2009 Trends in Environmental Law and Due Diligence

Environmental regulation has come a long way in the last 100 years. But environmental due diligence has been effected by the recent downturn in the commercial real estate market. In addition, there are some new laws that commercial real estate owners, lenders and brokers should be aware of. Joe Derhake is a environmental engineer and a principal at Partner Engineering and Science, Inc. based in El Segundo, California. Mr. Derhake is a friend of this Blog and its author. He was recently interviewed by Jessica Lillian of MortgageOrb.com, a blog for commercial real estate professionals. She asked Mr. Derhake about the effect of the lending slowdown on environmental due diligence on commercial properties, and about the trends in environmental law for commercial property in 2009. The interview is reprinted below.

Q: Have the more stringent lending and underwriting standards these days translated into more attention paid to the environmental component of the due diligence process?

Joe Derhake: The short answer is yes, we are definitely seeing a trend in that direction. Lending decisions are influenced by deal people and credit people, and as of late, the credit side is the more powerful group. For the environmental consultant, that means more thorough due diligence. Lenders are now more likely to order Phase I Environmental Site Assessments instead of limited products.

When contamination is found, however, the enthusiasm among lenders for quantifying the environmental problem and trying to underwrite around the problem is low. Lenders would prefer to pass on the deal.

Q: Vapor intrusion has received a lot of attention lately - though many in the lending community seemed somewhat unaware of it until recently. What emerging environmental issues are you seeing now?

Derhake: While the ASTM 2008 vapor intrusion standard created a lot of discussion in the environmental professional community, clients have been hesitant to use the new standard, instead relying heavily on the Phase I Environmental Site Assessment to address these environmental concerns.

An up-and-coming environmental issue is energy consumption, and California is leading the charge with Assembly Bill 1103, which mandates that all California nonresidential buildings participate in the Federal Energy Star program beginning in January 2009.

Benchmark data showing the building's relative energy consumption performance will be collected throughout 2009. After Jan. 1, 2010, building owners will be required to disclose these data to buyers, lessees and lenders. Energy Star will rate buildings against other buildings within the same class - adjusted for climate, but not age. Buildings within the top quartile are eligible to be recognized as an EPA Energy Star Building and can use the Energy Star label to communicate their energy efficiency to tenants, lenders and other stakeholders.

Not only will highly ranked buildings be more likely to capture a green premium when the property sells or rents, but analysis of these data will yield opportunities of energy savings and, ultimately, improvement of net operating income.

Will green buildings ever receive any sort of preferential treatment from lenders? Bank of America, Wells Fargo Bank and Citibank are among the national lenders that have committed themselves to billions of dollars of green lending.

To date, much of the green lending has focused on building green and LEED construction. However, Energy Star-rated buildings are gaining more and more attention, and with the data required by AB 1103 becoming available in the next year, lenders will have more objective standards to judge their collateral.

Lenders could easily aggregate their portfolio's Energy Star Rating and set goals to improve their portfolio over time. It is possible that other states will follow suit and implement similar building energy disclosure requirements in the future.

Q: What steps can cash-strapped financial institutions take to manage the costs involved with environmental assessments?

Derhake: Environmental policy can be thrifty and smart. To be thrifty, lenders should consider limited environmental products, such as environmental transaction screens and historical environmental reports. Historical environmental reports are inexpensive (typically under $500) and focus solely on the history of the property.

This is a perfect product for an asset that clearly has no issues, due to a benign use such as residential or office, and most reasonable concern is centered on what was there before the current development. If environmental concern is identified during the historic research, further due diligence can be conducted.

Q: What are the most common forms of contamination you are finding these days? Are there any recent technological advancements in remediation strategies?

Derhake: The types of contamination that we find are across the board. However, the type of contamination that is receiving greater scrutiny by regulators is volatile organic compounds, which include chemicals such as benzene (an additive in gasoline and an industrial solvent) and tetrachloroetheylene (PCE, a drycleaning solvent). These volatile chemicals are toxic and represent a vapor intrusion risk.

The concern that these chemicals will migrate up into buildings and create a cancer risk for occupants is driving cleanups. Many state regulators require soil vapor testing for all sites. To achieve closure, a property owner has to show that the levels of soil vapor are below action levels. Generally speaking, soil vapor-based action levels are more stringent than soil matrix-based action levels.

Volatile organic compounds have historically been remediated via soil vapor extraction and dual phase extraction. Each of these technologies involves more or less sucking the contamination out of the ground. We install vapor extraction wells, connect the wells to large blowers and pull. The toxic vapor stream extracted must then be treated.

In-Situ Chemical Oxidation (ISCO) is proving to be a significant alternative technology. ISCO involves injecting a reactive chemical into the ground, and the reactive chemical oxidizes the contaminant upon contact. This technology works very quickly, and for some contamination plumes, it is very cost-effective.

Q: What is the latest on the regulatory front for environmental compliance/liability issues? What might be on the horizon for 2009?

Derhake: California, Oregon and other states have published soil vapor action levels. When professionals are cleaning a site, the question becomes, "How clean is clean?" Environmental professionals compare our testing data to the action levels.

Historically, we collected soil samples and compared these data to soil matrix action levels. Lately, closure sampling must also consider soil vapor analysis, and we must compare these to far more stringent soil vapor action levels.

This shift is profound, as sometimes it means that the remedial system must run another year or more.

The Federal EPA has not yet pushed for any such soil vapor standards. With a new administration coming in 2009, we may see the Federal EPA addressing this issue. Commercial real estate owners do not benefit from stricter standards, as it likely will increase cleanup costs. However, greater uniformity from state to state makes environmental risk management easier.

To learn more about Joe Derhake's firm, Partner Engineering & Science, Inc., click here.

Real Estate Contracts -- What is Expressed is Understood; What is Not Can Be Implied By the CA Supreme Court

The legendary folksinger, Pete Seeger, once offered these words of wisdom about written contracts: "Education is when you read the fine print. Experience is what you get if you don't."

In recent years, many individuals and companies decided to obtain experience instead of education by signing loan documents or issuing mortgage backed securities without reading the fine print.

But what if a written contract is silent on an important deal point? You cannot read what isn't there, whether it is in bold or fine print. In late December 2008, the California Supreme Court told us "it ain't necessarily so" in Patel v. Liebermensch (filed 12/22/08) S156797.

In that case, the parties (apparently acting without lawyers) entered into a written lease of a condo with an option for the tenant to buy. The written option contained the essential terms of the purchase except for the time of payment. It was also silent about using an escrow for the purchase. A dispute arose between the parties after the tenant exercised the option to buy, and they could not agree to the terms of a purchase agreement. The tenant, Patel, brought a specific performance action to enforce the option agreement. Patel won at trial and lost before the Court of Appeal which ruled the option agreement was too uncertain to specifically enforce. (See, August 23, 2007 post about the Court of Appeal opinion in this case.)

The Supreme Court had little trouble filling in the blanks. First the Court reasoned, " . . . while the parties are obviously free to include escrow specifications in the contract of sale, they are not necessary terms." Once you assume the parties implicitly decided to have an escrow, the rest is easy. "In the absence of a specified time of payment, a reasonable period is allowable under Civil Code section 1657." In other words, the Court concluded that it is reasonable to assume the purchase price would be paid when the implied escrow closed.

This opinion offers both education and experience for parties to a real estate contract in California. If you are willing to invest the time and money to take your case to trial, then to the Court of Appeal and finally to the Supreme Court, you can get a definitive opinion about what the parties did (and did not) agree to. This took about 3 years in the Patel case. During that time, the real estate market declined substantially and it became much more difficult to obtain financing.

If you want to save time and money, it is better to hire a lawyer at the outset so that your agreement covers the essential points of agreement and the incidental points as well. In the case of an option to buy real estate, you can agree to the form and content of the purchase agreement itself to avoid problems down the road.