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.

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)

Vapor Intrusion and Old Landfills

As a child, I remember summer vacations at my uncle's cottage in the Catskill Mountains (or bungalow in the parlance of the region) where one of the fun trips was going to the local town dump where garbage was burned.

Towns across the country had local dumps  but were forced to close these "open dumps" following the passage of the 1965 Solid Waste Disposal Act which became Subtitle D of RCRA in 1976. The precise locations of the dumps were usually not recorded and with the passage of time, the lines became very blurred. Indeed, as metropolitan areas expanded, many of these once-rural towns became bedroom communities and home builders bought up what now looked like undeveloped fields for new suburban developments.

The discovery of vapor intrusion by the plaintiffs bar coupled with the economic downturn seems have resulted in an increasing number of lawsuits projects that were built on or near former landfills. A recent example involves the lawsuit in the Rochester area of New York where residents have sued former home builders and the local government over vapor intrusion eminating from an old solid waste landfill.

In Schroder v Ontario Properties, et al, the complaint alleges that a variety of hazardous materials were disposed at the Old Rochester City Landfill from the mid-1950s until it was closed in 1964 although the plaintiffs claim additional illegal dumping occurred for another decade. In 1980, the state of New York placed the landfill on the state superfund list but delisted it in 1994. In 2009, a developer sought to enroll the site into the state brownfield program but the application was initially denied. To buttress its case, the developer collected vapor intrusion samples which identified a variety of VOCs and concentrations of methane above explosive lower limit were present in the soil gas near and below homes that had been built in the 1980s. Some of the plaintiffs homes also allege that a portion of the old landfill extends beneath their residences based on the presence of waste material that was observed during advancement of the soil vapor probes.

The plaintiffs are alleging the defendants failed to take reasonable precautions with respect to the contaminants and failred to detect or disclose the presence of the contaminants to the plaintiff home owners. The plaintiffs are seeking property damages and medical monitoring and restitution of expenses to remediate the contamination. They also assert an inverse condemnation claim against the local government.   

Consultants who fail to identify the presence of a former landfill or raise concerns about potential impact of a former landfill located near a property could find themselves subject to a malpractice action. One of the leading examples was the case I discussed in the November 2007 issue of the Schnapf Environmental Law Journal (available from my website at http://www.schnapflaw.com/).

In Watco v. Pickering Environmental Consultants, Inc., 2007 Tenn. App. LEXIS 364 (Ct. App. 6/5/07), a state appeals court affirmed a ruling by a trial court granting a judgment in favor of a consultant-defendant. In this case, the plaintiff agreed in December 1994 to purchase a 169-acre tract of undeveloped wooden land from National Bank of Commerce (NBC), acting as trustee for the Norfleet Charitable Remainder Uni-Trust (Norfleet Trust),  for $880, 588. The purchase was contingent on a satisfactory phase 1 that conformed to the ASTM E1527-94. At the time of the phase 1, the land adjacent to the west was county park. The defendant completed the Phase 1 in July 1995 and provided an opinion letter to plaintiff acknowledging that the report was in connection with the sale of the property and expressly provided that the plaintiff could rely on the report. The letter went on to state that the defendant had not identified any “hazardous materials or environmental conditions” associated with current of former uses, and that no “significant environmental concerns” were identified in the surrounding areas that would represent a  “significant environmental concern” to the property.  As a result, the letter indicated that further environmental review was not recommended.

As it turned out, the county park had formerly an unlicensed municipal landfill that had operated from approximately 1955 to the mid-1970s. The land containing the unlicensed landfill had actually been owned by the Norfleet Trust and NBC had conveyed the land to the Shelby County Conservation Board pursuant to two deeds in 1980 and 1986.

During grading operations for a residential subdivision in March 2004, the plaintiff discovered garbage buried at a depth of 3 to 5 feet under approximately 30 acres of the western portion of the property. The plaintiff incurred substantial costs removing the garbage, and had to delay development while the solid waste was excavated and replaced with clean fill. The plaintiff then sought damages for professional negligence and negligent misrepresentation. The defendant filed a claim against NBC seeking indemnity under the Phase 1 contract but the court granted NBC’s motion to dismiss on the grounds that the contract provided that disputes between the parties were to be resolved through arbitration.
     
In its claim for negligent misrepresentation, the plaintiff claimed that the defendant made a false statement when it stated it had complied with ASTM E1527-94. The parties also agreed that the ASTM E1527-94 established the standard of care for the professional negligence claim. The plaintiff’s expert witness testified that the Phase 1 did not identify the former landfill, that he was able to learn about the existence of the former landfill by contacting local officials and that defendant’s failure to interview additional persons constituted a breach of its professional standard of care. The defendant’s expert testified that the defendant had reviewed the standard database records provided by Vista Environmental Information and that the landfill was not identified in any of these records. Thus, the expert concluded that the records were not reasonably ascertainable or practically reviewable. The trial court found that both experts were equally qualified, informed and credible. In its decision, the court noted the plaintiff had the burden to prove that the defendant did not conform to the applicable professional standard. Because the proof was equally balanced as to whether the defendant had a duty to conduct further interviews than those required in the ASTM E1527-94, the court found in favor of the defendant.

On appeal, the court reviewed three components of the ASTM E1527-94 that environmental consultants were required to satisfy: Records Review, site reconnaissance and interviews.The plaintiff’s expert testified that he his own record search uncovered minutes of a 1978 meeting held by the Shelby County Conservation Board where the residential landfill had been discussed. He asserted that the defendant could have easily obtained this record and therefore discovered the prior existence of the landfill. However, on cross-examination he admitted that the minutes did not precisely describe the name or location of the landfill and that the landfill had not been identified in any of the standard public records. He admitted that the defendant had reviewed all of the standard records and that the Vista system used by the defendant was an acceptable method for reviewing the standard sources of records required to be reviewed under ASTM E1527-94.

The site inspection had been performed by an intern who had been supervised by a senior member of the defendant. The inspector had noted undulating terrain that was consistent with a previously known use as a quarry and observed some construction debris on an adjacent property. The parties agreed that the construction debris observed by the intern would not have resulted in the discovery of buried garbage located on a different adjacent parcel The plaintiff’s expert admitted that the site inspection would not by itself had resulted in any evidence of an recognized environmental condition at the property or that the park had formerly been used as a dump. However, he testified that because the adjacent site was a county park, the defendant should have contacted the conservation board since that would have “probably lead to further information”.     
           
Prior to phase 1, NBC had advised the defendant that the real estate broker should be contacted for information about the prior uses of the property and other information. The plaintiff’s expert testified that the broker did not good knowledge of the uses and physical characteristics of the property and therefore could not qualify as a “key site manager” that the defendant was required to interview. Instead, the plaintiff’s expert asserted that the defendant was obligated to conduct interviews of additional persons such as the former owner or adjoining property owners. However, on cross-examination ne conceded that the ASTM E1527-94 did not require interviews of former owners of the property or adjoining landowners.

The court concluded that while the ASTM E1527-94 standard directed the consultant to make an initial inquiry of contacting a key site manager, the standard allocated to the user the task of identifying the key site contact. Since NBC designated the broker as the key site contact, it was reasonable for the defendant to infer that the broker had good knowledge of the uses and physical characteristics of the property for purposes of complying with the interview component of the standard.

Regarding section 10.5.1 of ASTM E1527-94 providing that the consultant make a reasonable attempt to interview at least one staff member of one a local fire department, health agency or local/regional office of a state agency having jurisdiction over hazardous waste disposal or other environmental matters, the defendant produced evidence that it had called and sent a follow-up letter to the state environmental agency and that the local office responded that the property was not on any known state list of sites with known or suspected releases of hazardous substances, and that none were identified within a four-mile radius. One of the defendant’s employees also testified that it had contacted the local office of the USDA Soil Conservation Service which was unaware of any environmental problems with the property. The court noted that both experts agreed that these agencies were appropriate sources of knowledgeable government officials and that these interviews technically satisfied the ASTM standard. Accordingly, the court found that the plaintiff failed to establish by a preponderance of the evidence that the defendant had provided false information when it stated it had complied with the ASTM standard and affirmed the judgment entered by the trial court dismissing the claim of negligent misrepresentation.

On the professional negligence claim, the appeals court began its analysis by stating that a standard of care is “that level of care and diligence ordinarily employed by the average firm practicing in the same area and at the same time. A ‘standard’ such as ASTM E1527 only become the ‘standard of care’ if it us embraced as the ordinary way things are done” The court also note that the ASTM standard is by definition a flexible standard so that the way it will be applied will vary between consultants in different areas and at different times. The court discussed a 2000 study by the local Association of Soil and Foundation Engineers (ASFE) indicating that 73% of phase 1 proposals evaluated stated they would conform to ASTM and that not a single report was in strict conformance to the standard.

Based on this study and the totality of both experts’ testimony, the court concluded that the standard of care and ASTM standard were not equivalent at the time of the 1995 Phase 1. As a result, the court said it would not limit its focus to the defendant’s conformance to ASTM in determining if defendant was negligent. The plaintiff’s expert testified that he had not conducted a formal study of the standard of care for Shelby County and similar communities in 1995 and that his testimony was based on his years of experience with consulting firms.

When asked if the defendant had complied with the standard of care for conducting phase 1 ESAs in Shelby County, the plaintiff’s expert simply indicated that it was his opinion that the defendant had breached the standard because they should have made some effort to find a knowledgable person to interview about the past uses of the land around the site since they knew it had been a quarry, there were “little tell-tale” signs that it had occurred right to the boundry, that there was level ground which means it had been filled and defendant needed to find a person who could discuss what was used to fill the land.

In contrast, the defendant’s expert specifically testified that he had reviewed six other environmental reportds that had been conducted in Shelby County in 1995 and that based on this review, the defendant’s report has conformed to the standard of care. He said the defendant was provided the name of a person to contact by the landowner, the contact indicated that the adjacent land had been used as a quarry, no evidence of dumping was observed during the site reconnaissance and the standard of care in effect in 1995 in Shelby County did not require the defendant to interview prior owners or adjacent owners. As a result, the court affirmed the trial court’s ruling that the plaintiff had failed to establish by a preponderance of the evidence that the defendant had breached the applicable standard of care.

This case is full of nuggets for environmental consultants, attorneys and their clients. First, although this case came to trial 20 years after the CERCLA innocent purchaser defense was enacted at a time, the case illustrates that real estate developers, lenders and attorneys should not assume that the ASTM E1527 will necessarily serve as the standard of care for the environmental consulting industry. In some cases, the local due diligence practices may vary and not rise to the level that may be required to successfully assert liability defenses. In other instances such as New Jersey, the ASTM E1527 will not satisfy the requirements of the state innocent purchaser defense. Nevertheless, the case does show how the ASTM E1527 protocol has evolved and improved over the years.  

Bank Kept In Case On Claims For Incomplete Disclosure of Environmental Issues

In Ironwood Homes v Bowen, 2010 U.S. 58750 (D.Or. 6/14/10), purchasers of farm land subsequently discovered that the property had been used as a disposal site for tannery waste.   Plaintiffs asserted a variety of federal and state law claims against a range of defendants, including two banks that had a history of involvement in the site.

One bank served as the trustee that managed the affairs of the tannery owner, while the other bank provided financing to the plaintiffs.  The lender bank reviewed an environmental report concerning the property, but misstated the conclusions contained in the report to the plaintiffs.  In particular, the bank’s employee incorrectly described the environmental risk associated with the property as “low” and also stated that the report had concluded that no further environmental investigation was warranted.

The court denied motion to dismiss by bank on claims for fraudulent concealment and reckless misrepresentation, negligent misrepresentation, and non-gratuitous negligent advice. The court also denied the lender motion to dismiss that an indemnification in loan modification agreements released plaintiffs’ claims against the bank, ruling that if plaintiffs agreed to the modifications because they had been unaware of the bank’s knowledge about the true environmental condition of the property, the release might be considered unconscionable and therefore unenforceable. 

The court also rejected a state contribution claim brought by the trustee bank against the lender bank, holding that the contribution claim was barred because the trustee bank failed to allege that the lender bank “in any way ‘caused, contributed to, or exacerbated the release’ of contaminants or ‘hinder[ed] or relay[ed] entry to, investigation of, or removal or remedial action at’ the contaminated property.”

FHA Loan Originator Is Not liable for Failing to Test for Arsenic in Water Well

There are a line of cases where plaintiffs have tried to hold banks liable for not disclosing environmental issues known to the lender but not disclosed to the owner . Most of these cases involve foreclosure sales. However, a few involve borrowers who obtain loans to purchase property.

In Voelker v Home Office Realty,  home owners in Michigan claimed that banks involved in the FHA loan process failed to sample well water for arsenic despite knowledge that a local landfill might have impacted the drinking water supply. The plaintiffs noted that the FHA Mortgagee Letter 95-34 (July 27, 1995) requires Direct Endorsement Lenders to sample drinking water in accordance with local and state private well regulations as well as for contaminants of local concern.

The loan originator authorized retained a contractor to test the well for the usual potable water parameters. Years after buying the house, two of the plaintiffs developed cancer that they alleged was a result of exposure to arsenic in the potable water.

The trial court dismissed the claims on the grounds that alleged lender was just a loan originator and that it had no obligation to test the well water. The appeals court affirmed.

Borrowers often confuse a lender concluding that a phase 1 was acceptable from a determination that a property is "clean". The phase may identify environmental conditions that fall within a lender's risk tolerance. Indeed, during the CMBS craze, many originating banks were not concerned about environmental issues since they knew they would be selling the loans to the CMBS collective and thus were not exposed to collateral or payback risk. 

In a separate string on radon, there has been an extended exchange on why banks are not requiring radon sampling for properties located in radon zones 2 and 3 since radon is a carcinogen. This case illustrates why banks are reluctant to go go beyobd minimum environmental requirements. In this case, the plaintiff argued that the loan originator had an obligation to interpret the FHA letter to determine if additional parameters had to be tested as part of the water quality sampling. Fortunately for the loan originator, the count found it was not a "lender" for purposes of the FHA loan process and therefore had no obligation to determine what sampling was appropriate. 

Presumably, even if the loan originator could have been deemed to be a lender, it could stil have avoided liability by arguing that it relied on the expertise of the well tester to determine what parameters had to be analyzed. Of course, the FHA letter seemed to go require more than what was required under state or local drinking water regulations if there were local conditions that warranted sampling additional chemicals of concern, and the well tester might not have known about this additional FHA requirement. By ruling that the loan originator was not an FHA "lender", the court did not have to address the merits of the claims.

Home Builder Seeks Cost Recovery Despite No Pre-Acquisition Diligence

We all know that lender due diligence and underwriting standards were "lax" during the great real estate bubble of the past decade. However, I continue to be astounded by the indifference that developers exhibited to environmental issues since after all they were taking title to potentially contaminated land. Now that the developers have been stuck with cleanups and are unable to sell the homes, they are trying to use lawsuits to compensate for their lack of diligence.  Following is a recent example of such a case. I will discuss another interesting case in a separate post.

In KB Homes v Rockville TBD Corp. George and Patricia Kopetsky (Kopetsky) purchased some unimproved farmland in 1989 that was adjacent to the defendant Rockville plant that manufactured airplane components. Kopetsky did not perform any environmental due diligence prior to acquiring the farm land.
As part of a 1993 asset sale, an environmental investigation determined that TCE had been discharged into the facility’s septic system located on the eastern portion of the property. In 1995, the defendant entered into the Indiana Voluntary Remediation Program of the facility and subsequently determined but the levels were below the cleanup standards. The septic system was decommissioned and the Indiana Department of Environmental Management (IDEM) issued a Certificate of Completion in 1996.  A subsequent investigation performed on the western portion of the property in 1997 and 1998 revealed a plume of TCE-contaminated groundwater that had migrated from the facility and beneath a portion of the Koetsky’s farmland.
In the meantime, the Kopetsky submitted a plat plan for a subdivision known as Cedar Park in 1998. After they received plat approval, Kopetsky entered into a lot purchase and option agreement with Dura Builders.

In the agreement, Kopetsky represented that the Cedar Park land was free of any hazardous materials and promised that he would, at each closing, execute a vendor's affidavit certifying the environmental condition of the lot The affidavits stated, in part, that the land did not contain any hazardous waste or materials, and that no disclosure statement was required to be filed pursuant to the Indiana Responsible Property Transfer Law. Kopetsky also represented to their lender that “after due investigation and inquiry, no contamination was present at the property.

In 1999, Dura Builders began purchasing lots from Kopetsky but did not perform any environmental due diligence either before executing the lot purchase agreement or actually purchasing the individual lots.  In 2002, a consultant retained by Cedar Park provided Kopetsky with groundwater monitoring results showing that a portion of the Cedar Park property was impacted with TCE-contaminated groundwater. A cleanup to non-residential standard was proposed but Kopetsky objected because since this would prevent the sale of the land for residential development.  Kopetsky continued to sell lots to Dura Builders but did not notify Dura of the contamination.

In 2004, KB Homes acquired Dura Builders. KB did not conduct environmental due diligence prior to acquiring Dura Buildings. Indeed, KB did not learn of the contaminationuntil March 2005 when KB had performed its own sampling. KB was forced to halt construction as buyers were either unable to obtain financing or walked away from their contracts. In 2007, KB filed a complaint against Rockville, Kopetsky, and Patriot Engineering for negligence, trespass, nuisance, breach of contract and constructive fraud. KB requested damages for reduction in value of its property as a result of the TCE contamination; legal and consultant fees; fees paid to maintaining the lots and homes; and interest on the capital investment made unproductive by the contamination.

The trial court granted Rockville’s motion for summary judgment and KB appealed. The Indiana Court of Appeals agreed that the KB could not bring a trespass claim because it did not have possession of the land at the time that the activity that caused the contamination had occurred.

On the nuisance claim, the appeals court said the lower court erred when it found that Rockville could have not foreseen that a release of TCE could harm an adjoining property. However, the court went on that under Indiana law, the nuisance claims could not proceed because Rockville had sold the property in 1993 and the actions that caused the contamination had occurred prior to the time KB acquired the sale.

For the negligence claim, though, the appeals court said that the trial court had erred when it granted summary judgment. The trial court had that the damages that KB sought were economic in nature and therefore were not recoverable in a negligence action. Under the economic loss doctrine, parties may not use tort law to try to evade an allocation of risk that was negotiated in a contract. However, the appeals court said that KB did not have a contractual relationship with Rockville so its negligence claim was not an attempt to circumvent a contractual limitation. KB’s claims against Kopetsky and Patriot Engineering have yet to be resolved.

Brownfield Developer Relying on EPA Assessment Seeks Cost Recovery from PRP

In Shenandoah LLC v. Green Mountain Power, David Shlansky entered into a Purchase and Sale Agreement with Green Mountain Power Corp. (GMP) in June 2003 to acquire the Haviland Shade Roller Mill for $150K. GMP and its predecessors had owned the property since 1926 but had leased it to predecessors of Goodrich Corporation beginning in 1942 who manufactured airplane parts.
In the purchase agreement, GMP made a number of representations and warranties including that (1) it had not received any written notices of alleged violations of federal, state or local laws regarding the property, and (2) that to its actual knowledge “but without inspection”, there were no hazardous wastes or toxic materials located at the property whose generation, disposal or storage would have been regulated. The representations were to survive one year.

Shlansky was also given a 60 day inspection period to determine if the environmental conditions of the property were satisfactory including but not limited to hazardous materials in the buildings, groundwater and soils. If the inspection revealed conditions that were unsatisfactory to Shlansky, the agreement provided that Shlansky could terminate the agreement upon five days written notice. Shlansky reportedly asked the GMP facilities manager if GMP had performed any environmental assessments of the site. Allegedly, the facilities manager told Shlansky that an environmental assessment had been performed, that no contamination had been discovered other than some asbestos pipe wrap, that the report was prepared by a competent consultant but that it was the policy of GMP not to disclose such reports “to preserve the privilege of such reports”.  Shlansky subsequently entered into an addendum to the agreement where the parties acknowledged that all contingencies that would entitle the buyer to terminate the agreement had been waived or satisfied..

In July 2004, Shlansky entered into an assignment agreement with Shenandoah whereby the Shenandoah acquired Shlansky’s rights to acquire the site. After Shenandoah obtained the required local permits for the proposed redevelopment project, it contacted the Addison County Regional Planning Commission who had obtained a grant from EPA to perform brownfield assessment grants. The Commission entered into an agreement with ATC to perform a phase 1 of the site. The phase 1 was completed in November 2007-three years after Shenandoah acquired title to the site. The phase 1 recommended additional investigation of staining on wooden flooring and other areas that could have been impacted from historical uses. The phase 2 which was also funded by the Commission and approved by EPA’s brownfield grant program was completed in September 2008. The phase 2 identified elevated levels of PCBs in the main building and an annex along with SVOCs, TCE in soil gas and diesel range organics in the soils. ATC recommended that the PCB-contaminated wood flooring be removed, a soil management plan be implemented during construction activities and that vapor mitigation system be installed along with a vapor barrier as engineered controls.
In an exchange of letters beginning in December 2008, Shenandoah LLC (Shenandoah) sent a letter to GMP requesting that GMP accept responsibility for the costs to remove all hazardous building materials from the property. The letter claimed that GMP was a responsible party under CERCLA and that Shenandoah was relieved from liability under the 2002 brownfield amendments to CERCLA. GMP responded that the presence of hazardous materials in building materials did not trigger CERCLA liability and that to the extent there was a release into the environment, Shenandoah was not relieved of liability because it had not performed an appropriate inquiry prior to acquisition. Moreover, as assignee of Shlansky, GMP said that Shenandoah had waived its inspection rights under the agreement and therefore GMP had no obligation under the agreement to remedy the environmental conditions at the site. Shenandoah then filed a seven-count complaint seeking, among other things, a declaratory judgment that GMP is liable under CERCLA along with breach of contract, negligent misrepresentation and fraud counts.

This case has lots of yummy kernels. The copy of the agreement that was attached to complaint has handwritten notes in the margins of the inspection paragraph indicating that “we did rely, we relied on their reps”. If true, this was a classic blunder by the purchaser. Environmental representations and warranties should never be used in lieu of environmental due diligence. The proper role of representations and warranties is to help the purchaser narrow the issues that need to be investigated. Here, with a facility that had been used since 1926 for a variety of industrial purposes, reliance on written representations and any alleged oral representations of the facility manager was just plain foolish. This is just another example of a purchaser being penny wise and pound foolish by trying to avoid the rather minimal costs of a phase 1 and phase 2.

Likewise, the plaintiff obviously did not understand the requirements of the CERCLA bona fide purchaser and innocent landowner defenses when it neglected to perform a phase 1 prior to taking title to the property. And even when it proceeded to have a phase 1 performed three years later, it had the work done by a consultant retained and paid for by the regional commission. While the preamble to the AAI rule indicated that local governments could conduct all appropriate inquiries for a third party, all aspects of the AAI rule must be satisfied. Without the benefit of a pre-acquisition phase 1, Shenandoah could not satisfy a number of AAI requirements including the relationship of the purchase price to the fair market value, any specialized knowledge of the purchaser at the time of purchase, the presence of environmental liens as well as commonly known and reasonably ascertainable information .

Despite the language in the three paragraphs in the preamble to the final AAI rule allowing all appropriate inquiries to be done by one party and transferred to another, it remains good practice for persons seeking to assert one of the CERCLA landowner liability protections to conduct their own AAI investigation, especially where the transferee is going to redevelop the property. Environmental due diligence involves a series of complicated tradeoffs and a person who does not intend to be the ultimate developer of a site may have very different risk tolerances than the person who is going to be moving dirt, incur remedial risk and long-term obligations associated with the property.

Information gathered by local governments as part of brownfield assessment grants can certainly be used in subsequent phase 1 reports and can be helpful in refining the issues associated with a particular site. However, the person who seeks to claim the liability protection should perform its own AAI-compliant report.

Based on the reps and warranties in the contract as well as the narrative in the complaint, it appears that Shenandoah may have anticipated that the only environmental risks at the property would be lead-based paint and asbestos. Perhaps Shenandoah was only focused on these building interior issues. In any event, the agreement contained what is known as a “big boy” clause which states that there were no other covenants, promises, agreements, conditions or understandings, oral or written, except as herein set forth.” In the absence of fraud, courts tend to uphold “big boy” clauses especially when coupled with a statement that the agreement embodies the entire agreement and understandings between the parties. It is very difficult to prove a fraud case. As pled, the facts in this case do not paint the kind of sympathetic picture that might lead a court to conclude that the plaintiff was victimized by the seller. It will be interesting how the court handles this case. In the meantime, the best option for the plaintiff might be to go back to the brownfield grantee and try to apply for a brownfield cleanup loan.

Federal District Court Grants Summary Judgment to Consultant in Malpractice Action

Earlier this year, a federal district court denied a motion to dismiss filed by a consultant in Hawaii Motorsports Investments v Clayton Group Services. Because the decision involved a motion to dismiss, the court was not ruling on the merits of the case but simply if the plaintiff had alleged sufficient facts to proceed with the case.

Recently, the defendant filed a motion for summary judgment and this time, the court ruled in favor of the defendant, holding that the consultant was not liable to the purchaser of the property.  Since this parties had the opportunity to conduct discovery since the motion to dismiss, the recent opinion also contains some additional interesting facts that not only shed light on this case but provide some helpful lessons.

In this case, Hawaii Motorsports Center Limited Partners ("HMC") had leased the Hawaii Raceway Park from the Campbell Estate since 1988. HMC decided to purchase the site in 2005 for $13MM and then flip the property by way of an assignment of rights to Irongate Wilshire, LLC ("Irongate") for approximately $20 million. Irongate then retained the defendant to perform a phase 1 which identified several environmental conditions. The consultant orally advised Irongate that the remediation costs could range from $200,000 to $4 million. Irongate was concerned that the contamination could impact its ability to develop the site into individual lots. On October 25, 2005, Irongate disclosed the results of the phase 1 and the remediation estimate to one of the principals of HMC

Around the same time, Campbell advised HMC that for tax reasons, HMC could not simply assign the property but had to have an ownership interest. As a result, on October 26th, HMC and Irongate signed a letter of intent to form a joint venture to purchase the property whereby an Irongate special purpose entity would contribute $13,200,000 in the form of a letter of credit in favor of Campbell. In return for Irongate's payments, HMC would assign its interest in the property to the joint venture. Instead of receiving $7 million, HMC would receive four payments of $250K.

On October 31st, the defendant sent an email to Irongate providing its cost estimate. The defendant indicated that the $200K remediation cost was the “Likely Scenario” with  $1 to 2 Million as the “Bad Case” and $4 Million as the “Extreme Worst Case” scenario.

The joint venture arrangement was finalized on November 1st whereby Hawaii Raceway Investors, LLC  The defendant emailed a copy of its phase 1 to Irongate on November 4th and a proposal for a Phase II on November 16th. The phase 2 proposal indicated that the defendant would "perform this project under previously negotiated terms and condition by and between [BV] and HMC Irongate Hawaii Raceway Investors LLC. The reference to JV entity was in error since the previously negotiated terms and conditions had been agreed in September 2005, before the joint venture was formed.  

Irongate forwarded the phase 2 proposal to HMC on November 22nd who retained its own consultant to evaluate the proposal. HMC’s consultant concluded that the majority of recommendations were inaccurate, stating, "Having failed to complete the minimum level of research required during Phase 1, [the defendant] should have recommended further record reviews and interviews  [instead of recommending] a Phase II ESA." He said that remediation cost estimate of $200,000 to $4 million was "entirely lacking in credibility or reliability and should be considered a guess.

HMC filed a lawsuit against the consultant, claiming the firm was professional negligence,  negligent misrepresentations, tortious interference with HMC's prospective business advantage as well as slander of title. Although the consultant was retained by Irongate and the report was addressed to the buyer, the plaintiff asserted that the consultant knew the parties would use its report to negotiate the terms of their agreement. In its ruling on the motion to dismiss, the court found that the plaintiff/seller had alleged sufficient facts indicating it was an intended beneficiary of the report and that it was foreseeable that it would be damaged if the report was inaccurate. The court also found that although the report expressly provided that only Irongate could rely on the report, said it was unclear from the record created at that time if the plaintiff knew of the limitation or had reason to know if could not rely on the report.

The defendant sought summary judgment on all counts. On the professional negligence claim, HMC argued that the defendant owed a duty arising from the "special relationship" between an environmental consultant and a party that may have seen the environmental report prepared by the environmental consultant. The court said the factors in had to consider in determining if a duty included if there was a special relationship existed between the parties, if the harm was foreseeable, the degree of certainty that the injured party suffered injury, the closeness of the connection between the defendants' conduct and the injury suffered, the moral blame attached to the defendants, the policy of preventing harm, the extent of the burden to the defendants and consequences to the community of imposing a duty to exercise care with resulting liability for breach, and the availability, cost, and prevalence of insurance for the risk involved.

The court found that HMC had not established any facts to support a special relationship between it and the defendant. The court said there had not been any no contract between HMC and the defendant, that HMC was not an intended third-party beneficiary of the contract between the defendant and Irongate, and that there was simply no evidence that the defendant intended the report, information in it, or its estimates as to remediation to be given to HMC.

Likewise, the court found that HMC had not established any facts showing the harm foreseeable. The court noted that after HMC obtained the right to buy the Campbell Estate's property, HMC had many months to find financing and hire a consultant to prepare an environmental assessment. Moreover, since HMC was the lessee on the property for nearly 20 years, the court said HMC had ample opportunity to discover the condition of the property. Under those circumstances, the court held that HMC had no reason to be affected by inaccurate information about environmental conditions on the property, and that the defendant could not have foreseen any such impact on HMC.

As to the degree of certainty that HMC suffered harm and the closeness of the conduct and the injury suffered, the court concluded that it was, at best, unclear whether HMC suffered any injury because of the defendant’s allegedly faulty information. While HMC claimed it was injured because Irongate reduced the price it was willing to pay for the property, the court noted that Irongate initially offered to pay HMC $7 million for the property under the express condition that Irongate could withdraw from that offer at any time. Additionally, the court said, change in price flowed from the change in the structure of the deal to a as a joint venture.

Regarding the moral blame and policy factors, the court said there was no evidence that the defendant’s actions were immoral or blameworthy, or that imposing a duty would prevent any harm. In contrast, the court said that HMC could have easily countered any adverse report by hiring its own environmental consultant. Indeed, the court suggested that if HMC lacked independent knowledge of the status of the property it had occupied for so long, it would have prudent to commission its own report.

Finally, with respect to the consequences to the community of imposing a duty to exercise care and any resulting liability for the risk involved, this court concluded that imposing such a duty would create additional burdens for the community. The court said that if a consultant could he held liable to a third party that the consultant never intended to benefit, then  that consultant will surely increase the cost of any assessment to cover the risk and the likely cost of greater insurance

On the claim for negligent misrepresentation, the court began its analysis by noting that Hawaii courts have  limited the scope of liability for negligent misrepresentation to person that a defendant intended to benefit or knew the recipient intended to transmitted the information to another person. On the first factor, the court said there was simply no evidence that the defendant intended to benefit HMC. The court said there was  no evidence that the defendant ever intended to transmit its report directly to HMC since the defendant gave its report to Irongate only after Irongate and HMC had decided to form a joint venture and had agreed on the reduced price. There is also no evidence that HMC saw BV's draft summary of the report, dated November 3, 2005, before the formation of the joint venture or that HMC ever saw the report prior to the formation of the JV.

Turning to whether the defendant could be liable to HMC based on any knowledge that Irongate intended to supply the results of the phase 1 and the cost estimates to HMC, the court noted that during the time Irongate was negotiating with HMC and finalizing the acquisition, the defendant did contact HMC to conduct a site inspection of the property and likely anticipated that its conclusions would be transmitted to HMC. However, the court found there was no evidence that the defendant knew or had reason to expect that Irongate or anyone else intended to benefit HMC by sharing the report or the cost estimates with HMC.  

Even if there were evidence creating a factual question if the defendant knew that Irongate would transmit information to HMC for HMC's benefit, the court said HMC could not prevail on its negligent misrepresentation because there is no evidence that HMC reasonably relied on any such information since HMC’s own testimony was that its officials thought all along that the conclusions were false or inaccurate. To the extent HMC asserted that it relied on defendant’s, the court went on, such reliance was unreasonable. Moreover, the court said, HMC knew about   the environmental condition of the property or could have hired its own consultant. Finally, the court found there was no evidence that HMC relied on BV's environmental findings and estimates before agreeing to form a joint venture with Irongate. Instead, HMC agreed to the joint venture because it could potentially profit from the deal, and because it had to finalize its deal to preserve the option of buying the property from Campbell Estate.

EPA Evaluating Need for Vapor Intrusion Initiative For Urban Areas

EPs and their clients often overlook the potential for soil and groundwater contamination in densely-populated urban areas where soil is covered with impermeable surfacing and groundwater since there are not completed pathways. Unless floating product is detected, the potential for vapor intrusion is often overlooked. Even when the potential for VI is evaluated, the urban environment can present extraordinary and unique challenges.The plethora of utilities and other conduits can create multiple preferred pathways that require property owners, their lenders and professional service providers to discard any assumptions about acceptable distances from presumed sources and the potential for degradation. Because of the multiple current and former sources, it can be a daunting task of identify the source of the spill that has created the potential for vapor intrusion. Without a known source, it can be difficult to fashion a remedy and many state remedial programs must identify a source before they can spend public money. In many instances, the best alternative for property owners who cannot identify a source of the vapors is just to go ahead and incur the cost of installing a vapor mitigation system to cut off potential exposures to occupants.Because of the many challenges that are unique to urban areas, EPA's region 2 office held a meeting this week with a group of stakeholders to discuss developing a urban area VI pilot program. We discussed a number of strategies that could be implemented by local governments and the stakeholders will continue to meet the rest of the year. It is possible that the work from this effort will serve as a basis for adopting similar VI strategies in other urban areas