Should a VEC Always Be a REC?

In a recent ASTM conference call, several consultants took the position that they could not envision a circumstances under which a “vapor encroachment condition” (VEC) identified pursuant to ASTM E2600-10 would not be a “recognized environmental condition” (REC) pursuant to ASTM E1527-05.

 

I was surprised by this statement and therefore have decided to post about this issue. I happen to think that many VECs actually could be considered “de minimis conditions” that do not rise to the level of a REC.

The term "vapor encroachment" is a term of art created by ASTM 2600. It has no basis in law or science since the regulatory driver is "vapor intrusion"- the migration of vapors into building structures.  Since a VEC has no regulatory significance, it cannot serve as a basis for creating CERCLA liability-which is the focus of the ASTM E1527 Phase 1.

All a VEC means is that there may be a vapors at the boundry of the property. A VEC determination is simply an interim step. The user can decide to ignore the VEC finding or decide to pursue the issue further to determine if it rises to the level of a REC.

A VEC without any evidence of a completed exposure pathway will not result in enforcement if brought to the attention of regulators- the ASTM definition of de minimis condition. To me, it is  akin to contaminated groundwater that has migrated onto a site where the groundwater is not being used for drinking water and the state does not pursue owners of impacted properties.

In the absence of exposures to persons in structures, there will not be CERCLA liability. The main  liability concern for vapor intrusion is toxic tort liability. In the absence of vapors migrating into structures, there will not be toxic tort liability.

To me, the E2600 process and VEC determination is a waste of a client's money. If there are solvent sites within the E1527 search radius that could present a risk of Vapor Intrusion, the EP provides value to its client by determining if there is a potential for vapor INTRUSION. This can be done from site specific information or fairly inexpensive soil gas sampling.

Some Banks Starting To Limit List of Approved Consultants

During the peak of the market bubble, the lists of approved consultants that I maintained for some of our CMBS clients exceeded a dozen pages. Often times, we would approve a consultant who was not on the list on a one-off basis if they did a phase 1 that was acceptable in scope and who had a strong relationship with the borrower. Some lender clients did not even go through the drill of preparing a list of approved consultants but simply wanted to make sure that the phase 1 reports met their SOWs.

As the CMBS market slowly revives, it appears that many banks are keeping a tight rein on the universe of consultants who can do work for them. Previously dormant shops that are starting to ramp up to originate CMBS loans are asking me for a "short list" of consulting firms. Often times, the list is around a half-dozen.   And the lenders are trying to evenly spread around the work.

Some banks are also starting to disqualify firms that heavily rely on independent contractors who are known as "1099" employees. The feeling is that firms that use a higher percentage of independent contractors may not be consistently providing quality work.

This smaller universe of consultants does make my job easier and helps promote better quality work. With firms in the on-deck circle and sitting on the bench waiting to get called up, we dont have much tolerance for firms that do not consistently meet our expectations. Even some of the phase 1 mills are starting to produce better reports.

Now if we could only get EPA to require that the site visits be conducted by EPs...........

NY Case Illustrates Why Borrowers Should Not Simply Rely on Lender Approval of Phase 1

Lenders have long played a role as “surrogate regulator” in transactions. In many cases, lenders force potential borrowers to investigate suspected contamination and frequently require remediation under state oversight. Borrowers often balk at these requests any may even retain their own independent consultants to try to convince lenders that the work is not required or necessary.

However, borrowers usually do not exhibit such independence when the lenders are ok with the site conditions. Borrowers typically believe that a site is “clean” if a bank determines that a phase 1 is acceptable. However, what many borrowers do not realize is that lenders are positioned differently than property owners from a liability standpoint and therefore may have risk tolerances that are different from those who take title to potentially contaminated property.

First, because of the secured creditor exemption under CERCLA and most state superfund laws, lenders will not be liable for remediation unless the borrower encountered financial difficulties and the bank either takes over the borrower’s operations or forecloses on the property. During the loan origination phase of a loan, borrower default seems remote to a lender since after all its willingness to lend is based on its belief that it has a viable borrower.

Second, since most lenders no longer hold loans on their books but sell the mortgages for securitization, the originating lender is not really concerned about a future default. So long as the loan has been originated in accordance with the loan procedures and underwriting that is acceptable to the trusts that sell the CMBS loans to investors, the risk of a “comeback” to the originating loan is minimal.

We have previously reported on cases where borrowers have sued banks and consultants on grounds that lender misled them by approving the phase 1 or that the consultant failed to find contamination. In the traditional lender/borrower relationship, the lender usually prevails. The few cases where lenders have been found liable for misrepresentation have been where they sold the property to the plaintiff.

A recent case in New York illustrates the differing risk tolerance of lenders and the implications for property owners. In Ridge Seneca Plaza v BP Products, et al, 2011 U.S. Dist. LEXIS 47288 (W.D.N.Y. 5/2/11), First Allied agreed to sell shopping center to Sylvan Enterprises (Sylvan) in 2000. The consultant retained by Sylvan and its counsel prepared a phase 1 that discussed a 1994 tank failure at an adjacent gas station. Because the NYSDEC database showed that the spill was closed, the consultant determined the closed spill was not a REC (it is unclear if the closed spill was flagged as an HREC). However, the consultant did not identify a second spill reported that was reported in 1999 (a year before the current transaction) when the tanks were removed. The consultant also failed to identify former dry cleaner at shopping center b/c used wrong address.

Sylvan subsequently assigned the contract to purchase the property to the plaintiff who was an affiliated entity (owned by same principals). The plaintiff closed on the shopping center in 2001.  When the plaintiff refinanced its loan in 2002, the consultant updated the phase 1 but again did not mention the former dry cleaner or the active second spill.

In 2004, the plaintiff’s principals decided to refinance so they could take some equity out of the property. However, the 2004 lender was not comfortable with the proximity of the gas station and required a phase 2. The plaintiff’s principal discussed the concept of a phase 2 with the original consultant who said a phase 2 could “open a can of worms”. The plaintiff’s principal argued to no avail with the lender that the phase 2 was unnecessary.

Apparently, the favorable loan rate outweighed the risk of the phase 2 since the borrower agreed to do the phase 2. The investigation discovered floating petroleum product on a portion of the site near the gas station and PCE contamination from the former dry cleaner.

The plaintiff then filed a contribution action against the seller of the property alleging misrepresentation and fraud as well as a breach of contract and malpractice action against the consultant. In a series of rulings, the federal district court for the northern district of New York ruled that because the plaintiff had taken title pursuant to an assignment of an "as is" agreement, it could not maintain action against the seller. In addition, the court ruled that that there was no contractual relationship between the consultant and the plaintiff (formally known as “privity of contract”), the plaintiff could not bring a breach of contract action. Moreover, the court ruled that plaintiff could not bring a malpractice action because the plaintiff had no right to rely on the report and therefore consultant owed no duty to the plaintiff. And the court also said that even if the telephone conversations between the plaintiff’s principal (who also happened to be the principal of the assignor or originally contracting party) in 2004 about the phase 2 had created some enforceable relationship between the entities, the plaintiff had waited too long to bring its lawsuit.

A column in today's NY Times discussing the book "The Deal from Hell" provides further examples of this situation. The article says the book illustrates a "breathtaking level of cynicism and self-dealing" by a particular investment bank, and excerpts some of the emails of bank analysts. My favorite excerpt is the following:

"There is wide speculation that [Tribune] might  have so much debt that all assets arent gonna cover the debt in case of (knock knock) you know what. Well, that's what we are saying, too. But we're doing this 'cause its enough to cover our bank debt: our (here I mean JPM's) business strategy for TRB but probably not only limited to TRB is "hit and run'"  

Borrowers should remember this the next time their lender says the phase 1 is ok. The borrower should independently determine if the phase 1 is acceptable to its needs. Remember that a borrower may be liable as the property owner while a lender who does not exercise control over the property or take title will be able to stand behind the secured creditor exemption.

Appeals Court Affirms Class Action Certification for Defective Radon Systems

A New Jersey court affirmed certification of a class action involving residents of a condominium complex who alleged that radon mitigation systems were improperly installed. The defendants are the developer,  the engineering firm who installed the radon systems, and the condo association which was responsible for maintaining the radon mitigation systems at the villa residences.

The development known as Overlook at Lopatcong consists of 384 residential units comprised of 142 villas, 132 garden houses and 110 townhouses. The development is located in an area in New Jersey known as Tier 1 Area  which requires new residential structures to be equipped with fully functional radon resistent construction pursuant to N.J.S.A. 5-23-10. The villas were constructed so that every two units shared a common basement and a radon mitigation system. The townhomes and garden homes each had their own systems.

The plaintiffs filed an eight-count complaint alleging defendants improperly designed, installed, maintained and tested the radon mitigation systems. Plaintiffs pled theories of negligence, gross negligence, trespass, nuisance, fraud, consumer fraud, and assault and battery; and sought injunctive relief, which included medical monitoring and periodic testing of radon levels in the residences. Plaintiffs subsequently moved for class certification.

To support their motion, plaintiffs submitted the certification of a  former  employee of the engineering firm assigned to the development, and three reports from their expert. The former  employee averred that when many of the units were tested for radon before a certificate of occupancy was issued, the units were tested with doors and windows open as directed by a RAdata employee. He also said  that one radon pump was used for multiple dwellings to save money, and many units had cracks in basement slabs because Segal would not pay for expansion joints.

The plaintiffs experts Some of the systems use the drainage pipe to the sump pit to transfer negative pressure to the neighboring unit, thereby reducing radon in both basements, but if the sub-drainage pipe fills with water, negative pressure to one unit is cut off allowing radon levels to rise in the basement. In many homes the sump covers were unsealed, which keeps radon from being eliminated from the basement. In other systems, exterior exhaust pipes terminated before reaching the roof and were thus too close to upper story windows, which can result in the reentry of radon through an open window.  All of the  [*5] outside mounted fans that were inspected had holes drilled into the pipe under the fan, which causes a loss of efficiency and premature fan failure. In all the homes with unfinished basements that were inspected, no floor to wall joints or cracks were sealed. In the expert's opinion, these and other deficiencies were sufficient to require that all units have radon tests performed.

In October 2010, the trial court  certified a class of all current owners of units  for negligence, gross negligence, nuisance and assault and battery claims. The court also certified a sub-class against the Condo Association of all current owners of villas for nuisance and trespass claims. The court also denied plaintiffs' motion to certify a class for fraud, consumer fraud, and the remedy of medical monitoring. In May, the appeals court affirmed the class certification. Casale v Segal & Morel et al. 2011 N.J. Super. Unpub. LEXIS 1228 (App. Div. 5/12/11).

Since radon mitigation systems are frequently used for vapor intrusion, this case could provide support for future vapor intrusion litigation.   

CMBS Lender Kept In Case Over Questions About Environmental Disclosure

The federal district court for the Southern District of New York denied a motion to dismiss filed by Morgan Stanley Mortgage Capital, Inc (MSMC)that it failed to adequately disclose environmental conditions at a shopping center and should not be required to buy back the $81MM loan. This case has some yummy nuggets.

In this case, MSMC originated a $81MM loan to City View LLC to finance the acquisition of a shopping center in December 2006. The shopping center had been constructed on a former landfill, was required to monitor methane gas and had been subject to a number of notices of violations. In 2006, Walmart which was the largest tenant of the shopping center and occupied nearly 29% of the net square footage began complaining about methane gas. Just before the loan was closed, Wal-Mart issued a Notice of Default accusing the seller of failing to manage the methane gas and alleging that methane gas levels had reached dangerous levels.  The seller of the property and Wal-Mart then entered into a series of letter agreements where seller agreed to address the methane problem. The seller and borrower also entered into a Walmart Indemnity Agreement where the borrower agreed to assume the obligations to cure the methane problem. On the day of the closing, Wal-Mart also sent the defendant an estoppel certificate identifying the methane problem and setting forth the landlord's obligations to cure the problem. Eventually, Wal-Mart terminated its lease in 2009 and the borrower defaulted on its debt service payments.

The phase 1 had not identified any RECs. However, it had identified methane as an "item of concern". It has also disclosed that the shopping center had been constructed on a landfill, that it was required to monitor methane and that there had been notices of violations that would require at least $100K to repair.
Meanwhile,  MSMC sold the loan in May 2007 to an affiliate entity pursuant to a Mortgage Loan Purchase Agreement (MLPA). The loan was then deposited into a Morgan Stanley CMBS Trust pursuant to a pooling and servicing agreement (PSA) with the plaintiff named as Trustee.

The MLPA contained an environmental warranty that an environmental assessment had been performed and that the MSMC had no knowledge of any material and adverse environmental conditions or circumstances affecting the property that was not disclosed in the report. MSMC also warranted that there were no material defaults.

The plaintiff through the special servicer filed a complaint seeking to require MSMC to re-purchase the loan. The complaint alleged that MSMC knew the loan was in default and failed to disclose it, and also failed to disclose the adverse environmental conditions affecting the property.  Interestingly, Phase 1 did not flag methane as a REC but as an "item of environmental condition". In a motion to dismiss, MSMC asserted that it had disclosed all of the environmental risks associated with the property including that the property had been built on a landfill, required monitoring for methane, was under the supervision of the Ohio EPA and an escrow of $100K had been established tp resolve outstanding environmental violations.

However, the court disagreed, noting that the phase 1 said its purpose was to identify Recognized Environmental Conditions (RECs),  the report did not identify any RECs and characterized methane as an "item of concern". The court said that an "item of environmental concern" was not congruent with a REC, and there was a material dispute if the phase 1 had disclosed the existence of a material environmental threat.  Bank of New York Mellon Trust Company et al v. Morgan Stanley Mortgage Capital Inc., 11-0505 (S.D.N.Y. 6/27/11)

CERCLA Workplace Exclusion Does Not Bar EPA Cost Recovery Action

Defendant argued EPA had no authority to perform removal action involving plating lines where the release results in exposure exclusively within a workplace. Section 9601(22)(A) excludes from the statutory definition of release "any release which results in exposure to persons solely within a workplace, with respect to a claim which such persons may assert against the employer of such persons". 

The court ruled that Saporito could not benefit from this exclusion because this case did not involve a claim by a person against their employer. The court also rejected argument that the "consumer product in consumer use" exception in the definition of "facility" did not apply to electroplating business. US v Saporito, 2011 U.S.Dist. LEXIS 66456 (N.D.Ill. 6/22/11)

Many consultants and clients have mistakenly believed that vapor intrusion is not covered in the standard phase 1 scope of work because of workplace exclusion. In do doing, they have ignored the second half of the clause that limits the exclusion to circumstances where a person has made a claim against its employer.  . As a result, the potential for vapor intrusion has frequently not been evaluated.

This clause is actually a relic from a bill that had been considered by the US House of Representatives prior to the passage of CERCLA. That bill would have provided a remedy for personal injury due to exposure to hazardous substances. The workplace exclusion was intended to prevent a double recovery by precluding recovery where the worker had filed a workers compensation claim. The remedy for personal injuries was deleted from CERCLA during the last minute negotiations but the workplace exclusion was inadvertabtly left  in legislation that became  CERCLA