Environmental Concerns for Real Estate Purchases and Sales - Part 2

I.                   COMPREHENSIVE ENVIRONMENTAL RESPONSE, COMPENSATION AND LIABILITY ACT (“CERCLA”)

  CERCLA arose, in large part, out of the Love Canal case in Niagara Falls, New York. In the mid-1970s Love Canal became the subject of national attention when it was revealed that over 21,000 tons of toxic waste had been buried at a site where a residential subdivision was later constructed. Construction work and heavy rains released the chemicals causing a public health emergency.

In the aftermath of Love Canal, and other similar situations, the United States Congress took up the debate of how to deal with those kinds of historically contaminated sites. Clearly, if the party responsible for the contamination is still around and financially viable, that party should pay for the cleanup. But the real fight occurred over what happens in those instances where the party that caused the contamination is no longer around or not able to pay for the cleanup. Should the taxpayers pay for the cleanup? Or should someone else? The conclusion reached in Washington was that the people most likely to benefit from the cleanup should pay for it. Out of that decision came CERCLA in 1980.

A.                To Whom Does Superfund Liability Extend?

CERCLA, more commonly known as the Federal Superfund Act, was originally adopted in 1980 and should be a primary consideration for anyone considering the purchase of any real property, other than a single-family home[1]. CERCLA was designed to create four classes of Potentially Responsible Parties (“PRPs”) that would bear the cost of cleaning up contaminated properties across the United States. Congress determined that anyone falling within one of four classifications should be a PRP, regardless of fault, therefore all Responsible Parties are strictly liable, as well as jointly and severally liable, for any cleanup of the contaminated property. The four classes of PRPs[2] are owners, operators, transporters, and generators (aka “arrangers”).

An early leading case which thoroughly discusses Congressional intent in adopting CERCLA and, in the process, holds that CERCLA liability is strict is State of New York v. Shore Realty Corp., 759 F.2d 1032 (2^nd Cir., 1985). In Shore, a sophisticated real estate developer, Donald LeoGrande, formed Shore Realty Corp. for the purpose of purchasing 3.2 acres of waterfront property in Glenwood Landing, New York. The property was located on a small peninsula surrounded on three sides by the waters of Hempstead Harbor and Mott Cove. LeoGrande planned to develop the property as a condominium project. He was the sole stockholder and officer of the corporation.

At the time of acquisition, LeoGrande knew that hazardous wastes were stored on the site and that cleanup would be expensive, although neither LeoGrande nor the corporation had participated in the generation or transportation of the nearly 700,000 gallons of hazardous waste on the premises. The hazardous wastes were held in five large tanks in a field in the center of the site. There were six smaller tanks also containing hazardous wastes, both above and below ground on the property. The tanks were connected by pipes to a tank truck loading rack and dockage facilities for loading by barge. Four roll-on/roll-off containers and one tank truck trailer held additional hazardous wastes. There were two dilapidated warehouses on the property, one of which contained over 400 drums of chemicals and contaminated solids, many of which were corroded and leaking.

Shore retained WTM Management Corporation to conduct an environmental investigation of the property prior to purchase. WTM determined that the tenants on the property, Applied Environmental Services, Inc., and Hazardous Waste Disposal, Inc., were illegally operating hazardous waste storage facilities on the property. WTM further discovered that there had been several spills of hazardous waste on the property over the years, including a large spill in 1978, two years prior to the adoption of CERCLA. Although there had been some attempt at cleanup, WTM’s testing revealed that hazardous wastes, such as benzene, were still leaching into the groundwater and the waters of the bay immediately adjacent to the bulkhead abutting Hempstead Harbor. WTM estimated that the cost of environmental cleanup would range from $600,000 to over $1,000,000 before development could begin.

After receiving WTM’s report, LeoGrande sought a waiver of liability from the State Department of Environmental Conservation (“DEC”) for the disposal of the hazardous wastes stored at the site. DEC denied the waiver, but Shore closed the transaction, taking title to the property on October 13, 1983. Shore evicted the tenants from the property on January 5, 1984. However, between October 13, 1983, and January 5, 1984, nearly 90,000 gallons of hazardous chemicals were added to the existing tanks. During a state inspection on January 3, 1984, it was evident that the deteriorating and leaking drums of chemicals in the warehouse had been brought onto the property. As the tenants did not clean up the property upon their eviction, the conditions at the property when Shore’s employees took over the site were even worse than those described by WTM in its report.

Shore made some improvements to the property, including sealing all the pipes and valves and continuing the cleanup of earlier spills, but did nothing about the thousands of gallons of hazardous waste standing in the deteriorating tanks, until June 1984.

On February 29, 1984, the State of New York brought suit against Shore and LeoGrande under CERCLA and New York nuisance laws.

Shore and LeoGrande raised several defenses to the suit. First, the defendants argued that they could not be liable because they were not the cause of the release of hazardous substances. They pointed out that they neither owned the site at the time of disposal of the hazardous wastes nor caused the presence of the hazardous wastes at the property. The Court pointed out that CERCLA holds four classes of persons liable:

(1) the owner and operator of a vessel…or a facility[3],

(2) any person who at the time of disposal of any hazardous substance owned or operated any facility at which such hazardous substances were disposed of,

(3) any person who by contract, agreement, or otherwise arranged for disposal or treatment, or arranged with a transporter for transport for disposal or treatment, of hazardous substances owned or possessed by such person, by any other party or entity, at any facility owned or operated by another party or entity and containing such hazardous substances, and

(4) any person who accepts or accepted any hazardous substances for transport to disposal or treatment facilities or sites selected by such person.

In response to the defendants’ arguments that CERCLA has a causation element, the Court said, “Shore claims that Congress intended that the scope of section 9607(a)(1) be no greater than that of section 9607(a)(2) and that both should be limited by the ‘at the time of disposal’ language. By extension, Shore argues that both provisions should be interpreted as requiring a showing of causation. We agree with the State, however, that section 9607(a)(1) unequivocally imposes strict liability on the current owner of a facility from which there is a release or threat of release without regard to causation…accepting Shore’s arguments would open a huge loophole in CERCLA’s coverage. It is quite clear that if the current owner of a site could avoid liability merely by having purchased the site after chemical dumping had ceased, waste sites certainly would be sold, following the cessation of dumping, to new owners who could avoid the liability otherwise required by CERCLA. Congress had well in mind that persons who dump or store hazardous waste sometimes cannot be located or may be deceased or judgment-proof.” Id. at 1045.

The defendants also contested whether or not there had been a release at the property. The Court rejected those arguments out of hand, stating, “We hold that the leaking tanks and pipelines, the continuing leaching and seepage from the earlier spills, and the leaking drums all constitute ‘releases.’ Moreover, the corroding and deteriorating tanks, Shore’s lack of expertise in handling hazardous waste, and even the failure to license the facility, amount to a threat of a release.” Id.

The defendants argued that because the property was not on the National Priority List (“NPL”) that the State’s actions were inconsistent with the National Contingency Plan (“NPC”) and thus they could not be found liable under CERCLA. The Court held that inclusion on the NPL is not a requirement for the State to recover its response costs.

The defendants also attempted to raise the affirmative defense that they were an innocent party. The Court rejected that contention, as well, stating, “Shore also claims that it can assert an affirmative defense under CERCLA, which provides a limited exception to liability for a release or threat of release caused solely by an act or omission of a third party other than an employee or agent of the defendant, or than one whose act or omission occurs in connection with a contractual relationship, existing directly or indirectly, with the defendant…if the defendant establishes by a preponderance of the evidence that (a) he exercised due care with respect to the hazardous substance concerned, taking into consideration the characteristics of such hazardous substance, in light of all relevant facts and circumstances, and (b) he took precautions against foreseeable acts or omissions of any such third party and the consequences that could foreseeably result from such acts or omissions. 42 U.S.C. § 9607(b)(3). We disagree. Shore argues that it had nothing to do with the transportation of the hazardous substances and that it has exercised due care since taking control of the site. Who the ‘third part(ies)’ Shore claims were responsible is difficult to fathom. It is doubtful that a prior owner could be such, especially the prior owner here, since the acts or omissions referred to in the statute are doubtless those occurring during the ownership or operation of the defendant. Similarly, many of the acts and omissions of the prior tenants/operators fall outside the scope of section 9603(b)(3), because they occurred before Shore owned the property. In addition, we find that Shore cannot rely on the affirmative defense even with respect to the tenants’ conduct during the period after Shore closed on the property and when Shore evicted the tenants. Shore was aware of the nature of the tenants’ activities before the closing and could readily have foreseen that they would continue to dump hazardous waste at the site. In light of this knowledge, we cannot say that the releases and threats of release resulting of these activities were ‘caused solely’ by the tenants or that Shore ‘took precautions against’ these ‘foreseeable acts or omissions.’” Id. at 1049, 1050.

There are many issues discussed in Shore outside of the CERCLA examination, but one other is of note. The Court held LeoGrande personally liable as an operator, without piercing the corporate veil. The Court stated, “…the definition of ‘owner or operator’ excludes ‘a person, who, without participating in the management of a…facility, holds indicia of ownership primarily to protect his security interest in the facility.’ Id. § 9601(20)(A). The use of this exception implies that an owning stockholder who manages the corporation, such as LeoGrande, is liable under CERCLA as an ‘owner or operator.’ That conclusion is consistent with that of other courts that have addressed the issue…In any event, LeoGrande is in charge of the operation of the facility in question, and as such is an ‘operator’ within the meaning of CERCLA.

“…we hold LeoGrande liable for the abatement of the nuisance without piercing the corporate veil. New York courts have held that a corporate officer who controls corporate conduct and thus is an active individual participant in that conduct is liable for the torts of the corporation…We need not address whether he is liable merely as an officer of Shore, for it is beyond dispute that LeoGrande specifically directs, sanctions, and actively participates in Shore’s maintenance of the nuisance.”

As we can see from the Shore case, because CERCLA liability is strict, it is important for purchasers of real estate to make certain they have taken all steps necessary to establish the few available defenses under CERCLA, discussed in Section III.B, below.

It is important for those in the real estate industry to understand that lessees of property can be PRPs under CERCLA. Commander Oil Corp. v. Barlo Equipment Corp., 215 F.3d 321 (2^nd Cir., 2000), is a case that shows both the risk a lessee of contaminated property faces and the decades of litigation that can ensnare anyone caught up in a CERCLA contribution action.

In 1963, Commander Oil became the owner of 2 lots in Nassau County, New York. Parcel 7B housed 12 above-ground petroleum storage tanks (“ASTs”) and was used by Commander Oil as a fuel depot, at least until 1967. In 1964 Commander Oil leased the office and warehouse space on adjoining lot 7A to Barlo, which was in the business of buying, manufacturing, and distributing petroleum-handling equipment. In 1969, Commander Oil leased lot 7B to Pasley Solvents & Chemicals, Inc., which used the site to repackage solvents purchased in bulk and to reclaim and revitalize used solvents. Under Pasley’s lease, Commander Oil retained the use of 3 ASTs on lot 7B.

In 1972 Commander Oil consolidated its leases. Under a single new lease, Commander Oil rented both lots 7A and 7B to Barlo, which in turn subleased lot 7B to Pasley. The nature of the sublease from Barlo to Pasley was fiercely contested in the litigation. Barlo characterized itself simply as a rent conduit and the lease and sublease of 7B as a bookkeeping measure implemented entirely at Commander Oil’s behest. Barlo claimed that the new arrangement did not change the actual relationship between the 3 parties and that Pasley continued to treat Commander Oil as its lessor. Commander Oil, referring to instances of Barlo’s alleged involvement with Pasley’s activities on lot 7B, and to the fact that Barlo derived a profit, albeit a small one, from the sublease arrangements, took a contrary position.

In 1981, contamination was discovered by regulatory authorities on lot 7B. The New York State Department of Environmental Conservation (“DEC”) charged Pasley with violating the Nassau County Fire Prevention Ordinances. Pasley agreed to drain its tanks, remove solvents it had stored on the lot, and vacate the premises.

Six years later, the EPA ordered Commander Oil to conduct an investigation and a feasibility study to determine the extent of the contamination and to propose a plan for its remediation. In 1988, the EPA sought reimbursement from Commander Oil and other defendants for response costs incurred by the Federal government in remediating the site. On January 26, 1996, Commander Oil and other defendants entered into a consent decree in which “Commander agreed to design and implement response actions at the site and to reimburse the United States for past and future response costs incurred in connection with the Site.” (Consent Decree, ¶ 20). In turn, Commander Oil received contribution for those costs from certain defendants, who ultimately settled for $1,849,127.91.

In 1990, Commander Oil filed suit pursuant to CERCLA against Barlo and Pasley for contribution or indemnification of its costs paid to EPA, among other claims. The only contested issue on appeal relevant to this discussion was whether or not Barlo was an “owner” within the meaning of CERCLA. The lower court had ruled that Barlo was an owner and apportioned part of the liability to Barlo. Barlo argued that its status as a lessee/sublessor did not make it an “owner” within the meaning of CERCLA.

The Court said, “We are called upon in this case to resolve yet another ambiguity within CERCLA’s miasmatic provisions. CERCLA creates a regime of broad-ranging liability, permitting the government to recover its remediation expenses directly from parties responsible for pollution…and authorizing private parties to pursue contribution or indemnification from potentially responsible parties for expenses incurred responding to environmental threats. CERCLA creates various categories of potentially responsible parties, one of which is pertinent to this case: owners and operators of facilities…Absent a showing that one of CERCLA’s affirmative defenses applies, liability for owners and operators is strict.” Id. At 326.

The Court continued to be critical of the CERCLA statutes, stating, “CERCLA’s test offers no helpful guidance for interpreting the extent of owner liability. According to the statute: ‘The term ‘owner and operator’ means…any person owning or operating [a] facility.’ We are thus required to give content to a statutory tautology, a position to which we have become increasingly accustomed in the environmental context.” Id. At 326, 327.

After much discussion, the Court set out a non-exclusive set of standards for determining whether or not a lessee can be liable under CERCLA as an owner of property. The Court said, “We do not foreclose the possibility that in some circumstances lessees/sublessors may be liable as owners under CERCLA. Certain lessees may have the requisite indicia of ownership vis-à-vis the record owner to be de facto owners and therefore strictly liable. Such would probably be true of a lessee with the proverbial 99-year lease. While we need not define with specificity those factors that might transform a lessee into an owner, we note several that we think could be important, specifically: (1) whether the lease is for an extensive term and admits of no rights in the owner/lessor to determine how the property is used; (2) whether the lease cannot be terminated by the owner before it expires by its terms; (3) whether the lessee has the right to sublet all or some of the property without notifying the owner; (4) whether the lessee is responsible for payment of all taxes, assessments, insurance, and operation and maintenance costs; and (5) whether the lessee is responsible for making all structural and other repairs. This non-exclusive list is meant to reinforce the point that the critical question is whether the lessee’s status is that of a de facto owner and not whether it exercises control over the facility…Moreover, the critical relationship is that between the lessee/sublessor and the owner/lessor, not that between the lessee/sublessor and the sublessee.” Id. At 330, 331.

The Court found that, in this instance, Barlo did not have sufficient indicia of ownership to be held liable under CERCLA. That decision came down 10 years after Commander Oil filed the suit against Barlo, 13 years after EPA ordered Commander Oil to pay for the cleanup, 19 years after the contamination was discovered, and 28 years after the lease arrangement that led to the litigation. If we learn nothing else from this case, we should be concerned about the amount of time and costs involved in contribution actions under CERCLA. Preserving affirmative defenses by completing “all appropriate inquiries” is far preferable to attempting to collect from other PRPs under CERCLA’s contribution action provisions.

B.                 Defenses to CERCLA Liability

It should be obvious to anyone that avoiding CERCLA liability should be a primary concern for anyone considering the purchase of real property. To accomplish that goal, any prospective purchaser of any property other than a single-family home, needs to establish one or more of the defenses set out in CERCLA.

When CERCLA was originally adopted in 1980, there were only three defenses to liability; Act of God, Act of War, and the “Innocent Owner” Defense.[4] Act of God and Act of War don’t come up too often, so let’s focus on the Innocent Owner defense.

The Innocent Owner Defense was the first true shield we had against CERCLA liability. To establish the defense, a property owner has to prove that “an act or omission of a third party, other than an employee or agent of the property owner, or a person whose act or omission occurs in connection with a contractual relationship, existing directly or indirectly, with the property owner, is the sole cause of the contamination. To accomplish that, the property owner must prove by a preponderance of the evidence that s/he:

a.         Exercised due care with respect to the hazardous substance concerned, taking into consideration the characteristics of such hazardous substance, in light of all relevant facts and circumstances, and

b.         Took precautions against foreseeable acts or omissions of any such third party and the consequences that could foreseeably result from such acts or omissions.” (emphasis added).

As with much of CERCLA, that language is not as clear as it could be, so let’s take a look at the key components of the innocent owner defense. First, note that the burden of proof is on the property owner to prove its defense, by a preponderance of the evidence. The key for the purpose of this discussion is to understand what constitutes a “contractual relationship.”

CERCLA actually gives us some help by defining “contractual relationship.” Land contracts, deeds, easements, leases, or other instruments transferring title or possession are documents that meet the definition of “contractual relationship.”

In other words, if the purchaser of the property uses any of those documents as part of the transaction, s/he is in a contractual relationship with the prior owner. As there is realistically never a real estate transaction that doesn’t involve at least one of those documents, there is always a “contractual relationship” in every real estate transaction between the buyer and the seller.

Because of the definition of “contractual relationship”, to claim the innocent owner defense in any real estate deal, the purchaser has to establish that:

(i) At the time the defendant acquired the facility the defendant did not know and had no reason to know that any hazardous substance which is the subject of the release or threatened release was   disposed of on, in, or at the facility; or

(ii) The defendant is a government entity which acquired the facility by escheat [Reversion of property to the state in the absence of legal heirs or claimants], or through any other involuntary transfer or acquisition, or through the exercise of eminent domain authority by purchase or condemnation; or

(iii) The defendant acquired the facility by inheritance or bequest…

As the second and third conditions do not apply to the typical real estate transaction, we need to focus on the first condition, i.e. “at the time the property owner acquired the facility the property owner did not know and had no reason to know that any hazardous substance which is the subject of the release or threatened release was disposed of on, in, or at the property.” That one seems potentially usable, but how do we prove that you had no reason to know the property might be contaminated? We do it by conducting “All Appropriate Inquiries.”

At first blush, the innocent owner defense sounds pretty good. Just prove that you didn’t know that the site was contaminated and had no reason to know that the site was contaminated prior to your acquisition of it, and you aren’t liable. But it hasn’t worked as well as property owners and the federal government would have liked. What was happening was that sophisticated real estate investors and developers were doing their environmental due diligence prior to acquiring a property, but as soon as there was any indication that the property might be contaminated, the prospective purchaser was walking away from the deal, rather than risk CERCLA liability. Because developers and real estate investors would not touch a contaminated site, thousands of those properties across the country were essentially undevelopable and became blights on their communities, what came to be known as Brownfields.

Congress attempted to remedy that problem by adopting the Small Business Liability Relief and Brownfields Revitalization Act,[5] now better known as the Brownfields Amendments. The Brownfields Amendments added two new defenses to CERCLA liability in an attempt to get investors and developers to buy and redevelop contaminated sites. 

The first was the Migration defense, but it really hasn’t added a lot to the innocent owner defense because it suffers from the same requirement that the purchaser of the property not have a reason to know that the site is contaminated before you acquire the property.

The new defense established by the Brownfields Amendments that really has some benefit to prospective property owners is the Bona Fide Prospective Purchaser defense (“BFPP”). The BFPP defense exempts bona fide prospective purchasers (and their tenants) from owner liability so long as the purchaser does not impede:

•           the performance of a response action, or a

•           natural resource restoration.

This is the defense to CERCLA liability that is actually useful at times, and the one we strive to create and keep in place for our clients in any real estate transaction in which we know or suspect there is contamination at the property.

To be a bona fide prospective purchaser under CERCLA, the following 8 requirements must all be met:

1.         All disposal must have taken place before the date of purchase; and

2.         The purchaser must have made all appropriate inquiries prior to acquisition; and

3.         The purchaser must exercise appropriate care with respect to any release after acquiring the property; and

4.         The purchaser must provide full cooperation, assistance, and access to persons authorized to undertake response actions or natural resource restoration; and

5.         The purchaser must comply with land use restrictions (which are basically environmental deed restrictions) and cannot impede performance of institutional controls (which are engineered solutions to contamination, such as hard caps and monitoring wells); and

6.         The purchaser must comply with all information requests; and

7.         The purchaser must provide all the legally required notices regarding releases of hazardous substances; and

8.         The purchaser cannot be potentially liable or affiliated with any other person potentially liable for the release.

That’s a lot, and while not necessarily easy to accomplish, these are things prospective purchasers can often accomplish in most real estate transactions.

There are other more specialized defenses, such as a safe harbor for lenders, contained in CERCLA, but those are beyond the scope of this paper.