132007 Model Toxics Control Act

Applying the New ‘All Appropriate Inquiries’ Standard: Implications for Liability Protection and Risk Assessment by Joshua M. Lipsky [email protected]

1201 Third Avenue, Suite 320 Seattle, Washington 98101 (206) 292-6300 www.cascadialaw.com Joshua M. Lipsky Applying the New ‘All Appropriate Inquiries’ Standard: Implications for Liability Protection and Risk Assessment Page 2 of 12

I. INTRODUCTION AND HISTORY OF ALL APPROPRIATE INQUIRIES...... 1 II. AAI TO SUPPORT ENVIRONMENTAL LIABILITY DEFENSES...... 2 A. State and Federal Liability for Hazardous Substance Cleanup...... 2 B. CERCLA Liability Protections Requiring AAI...... 2 C. MTCA’s Innocent Landowner Defense...... 4 III. ALL APPROPRIATE INQUIRIES TODAY...... 5 A. Key Elements of the New AAI Standard...... 5 B. Key Changes, Implications and Potential Consequences Arising Under the New AAI Rule...... 8

I. INTRODUCTION AND HISTORY OF ALL APPROPRIATE INQUIRIES

In general, performing an environmental site assessment provides buyers, sellers and lenders with critical information on the history and condition of property that may be contaminated. Such due diligence can: identify potential environmental liabilities that can then be addressed by applying legal defenses or via contract in the purchase and sale transaction; provide added confidence that a particular project will be financially viable and not impaired by environmental concerns; and ensure that the property will be eligible for bank financing or can at least identify to a bank’s satisfaction the environmental issues that must be resolved before a loan can be issued. Performing such assessments is almost always advisable when getting involved with new commercial or industrial property.

Recently, with the issuance of EPA’s final All Appropriate Inquiries rule, the standards for performing environmental assessments have changed. In 2002, Congress enacted the Small Business Liability Relief and Brownfields Revitalization Act (the “Brownfields Amendments”). The Amendments revised the then-existing innocent landowner’s defense to liability contained in the federal Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”), and created new liability exemptions for two categories of landowner: the bona fide prospective purchaser and the contiguous property owner. In all three cases, the Amendments require that prospective owners seeking to take advantage of these liability protections must make “all appropriate inquiries” (“AAI”) into the potential for contamination of the property to be acquired. The Amendments set out general criteria for meeting the AAI standard and required EPA to come up with specific requirements for meeting the standard. Those requirements were proposed in November 2005 and took effect on November 1, 2006.

Understanding the new AAI standard is important to buyers and sellers of contaminated property, and to their lenders, for many reasons. Not only is the new AAI assessment a pre-requisite to establishing one of the three CERCLA defenses identified above; in addition, the Washington Model Toxics Control Act (“MTCA”) contains an innocent Joshua M. Lipsky Applying the New ‘All Appropriate Inquiries’ Standard: Implications for Liability Protection and Risk Assessment Page 3 of 12

purchaser defense that is available only to purchasers who (among other factors) perform “all appropriate inquiry … consistent with good commercial or customary practice.” While this MTCA defense does not directly reference the new AAI standard, as discussed below, the new AAI standard may effectively become the MTCA standard once it becomes commonplace in the industry.

In fact, EPA’s new AAI requirements are swiftly becoming the due diligence standard for property transactions. The American Society for Testing and Materials (“ASTM”), the organization widely relied upon for developing standardized due diligence requirements, updated its ASTM E1527-00 Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process to comply with the new AAI. EPA has confirmed that the new standard, E1527-05, complies with the new AAI requirements. Consequently, the new AAI standard is likely to be used for most environmental assessments, even when a CERLCA or MTCA defense is not at issue. Already, many lenders, governments, developers, and real estate professionals have institutionalized the application of the new AAI standards.

II. AAI TO SUPPORT ENVIRONMENTAL LIABILITY DEFENSES

A. State and Federal Liability for Hazardous Substance Cleanup

MTCA and CERCLA hold four broad categories of parties liable for the cleanup of hazardous substances:

 The current owners and operators of property.  The persons who owned or operated the property at the time of the disposal of hazardous substances.  The persons who arranged for the disposal of hazardous substances (usually known as “generators”).  The transporters of the hazardous substances, if they selected the site for disposal.

This liability is strict, retroactive, and joint and several; however, CERCLA and MTCA do provide several ways to avoid liability in the context of a real estate transaction.

B. CERCLA Liability Protections Requiring AAI

The 2002 Brownfields Amendments clarified protections against CERCLA liability for “innocent landowners” and provided new protection for contiguous property owners and so-called “bona fide” prospective purchasers. Joshua M. Lipsky Applying the New ‘All Appropriate Inquiries’ Standard: Implications for Liability Protection and Risk Assessment Page 4 of 12

1. CERCLA’s “Innocent Landowner” Defense. Prior to the 2002 Amendments, purchasers unaware of property contamination could avoid CERCLA liability if they were “innocent” at the time of purchase. However, the law did not define “innocence.” The 2002 amendments clarified the requirements for this “innocent landowner” defense. Among other things, the law clarified that the innocent landowner must perform AAI and, thereafter, must purchase the property without knowing, or having reason to know, of contamination on the property.

The amendments to the innocent landowner defense also add a new burden on purchasers seeking to use this defense, by requiring them to take “appropriate care” to deal with any contamination discovered on the site and to “cooperate” with future cleanup efforts. Thus, performance of AAI alone is insufficient to trigger the defense; due care and certain other post-acquisition requirements must be satisfied to maintain the applicability of this defense. For instance, under the 2002 amendments, the purchaser must prove that it fully cooperated with those carrying out response actions at the site; complied with land use restrictions and institutional controls at the site; and took reasonable steps to prevent further releases at the site.

A Rhode Island district court has determined that the new innocent purchaser standards are not retroactive. United States v. Domenic Lombardi Realty Inc., 290 F. Supp. 2d 198 (D.R.I. 2003). This means that persons who bought property before the effective date of the CERCLA amendment need comply only with the old standards. The court found that the new law "created additional, substantive requirements" and it would be unfair to impose these duties on past purchasers.

2. Bona Fide Prospective Purchaser Defense. The Brownfields Amendments also added a “bona fide prospective purchaser” defense. The law creates a new defense to liability for purchasers who are not “innocent” (in the sense that they knew about contamination before they purchased the property) but who did not cause the contamination themselves. Among other requirements, bona fide prospective purchasers must perform an AAI site assessment prior to purchase and may buy knowing, or having reason to know, of contamination on the property. Other important requirements include, but are not limited to: providing full cooperation, assistance, and access to persons taking response actions at the site; complying with any land use restrictions; and Joshua M. Lipsky Applying the New ‘All Appropriate Inquiries’ Standard: Implications for Liability Protection and Risk Assessment Page 5 of 12

taking “reasonable steps” to address releases of hazardous substances discovered.

3. “Contiguous Property” Defense. The Amendments also codified an existing EPA policy into a new affirmative defense for properties where the contamination migrates from a neighboring parcel. This has been termed the “contiguous property” defense. Property owners seeking to apply this defense must perform AAI prior to purchase and must buy without knowing, or having reason to know, of contamination on their property. Further, the owner cannot have caused, contributed to, or consented to the release of hazardous substances. Other requirements for this defense include but are not limited to taking “reasonable steps” to address releases discovered at the property; and providing full cooperation, assistance, and access to persons taking response actions there.

EPA has the discretion to apply this exception to parcels not literally adjoining the property that is the source of contamination. New guidance explains that the Agency will consider doing so for non- contiguous property owners based on case-specific facts. This includes whether the landowner’s property was affected by the non- contiguous property in a manner similar to the way it might have been affected by a release from an adjoining property.

Persons who fail to qualify for the contiguous property owner exemption because, for instance, they knew of the contamination when they purchased, may still qualify as bona fide prospective purchasers under the new Brownfields Amendments.

C. MTCA’s Innocent Landowner Defense

MTCA provides an “innocent landowner” defense to liability for owners of contaminated property who can establish that at the time they acquired the property, they had no knowledge or reason to know of any release of hazardous substances. To qualify for this defense, the owner “must have undertaken, at the time of acquisition, all appropriate inquiry into the previous ownership and uses of the property, consistent with good commercial or customary practice in an effort to minimize liability.” Ecology has not adopted rules specifying what steps constitute “all appropriate inquiry” for purposes of MTCA’s innocent landowner defense. However, Ecology’s rules provide that:

Any court interpreting this subsection (b) shall take into account any specialized knowledge or experience on the part of the person, the relationship of the purchase price to the value of the property if uncontaminated, commonly known or reasonably ascertainable Joshua M. Lipsky Applying the New ‘All Appropriate Inquiries’ Standard: Implications for Liability Protection and Risk Assessment Page 6 of 12

information about the property, the obviousness of the presence or likely presence of contamination at the property, and the ability to detect such contamination by appropriate inspection.

Strictly speaking, EPA’s new AAI regulations do not apply to MTCA. The federal AAI standard is considerably more stringent than the more flexible standard suggested by MTCA’s limited statutory language, but Ecology does not interpret the MTCA standard as inconsistent with the new AAI rule. In fact, Ecology has indicated that it expects that with the adoption of the new ASTM Phase I standard, E1527-05, what constitutes “good commercial or customary practice” will likely change to reflect the stricter ASTM standard. The agency has also noted that, in interpreting MTCA’s AAI requirement, courts may look to the federal standard, as they often do when a MTCA issue is unresolved. Consequently, prospective purchasers seeking liability protection under MTCA should apply the AAI standard or risk losing such protection because their site assessment was inadequate.

III. ALL APPROPRIATE INQUIRIES TODAY

On November 1, 2005, EPA published its new rules to set standards and practices for conducting AAI. See 70 Fed. Reg. 66069. EPA gave a “grace period” until November 1, 2006 before the new rules took effect. The new standards and practices address the ten AAI criteria that Congress identified in the Brownfields Amendments. These criteria, and how EPA has implemented them, are discussed below. In general, the purpose of the AAI inquiry is for prospective landowners seeking certain liability protections (described above) or CERCLA grant funding (for site characterization and assessment) to conduct an investigation of property prior to purchase “to identify conditions indicative of releases or threatened releases of hazardous substances….”

A. Key Elements of the New AAI Standard

1. Report and update results of an inquiry by an “environmental professional” (EP). Some of the activities included in AAI must be performed by an EP or someone acting under the EP’s supervision, while others can be performed by the purchaser or another person acting on behalf of the purchaser. EPA’s new rule sets minimum qualifications for EPs conducting AAI. These qualifications consist of a combination of education and experience. The allowable combinations are:

. Licensed or certified to perform environmental inquiries, or as Professional Engineer or Professional Geologist, plus three years’ experience; . Bachelor’s degree in engineering, environmental Joshua M. Lipsky Applying the New ‘All Appropriate Inquiries’ Standard: Implications for Liability Protection and Risk Assessment Page 7 of 12

science, or earth science, plus five years’ experience; or . Bachelor’s degree in another field, plus ten years’ experience.

EPA’s new rule requires a written report documenting the results of the AAI assessment. This report does not have to be submitted to EPA or any state agency, but should be kept by the purchaser for purposes of establishing the appropriate defense, if necessary.

The AAI report has to include the EP’s opinion regarding whether the inquiry identified conditions indicating a release of hazardous substance. Also, the report must identify, and the EP must comment on the significance of, any data gaps that affect the EP’s ability to form the opinion. Finally, the EP must state his or her qualifications, and must include a declaration stating that all AAI elements were performed in accordance with EPA requirements.

The new AAI rule specifies when AAI must be conducted. AAI must be performed within one year prior to the date of purchase (that is, prior to when the purchaser takes title to the property). EPA allows the use of information collected during previous due diligence exercises, provided that it is updated. In addition to the information that is unique to the specific transaction (e.g., the relationship of purchase price to fair market value, and specialized knowledge or experience of the purchaser) the following components of AAI must be updated within 180 days prior to the date of property acquisition:

. Interviews; . Searches for recorded environmental liens; . Review of government records; and

. Visual inspections.

Also, an EP must review the old and updated information, and provide a declaration stating that the AAI assessment was performed in accordance with EPA requirements.

2. Interview past and present owners, operators, and occupants of the subject property. An EP must conduct (or review and approve the conducting of) interviews with current owners and occupants of the property and with past owners and occupants of the property to the extent necessary to meet the AAI objectives Joshua M. Lipsky Applying the New ‘All Appropriate Inquiries’ Standard: Implications for Liability Protection and Risk Assessment Page 8 of 12

related to characterizing site history with respect to releases. Also, if the property in question is abandoned the EP must interview one or more owners or occupants of a neighboring property who may have observed historic uses of the subject property.

EPA’s new rule does not specify the questions that must be asked during the interviews. If there are numerous interview candidates, the rule allows EPs to use their professional judgment to decide which persons would be most knowledgeable about current and past uses of hazardous substances on the property, and to interview only those persons.

3. Review historical sources of information, such as chain of title documents, land use records, aerial photographs, fire insurance maps, and records of local historical societies. The search for historical records must extend as far back as it can be shown that the property was used for residential, agricultural, commercial, industrial, or governmental purposes. Under EPA’s new rule, an EP or someone acting under the supervision of an EP must conduct the search for historical information.

4. Search for recorded environmental liens. The new rule allows either the purchaser or the EP to conduct this search.

5. Review governmental records. Although EPA’s new rule does not specify particular records that must be reviewed, it identifies the following as types of records that should be searched: records of reported or threatened releases; records of activities, conditions, or incidents that may cause releases, such as regulatory permits; records in EPA’s CERCLIS and ERNS databases; and government registries of engineering controls, institutional controls, and land use restrictions. The search would have to include nearby and adjoining properties, as well as the subject property. An EP or someone acting under the supervision of an EP would have to perform this review.

6. Visually inspect the subject property and adjoining properties. If the owner will not grant access to allow an on-site inspection, then other means must be used, such as aerial photography or inspection from the nearest accessible vantage point. EPA’s new rule requires an EP, or person acting under the supervision of an EP, to conduct the visual inspection. However, because the visual inspection is so important, EPA strongly encourages that EPs Joshua M. Lipsky Applying the New ‘All Appropriate Inquiries’ Standard: Implications for Liability Protection and Risk Assessment Page 9 of 12

themselves perform visual inspections, rather than delegating this task to subordinates.

7. Consider any specialized knowledge or experience of the purchaser. This requirement has existed as part of the innocent landowner defense since 1986, and EPA stated in its new rule that it did not intend to change the nature or intent of this requirement, including any interpretations made by courts.

8. Consider the relationship of the purchase price to the property’s fair market value if not contaminated. Under EPA’s new rule, an appraisal is not required to satisfy this criterion. A more informal evaluation is sufficient – for example, by comparing the purchase price to prices of similar properties in the same area, or by consulting a real estate expert who can provide a comparability analysis. Either the purchaser or the EP can complete this requirement.

9. Consider commonly known or reasonably ascertainable information about the subject property. As with the specialized knowledge or experience criterion discussed above, this has been an existing element of the innocent landowner defense since 1986. EPA does not intend to change the nature or intent of this requirement, including any interpretations made by courts.

10. Consider the “degree of obviousness” that contamination is present or likely to be present on the property. Again, this requirement dates from the 1986 CERCLA amendments, and EPA does not intend to change the nature or intent of this requirement, including any interpretations made by courts.

B. Key Changes, Implications and Potential Consequences Arising Under the New AAI Rule Joshua M. Lipsky Applying the New ‘All Appropriate Inquiries’ Standard: Implications for Liability Protection and Risk Assessment Page 10 of 12

Summary of Main Differences Between the Final AAI Standard and the ASTM E1527-00 Standard Main Differences Final AAI Standard ASTM E1527-00 Definition of  Specific  No specific certification, Environmental certification/license, education, and licensing, education, or Professional experience requirements. experience requirements  Applies  Applies to all individuals only to individuals supervising all involved in conducting all appropriate inquiries. appropriate inquiries. Interview with Current Mandatory A reasonable attempt must be Owner and Occupants made to interview key site of the Subject Property manager and reasonable number of occupants. Interview with Past Interviews with past owners and Not required, but must inquire Owner and Occupants occupants must be conducted as about past uses of the subject necessary to achieve the objectives and property when interviewing performance factors in §§ 312.20(e)-(f). current owner and occupants. Interview with Mandatory at abandoned properties Discretionary Neighboring or Nearby Property Owners or Occupants Records of Activity and  No requirement as to who is  User’s responsibility Use Limitations (e.g., responsible for the search .  The search results must Engineering and  Scope of environmental cleanup be reported to the Institutional Controls) lien search includes those liens filed or environmental professional. and Environmental recorded under federal, state, tribal or  Scope of environmental Cleanup Liens local law. cleanup lien search is limited to reasonably ascertainable land title records. Government Records  Federal, state, tribal, and local  Federal and state Review records records  Local records/sources at the discretion of the environmental professional. Site Inspection  Visual inspection of subject  Visual inspection of property and adjoining properties subject property required. No required. exemption.  Limited exemption with specific  No specific requirement requirements if the subject property to inspect adjoining properties; cannot be visually inspected. only to report anything actually observed . Contaminants of Parties seeking CERCLA defense: CERCLA hazardous substances Concern  CERCLA hazardous substances and petroleum products EPA Brownfields Grant recipients:  CERCLA hazardous substances, pollutants or contaminants  petroleum/petroleum products • controlled substances Joshua M. Lipsky Applying the New ‘All Appropriate Inquiries’ Standard: Implications for Liability Protection and Risk Assessment Page 11 of 12

Main Differences Final AAI Standard ASTM E1527-00 Data Gaps  Requires identification of  Generally discretionary; sources consulted to address data  Sources that revealed no gaps and comments on significance of findings must be documented. data gap with regard to the ability of the environmental professional to identify conditions indicative of releases and threatened releases Shelf Life of the Written One year, with some updates required Updates of specific activities Report after 180 days recommended after 180 days Source: EPA-560-F-05-242, October 2005

1. New requirements for Environmental Professionals. The addition of specific qualifications for consultants supervising the AAI review is one of the major changes to AAI. The failure to utilize a qualified EP will invalidate the applicability of the AAI analysis for purposes of CERCLA liability protection. Finding the best consultant is always advised for this reason alone, but also for purposes of ensuring that information on the subject property is accurate and complete for assessing the efficacy of a property transaction.

2. Reliance on EP for Data Gap Reporting. As to several elements of the new AAI rules, the EP has more discretion than under ASTM E1527-00. For instance, the EP must determine when a good faith effort has been made to pursue an element of AAI such that the effort can be abandoned and cited as a legitimate data gap. Similarly, the EP must exercise its discretion as to the degree of significance to attach to a particular data gap that affect the EP’s ability to identify potential releases at the site. These decisions may profoundly affect the cost, timing, conclusions, and, ultimately, the validity of the AAI assessment. This emphasizes the importance of the EP’s role in AAI due diligence and the value of retaining an extremely well-qualified EP.

3. Increased Costs and Timing. The costs of performing a Phase I site assessment under the new AAI standard are higher than under the old standard. More importantly, performing under the new standard is taking longer, with mandatory interviews and additional sources to review. As a result, the timing of AAI may not be compatible with the period for environmental inspection provided for in standard real estate purchase and sale contracts. Further, the level of detail required under AAI may conflict with a potential buyer’s perceived interest in minimizing assessment costs and Joshua M. Lipsky Applying the New ‘All Appropriate Inquiries’ Standard: Implications for Liability Protection and Risk Assessment Page 12 of 12

merely obtaining a “ballpark” estimate of risk. In these cases, clients should be counseled to consider whether qualifying for liability defenses is important to the transaction or whether AAI is being required by a lender; if either is the case, the client must understand the risks of constraining the scope of the EP’s investigation.

4. Sampling Not Required but Data Gaps and Defenses May Demand it. AAI does not require sampling and analysis. EPA notes, however, that sampling may be performed to address data gaps that would otherwise render it impossible for the EP to provide a conclusion as to releases of hazardous substances on the property. This guidance may tend to dramatically increase the amount of sampling that is performed during the site assessment process. Further, EPA cautions that in some circumstances it may be wise to conduct sampling for purposes of maintaining liability protection. For example, the results of AAI may be inconclusive with respect to whether hazardous substances have been released on the property. If sampling is not done to make a conclusive determination, it may be impossible to meet other requirements of the BFPP or contiguous property defenses. As EPA’s new rule explains:

An inability to identify a release or threatened release during the conduct of all appropriate inquiries does not negate the landowner’s ongoing or continuing responsibilities under the statute, including the requirements to take reasonable steps to stop the release, prevent a threatened release, and prevent exposure to the release or threatened release once the landowner has acquired a property.

Finally, even if liability defenses are not at issue, sampling may be advisable to quantify the risk inherent in taking title to potentially contaminated property.

5. Confidentiality Interview Requirements. Many real estate transactions are sensitive matters, where early disclosure of a potential sale can threaten the transaction. Efforts to maintain the confidentiality of a particular transaction may be threatened by the mandatory requirements to interview past and present occupants of the property and, in the case of abandoned property, neighbors of the subject property. This may represent a conflict between a client’s business goals and the EP’s ability to draw conclusions regarding releases at the property. Working closely with the EP to Joshua M. Lipsky Applying the New ‘All Appropriate Inquiries’ Standard: Implications for Liability Protection and Risk Assessment Page 13 of 12

structure mandatory interviews may help to minimize risk to the transaction.

6. Lender Adoption of New AAI Standards. In November 2006, the Federal Deposit Insurance Corporation (“FDIC”) recommended that all lenders evaluate whether to require borrowers to apply the AAI standards. As a result, many lenders have adopted the new standards and many more are likely to. This means that, even where liability protection is not at issue, AAI often will be required. The lender AAI requirement will increase loan transaction costs and may require that such buyers obtain inspection extensions on existing contracts or negotiate longer inspection periods up front.

7. Requirements for Liability Protection Extend Beyond AAI. Potential landowners performing AAI to obtain liability protections should be aware that these protections also require them to take “reasonable steps” to address contamination discovered, to cooperate with future cleanup efforts, and to provide other post- acquisition care with regard to releases. EPA has stated in an interpretive memo that it believes that in requiring reasonable steps, “Congress did not intend to create, as a general matter, the same types of response obligations that exist for a CERCLA liable party (e.g., removal of contaminated soil, extraction and treatment of contaminated groundwater).” However, EPA noted that there “could be unusual circumstances” where reasonable steps would be “akin to the obligations of a potentially responsible party (e.g., the only remaining response action is institutional controls or monitoring, the benefit of the response action will inure primarily to the landowner, or the landowner is the only person in a position to prevent or limit an immediate hazard).” Consequently, parties evaluating their risk with the intention of relying on an AAI review and a liability defense should include in their calculus the risks and costs associated with providing post-acquisition care at the property.