The Environmental White-Glove Test: An Essential Management Tool

By Margolis, Joshua; Lehner, Kevin | Management Review, September 1988 | Go to article overview

The Environmental White-Glove Test: An Essential Management Tool


Margolis, Joshua, Lehner, Kevin, Management Review


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.

COMPONENTS OF

ENVIRONMENTAL AUDITS

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.

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