All too often we hear from our clients or prospects that they don’t feel that they need an environmental insurance policy because they have a “clean” Phase I report. Unfortunately, this can be a costly misunderstanding.
A Phase I Environmental Site Assessment is merely the guidance document that is used as a baseline by the environmental due diligence community. While having a clean Phase I report is a good start and does offer some level of comfort, by no means does it fully mitigate the environmental risk at the site. The Phase I report only provides a brief snap-shot into the environmental history at the site, and is only as good as the information that was available to create it. The Phase I report will not identify any operational exposures such as mold, legionella, disinfection, new spills, etc. that may occur during the day-to-day operations of a site. Operational exposures exist in just about every class of business and it is incredibly important to ensure that you are protected.
What A Clean Phase I Means
Let’s start out with what is required to be an ASTM 1527-13 compliant Phase I report. An ASTM compliant Phase I Report must include the following elements: current site visit, interviews, database research, historic source research, AUL/lien search and non-scope considerations, all summarized in a detailed narrative report. The entire Phase I Environmental Site Assessment (ESA) research and reporting process should be overseen by an environmental professional who meets the educational and experience requirements outlined by ASTM. The final report should be reviewed and signed by both the assessor and the environmental professional responsible for the scope of the Phase I ESA.
- Site visit: The site visit of the subject property should be conducted with a knowledgeable site contact who knows the property and has complete access.
- Interviews: Individuals with current and historical knowledge of the subject property should be interviewed by the environmental professional and/or assessor conducting the Phase I ESA. It is important to understand the current on-site operations, as well as historic operations, particularly regarding dry cleaners, gas stations, automotive repair and industrial operations.
- Database review: Third-party providers collect federal, state and tribal records on a regular basis, and summarize these records by regulatory agency and list. The data is gathered as it pertains to the subject property, via ASTM designated search radii, as well as adjoining and nearby properties that are located around the subject property.
- Historic sources: The Big Four of historic sources are widely regarded as historic topographic maps, Sanborn fire insurance maps, city directories and aerial photographs. There are additional historic sources that are available via local sources, such as the public library. The availability, quality and usefulness/applicability of the historic sources can vary by geography.
- AUL/Lien Search: The Activity and Use Limitation (AUL) and lien search can be acquired as a supplement to the database report and historic sources research provided by the data companies, this can also be obtained via a chain of title search. It may be valuable to understand whether the client expects the AUL and lien search to be conducted by the environmental professional or outside counsel, and whether it is included in the Phase I report or separate reporting.
- Report writing: The report is the repository of all the on-site assessment activity and research conducted to understand the environmental conditions on-site. It is important to document the information gathered, including the source of that information (third party data provider, site contact, public records, etc.).
- Non-scope considerations: While certain environmental conditions are outside the Phase I ESA scope, they are often considered as part of a thorough Phase I. Examples include asbestos building materials (ACM), lead-based paint (LBP), lead in drinking water (LDW), radon, wetlands, and seismic. Other additions might include an ALTA survey and septic/discharge evaluation. Please note it will be important to watch for emerging contaminants such as PFAS to be added as non-scope considerations in the future. The Phase I ESA report is valid for 6 months, and an update can readily be performed with an updated database report, historic sources search, AUL/Lien Search and site visit.
Limitations Of a Phase I And Coverage Considerations
One of the most important elements to understand regarding a Phase I ESA is the user requirements, and especially, first defining who the “user” is. As an example, a report prepared for a potential buyer will be intent on identifying potential liabilities associated with acquiring, owning and operating the subject property, which is why it is important to keep in mind caveat emptor, or buyer beware, as once the new owner takes title they are responsible for environmental conditions on-site, barring an indemnity from the seller. A Phase I ESA prepared for a lender for financing might consider environmental conditions on-site differently, as they are not intending on taking title to the subject property, although that can be a risk when the property is used as collateral in a future foreclosure.
Below are just a few scenarios to think about that would not have been identified in a Phase I report but would typically be covered by a pollution policy:
- Illicit abandonment: During the course of excavation a large area of buried construction debris was identified. The material was tested and found to contain asbestos-laden material. It was later determined by the state that the area needed to be remediated and the asbestos laden material was required to be hauled off site. This resulted in the site owner having to pay for the remediation, transportation of hazardous materials and delay expenses.
- Underground storage tanks: As the site is being excavated the contractor discovers a number of tanks that are full and some that leaked and contaminated soil and ground water. The contamination is determined to extend well beyond the boundaries of the site and will require a costly cleanup. The cleanup delays the projects for months and will require ongoing monitoring and remediation.
- Closed historic release: Upon purchase of the site the client conducts a Phase I report that identified a historic spill that had long been closed out by the state. At the time that the spill was closed the levels of contamination were deemed acceptable. Unfortunately, as the regulatory environment is ever-changing and science is constantly progressing, the state determines that the levels of contamination at the site now meet or exceed the threshold and further remediation is required. The site owner is now on the hook for further remediating the contamination.
- Mold outbreak: Mold is discovered in a hotel building and upon further investigation it is determined that the mold extends throughout one whole wing of the hotel. The hotel is subsequently shut down for a full mold abatement resulting in remediation and business interruption expenses with the potential for third-party bodily injury claims from guests who may have been exposed, as well as the associated defense fees.
Finally, it is important to review all of the transaction documentation, such as purchase and sale agreements, environmental indemnities, and loan documents to ensure that the there is no requirement for environmental coverage and that the client is not exposed through these agreements. Very often we find that these agreements are not as strong as one may think, leaving the client exposed to a potentially costly environmental claim.
The experts of NFP’s environmental practice are happy to assist in reviewing any documentation and discussing coverage on any account.
Additional Reading
Minimizing Environmental Liabilities Post Mergers and Acquisitions, NFP