Environmental Due Diligence for Real Estate Buyers, Sellers and Lenders Identifying and Mitigating Risks and Liabilities in Real Estate Transactions Today’s faculty features: 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10. TUESDAY, MAY 19, 2015 Presenting a live 90-minute webinar with interactive Q&A Derek Ezovski, President, Outsourced Risk Management Solutions, West Hartford, Conn. Cindy Karlson, Founder, Law Offices of Cindy J. Karlson, East Hampton, Conn. Rachel Rosen, Department Manager, Burns & McDonnell, Wallingford, Conn.
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Environmental Due Diligence for
Real Estate Buyers, Sellers and Lenders Identifying and Mitigating Risks and Liabilities in Real Estate Transactions
Structuring the deal to manage potential/actual environmental risk
Contract provision options and tools
Key negotiated definitions
Strategy practice pointers
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Structuring the Deal
Purchase and Sale Agreement
- Environmental liability risk allocation
- Walk away after due diligence
- Representations, warranties and covenants
- Remedies
- Indemnities
- Guarantees
- Releases and waivers
- Post-closing considerations
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Structuring the Deal
Modifying the Agreement After Due Diligence Period
- Purchase price reduction
- Environmental side agreement
- Site access terms and conditions
- Separate indemnity
- Pre-closing conditions
- Escrow agreement
- Environmental insurance
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Contract Provisions “As-Is” provisions
Boiler-plate language is a good starting point - The devil is in the details
- Drafting with due diligence goals in mind
Strategy on how you define terms is key
- Whether to use broad or very specific definitions and terms
depends on the deal context
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The Basics: Definitions What is a “Liability” for purposes of the contract?
- As broad as “violation and/or any noncompliance with any environmental law”
“Environmental Laws” - applicable federal, state, and local laws, including statutes, regulations, codes, judicial or administrative orders, and ordinances, relating to the protection of public health and welfare and the environment, including without limitation, those relating to the storage, handling and use of chemicals, or regulated substances to the generation, processing, treatment, storage, transport, disposal, investigation, remediation or other management of waste materials of any kind, and for the protection of environmental sensitive areas or threatened or endangered species.”
- Options :
- common law
- OSHA, health and safety considerations
- Define “Environment” separately
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The Basics: Definitions “Hazardous substance” — any and all substances or wastes that have been defined or
classified as hazardous, toxic, or harmful pursuant to any environmental laws or that are
regulated pursuant to such environmental laws, including petroleum and each of its
chemical constituents and by-products, PCBs, and asbestos in any form.
- Options include mold, lead-based paint, urea formaldehyde foam insulation
“Release” - depositing, spilling, leaking, pumping, pouring, emitting, emptying, discharging, injecting, escaping, leaching, dumping or disposing into the environment, whether intentional or unintentional.
- Keep in mind your indemnity when you determine the scope of these definitions
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Definitions: Vague or Specific?
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If too vague:
-Potential arguments over what is and is not included
If too specific:
-You could be cutting yourself off at the knees in the future depending on site developments
Deal strategy will effect the drafting of the definitions
Is simple better in some cases? Pick your battles.
Due Diligence Provisions
Materiality
- Pros and cons of defining Material Adverse Effect
Set the playing rules
– Communications with regulators (file reviews)
- Scope of allowed investigation (who is present and when)
Confidentiality
- How can you handle existing and potential sample results
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Due Diligence Provisions
Site access requirements - Notice, insurance, approved individuals
- Tied to approval by a consultant or a government entity
- Regulatory audit periods after remediation work
- Sunset provisions
- Breach of environmental reps and warranties
- Specific pre-closing environmental conditions
- Undisclosed liabilities
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Escrow Determining the amount of the escrow
- Consultants and lender input
What costs will be covered by the escrow
Who has rights to approve payment from the escrow
Potential hidden costs
Time and money involved with objections to escrow payment requests
Potential litigation
Lender’s role
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Practice Pointers Survival of the Fittest
Successors and assigns – “The indemnity obligations of Seller shall continue until Seller’s obligations under this agreement have been met and compliance achieved as set forth in Section X below.”
Buyer’s Remorse
“Buyer shall indemnify, defend and hold harmless Seller from any loss, cost, damage, or expense (including attorneys’ fees) actually incurred or sustained by Seller in connection with the release or disposal of Hazardous Substances on the Property by Buyer, its agents, tenants, employees and contractors.”
• More levels/forms of due diligence than ever before on more loans
• Seems to be a big push in the CRE market again…
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CRE Lending
• While increasing bank leniency and improved fundamentals have helped revive the CRE market, the high level of maturing debt remains a significant concern.
- excerpt from Deloitte CRE Study
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Issues Important to Lenders
• Collateral Devaluation
• Direct Liability - Loan origination to foreclosure
• Reputational Risk (Brand and Image)
• Operational & Enterprise Risk
• Credit & Trust Risk
•…but at the end of the day, the primary issue
for lenders is Business Risk
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How Did AAI Affect Lenders
• For the first time, there was a federal statutory
authority saying what is needed for a Phase I
environmental site assessment
• Biggest impact of AAI on lenders were the
changes to regulatory and government agencies
– specifically FDIC guidelines and the SBA
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“New” FDIC Guidance
• FDIC updated its Guidelines in November 2006.
• NCUA updated their guidelines and issued guidance in May
2008.
• FDIC’s guidance set the standard; FDIC is regarded as a
leader in terms of environmental requirements.
• FFIEC implemented environmental policy training/education for
examiners across all agencies (October 2007, May and June
2008)
• A majority of lenders have reconsidered and revised their
environmental policies.
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OCC Updates
• Develop policies and procedures that reflect potential environmental risks associated with lending
• Provide for receipt and evaluation of environmental reports prior to making final commitment.
• Ensure that persons responsible for evaluating environmental risk possess relevant knowledge, skill and competence.
• A bank’s policy should reflect the EPA’s AAI rule.
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NCUA Environmental Guidance
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Small Business Administration Update
• SBA updated its Environmental Policy
• Effective August 1, 2008 and updated six times
since (most recently in January 2014).
• Went from 1000 pages to 400 pages.
• Especially important for institutions with
preferred status who do SBA underwriting.
• 7A and 504 lenders must adhere to this policy.
• Has become default policy for many lenders.
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SBA Environmental Due Diligence Policy
2 levels of Environmental Due Diligence for SBA
1. Phase I – for high risk properties
• If property type/use matches the list of NAICS codes for Environmentally Sensitive Conditions
2. Records Search with Risk Assessment – low risk properties
• Includes a search of the government databases (compliant with AAI);
• A search of historical use records, and;
• A risk assessment by an environmental professional determining
whether the site is “High”, “Elevated” or “Low” risk
• New Gas Station/Dry Cleaner Requirements
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Impact of Lender Size/Resources
Regional & National Lenders
• Resources in place to understand environmental issues on the property
• Screen for lower-risk loans
• Have staff/internal resources to manage environmental risk
Credit Unions/Community Banks
• No on-staff environmental expertise (typically)
• Not as sophisticated with regard to environmental issues or due diligence options available
• Often rely only on environmental questionnaires and/or proceed without accurate knowledge of environmental condition of property
• Rely on external guidance to dictate their practices
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Trends from EBA Survey of National Banks
• Less “Command and Control” by ERM departments
• More flexible than in the past;
• More time going into reviewing reports provided by the
borrowers vs. bank commissioned reports.
• Slow adoption of sustainability and “green” programs • High default rates/foreclosures might be contributing
• Very consistent with past practices
• Continue to outpace credit unions/community banks in
risk management
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Environmental Due Diligence Options
• Environmental questionnaire (EQ)
• Desktop due diligence
• Transaction Screen Assessment (TSA)
• Phase I Environmental Site Assessments
• Phase II, III, Remediation, etc.
• Environmental insurance
• Storm water Issues
• Sustainability/Green Issues
• Environmental Insurance
• Others
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Common Commercial Issues
• USTs
• Fuel Oil Tanks
• Spills
• Storage/disposal of
Hazardous Waste
• Vapor Intrusion
• Gas Stations
• Dry Cleaners
• Mold, lead, asbestos,
radon, etc.
• Storm water Runoff
• Superfund
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Examples of Environmental Concerns for
Lenders
• Originations
• Foreclosures
• “Boring” property that used to be auto shop…
• Retail that used to be Gas Station
• Removal of waste from a property by lender triggers
possible action
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Summary
• Lenders have unique processes and reasons for conducting
due diligence.
• Market pressures have reinforced long-term trend to increased
due diligence.
• Regulators enforcing risk management due to a perceived
over-concentration of risk regarding commercial real estate.
• Risk Management (Credit, Collateral, Environmental, etc.) is as
critical as ever to lenders.
• Environmental and appraisals are both pieces of the puzzle
that are being revised under the current environment.