The Importance of Phase 1 ESAs and Understanding the New Standard

All prospective purchasers of commercial real estate should obtain a Phase I Environmental Site Assessment (ESA) of the property as part of the early due diligence process. This is necessary to determine if there are potential environmental issues and whether further invasive testing, such as a Phase II ESA, might be required prior to acquisition of the property.

What is a Phase I ESA?

A Phase I ESA should be conducted by an Environmental Professional (EP) and typically addresses the underlying land as well as any physical improvements to the property. The assessment of present site conditions, evaluation of risks of neighboring properties, examination of municipal and/or county planning files to check for prior land usage and permits granted, file searches with applicable public agencies having oversight responsibilities relative to the water quality and soil contamination issues, examination of historical aerial photography of the vicinity and validation of the chain of title documentation for environmental liens and Activity and Land Use Limitations (AULS) occurs during this phase. The actual sampling of soil, air, groundwater and building materials is usually not included, but will be performed in connection with a Phase II ESA if recommended based on the findings in the Phase I ESA report.

When is a Phase I ESA Recommended?

Phase I ESAs are also often recommended when a new lender is providing a loan on the subject real estate, in the event of a partnership buyout or redistribution of ownership, in connection with an application to a public agency for a change of use or other discretionary land use permit, or by a regulatory agency which suspects hazardous material contamination on the property.

CERCLA and Innocent Landowner Defenses

It is also important to note that under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA, also known as the Superfund), any owner may be held liable for the presence of hazardous materials on their real property, regardless of whether such owner caused the release. However, CERCLA includes several defenses that limit an innocent landowner's liability for pre-existing hazardous material contamination, including where such owner qualifies as a Bona Fide Prospective Purchaser (BFPP). To utilize the innocent landowner defenses under CERCLA, including qualification as a BFPP, an owner must have conducted "all appropriate inquiries" with regard to the subject property. A Phase I ESA may be used to satisfy the "all appropriate inquiries" requirement.

New ASTM E1527-21 Standard

On February 13, 2023, a new standard for the Phase I ESA went into effect, the ASTM E1527-21 standard (American Society for Testing and Materials). After a year-long transition period, only the new ASTM E1527-21 standard may now be used for any prospective new owners of property to meet the "all appropriate inquiries" component of the criteria to qualify for the innocent landowner defenses to avoid or limit potential liability for pre-existing environmental contamination under CERCLA.

Under the new ASTM standard, any prospective purchaser of real estate must independently do the following in connection with the preparation of the Phase I ESA:

1. Perform a search for environmental liens and AULs and provide any record thereof to the EP within six (6) months prior to the acquisition; a title commitment will usually satisfy this requirement.
2. Provide any commonly known or reasonably ascertainable information about the property from the local community, including, if known, past uses, past releases and past remediation of hazardous materials. This can be obtained from sources including, but not limited to, the current owner, neighboring owners, government officials, and the media.
3. Provide any relevant specialized knowledge regarding the likelihood of a release or threatened release of hazardous materials at the property or adjacent property. For example, is the prospective purchaser generally in the business of buying brownfields or does it have special knowledge of potentially hazardous substances used by the current owner.
4. Consider if the purchase price reasonably reflects the fair market value of a clean property, and if not, whether the price difference is due to the presence or threatened release of hazardous materials. This determination may be made by a consulting broker or by comparing similar properties in the vicinity and a third-party appraisal is not required.
5. Identify to the EP any indications of hazardous materials on, in or at the property.

The questionnaire containing responses to the above queries should be attached to the Phase I ESA under the new standards. The EP working with or on behalf of the purchaser should review and rely upon the questionnaire.

Reliance on Existing Phase I ESA

A prospective purchaser can rely on a pre-existing Phase I ESA that is dated within one (1) year of the acquisition date of the property. It is recommended that the prospective purchaser obtain a reliance letter from the EP associated with the previous review however, and the questionnaire discussed above must still be completed with the submission. The reliance letter should note that the EP reviewed and relied upon the questionnaire in affirming the existing Phase I ESA report. Additionally, when relying on a Phase I ESA dated within one (1) year of the acquisition date, the following specific parts of the new Standard Phase I ESA are required to be performed (or updated) within one hundred eighty (180) days before the closing date to meet the "all appropriate inquiries" component of the innocent landowner defenses to liability for pre-existing contamination under CERCLA:

1. Interviews with past and present owners, operators, and occupants of the property;
2. Searches for recorded environmental cleanup liens and AULs;
3. Review of federal, tribal, state, and local government records;
4. Visual inspection of the property and adjoining property; and
5. Signing the report (by the EP).

Limitations and Recommendations

A prospective purchaser should also be aware that EPs generally limit their liability under a Phase I ESA to the cost to prepare the Phase I ESA or some other small amount. There is usually very limited recourse for a prospective purchaser if a Phase I ESA contains inaccuracies or fails to follow the ASTM guidelines. Therefore, it is also recommended that prospective purchasers:

1. Review the Phase I ESA carefully and confirm that the questionnaire has been included in the Phase I ESA or reliance letter;
2. Confirm whether the Phase I ESA notes any environmental liens or AULs in a title report; and
3. Confirm the Phase I ESA or reliance letter states it was prepared for the purpose of achieving BFPP status. The new standards require the EP to state this in the assessment.

It is recommended that all prospective purchasers of commercial real property obtain a Phase I ESA in compliance with the new ASTM E1527-21 standard as part of their due diligence activities, and which may be used to satisfy specific requirements in order for a prospective purchaser/new owner of property to qualify for protection from potential liability under CERCLA for pre-existing environmental contamination.