THE ENVIRONMENTAL WHITE-GLOVE TEST: AN ESSENTIAL MANAGEMENT TOOL
Environmental audits are becoming one of the most important corporate management tools, particularly in major real estate transactions. "Two years ago, it was almost unheard of to do environmental audits in the ordinary course of a real estate acquisition," says Joseph Polito, chairman of the environmental law department for Hinigman, Miller, Schwartz and Cohn of Detroit, Michigan.
Today it's commonplace for buyers, sellers, and lenders wishing to protect their interests and mitigate potential liability to call in professional consultants and conduct environmental audits. Reasons to conduct an environmental audit differ according to the company's relationship to the property in question. For buyers, environmental audits are necessary to claim the "innocent landowner" defense if toxicity is later discovered. Also, buyers or their counsels can use knowledge of environmental liabilities uncovered during audits to obtain better positions at the negotiating table. Buyers may also conduct audits to verify the claims of sellers' audits.
From the seller's perspective, an audit can identify environmental liabilities such as on-site waste disposal, past spills of hazardous materials, and leaking undergound tanks that could come back to haunt the seller.
In some cases, the seller may desire to transfer these liabilities to the buyer; but if there is a chance the buyer would seek damages for the transfer of an undisclosed liability, the seller may wish to retain control over the liabilities. The damages sought and legal costs associated with this type of settlement could substantially exceed the amount the seller would have paid to handle the problem internally.
In addition, a seller may wish to substantiate a claim to a potential buyer that the site is "clean," or identify the scope of a specific liability to the buyer if the liability is to be incorporated into the negotiating process. Also, a seller may want to conduct an audit to counter the findings of the buyer's audit.
Another factor for the seller to consider is state regulations, such as New Jersey's Environmental Cleanup Responsibility Act (ECRA), which has provisions that require property sellers to remove hazardous residues prior to real estate transfer. ECRA stipulates that if the owners cannot provide a "negative declaration" of toxicity, they must submit a cleanup plan and make financial guarantees that actions necessary to render the site "clean" will be taken. Failure to comply with ECRA can be grounds for voiding the sale by either the state or the purchasere. Many states have already implemented or are considering similar legislation (see Table I, page 46). Prudent sellers will check state regulations before conducting an audit or selling a property.
In addition to buyers and sellers, many financial institutions are using audits to determine the value of collateral. "When banks secure a loan with a security interest in a piece of real estate, they must consider environmental integrity or run the risk of being held liable as an owner," says Polito. Also, should a lender exercise too much control over the borrowe's business activities, the institution could be considered an operator and incur Superfund liability as a result. Many lenders are refusing to foreclose on properties that have environmental liabilities. It is also becoming more common for lenders to have environmental audits performed before providing a loan to a prospective buyer.
Environmental audits can be conducted on four levels:
* A superficial paper review;
* Interviews with employees and regulatory agents;
* On-site observation; and
* On-site sampling.
When a purchase or merger is in the works, an environmental audit normally is conducted at the first three levels. Using this information, the auditor can then determine if on-site sampling is needed.
To ptimize time on the site and focus activities on particular areas of concern, initial data gathering occurs before visiting the property. During this phase, important clues about possible compliance and liability problems are discovered by investigating several sources.
The facility's environmental coordinator should be able to provide data on environmental management, permits and plans, and manufacturing operations. A title search will result in a list of owners. Insurance maps and aerial photographs often provide important clues about past activities and possible associated problems (abandoned underground tanks, for example, or filled-in surface impoundments). The U.S. Geological Service (USGS) can make hydrogeologic data available, and similar sources can provide information on possible receptors of environmental contamination. Local, state, and federal agencies keep files on spills, fires, explosions, underground tanks, and past environmental violations.
The first phase of data gathering results in a site profile and site-visit plan. Typically these should include the following information:
* Descriptions of current and past raw materials, manufacturing processes, products, environmental residuals, and associated management methods of hazardous and nonhazardous wastes;
* Scaled site maps identifying natural and manmade features of the site's surroundings, including community support systems and receptors relative to all areas where hazardous substances have been generated, manufactured, refined, transported, treated, stored, handled, or disposed;
* Site maps containing inventory and demarcation of all storage vessels, specifying their age, what they are made of, capacity, materials stored, and release history;
* A list of owners, lessees, neighbors, and their environmental management activities;
* Identification of permits and the legal requirements on company environmental policies, procedures, personnel responsibilities, and other management-related information applicable to the facility and its operations;
* Government inspections and enforcement actions, if any, and the response to these actions.
From this activity, a good auditor should be able to predict between 60 percent and 75 percent of what will eventually be discovered upon completion of the site visit and analysis of the data.
ON THE SITE
The purpose of the site visit is to verify what was discovered in the initial screening, fill in identified data gaps, and determine whether additional problem areas exist.
The entire grounds and all the facility's structures should be surveydd, along with once-active areaas that have fallen into disuse. In the life of an industrial property, any number of operations may have been conducted. For instance, what now is a field may once have been a creosoting operation, pesticide mixing area, salvage yard, underground fuel storage area, or plating line. Auditors should make special efforts to trace the locations and possible effects of past environmentally significant activities. These activities can sometimes be identified on historical aerial photographs or other photos of the facility.
If an unreported liability is discovered through an audit, there is often reason to believe the firm has additional problems. If this is likely, it is wise to take representative site samples to confirm the seller's claims. During this survey, particular attention should be directed toward insulating materials (asbestos), transformers (PCBs), and underground tanks, in addition to soil and groundwater sampling and analyses. Keep in mind that because the property owner is ultimately responsible for actions occurring on the premises, the activities of the facility's lessees should also be throughly investigated.
Obviously, it is easier for sellers to conduct environmental audits, because they have access to on-site information and are familiar with current practices. As a buyer, it is imperative to obtain full cooperation from the seller and regulatory agents to get an accurate perception of the environmental practices and liabilities associated with a potential merger or acquisition.
When choosing a firm to conduct an environmental audit, consider the investigatory capabilities of the firm in relation to the property in question, the auditors' ability to work with attorneys, and the firm's track record.
It is important to choose a firm that can handle all aspects of audits. "When choosing an environmental consulting firm, we look at the facility under consideration--the types of operations performed, length of time the facility has been in operation, location--to determine potential types of liabilities that may be found on-site; then we recommend a firm that is able to handle those types of liabilities," says Eric Sweitzer, an environmental attorney with Ogletree, Deakens, Nash, Smoak and Stewart of Greenville, South Carolina. "For example, if on-stie groundwater sampling is needed, the firm's engineers and technicians should be able to run testing equipment and devise a sampling plan," says Sweitzer.
The firm should also have an in-house laboratory facility and a competent hydrogeologic staff to evaluate soil and groundwater data results and protect client confidentiality. Quick turnaround on sample analysis is also an important consideration, because buyer-supported audits typically are initiated when negotiations are under way and a deal imminent.
"On the other hand, prospective sellers should conduct an audit before negotiations begin--especially if they're not very familiar with their property--to avoid wasted effort should the seller decide to retain control of the liability," says Sweitzer.
The auditing firm also should have experience with transfer contracts, which spell out specific environmental liabilities and determine which party is responsible for those liabilities. Even though contamination may have been found on the site, the buyer may still want to proceed with the purchase. The consultants and attorneys must then determine the proper contract language. "Often, this service can be performed more efficiently for clients when the law firm and environmental consulting firm have worked together on previous audits," says Sweitzer.
Also, check the environmental firm's track record and determine whether current clients are satisfied with its performance and ability to deliver. Environmental auditors should be able to estimate accurately the cost to rehabilitate the site. Although no consulting firm will guarantee audit projections, it should be able to provide reasonably sound cost estimates, based on the records and information known at that time.
When deciding whether to assume the risk of an environmental liability, managers should weigh potential risks against possible costs, keeping in mind the future use of the site.
Faced with on-site contamination, an owner has several options, ranging from no action to complete removal and off-site destruction at a permitted facility. A prudent owner or manage will consider both long- and short-term costs and risks before selecting a strategy.
In some cases, discovering an environmental liability at a potential purchase site can be advantageous to the buyer. If the seller does not wish to retain the liability, or the buyers prefers to assume it, the buyer may be able to bargain down the price, based on the risk assumed and the estimated costs of remedying the problems.
Owners considering remediation must also factor in the expected use of the property. Properties that will continue to be used for the same purpose may require less remediation than those to be used for a different purpose. For example, a former refinery site may require much more cleanup if it is to be turned into a residential development than if it were to remain in use as a refinery.
The decisions a company makes about a contaminated property may require substantial outlays of cash. However, in all cases, owners will incur greater remediation costs if forced to take action rather than voluntarily removing wastes.
With real estate transactions becoming more complicated every day, environmental audits are a tool for sellers, purchasers, and lenders to determine whether a potential purchase is a worthy investment.
Joshua D. Margolis is an environmental management analyst for Wisconsin-based consultants RMT, Incorporated. He assists industry and federal facilities in developing environmental audit tools, protocols, and industry audit programs. Kevin A. Lehner is an environmental scientist, also for RMT, where he conducts on-site audits and develops closure strategies.…