Thankfully, as most professionals involved in real property are aware, an AAI-compliant “Phase I” environmental investigation provides a mechanism whereby prospective purchasers, lessees, and lenders can all provide themselves some protection against unforeseen environmental liability under CERCLA and its state analogues. The AAI-compliant Phase I is a non-invasive investigation of the property and its history to identify any “recognized environmental conditions” (i.e., environmental conditions that may warrant additional investigation and/or remediation).

Often overlooked under the AAI rule, however, is that the Phase I investigation must have been performed within the year prior to the transaction, and certain elements of the investigation, including records reviews, environmental lien searches, visual inspections, and interviews must all have been performed within 180 days prior to the consummation of the transaction. Although this freshness requirement is clearly written into the AAI standard, it is not uncommon for the requirement to be overlooked in the race to closing on the transaction, particularly in cases where multiple properties are involved.

The risk in overlooking the freshness requirements is not only missing out on the limited AAI safe harbor; it is also in creating a false sense of safety due to outdated environmental diligence. For example, in Standard Bank and Trust Co. v. The English Company, the purchaser of a property at foreclosure auction did not conduct an updated Phase I investigation, but instead relied on an outdated Phase I included in the bid package. The outdated Phase I did not identify environmental impairments that would have been revealed by an updated records search as part of the Phase I process. Setting aside the safe harbor implications, the purchaser at auction did not even have an accurate view of the impairments on the property it was buying, which is the ultimate purpose of conducting due diligence.

Although environmental due diligence may seem pro forma, it is nonetheless a critical component of any commercial real property transaction. Prospective purchasers, lessees, and lenders should (1) ensure their environmental diligence is performed by a reputable consultant in conformance with the AAI standard, including the freshness requirement, (2) be aware that the Phase I does not cover many common environmental concerns such as lead paint, asbestos, mold, and the presence of wetlands, all of which may affect development plans, and (3) be aware that a Phase I may only be the first step, as it may reveal conditions that require additional investigation and/or remediation.

To many prospective purchasers and lessees of real property, and to many lenders involved in such transactions, environmental due diligence can seem pro forma; it is simply the box you check in order to achieve the inevitable completion of the transaction. Those thoughts are according to Matthew Dombroski, an environmental litigation attorney at Manatt, Phelps & Phillips LLP, located in the New York office, and Michael C. Polentz, co-chair of the real estate and land use practice group at Manatt, Phelps & Phillips LLP, located in the Palo Alto office. According to the two, environmental impairment can rear its ugly head in multiple, extremely costly ways, however, so those prospective purchasers and lessees, and their lenders (as well as their respective environmental counsel), must ensure that environmental due diligence is performed carefully and without shortcuts. In particular, they say, these parties should cause any environmental due diligence to be performed so as to satisfy the “All Appropriate Inquiry” or “AAI” requirements for limited safe harbor, including the often-overlooked “freshness” requirements of the AAI standard, which will in turn provide the prospective purchaser, lessee, and lender a robust environmental characterization of the property for valuation and risk mitigation purposes.

The views expressed in the commentary below are Dombroski and Polentz' own.

The federal Comprehensive Environmental Response Compensation & Liability Act (“CERCLA”) and its state analogues generally take a very expansive view of liability for environmental contamination and include owners and operators (e.g., lessees) as potentially liable parties without regard to whether such parties actually caused the underlying contamination. Furthermore, because CERCLA liability is joint and several, such an owner or operator can find itself responsible for the entire cost of cleanup (including certain associated legal fees).

Although lenders are, in most circumstances, protected from direct liability in connection with environmental conditions at a collateral property, lenders are not fully insulated from the effects of environmental contamination of collateral property. Indeed, due to the presence of unexpected environmental conditions at the subject property, (1) the contaminated property's value as collateral may be impaired; (2) the contamination and costs associated therewith may impair the borrower's ability to repay the loan; and (3) if the environmental conditions are severe enough, the lender may suffer reputational consequences.

Thankfully, as most professionals involved in real property are aware, an AAI-compliant “Phase I” environmental investigation provides a mechanism whereby prospective purchasers, lessees, and lenders can all provide themselves some protection against unforeseen environmental liability under CERCLA and its state analogues. The AAI-compliant Phase I is a non-invasive investigation of the property and its history to identify any “recognized environmental conditions” (i.e., environmental conditions that may warrant additional investigation and/or remediation).

Often overlooked under the AAI rule, however, is that the Phase I investigation must have been performed within the year prior to the transaction, and certain elements of the investigation, including records reviews, environmental lien searches, visual inspections, and interviews must all have been performed within 180 days prior to the consummation of the transaction. Although this freshness requirement is clearly written into the AAI standard, it is not uncommon for the requirement to be overlooked in the race to closing on the transaction, particularly in cases where multiple properties are involved.

The risk in overlooking the freshness requirements is not only missing out on the limited AAI safe harbor; it is also in creating a false sense of safety due to outdated environmental diligence. For example, in Standard Bank and Trust Co. v. The English Company, the purchaser of a property at foreclosure auction did not conduct an updated Phase I investigation, but instead relied on an outdated Phase I included in the bid package. The outdated Phase I did not identify environmental impairments that would have been revealed by an updated records search as part of the Phase I process. Setting aside the safe harbor implications, the purchaser at auction did not even have an accurate view of the impairments on the property it was buying, which is the ultimate purpose of conducting due diligence.

Although environmental due diligence may seem pro forma, it is nonetheless a critical component of any commercial real property transaction. Prospective purchasers, lessees, and lenders should (1) ensure their environmental diligence is performed by a reputable consultant in conformance with the AAI standard, including the freshness requirement, (2) be aware that the Phase I does not cover many common environmental concerns such as lead paint, asbestos, mold, and the presence of wetlands, all of which may affect development plans, and (3) be aware that a Phase I may only be the first step, as it may reveal conditions that require additional investigation and/or remediation.