When A Lender is Thinking of Foreclosure

Many "lenders" (i.e., investors, B-piece buyers, mezz lenders) who never imagined that they would be taking title to property are now finding themselves either commencing foreclosure actions or suddenly holding stock/membership interests in an entities that hold title. Because these "lenders" never thought they would foreclose, they did not take the time to learn about the secured creditor exemption or were told a fanciful story by a non-environmental lawyer or a non-lawyer who was providing legal advice. As a result, these "lenders" are not fully aware of (1) the limitations of the secured creditor exemption) and (2) post-foreclosure obligations to preserve that immunity.

Further complicating the problem is that since the lenders thought they were taking interests in AAA-rated notes, the underlying loan documents did not spell out the foreclosure procedures. At the other extreme are the indentures or trust documents that require trustees to make sure the properties are in compliance with all laws prior to commencing foreclosure.    

Many professionals will tell clients how the secured creditor MAY be able to protect them. However, I think this does a disservice to the client who is already under enormous stress from the losses it has already incurred and who may be willing to grasp at any straws regardless of how illusory or elusive to stop the bleeding.

Instead, I found it more useful to tell them that they should act as if the secured creditor exemption does not apply to them. In other words, they need to make decisions based on the idea that they may be liable simply on the basis of their naked title. 

This approach helps to focus the client on the potential environmental risks. Once the client appreciates the potential risk, we can have a more realistic discussion on its exit strategy, the scope of the diligence, and potential risk mitigation strategies.  

I am not suggesting that one unduly scare or alarm a client. Instead, I am suggesting that one should let the client know that the exemption may not apply for reasons we might not yet know and that their decision-making should be informed by the potential that this line of defense might not be available. The clients can then do what they do every day-evaluate the potential risks of a transaction.

Environmental liability is just one of the risks associated with a foreclosure. Once a client is aware that it might have such liability, it can decide what risk mitigation strategies, if any, they might want to employ based on their own risk tolerance. Sometimes, clients have walked away from the asset because of the uncertainty associated with pre-existing conditions, However, I have also had clients perform additional due diligence to try to develop potential cleanup estimates (based on what passed as an AAI-compliant report during the loan origination, this may be the first time real diligence is done on the property), explore insurance, enroll in a voluntary cleanup program, and sell the note at a reduced price. Sometimes the lender/investors have taken such a "haircut" that they have been willing to roll the dice on possible liability and take title because they think there is inherent value in the property that they or some third party may be able to realize down the road.

An Explanation of the CERCLA Indoor Air Exclusion and its Implications for E1527 and E2600

For years, lawyers and environmental consultants have puzzled over the meaning of the indoor air exclusion of CERCLA. The definition of release excludes  any releases which (1) results in exposure to persons solely within a workplace and  (2) with respect to a claim which such persons may assert against their employer.
This was a puzzling provision since it refers to exposure to persons yet CERCLA does not provide any remedy for personal injury. Over time, the second clause of the exclusion was ignored so that many consultants came to believe that indoor was not covered by a phase 1 unless the client specifically requested such coverage. Indeed, ASTM E1527 provides that indoor air quality along with radon, lead-based paint and asbestos are  non-scope items.

Adding to the confusion is that ASTM E1527 also provides that a recognized environmental condition can include releases into building structures. The uncertainy over the indoor air exclusion was largely ignored until EPA and state remedial programs began focusing on vapor intrusion. Now that vapor intrusion is increasingly becoming a popular tool for toxic tort lawyers, environmental consultants are growing concerned that they may become subject to malpractice actions or breach of contract actions for failing to assess VI during their phase 1 reports.

While doing research on my upcoming article "Playing Poker With Pollution" which calls for revising the CERCLA reporting obligations and  sampling of RECs for owners to satisfy their AAI obligations, I came across language in the preamble to the original section 103 reporting obligations that appears to shed light on the meaning of the indoor air exclusion.

According to EPA, the indoor exclusion was a relic of an earlier House bill that had contemplated that CERCLA would provide a remedy for personal injury. Apparently this section was left in the legislation after Congress decided to drop the provision providing for a remedy for personal injury due to exposure to releases of hazardous substances.  This also explains the second clause of the exclusion referring to workers compensation claims. The old bill would have provided relief to person injured in the workplace from releases of hazardous substances unless they could file a workers compensation claim to avoid duplicate claims.

So, the answer to the decades-long answer is that releases of hazardous substances into indoor air should be covered by phase 1 reports. Of course, whether the applicable standard is the OSHA PELs or levels established for state remedial programs is a discussion for another post.

Seller Not liable For Failing to Disclose Wetlands Report

In Harshman II Development Co., LLC v Meijier Stores Limited Partnership, 2010 Ohio App. LEXIS 314 (2/5/10)  the defendand purchased a 19.23 acre parcel  in Dayton, Ohio in 1992 to build a wholesale store. Prior to acquiring the property, the defendant obtained a phase 1 and phase 2 along with letter from Woolpert Consultants  The Woolpert Report identified five isolated wetland areas on the property totaling approximately 0.293 acres. The Woolpert Report concluded that because of the limited acreage of the wetlands,  the wetlands could be filled pursuant to nationwide permit # 26 and without filing notification to the Army Corps of Engineers. For other reasons, the defendant abandoned its plans to build the store, and the property was never developed.

In 1994, the defendant retained a former commercial real estate realtor/broker  to list the property for sale. As a promotional tool to aid in the sale of the property, the defendant drafted a Site Evaluation Information Sheet ("SEI") that identified the three environmental reports

In 2004, the Ohio Environmental Protection Agency  ("OEPA") obtained permission from the defendant’s real estate manager to enter the property and determine if a specific type of salamander was present on the property. The agency subsequently issued a report identifying the property has having three Category 3 wetland areas. This category is reserved for the most important wetlands under the state wetlands program and  may only be disturbed upon a showing of a”demonstrated public need”. The OEPA did not provide the report or its findings to the defendant, nor was the report made available to the public.

In 2005, the plaintiff entered into a real estate option contract to purchase the property for $1.470MM. The agreement provided the property was being sold "as is" but allowed plaintiff to conduct its own inspection of the property In connection with its due diligence, the plaintiff requested all environmental reports pertaining to the property. Defendant provided copies of the phase 1 and phase 2 reports but did not forward the Woolpert Report prior to the closing. The Phase I and II reports did not identify the existence of jurisdictional wetlands on the property. The cover letter forwarding the environmental reports specifically stated "please note that neither Meijer nor its consultant make any representations or warranties to you or your firm concerning the accuracy or completeness of the enclosed report, and you should independently verify the information to your own satisfaction.” The plaintiff retained ERAtech, Inc. to conduct a Phase I Environmental Report which disclosed the existence of low-lying wet areas on the property but did not evaluate if the wetlands were “jurisdictional wetlands”.

Shortly after purchasing the property in January 2006, the plaintiff began clearing the property to construct a mall and began to fill in the wet areas. OEPA subsequently issued an order halting the work and charged the plaintiff with illegally disturbing jurisdictional wetlands without a permit.

The plaintiff filed a lawsuit against the defendant for fraud and breach of contract, arguing that that the existence of the jurisdictional wetlands was a latent defect in the property which Meijer had failed to disclose by intentionally withholding production of the Woolpert Report. The trial court granted the defendant’s motion for summary judgment in its entirety. 

The appellate court held that the plaintiff had failed to establish that seller fraudulently concealed the existence of the wetlands on the property by failing to provide the buyer with the report regarding the discovery of such. The court noted that the broker had sent a letter to the defendant raising the possibility of a “wet land issue", and while acknowledging that this raised some issues regarding whether the plaintiff was aware of the existence of wetlands on the property, the court said it could not ignore the fact that the plaintiff was had experienced, knowledgeable, and sophisticated commercial real estate lawyers and developers.

The court also found that the presence of jurisdictional wetlands on the property was an open and obvious condition that the buyer who had unimpeded access to the property could have discovered upon reasonable inspection. The court noted that the National Wetlands Inventory Map not only revealed the existence of jurisdictional wetlands on the property but was used by the consultant retained by the plaintiff after development was halted on the property by the EPA to confirm the presence of wetlands. Moreover, the court pointed out that the plaintiff even attempted to use the presence of the wet areas to negotiate a lower purchase price.

The court also found that the 1992 Woolpert Report would not have been relevant to the plaintiff because the state wetlands program  had become much more restrictive in 2001 and the size of the wetlands had changed-growing to approximately .82 acres of the property. The court also found persuasive the testimony of two of the defendant’s employees that a wetlands assessment was a separate and distinct inquiry from the Phase I and II environmental reports, and they thought that the plaintiff was only seeking to obtain copies of those report. 

The plaintiff had originally named ERATech as a defendant but agreed to dismiss the consultant from the case and try to resolve its claim through an arbitration proceeding. The state Supreme Court declined to hear an appeal of this case in June

Extended SOL May Apply For Consultant Malpractice Case

In Plato Associates LLC v Environmental Compliance Services, 2010 Conn. LEXIS 400 (11/9/10), the plaintiff retained the defendant in 2000 to perform a phase 1and phase 2 in connection with a financing for an acquisiiton of a property and construction loan. One of the conclusions of the defendant's report was that the property did not contain an "establishment", the existence of which would have triggered compliance with the Connecticut Transfer Act (CTA).

The plaintiff closed on the construction loan and received the first advancement under the loan. During the proces of refinancing the loan in 2007,  the plaintiff discovered documentation showing that a former tenant of the property had generated thousands of hazardous wastes at the site, thereby causing the property to be considered an "establishment" and triggering compliance with the CTA.

Plaintiff filed a breach of contract and malpractice claim shortly thereafter. Defendant moved for summary judgment on grounds that the breach of contract claim was barred by the six-year statute of limitations (SOL) and the malpractice claim by the applicable two-and three-year SOLs. The plaintiff argued that the seven-year SOL for professional engineering services rendered in connection with an improvement to real property applied (Conn. Gen. Stat. 52-584(a)). The trial court granted the defendant's motion and plaintiff appealed.

On appeal,  the defendant's argued that (1) they had not provided "professional engineering services", (2) that any services were not provided in connection with any real estate improvements but in connection with a bank loan and (3) that the monitoring wells did not qualify as "improvements" because they added no value to the property.  The Connecticut Supreme Court rejected these arguments and reversed the lower court.

On the first issue, the court found there was a genuine issue of material fact whether the services performed constituted "professional engineering services". The court noted the defendant identified itself as a professional engineer and licensed environmental professional and that the definition of "professional engineer" was broad enough to encompass the services provided by the defendant.

On the issue of the purposes of the services, the court found there was a genuine issue of material fact if the services were rendered in connection with the "planning" for improvements since the report was key to obtaining the financing to construct the improvements. The court noted that the report expressly stated that it purpose was to identify conditions that might impose environmental liability or restrict the use of the property, and did not mention that it was one to facilitate a bank loan.

Finally, the court rejected the notion that the monitoring wells could not be an  "improvement" because they did not add value and were simply to to assist the plaintiff in obtaining a loan. The court said the term has been defined to include any alteration or development of property to enhance or promotes its use for a particular purposes. The court noted the construction of the wells and testimony of the plaintiff that without the wells it would not have been able to secure its financing. According, the court said it could not rule as a matter of law that the wells were not an improvement to property for purposes of the seven-year SOL.