Environmental Due Diligence In Bankruptcy
Joseph F. Boyd
published January, 2002, Howard County Business Monthly

The process of bankruptcy can be an arduous one, but complicating the process exponentially are risks associated with environmental issues that are attached to a property to be either liquidated or redeveloped. Environmental issues will not only reduce the property value and stigmatize the property, but additional liability can be incurred in the form of remediation costs, monetary penalties imposed by Federal and state laws and regulations, and tort damages for personal injury or property damage. All of which can be extremely financially detrimental to the responsible party or parties.

There have been numerous bankruptcy cases where the market value for a property was significantly reduced because of extensive contamination. Cases like this are significant not only because of the environmental stigma that can be attached to a property, but lowered property value can be supported by the measure of damages incurred on the property or environmental cost recovery. In addition to the financial blows brought about by environmental cost recovery, the Federal government enacted the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) in 1980 and amended in 1986, which requires the remediation of contaminated properties and forces the responsible parties to pay for it. CERCLA imposes liability on four categories of responsible parties for costs associated with the release of hazardous substances: The present owner or operator of the contaminated facility (includes lenders and liens); any person who owned or operated the facility at the time at which hazardous substances were disposed at the site; any person who arranges for the disposal, treatment, or transport of hazardous substances owned by or possessed by such person; Any person who accepts hazardous substances for transfer to a disposal or treatment site selected by such person. 42 U. S. C. §9607 (a).

How can this environmental risk be reduced or avoided? Environmental risk is reduced by the process of environmental due diligence. The purpose of environmental due diligence is to assess the environmental condition of a property to determine the level of environmental risk associated with a transaction to evaluate possible constraints on the planned use of the property imposed by the environmental condition of the property. There are three questions that come into play in the process of environmental due diligence: Are there any conditions on the property that will cause an increased environmental liability? The property can pose no harm or substantial threat to public health or safety. Can documents be provided showing that the property is in compliance with all environmental laws? This can range from storm water outflows to underground storage tank (UST) registration/compliance. Does the intended use of the property include the integration of the environmental conditions and constraints?

Areas where environmental due diligence can play a role are real estate transactions, mergers and acquisitions, internal auditing due to an incident of incompliance, loan transactions, insurance underwriting, securities disclosures, and bankruptcy law. Since the enactment of CERCLA, environmental due diligence has become a major tool in reducing risk before and during ownership of a property. It is designed to uncover potential circumstances related to commercial and industrial property that could cause an owner or operator of the property to incur liability.

Environmental due diligence involves, at a minimum, the completion of a Phase I Environmental Site Assessment (ESA). A Phase I ESA involves a thorough review of permits, compliance records, and governmental regulatory files concerning the property in question, and the evaluation of any off-site waste management facilities used by the facility. A title search dating back to 1940 is completed to determine the prior uses of the property and waste disposal practices. It also includes a geologic review and a historical review using aerial photographs, topographic maps, and other various documents. A visual inspection or site reconnaissance of the property is completed to identify obvious signs of problems with past disposal practices, such as stained soil or rusted and deteriorating drums, or the presence of underground storage tanks. These are the minimum requirements stated in the environmental due diligence guidelines issued by the American Standard for Testing and Materials E 1527 (ASTM), which has become the standard for most organizations and involved parties. Some lending institutions have more stringent requirements including a visual inspection for lead based paint, asbestos, PCB containing electrical equipment, radon, and wetlands. Depending on the results of the Phase I ESA, a Phase II may be in order, which requires additional soil and groundwater sampling and analysis to determine the type and extent of contamination.

There is no guarantee that the completion of environmental due diligence will reveal every environmental issue, because of the subjectivity associated with the inquiry. Those performing the inquiry are subject to mistakes, but mistakes can be alleviated by using the ASTM standard and contracting a reputable environmental firm. Even though the minimum environmental liability attached to a property cannot be completely assured, it should still be performed, because it can mean the difference in paying $10,000 or tens of millions of dollars in