Options for Handling Environmental Risk in Real Estate Acquisitions

In any acquisition that includes real estate, a buyer needs to take care to properly assess the real property to be acquired for potential issues, both in general and specific to the buyer's plans for the property.  Any purchase agreement for real property needs to build in sufficient time to determine these risks and negotiate other provisions in the purchase agreement that allocates the environmental risks between the buyer and seller to each party's satisfaction.

Sometimes conducting a Phase I environmental review may be sufficient, but in many cases, it is not. Depending on prior and/or current uses of the property, further environmental testing many be necessary to determine whether any contamination is present that would trigger strict liability on any landowner in the chain of title.  Also, a buyer needs to take into consideration what will be done with the property after closing. If demolition and construction will occur, many additional issues will need to be considered, such as the presence of asbestos, whether there are wetlands on the property, or any special designations (e.g., endangered species or historical designations), any of which could prevent or significantly delay a project. 

Here are some options for dealing with potential environmental issues when acquiring real estate:
  • Adequate Due Diligence Periods -- To the extent a buyer does not already possess complete environmental diligence on the property prior to entering into a purchase agreement, sufficient time needs to be provided for in the agreement to conduct all the reviews, studies, tests, etc. that are appropriate to fully understand the condition of the property and the regulations that may affect how it is developed.  Earnest money frequently becomes nonrefundable after expiration of the due diligence, such as title, survey and environmental.  A seller may be willing to allow sufficient time for the diligence to be conducted but no more. From the seller's perspective, it is important to ensure that the transaction keeps moving and is not unnecessarily prolonged.
  • Closing Conditions; Remediation -- If a buyer has specific plans for the property and the presence of certain environmental conditions or regulatory hurdles can prevent these plans or severely delay them, then appropriate closing conditions should be included in the purchase agreement that allows the buyer to walk if a condition isn't met.  The seller needs to consider the risks to a failed closing due to these closing conditions. Whether or not a seller should accept any closing condition, and/or the refund of any earnest money, will depend on how desperately the seller needs to sell and whether there are any other potential buyers to consider.  A seller will want to negotiate the closing conditions as narrowly as possible to minimize delays and risks to closing.  In instances where the contamination is known to both parties, the buyer may want to require the seller to remediate the contamination to an agreed upon condition prior to the buyer closing on the sale.  There can be substantial risks to both parties in this situation. What if, despite the remediation, regulatory action is initiated against the buyer after closing? Who retains responsibility after closing, the required level of cooperation between the parties,  and other potential issues should be considered and addressed in the agreement.
  • Indemnification -- The ultimate tool for allocation of risk, buyers and sellers can negotiate who will be responsible for environmental liabilities that arise on the property post-closing, including allocating percentages of responsibility, survival periods for seller's obligations, deductibles and caps, and other limitations or remedies.  
  • Escrow -- The parties may also want to consider paying a portion of the purchase price into an escrow account held by a third party. If buyer claims arise under the indemnification obligations during a proscribed time frame, then final claims can be paid out of the escrow account.  This option is especially useful if a buyer has any concern that the seller and the purchase funds will be not be around later to pay a claim that might arise. 
  • Insurance -- In some instances environmental insurance might be an option. Insurance coverage for potential property contamination will require a significant deductible and premiums will be paid in advance. It's usefulness is in allowing the parties to quantify a known dollar exposure for claims made during the policy term, based on the deductible, premium costs, etc. dictated by the policy terms. How these costs are allocated between the buyer and seller is a matter of negotiation.  Other insurance policies are available when the contamination is known and the cost of remediation can be adequately estimated. This insurance will cover any additional costs beyond what was estimated. Again, its purpose is to limit the monetary exposure.
The options identified above barely scratch the surface of all the forms these negotiations can take.  It is critical that each party be advised by competent real estate counsel who can help to identify all the potential issues and negotiate an allocation of risk acceptable to both parties.

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