This article originally appeared in the Colorado Real Estate Journal, June 4, 1997 Reviving third-party liability defense By Roger L. Freeman Davis Graham &Stubbs LLP When it comes to purchasing or leasing property with any type of environmental problem, the rule of thumb in the real estate industry, until recently, has been pretty straightforward: Forget it! This mind-set is largely a result of the sweeping liability net created by the Comprehensive Environmental Response, Compensation, and Liability Act, 42 U.S.C. ยง 9601, et.seq. (CERCLA or superfund). In fact, much of the growth in the environmental industry has been driven by concern over CERCLA liability resulting from the acquisition of real property. This pervasive fear of environmental liability has been mitigated recently by at least three developments. The first is the codification of the "secured creditor" exemption from CERCLA liability, which protects lending institutions' protection when taking routine steps to protect their collateral - as opposed to actively managing or operating the real property or the underlying facility. Specific "lender liability" rules now have been added to CERCLA to guide lenders in staying on the right side of the CERCLA liability line. A second development is the enactment of voluntary cleanup programs in many states (including Colorado). These programs allow parties to a real estate transaction to receive government approval of cleanup (or "no action") plans, providing certainty as to what environmental work must be done on a property and thereby minimizing unknowns. The third and most recent development involves the evolution of case law under the "third-party" defense to superfund liability. Long viewed as an illusion or pipe dream, several recent court decisions now make it clear that invoking this defense while still difficult, is certainly achievable. The evolution of an authentic third-party defense is good news for the real estate industry, and has several practical ramifications for lessors, lessees and purchasers of real property. To paraphrase this convoluted provision, to assert the third-party defense under CERCLA, one must: (1) have no contractual relationship with the original polluter and (2) take adequate care and protection against environmental releases once the property is acquired and leased. Up until the end of 1991, very few decisions had actually upheld the defense. Recently, however, a spate of cases have honed in on its wording and found that if purchasers or lessees or property have no contractual relationship to the prior polluter, they meet this critical element regardless of whether they knew or should have known about existing pollution. By finding that no contractual relationship existed between the new purchaser/lessee and the original polluter, courts have upheld the third-party defense without requiring a pre-acquisition site assessment. In other words, a party with no nexus to the pollution now can be more comfortable by taking adequate precautions in the future if contamination is discovered, it can retain control over its liability even if no Phase I environmental audit
was performed prior to purchase or lease. Historically, the tortuous path required to meet this defense has precluded environmental counselors from being able to assure a purchaser, broker or lessee that they are protected from environmental liability. Under the new case law, however, environmental advisors may issue an opinion to many purchasers and lessees that, as long as they have no contractual relationship with the original polluter and take adequate precautions and exercise due care in the future with respect to hazardous substances, they have a strong chance of successfully avoiding CERCLA liability. This development may have a substantial impact on both the need to conduct detailed Phase I or II audits and the need for extensive wrangling environmental indemnities and warranties, both of which often delay closing and dramatically increase costs. Of course, this streamlined approach works only with respect to liability under CERCLA; environmental liability arising from other regulations, such as those governing asbestos (which is subject to pervasive new OSHA rules), is not affected. Nevertheless, since a vast majority of environmental issues arising in transactions are driven by CERCLA, these new case developments in conjunction with other tools, present an opportunity to break the environmental logjam in real estate transactions. Two key steps are still required in any transaction. First, some environmental inquiry must by made to ensure that the activities of the seller/lessor (e.g. the person with whom the purchaser/lessee has a contractual relationship) have not in any way caused environmental contamination. Such an inquiry, however, can be far less costly than a typical Phase I or Phase II investigation. In many situations, it will be apparent that the most recent owner has done nothing to create pollution. If there is reason to believe that the property is contaminated, a Phase I audit should be conducted to confirm or alleviate those suspicions. Second, if contamination is discovered after the transaction, parties must take adequate precautions and exercise due care to prevent exacerbating the problem. A number of parties - who otherwise could have been protected - have been tripped up by this part of the defense. One problem that often arises is how a lessee or purchaser can take reasonable care and adequate precautions without first knowing whether contamination is present. Certainly, if there is any evidence of contamination found on the property after acquisition, the purchaser/lessee should be proactive about investigating further, notifying the appropriate agencies and otherwise preventing the problem from mushrooming. The due care requirement requires a property owner to take steps to prevent additional releases of contaminants and undertake reasonable further investigation - a property owner cannot avoid liability by hiding his head in the sand. Yet, several courts have now indicated that if pollution is discovered after a real estate transaction, and the current owner/lessee did not perform a pre-acquisition site investigation, there is still a potential defense to liability available, even if the current owner/lessee has not performed a cleanup. Of course, concerns over diminished property value are not solved by having a CERCLA defense, and fear of unknown problems lurking just beneath the surface of one's investment will continue to drive environmental reviews. The point here is that in a typical, straightforward property transaction involving a purchase (or, even more so, a lease) of commercial property, where no ongoing waste issue is presented, there may be an alternative to automatically performing detailed environmental studies. If a prospective purchaser can be reasonably certain that the other party in a real estate transaction did not
engage in any activities that might result in contamination of the property, the possibility of someone far down the chain of title did cause the contamination is not as threatening as it has been. This development also may lead to more productive and widespread use of properties in urban, previously industrialized areas (now known as the "brownfields" movement). Ideally, Congress and the courts will continue to develop more practical and balanced interpretations of CERCLA to allow the superfund machinery to focus on sites that truly require remediation.