$35M Brownfield Project Derailed by Methane Gas

Earlier this year, I discussed the BNY Mellon v Morgan Stanley Mortgage Corp where  the defendant/mortgage originator has been sued by the CMBS trust for a $80MM shopping center loan where methane gas issues led to a default. See detailed post at: http://lschnapf.blogspot.com/2011/07/cmbs-lender-kept-in-case-over-questions.html

Now we have another case involving a $35MM development loan where a bank is a plaintiff and is seeking damages from several environmental consultants for failing to anticipate methane gas problems at the development site. In this case, the development site contained two former landfills that had been closed before the current closure requirements went into effect. The defendants filed motions to dismiss the complaint and while the court agreed to dismiss some of the claims, it allowed the negligence and CERCLA claim to proceed to discovery.

In Bancorpsouth Bank v. Environmental Operations, Inc., 2011 U.S. Dist. LEXIS 117010 (E.D. Mo. 10/11/11), the City of Hazelwood (City) requested proposals to redevelop an approximate 150-acre  blighted area known as the Robertson Development Project (Site). This area formerly contained two landfills, several auto body/salvage yards, demolished residences, a gas station, petroleum bulk storage facility and some small manufacturing concerns. The City wanted to construct a warehouse and light industrial complex.

After several years, the city received an acceptable development proposal and adopted an ordinance selecting McEagle Development LC as the developer of the Property. In November 001, Geotechnology, Inc. (Geotech) prepared a phase 1 environmental site assessment (ESA) to the County of St. Louis. Interestingly, despite the fact that a large portion of the Site consisted of what was called the Edwards Landfill (Landfill), the ESA expressly provided that an evaluation of methane gas was not included within the scope of services. The ESA identified the aforementioned former uses as RECs. However, in discussing the former landfill, the report simply stated that “The vertical and horizontal extent [of the landfill] is unknown as well as the composition of on-site materials. Deleterious materials anticipated in this area (sp) and should be a consideration to both the geotechnical design of the development as well as to the environmental cleanup. The fill may facilitate (sp) utilizing a method other than probing/boring to sample both bearing capacity and contaminants. Therefore it is recommended that after a site plan has been developed, the environmental sampling and geotechnical investigation be coordinated to take place concurrently.” Unlike the phase 1 in the Morgan Stanley case, this phase 1 did not mention the potential for methane gas or flag it as an item of concern,

In October 2002, the City and Hazelwood Commerce Redevelopment Corporation (“HCRC”) entered into a Development Agreement whereby the granted HCRC the right to acquire the Site including the parcels containing the Edwards Landfill. HCRC then assigned its acquisition rights back to the City so that it could begin the process of assembling the various parcels by way of eminent domain.

Between 2003 and 2005, HCRC retained Geotech to prepare a number of sampling reports. These reports identified nine areas of concern related to the former uses. Again, the reports did not study or evaluate the potential presence of methane.

In July 2004, the Industrial Development Authority of the City of Hazelwood submitted a brownfield application to the Missouri Department of Economic Development (“MDED”). This application was approved and the project became eligible for over $6.9MM in Brownfield Tax Credits. The tax credits were later sold to a tax credit purchaser.

In April 2005, Environmental Operations Inc (EOI) and Geotech prepared a Remedial Action Plan (RAP) where Geotech would act as the oversight consultant and EOI would perform the environmental remediation activities. Pursuant to the RAP, salvaged automobiles and larger waste would be removed and disposed of off site. Building debris from former site structures would be removed and existing site structures would be surveyed for asbestos. In addition, approximately 400,000 cubic yards of landfill material would be excavated and screened. Items between six and 12 inches were to be transported to an onsite engineered cell that was to be designed with 24- inch thick clay liner and capped by 60- inch clay cap. The fine material (less than six inches) was to be used as deep fill elsewhere at the Site. The material excavated for the engineered cap was to be used for grading elsewhere at the Project. A stormwater retention basis was to be constructed on top of the engineered cell. Upon completion of all remediation activities, a final report would be prepared and submitted to the MDNR for issuance of a no further action letter. Interestingly, the RAP did refer to the presence of volatile and semi-volatile organic compounds at the Property but did not address the potential for methane gas. The RAP was amended in February 2006 to provide for pumping and discharging trapped water from within the engineered cell area. No provision was made for the accumulation of methane gas within the cell

Meanwhile Hazelwood Commerce Center LLC (“HCC LLC”) and The Signature Bank entered into a one year $11.5MM Land Acquisition Loan Agreement in October 2005. The proceeds from this loan were to be used solely to complete the assemblage of the parcels for the Project and related expenses. HCC LLC made representations that the Site was in compliance with environmental laws and that there were no Hazardous Materials (the definition included reference to flammable substances) except as disclosed in the environmental reports and the RAP.    

In June 2006, HCC LLC and EOI entered into an Environmental Services Agreement to implement the RAP. This agreement required EOI to achieve substantial completion of the landfill remediation work, other than capping the engineered cell, within seven months, and to achieve substantial completion of the cap within twelve (12) months. All other remediation work was to be completed within fourteen (14) months which would be memorialized by a No Further Action Letter from the MDNR. The agreement also provided that EOI would obtain a Premises Pollution Liability Insurance Policy (“PPL Policy”) and a Remediation Cost Contamination Insurance Policy (“RCC Policy”) with collective coverage of up to $5MM.

In June 2006, the City and HCC LLC entered into a Remediation and Development Agreement (the “Remediation and Development Agreement”) where the City agreed to enter into a Purchase and Sale Agreement (PSA) to sell the landfill site to HCC LLC. The City was to deposit the proceeds from the sale as an initial contribution to the Remediation and Development Project Trust Indenture (the “Project Trust Indenture”). The PSA was executed the same day along with Collateral Assignment of Environmental Services Agreement and Consent of Contractor that granted Signature Bank an assignment and security interest in the Remediation and Development Agreement as well as the related agreements

With the execution of the foregoing documents, Signature Bank then entered into a $35MM Development Loan Agreement in August 2006. The purpose of the loan was to pay off the pre-existing Acquisition Agreement and to fund the activities required for the Project. However, the Development Loan proceeds were not to be used to fund the remediation which was to be financed from the sale of the tax credits and the other public financing.

In April, 2008, bubbling gas was observed rising through the detention basin constructed atop the engineered cell. EOI collected measurements for methane by placing a stainless mixing bowl directly over the bubbling area for approximately five minutes and then inserting a testing device under the mixing bowl to read the content of the “trapped” air. EOI found no methane and forwarded the test results to MDNR. EOI requested that MDNR consider the potential for methane gas generation or contamination a closed issue. However, MDNR directed EOI to install gas monitoring wells which revealed the presence of explosive levels of methane not only within proximity of the engineered cell but throughout the Site.  

The borrower eventually defaulted on its loan and the successor to Signature Bank filed its complaint. The bank alleged that because of inadequate investigation and design, dangerous levels of methane gas affect large portions of the Property, further construction and sale of lots at the Project cannot proceed pending further remediation of the methane conditions. The bank estimates the additional work to address the methane gas will exceed $10 MM

I cannot imagine how three environmental firms failed to raise methane gas as a potential issue for a project involving the redevelopment of and disturbance of an old landfill. This would have been the first issue that I would have thought they would have raised.

Class Action Lawsuit for Radon Mitigation Systems Against Developer and Engineering Firm

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 that 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. New residential structures constructed in Tier 1 Areas must be equipped with fully functional radon resistant 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 town homes 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 stated 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 supervisor. 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 plaintiff also introduced evidence of design and construction flaws. The plaintiffs’ expert said some of the systems were designed with a drainage pipe that was connected to a sump pit to transfer negative pressure to the neighboring unit, thereby reducing radon in both basements. However, the experts said that if the sub-surface system filled with water, this would interfere with the negative pressure system to the other unit, thereby allowing radon levels to rise in the basement.

The plaintiffs also provided evidence that many homes did not have sealed sumps covers and that the absence of the sealed covers  prevented radon from being eliminated from the basements. The plaintiffs also showed that other homes had exterior exhaust pipes that terminated before reaching the roof or were located too close to upper story windows, allowing for reentry of radon through an open window.  The plaintiffs’ experts also said that all of the outside mounted fans that were inspected had holes drilled into the pipe under the fan, which caused a loss of efficiency and premature fan failure. In all the homes with unfinished basements that were inspected, none of the floor to wall joints or cracks were sealed. In the opinion of the experts, 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.

Brokers Coming Into Cross-Hairs Over Environmental Disclosure

With property values continuing to plummet in the wake of the Great Recession, it is probably not surprising that brokers are increasingly finding themselves embroiled in lawsuits over scope of environmental disclosure. The risk is particularly heightened in states with Property Conditions Disclosure laws. Common issues involve mold, lead-paint, asbestos, radon, poor drinking water quality and leaking home heating tanks.

In an post earlier this year, I discussed how parties in residential transactions in the State of Washington are frequently taking the Ostrich approach when it comes to USTs and ignoring the tank condition for fear of further impacts on property value. Further complicating the issue is that in some states, home inspectors have no obligation to assess condition of heating oil USTs.

Following are some examples of recent lawsuits involving brokers and residential transactions:

Amethyst v. Marcus & Millichap Real Estate , 2011 Cal. App. Unpub. LEXIS 3641 (2nd AppDiv May 16, 2011)(compel arbitration)

Melgardejo v Evans, (8th Jud. Cir. Alachua Cty, Fl)(Complaint)(proximity to superfund site)

Blackmore v Re/Max, 2010 Ida. LEXIS 124 (Id. 2010)

Hall v. Hall, 2010 Mont. LEXIS 401 (Mt. 2010)

Commercial brokers are not subject to the Property Disclosure laws and plaintiffs have to show some contractual or other duty to be able to prevail against a commercial broker. A recent case illustrating this trend is  Movassate v Dudley Ridge Properties, 2011 U.S.Dist. LEXIS 15808 (N.D.Cal. 2/16/11) where the buyer discovered groundwater contamination after taking title to the property.

In New York, many real estate lawyers advise clients selling homes located in downstate counties not to complete the property condition disclosure statement but instead pay the $500 statutory penalty for non-compliance. The lawyers feel it is better for their clients to give the buyer the statutory $500 credit for not preparing the statement rather than risk unlimited liability for common law misrepresentation.

In many states, residential purchasers frequently do not have to retain counsel and simply rely on their brokers. In those states, brokers need to be very careful when preparing the forms.  It would probably be a good idea for brokers to develop relationships with environmental consultants

State Appeals Court Allows Claim To Proceed for Failing To Comply With Property Condition Disclosure Law

Plaintiff entered into agreement o purchase home for $296,900. Seller provided Buyer with a Residential Property Condition Disclosure Statement (PCDS) Report prior to the closing. Buyer did not receive a home inspection report until after the closing though buyer personally inspected home for two hours prior to closing. 

After the closing, the plaintiff learned of a heating oil tank that had been hidden by grass, rotted wood that had been newly painted and discovered termite damage when it removed the pool house floor. Plaintiff spent approximately $38K on repairs and then sold house for $440K for profit of approximately $150K. The plaintiff then sought its out-of-pocket expenses from defendant, claiming defendant had violated the PCDS law and had committed fraud.

On motion for directed verdict, trial court found there was a genuine issue of fact if the seller had disclosed material information that it knew was false, incomplete or misleading.  In addition, the court found the plaintiff had failed to conduct a reasonable examination of the Property and that this failure to review the inspection report violated its duty to exercise reasonable diligence. The court also found the plaintiffs had failed to prove damages because plaintiff had made profit on the sale of home.

Plaintiffs then appealed the PCDS ruling. The appeals court ruled that there were material questions about the reasonableness of plaintiff's inspection and amount of damages that should have gone to the jury.  

Plaintiff made nearly $150K when it sold house 18 months after taking title.  This case seems to fall into the piggish category.  Coake v Burt, 2010 S.C. App. LEXIS 245 (Ct. App. 12/1/10)

Consultants Survive Lawsuit For Negligent Investigation and Remediation of Brownfield Site

Buyer agreed to purchase former oil field in 1996 to develop for residential complex.  Contract included 40 pages detailing  remedial obligations of parties. Buyer had five years to complete investigate of property and inform seller of contamination. If cleanup exceeded $30MM, seller could take over cleanup. Contract also provided that after completion of sellers' corrective action plan, seller will have been deemed to have assigned to buyer any rights seller may have against contractors.

In 1996, buyer retained consultant (consultant 1) to investigate site and Huntington Beach Fire Dept approved remedy to remove lead-contaminated soils. In 1997, Seller retained a second consultant  (consultant 2) for $15K to remove 10 cyds of lead-contaminated soil. Later that year, seller advised the buyer that its costs were approaching $30MM threshold and that seller intended to take over cleanup to better manage costs. During soil excavation performed by the second consultant, additional lead-contaminated soil was discovered approximately 15 feet from prior excavation area. The seller then retained consultant 2 to excavate and dispose oil-contaminated soil.

Buyer claimed it had suffered $3MM in costs and sued consultant 1 for breach of consultant and negligence. Using a six-part test employed by California courts for determining if a duty exists to third parties who are not in contractual relationship with the alleged wrongdoer, the court found consultant owed no duty to buyer. The court said the first consultant had been retained by the seller and that buyer did not have right to enforce the contract as a third party beneficiary because the contract did not disclose that the seller was not the property owner. Moreover, the court said the first consultant had excavated the specific contaminated area provided in the contract and had no obligation to investigate other areas of the site. The court also noted that the buyer had the opportunity to review the work being done by the consultants and it should not be rewarded for failing to audit this work. Finally, the court said that imposing a $3MM liability on the consultant for a $15K project would not be in the public interest since such disproportionate liability would discourage consultants from engaging in such work.

This case is particularly important to purchasers, developers or lender who are relying on another party to investigate and remediate a major development site. In such instances, it is important that the "passive" party retained its own expert to actively supervise the work.

Makallon Atlanta Huntington Beach LLC v Chevron Land and Development Company, 2011 Cal. App. Unpub. LEXIS 1911 (Ct. App. 3/14/11)