Seller's Advance Due Diligence in Contaminated Real Estate Transactions

Brownfields are defined by the Environmental Protection Agency as abandoned, idle or underutilized industrial and commercial facilities where expansion or redevelopment is made problematical by real or perceived environmental contamination.

Investing in, owning, developing, or making a loan secured by contaminated real estate involves risks that may be difficult to assess and quantify.  The risks facing brownfield investors and lenders arises from federal and state statutes and regulations.  In 1980, federal legislation entitled the Comprehensive Environmental Compensation and Liability Act ("CERCLA") was passed.  This is also known as the Superfund Law which covers several potentially responsible parties for brownfield related liability.

The CERCLA legislation has given rise to a variety of unintentional problems.  Investors and developers who were fearful of becoming entangled as a responsible party under CERCLA chose to avoid infill brownfield sites and instead built in outlying greenfield locations.  Those decisions and fears gave rise to urban sprawl, decentralization of employment and reduction of property tax base.  Certain owners of contaminated property attempted to avoid the strict liability doctrine of CERCLA by concealing information and not publicly reporting environmental financial liabilities. 

In addition, lenders were reluctant to offer financing to brownfield projects as a result of their concern that they may become owners through foreclosure.  A number of municipalities refused to take possession of tax delinquent contaminated properties because of the potential environmental liabilities.  The fear of becoming a potentially responsible party under CERCLA blocked many efforts to remediate, redevelop, and sell brownfield properties.

The uncertainties involved in selling contaminated real estate make those transactions expensive, complex and likely to not close.  Concerns about the cost of environmental due-diligence, the cost of cleanup, the difficulty of obtaining closure from environmental agencies, and the risk of acquiring expensive environmental liability make selling a brownfield site a difficult real estate transaction. 

Sellers become discouraged because buyers are reluctant to make offers due to the high cost of environmental due diligence, cleanup and related risks. Moreover, these transactions may suffer from lengthy delays due to the environmental studies and negotiations between the parties and the government agencies.  Sales of contaminated properties are often frustrating to transact.

In the 1990's, citizens and communities focused on reducing urban sprawl and modifying the unworkable cleanup standards mandated by federal and state regulators.  These legislative changes removed some impediments to brownfield redevelopment. The changes included lender and buyer liability reforms, adoption of risk-based cleanup standards and relaxation of site closure requirements.

In addition, technical progress in site investigation and remediation technology and the growth of the environmental engineering market reduced the costs of environmental due-diligence and cleanup.  Environmental insurance companies took advantage of opportunities created by regulatory reform and lower remediation costs by creating insurance products to manage and transfer environmental risks.

The recent changes in brownfield laws, technology, and environmental liability insurance have reduced risk and uncertainty and created new opportunities to sell properties that would have been unsalable in years past.  However, parties who exploit the recent brownfield regulatory, technical, or financial opportunities need to carefully understand site conditions.  As a result, there remain significant risks and higher transaction costs in these transactions.

Marketing and Seller's Due Diligence
It is beneficial for the owner of contaminated real estate to complete environmental due diligence in order to make an informed decision about the value of the property.  When a seller decides to market contaminated real estate without doing environmental due-diligence, there is a typical sequence of events.

The seller enters a listing agreement with a broker who then markets property;  a buyer or buyers make offer(s) to purchase with contingencies and due-diligence conditions in order to obtain information about the property and the contamination.  The offer(s) to purchase is/are negotiated and an acceptable agreement is signed and buyer undertakes environmental due-diligence reports at its expense, i.e. Phase 1 and, possibly, Phase 2 environmental reports.  At that point, various results are possible:

1.  If the buyer is satisfied with the environmental report, it may remove contingencies and due-diligence conditions and transaction may close.
2.  The buyer and seller may re-negotiate the contract terms and price based on the due-diligence results.
3.  The buyer may request more time for additional testing or for obtaining approvals or closure from the environmental agencies.
4.  The buyer may refuse to remove contingencies and due-diligence conditions so that the contract comes to an end.

From the seller's perspective, the traditional approach of letting the buyer perform all due diligence after the contract is signed suffers from inherent flaws.  First, prospective purchasers may be reluctant to make offers because they have no information about the type or extent of contamination on the property.  A buyer may waste a great deal of time and expend large sums of money investigating the environmental aspects of a property in a transaction which ultimately does not close.

Experienced buyers recognize the inherent risks so they will typically discount their offer price substantially to reflect potentially extensive due-diligence costs or attempt to share or transfer costs to sellers.  The seller lacks essential information to quantify the cost of remediating the contamination or the reduced value of the property due to the existence of contamination.  Without this essential information, the seller cannot negotiate in an informed manner or to select the most desirable offer.

Moreover, lengthy delays and continuation of contract price negotiations are inevitable when the buyer is forced to enter expensive due-diligence because minimal information was available at the time of the offer.  Lastly, under flexible and risk based closure regulations, certain site uses such as residential housing may be proscribed or conditionally limited if residual contamination exceeds threshold limits.  Without meaningful information, sellers may waste time and money negotiating with buyers whose proposed usage is inconsistent with environmental conditions present at the property.

The seller is well advised to conduct critical due diligence activities prior to marketing a brownfield.  The advance due-diligence should conquer buyers' reluctance to purchase and to provide the seller with a clearer basis for determining the value of its property, quantifying environmental risks and evaluating offers which may be presented.

Due Diligence Methodology

To prepare a brownfield property for sale, it is recommended that owners arrange Phase 1 and possibly Phase 2 environmental site assessments ("ESA's").  A Phase 1 ESA is the starting point in the environmental due-diligence.  The primary goal of a Phase 1 report is to discover if prior environmental management practices created Recognized Environmental Conditions ("REC's").  REC's constitute the presence or likely presence of hazardous substances under conditions that suggest a release into the ground, groundwater or surface water. For sites with lengthy commercial or industrial usage, REC's are commonly discovered.  Follow-up investigation is required to determine if potential releases have actually occurred.  These might include, for example, soil and groundwater contamination from underground petroleum storage tanks, past usage of solvents and releases at surrounding properties.

Based on the phase 1 results, the seller may elect to undertake a Phase 2 investigation to assess concerns stated in the Phase 1 report.  The Phase 2 investigation may include detailed reviews of environmental files for off-site releases on neighboring properties to determine if other properties might be contaminating the seller's property.

The REC's on the subject property need to be investigated.  For example, a survey using scientific instruments may be performed on areas where underground storage tanks were suspected and sample borings may be made to collect soil and groundwater samples.

Underground tanks may be removed to prepare the property for sale and remove uncertainty and contaminated soil may be selectively removed.  The Phase 2 report may recommend that particular areas may be submitted to state environmental authorities for closure.  Additional borings and groundwater monitoring wells may be recommended to clarify the extent of soil and groundwater contamination.  The additional data may be presented to regulators in order to obtain closure or to quantify remediation cost estimates to prospective buyers and environmental liability insurers.

If the sampling results reveal groundwater contamination from surrounding properties, the owner may apply to the state regulators for a liability exemption.  Regulators may require that residual soil contamination not fully removed be acknowledged on the property deed. 

Evaluating Offers to Purchase

During the marketing period, the marketing efforts of the seller's real estate broker may produce offers with a wide price range due to buyers' different use values and risk tolerances.

An appraisal for the seller may include a review of the Phase 1 and Phase 2 studies.  The seller's appraiser will consult with the environmental engineers who performed the studies and understood the onsite contamination.  The estimate of costs to remediate the contamination by seller's environmental engineers should be factored into the seller's appraisal.

There may be a wide divergence in the offered prices in various offers to purchase.  An offer to purchase which takes into consideration the costs of remediation estimated in the environmental reports may be higher than a no contingency offer.

Offers may be submitted which are contingent on obtaining federal and state grants within a lengthy period after acceptance of offer. This type of offer may be undesirable because of the lengthy contingency period.  Another buyer may submit an "as is", no contingency, no due-diligence offer which is submitted at a low price level because the buyer would be assuming the costs of additional detailed testing and studies, the risks of being bearing unexpectedly high costs of remediation to obtain case closure and all the risks of environmental liability.  Moreover, the buyer may be prepared to forego a portion of the monies to be held in an escrow account, pending the results of the testing and remediation.

Hence, by possessing advance due-diligence information, the seller is able to objectively lessen the value of potential risks and reject low offers.  Without the information, the seller would not have a reliable basis for quantifying or estimating the value of the above variables.
In the case of a distressed seller which was in bankruptcy, any prospective liability after closing would be a moot issue.


Selling contaminated real estate is an extremely difficult, risky and complicated process. The common approach of putting the property for sale and waiting for offers to purchase, which typically contain lengthy due-diligence provisions, increases the risk that the transaction may ultimately fail.  Buyers need accurate information about the nature and extent of the contamination in order to be able to make informed offers.  Sellers, buyers, and appraisers require a solid base of environmental information to be able to objectively quantify the lowered value of the property that results from the existence of real or perceived environmental problems.

From the seller's perspective, having the important environmental information in advance of marketing the property will assist in the evaluation process because the appraiser and/or broker can receive the counsel of the seller's environmental engineers.  By entering into a transaction with a firm base of information from which to make decisions, there is less opportunity for costly time delays, re-opening contract negotiations and unnecessary or redundant environmental investigations.

By working together prior to marketing a brownfield property, the appraiser, the environmental engineer, the broker and the seller can create a sound foundation for the valuation of the property and any subsequent negotiation of the offer to purchase.

Brownfield transactions necessitate advance cooperation and coordination of all of the professionals hired by the seller and involved in advanced due-diligence activities. The result will be a transaction that has a higher probability of closing in a shorter time frame and with lower environmentally connected transaction costs.

In summary, the seller may undertake Phase 1 and Phase 2 due-diligence to reduce as much uncertainty as possible prior to the sale.  The seller may limit actual remediation to the most obvious elements such as tank removals, minor excavation and monitoring to establish that residual contamination did not spread off-site. The seller may seek "flexible closure" by leaving low concentrations of contaminated soil and groundwater in place in exchange for placing deed restrictions on title.