filed a lawsuit alleging that RPS and Guido had fraudulently misrepresented the condition of the property. The plaintiff asserted it had relied upon the statements in the bank questionnaire that the septic system was “totally new” in purchasing the property without a septic inspection. The trial court denied the defendants’ motion to dismiss the complaint and granted plaintiff’s motion on the fraudulent misrepresentation claim. The court also ruled that corporate veil of RPS could be pierced to impose personal liability on Guido.

On appeal, Guido claimed his misstatements on the questionnaire were mistakes because he believed the questions pertained only to the current condition of the property. Guido also argued the plaintiff could not have reasonably relied on those statements since the plaintiff failed to exercise its contractual right to inspect the septic system or to independently search public records to discover the environmental history of the septic system.

The appeals court said that while New York traditionally follows caveat emptor in commercial real estate transactions, a seller may be liable for failing to disclose information if the conduct constitutes active concealment. Since the defendant admitted the falsity of the statement made in the bank questionnaire and plaintiff asserted it had relied upon those statements, the appeals court said the trial court had properly denied the motion to dismiss the complaint.

The court found that the plaintiff’s failure to exercise its rights to inspect the septic system did not as a matter of law prevent the plaintiff from asserting that it justifiable relied to its detriment on the misstatements in the bank questionnaire. The court reasoned that the “totally new” statement in the property description was technically false and there was a material question of fact if Guido knowingly intended to deceive, given his assertion that the system had been replaced twice in recent years at great expense to him and thus — in his opinion — was “totally new.” Further, the court found that Guido’s explanation that he believed the questionnaire was only referring to the present state of the property was belied by the unequivocal references in the questions to both the past and current status and events.

However, the court held the trial court improperly concludes as a matter of law that plaintiff had established reasonable reliance on the alleged misrepresentation because there were material questions of fact that had to be determined by a jury. These material questions of fact included if the representation that the septic system was totally new was knowingly made to induce plaintiffs’ reliance, if plaintiffs actually relied upon Guido’s answers in the environmental questionnaire in deciding to purchase the property, if the reliance was reasonable based on plaintiffs’ real estate experience and if plaintiff could have ascertained the facts with reasonable diligence, particularly where the contract contained a septic system contingency clause that plaintiffs waived. Accordingly, the court reversed the summary judgment ruling in favor of the plaintiffs, denied the defendants’ motion for summary judgment and remanded the case back to the trial court.

Many states also have property disclosure laws that sellers are required to prepare. For the very reasons illustrated by this case, many New York real estate lawyers advise their seller clients not to prepare the disclosure statement since the statutory penalty for non-compliance is a $500 price reduction. The real estate lawyers feel it is better for their clients to pay the $500 penalty than run the risk of making a material misstatement that could result in significant liability for misrepresentation.

Likewise, environmental consultants routinely submit environmental questionnaires to property owners and their clients as part of the phase 1 process I routinely urge purchasers and lending clients not to complete the questionnaire. 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 is a rare occasion when the purchaser or lender has 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.

It should be noted that the EPA All Appropriate Inquires (AAI) rule (40 CFR 312) 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 is to be obtained by the prospective landowner or grantee are known as “additional inquiries” and set forth in 40 CFR 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, 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. [emphasis added].  Although we continue to believe that the information collected or held by the prospective landowner (or grantee) should be provided to the environmental professional overseeing the other aspects of the all appropriate inquiries, we agree with commenters who asserted that prospective landowners and grantees should not be required to provide this information to the environmental professional. Commenters argued that property owners (and grantees) may want to hold some information (e.g., the purchase price of the property) confidential. CERCLA liability rests with the owner or operator of a property and not with an environmental professional hired by the prospective landowner and who is not involved with the ownership or operation of the property.

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.”

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 said [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

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. Ultimately, CERCLA liability rests with the owner or operator of a facility or property owner and it is the information held by the property owner or operator that may be reviewed in a court of law when determining an owner or operator’s liability status, regardless of whether all information was disclosed to an environmental professional during the conduct of all appropriate inquiries.”

In sum, 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).