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September 2, 2010

What commercial lenders need to know before foreclosing

  • Environmental conditions could reduce the property's value or create a cleanup liability.
    Farallon Consulting



    Thousands of commercial properties face potential foreclosure as the result of a struggling economy and the pressure of $1.4 trillion of nationwide commercial real estate loans coming due in the next five years. Lenders can take action up front to manage the environmental and financial risk inherent in the foreclosure process.

    A lender considering foreclosure on a commercial property should conduct an assessment of the property for environmental conditions that could reduce the property's value or create a cleanup liability once the lender assumes ownership.

    Under the federal Comprehensive Environmental Response, Compensation, and Recovery Act — commonly known as Superfund — property owners and operators are potentially liable for a release of any hazardous substance at their property.

    Lenders generally are exempt from Superfund liability on the basis of two provisions. First, the lender does not participate in the management of the facility, but holds "indicia of ownership" primarily to protect its security interest in the facility. Second, the lender acts quickly to divest itself of the facility after foreclosure.

    A lender gains additional protection against environmental liability under the "innocent landowner" provision of Superfund by making"all appropriate inquiry" (AAI) into the history and past uses of a property before foreclosing on it.

    Hidden conditions lurking?

    A Phase I Environmental Site Assessment (ESA) compliant with ASTM International standards and U.S. Environmental Protection Agency AAI rules will provide sufficient information on the environmental condition of a property. An ASTM-compliant Phase I ESA is a risk-management tool that can assist the lender (or user of the report) in satisfying one of the requirements to qualify for protection from potential liability under Superfund.

    A Phase I ESA provides legal protection if it is performed before the buyer takes control or ownership of a property. It allows the lender to claim innocent landowner status, providing protection for the lender from environmental cleanup liability under Superfund.

    A Phase I ESA must be completed by an environmental professional who meets the educational and experience requirements outlined by ASTM. The environmental professional evaluates the soil, surface water and groundwater at a property — in addition to the physical improvements that have been made to the property and its surroundings — for the purpose of identifying recognized environmental conditions.

    A recognized environmental condition is defined by ASTM as the presence or likely presence of any hazardous substance or petroleum product on a property under conditions that indicate an existing release or a material threat of a release of any hazardous substance or petroleum product into structures on the property or into the ground, groundwater or surface water of the property.

    A Phase I ESA will identify recognized environmental conditions via site reconnaissance and visual observations; interviews; record, regulatory, map and photograph reviews; and historical usage research. If a lender is seeking liability protection under Superfund, the Phase I ESA report must be prepared no more than six months prior to taking possession of the property.

    A defensible Phase I ESA meeting the AAI criteria for liability protection is a critical element of thorough environmental due diligence. Hiring a qualified environmental professional can result in ongoing communication about a property and timely notification of a significant discovery. The cost of a Phase I ESA is typically $2,500 to $3,500, depending on the size and complexity of the property.

    Being proactive

    Scheduling a Phase I ESA early in the foreclosure process can be decisive in obtaining property access for inspection of a site. The site reconnaissance supplies information about a property that is not available anywhere else, improving the accuracy and completeness of the conclusions and recommendations. Additionally, sufficient time must be allowed for the necessary regulatory and public agency reviews.

    Environmental issues besides the hazardous substances and petroleum products addressed by ASTM and AAI rules may be present at a property. Examples include asbestos-containing materials, lead-based paint, moisture intrusion, radon, vapor intrusion and wetlands. While these "business risk" issues are considered outside the scope of the ASTM standard, lenders often find it advantageous to include them in a Phase I ESA.

    A Phase I ESA can be used as a risk management tool to provide protection from Superfund liability. It also is often used to identify potential environmental risks at a property such as improper storage and handling of hazardous materials, underground storage tanks, historical dry-cleaning operations, and historical automobile service and/or repair facilities. Such historical operations often involved hazardous substances and petroleum products that frequently resulted in contaminated subsurface soil and/or groundwater due to the lack of environmental regulations governing the use of these materials prior to the 1980s.

    If a Phase I ESA reveals recognized environmental conditions in connection with a property, conducting a Phase II Environment Site Investigation may be recommended to examine the conditions in greater depth. This may include a regulatory file review, additional interviews, a subsurface investigation, or other site-specific action.

    The potential liabilities created by adverse environmental conditions are an important consideration that lenders should examine as part of the foreclosure process. A Phase I ESA performed by a qualified environmental professional is an effective way to manage the environmental risk of the foreclosure process and potential financial burdens.

    Tina Huff is an associate regulatory specialist at Farallon Consulting, a registered environmental assessor and an active member of ASTM International Committee E50 on environmental management, risk management and corrective action. Kristin Darnell is a project scientist at Farallon, managing environmental investigations and contaminant remediation.

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