Phase What? Understanding Environmental Reports In Real Estate Transactions04-Nov-15
By Sean Parker
Most of us have heard of cases where a purchaser of real estate discovers contamination after the deal has closed, or where a purchaser later learns that a known potential condition turns out to be far worse than previously thought. There are a variety of tools a lawyer can use to minimize and mitigate the risk of entering into the purchase, sale or lease of real estate with potential environmental liabilities. The lawyer’s toolbox includes: indemnities, holdbacks, buyback provisions, insurance, among others. However, choosing which tool to use and how to use it is often based on information contained in a report prepared by an environmental consultant.
The focus of this article – understanding environmental reports and the reliance that can be placed on them – is intended to help potential vendors and purchasers understand the information that may be available to them, limitations of that information, and how to factor the limited information into the deal to apportion the risk borne by each party.
The legal maxim of caveat emptor, or “buyer beware”, is often determinative of matters regarding the sale of contaminated land. While the liability of each party can be managed through contractual terms in the sale agreement, those terms are based on the parties’ understandings of the applicable environmental conditions, which is often based on information gained through environmental investigations and the accompanying reports.
Baseline Conditions and Types of Assessments
The starting point for assessing environmental risk in a real estate transaction is understanding the baseline environmental conditions. Although this sounds simple, actually obtaining useful information, recognizing the limitations of that information, and identifying other unknown factors can be a challenging endeavour.
For most typical commercial real estate transactions, one will try to ascertain what baseline environmental conditions are by hiring an environmental consultant to prepare a Phase I and potentially a Phase II Environmental Site Assessment and accompanying report(s).
A Phase I assessment does not involve any intrusive investigations, such as collecting soil or groundwater samples. Phase I assessments are limited to a review of historical documents such as previous environmental reports for the subject property or neighbouring properties, directories of former businesses that operated on the property, fire department records, aerial photographs, etc.
Phase I assessments also involve a site visit(s) and visual inspection, and may include interviews of people who have useful information about the property (e.g., previous or current owners, tenants and neighbours). The purpose of a Phase I assessment is to identify areas of potential environmental concern, if any, and recommend further investigations that may be warranted. A Phase I assessment is limited in the sense that it does not provide any hard scientific data of the actual environmental conditions – no samples are taken.
If a Phase I assessment recommends further investigation, a Phase II assessment may be undertaken. A Phase II assessment generally involves collecting samples of soil, groundwater, surface water, building materials and other items recommended by the consultant. The objective of a Phase II assessment is to understand the actual environmental conditions (i.e., contamination). Essentially, the Phase I assessment tells you where to look and what to look for; the Phase II actually looks and tells you what the conditions are, at least with respect to the areas tested and substances tested for.
There are standardized and generally accepted methodologies for carrying out Phase I and Phase II assessments and it is advisable to ask any consultant that you are considering working with if they conduct investigations in accordance with recognized standards. While there are a multitude of environmental consultants who offer a wide variety of experience, expertise, and prices, it is advisable to use only a specialized, qualified and reputable consultant. Although there is currently no governing body in Alberta that accredits “environmental consultants” as such, most are accredited professionals such as engineers, hydrogeologists, agrologists, etc. Accordingly, it is advisable to ensure that your consultant is or has access to qualified and accredited professionals with appropriate expertise.
The cost of a Phase I and/or Phase II assessment will generally be driven by the site characteristics, but estimates may vary between consultants. Do not be tempted by a low cost estimate alone. The cost of the investigation itself should not be the determinative factor when deciding which consultant to use or whether to undertake an environmental investigation at all. Rather, the main consideration should be: who can provide me with the best information that will be most useful to me when identifying and assessing my risk? The savings from using a less expensive consultant may pale in comparison to the costs of remediation and other expenses resulting from issues that a more qualified consultant would have identified.
Limitations and Qualification of Information
Even the most thorough environmental investigations, conducted by the most qualified consultant, will always leave some unknowns that ought to be accounted for when apportioning the risk between the parties to the transaction.
Limits on knowledge of the environmental conditions often result from the fact that the whole site will not be tested. It is often impractical and cost prohibitive to conduct a full site sampling regime, which may not be warranted in any event. That is the rationale behind the two-step (i.e., Phase I and Phase II) assessment process. Consultants know of these limitations as well as, or better than, anyone else, and generally include robust qualification and limitation of liability clauses in their service contracts and assessment reports. The main qualifications most often seen are:
- That findings and conclusions are based on the information available and reasonable engineering judgment;
- The contents of the report can only be relied on by the party that the report was prepared for; and
- Liability of the consultant is limited to the amount equal to fees received by the consultant for that work.
The qualification that findings are based on engineering judgment means that any conclusions and recommendations are not held to a standard of perfection. The consultant has used the best information available to them to make certain assumptions and to draw certain conclusions. In general, the consultant will be held to the degree of care and skill ordinarily exercised by a member of the profession practicing in similar circumstances and localities at that time.
Reports or other contract documents often include a qualification where the client recognizes that environmental conditions may vary across the site and the conclusions presented are based on the data from the limited and specific locations tested. This is not to say that a consultant’s report cannot be relied on, or that a consultant can effectively preclude all liability for the advice they give. Courts have held that a consultant cannot contract out of all liability for the work that they are doing when it is that very work that they were hired to complete and where the client is clearly relying on the findings and advice.
The limitation that a report can only be relied on by the party for whom the report is prepared is an important qualification that is often overlooked. The implication of this qualification is that if the findings of an investigation prove to be deficient, the only party that could seek recourse against the consultant is the one that the report is actually prepared for. Phase I and Phase II reports typically state on the cover page and introductory paragraphs the party that the report was prepared for.
As an example, suppose a potential purchaser requires the vendor to have a Phase II assessment completed and to provide the results to the purchaser. The vendor hires a consultant to conduct the investigation and issue a report. The report is issued to the vendor and discloses no contamination in excess of the applicable regulatory criteria. The purchaser buys the property relying, at least in part, on the Phase II report. After the deal closes, the purchaser discovers significant contamination that will cost more to remediate than the site is worth. In these circumstances, if a qualification is contained in the report that restricts the parties that can rely on the report, the purchaser would have no recourse against the consultant in either tort (i.e., negligence) or in breach of contract because the report was prepared for the vendor only.
However, this type of qualification can often be waived if the third party (i.e., the purchaser in the example above) obtains written consent from the consultant that they can rely on the report as if it had been prepared for them. Not surprisingly, consultants usually charge a fee for providing such consent and would only provide it before any deficiency in their work is known.
The qualification that liability is limited to the amount of fees received by the consultant can have significant implications. The total fees received by a consultant may be a mere fraction of the cost to remediate the property or decreased value of the recently discovered contaminated site.
While there are limits to the utility and reliability of environmental investigations and reports, there are certainly very competent consultants who do excellent work and provide valuable information and advice to their clients. Phase I and Phase II assessments are often a critical part of performing due diligence when contemplating a transaction.
Parties ought to understand the limitations of the different types of assessments and qualifications that may be placed on the findings presented. By better understanding the information presented, the potential limitations of that information, and the restrictions on one’s ability to rely on it, parties are better equipped to appreciate the risks associated with a particular transaction and to structure the deal and protect their interests accordingly.
Sean would like to thank Sarah Levine for her assistance in researching this article.