CHAPTER 3 CONSIDERATIONS BEFORE YOU BUY OR LEASE: AVOIDING A TOXIC SURPRISE
| Jurisdiction | United States |
(Nov 1988)
CONSIDERATIONS BEFORE YOU BUY OR LEASE: AVOIDING A TOXIC SURPRISE
Attorney-at-Law Pillsbury, Madison & Sutro
San Francisco, California 94120
November 16-17, 1988
I. INTRODUCTION: A WHOLE NEW DIMENSION TO OUR LIVES.
The importance of undertaking a thorough due diligence investigation of real property to be acquired, leased, or given as security for a loan, has always been obvious; however, the scope of that due diligence is changing. In anticipation of the development and/or acquisition of mining or oil and gas properties, businesses have long been familiar with the need (a) to conduct geological, geophysical and geochemical analyses; (b) to evaluate engineering feasibility, reserves, production capabilities and the like; (c) to determine whether control of the property can be obtained through acquisition, leasing or joint venturing; (d) to analyze the state of title and what will be needed to perfect title; (e) to determine whether utilities and roads access the property; and (f) to investigate whether financing can be obtained and what form it would take (e.g., bank loan, joint venture, syndication, or sale of stock), as well as many other factors too long to note here.1
With the increasing growth of preservation-oriented groups and citizen effort to prevent or severely restrict mining and oil and gas operations, the industry has become sensitized to the laws affecting use of wetlands and the possibility that in certain geographic areas such activities could impact either upon endangered species or natural resources, as in the case of offshore drilling. But
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perhaps the greatest risk to profitable natural resource extraction now comes from federal and state laws which impose significant liabilities on owners and operators of properties that become contaminated by releases or discharges of hazardous substances (see Federal Comprehensive Environmental Response, Compensation and Liability Act, 42 U.S.C. § 9601 et seq. ("CERCLA"); and Resource Conservation and Recovery Act of 1976, 42 U.S.C. § 6901 et seq. ("RCRA")).2
Under these laws, liability is strict (New York v. Shore Realty Corp. (2 Cir. 1985) 759 F.2d 1032, 1042), and does not turn on issues of negligence or even whether the "potentially responsible party" ("PRP") caused the contamination. Thus,
(a) A current property owner may be ordered by the government to clean up his property even though he did not cause the contamination, and irrespective of whether his property is the source of that contamination;
(b) A current owner may be required by the government to clean up other property if the contamination is coming from his property, even though the current owner did not cause that contamination;
(c) A property owner can be required to clean up contamination caused by his tenant; and
(d) A company that purchases the stock of another company and then merges or consolidates with it can be liable for decades-old contamination caused by the acquired company.3
Whether or not the property owner is the originator of the pollution, vis-a-vis the government, he
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can nonetheless be held responsible for the entirety of the cleanup. One author has noted that the idea of "fairness" as it relates to pre-existing or "antecedent" contamination problems simply does not exist:
"The sweep of CERCLA liability may seem 'unfair,' but to some extent, CERCLA is intentionally 'unfair.' Accordingly, any attempt to rely upon the exercise of administrative discretion to mitigate an apparently unjust result will fail. Moreover, enforcement efforts have tended to focus on ensuring cleanup without regard to 'guilt' and so the question of blameworthiness is often of less consequence than the question of identifying a 'deep pocket' that can afford to pay."4
Traditional real estate lawyers are now being asked by their clients with ever greater frequency to advise about the risks of owning, selling, buying, leasing and operating real estate in light of the growing awareness of environmental cleanup liabilities, both known and contingent. We have seen transactions, typically involving industrial, manufacturing, agricultural and warehousing properties, grind to a halt as buyers demand extensive environmental investigation and certainty from environmental enforcement agencies as to the need for, and scope of, environmental cleanup, and lenders back away whenever even small levels of contamination are discovered. While these concerns may not have yet so greatly impacted upon the natural resource development industry in light of the profit potential thought to exist for such properties, this author, for one, believes that the impact of the environmental laws which we have seen affecting other real estate transactions will soon, if it has not already, come to have the same impact on natural resource real property transactions. (See Appendix II for summary description of five mining properties which have become Federal Superfund sites).
II. THE APPROACH: INVESTIGATE POTENTIAL CONTAMINATION BEFORE YOU BUY OR LEASE.
The obvious answer to the question: "How to avoid a toxic surprise?" is that sellers and buyers, or landlords
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and tenants, and their lenders, should conduct an environmental due diligence assessment prior to closing the transaction and then allocate potential risks and liabilities between or among themselves through various contractual arrangements.5
An environmental due diligence investigation (often referred to as an environmental audit or environmental site investigation),6 has two aspects: (1) an investigation of the historic and present uses of a site, often accompanied by on-site testing of surface and subsurface soils, groundwater, areas containing asbestos, and equipment containing polychlorinated biphenyls ("PCBs"); and (2) an analysis of the compliance of current operations with environmental permitting requirements, such as an NPDES permit for point source discharges under the Federal Water Pollution Control Act (the "Clean Water Act," 33 U.S.C. §§ 1251 -1376; id. § 1344), or an air emission permit under the Clean Air Act (42 U.S.C. § 7401 et seq.) regulating the release of fugitive dust emissions. If operations are to expand, change or recommence in their entirety, then the compliance review will analyze whether the new property owner can obtain the requisite permits to allow the company to develop and operate the facility in compliance with applicable regulatory requirements and in a manner that will allow a profitable return.
Such an investigation will have a great impact on the timing and cost of the transaction. The site assessment effort followed by the negotiations which ensue as a result of the matters discovered, invariably slows transactions down, often to a snail's pace, adds to the up-front
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investigation costs, and may also add an element of contingent liability that may not be quantifiable before a closing. In many cases, the cost of cleanup may be greater than the fair market value of the property in question. Whether that will be true of natural resource properties remains to be seen. However, there are presently at least ten former mining properties on the National Priorities List of Federal Superfund sites (40 C.F.R. § 300.66(c) ), and as of June 1988, at least three other mining properties were proposed for listing. In 1986 dollars, typical costs associated with a Superfund cleanup were as follows:
Remedial Investigation and Feasibility Study: $ 875,000
Remedial Design: $ 850,000
Remedial Action: $ 8,600,000
(June 24, 1988 Federal Register, 53 F.R. 23994.)
Before a company will be in a position to negotiate the particulars of a transaction, there is much it will need to learn:
(1) The parties will need to understand their legal rights and potential liabilities, both statutory and at common law, and the regulatory enforcement environment in which the project is located.
(2) Each party should consider the proper scope and timing of an environmental audit.
(3) The buyer should evaluate which permits will be required either to continue or expand an ongoing operation or to start new production, and whether environmental assessment and/or remediation will be required, and possibly approved or completed, before the new permits will be issued.
(4) A buyer or ground lessee should learn early on of the requirements of its lender.
(5) Each party should assess the financial strength of the other and its likelihood for being around in the future.
(6) The parties should consider how all of this information will impact on the intended timing and cost of the transaction, and its very structure.
With all of the foregoing in mind, and when environmental information about the property becomes known, the parties may wish to rethink the structure of their transaction, as for example, changing a contemplated stock
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purchase to a purchase of assets only, or a lease with an option to buy, and then draft appropriate contractual risk allocation provisions into their documents which will address the following areas of concern:
(1) Buyer's license to enter the property prior to closing in order to conduct an adequate environmental investigation, coupled with buyer's indemnity of seller for any damage or injury caused during the course of such investigation;
(2) Buyer's right of access to the seller's records, files, permits, correspondence with environmental enforcement agencies, and seller's employees;
(3) The scope, management, payment for and confidentiality of any environmental reports generated during the course of such investigation;
(4) Representations and warranties of the seller or landlord regarding the current environmental condition of the property;
(5) Indemnities which address responsibility for third-party claims and possible financial...
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