Reconsidering Environmental Considerations 2006

ARNSTEIN & LEHR LLP Attorneys at Law

Environmental Practice

Reconsidering Environmental Considerations in Commercial Real Estate Transactions 2006: New Alternatives and New Opportunities

Author William J. Anaya 312.876.7109 direct [email protected]

About William J. Anaya William J. Anaya chairs our environmental practice group at Arnstein & Lehr, LLP. Bill brings abundant environmental experience in regulatory, permit, cleanup liability, and cost recovery cases, as well as providing counsel to our lawyers involved in corporate and real estate transactions.

Environmental cleanup liability has been a consideration in commercial real estate transactions for the past two and one-half decades, but the law's response to that stimulus has changed significantly in just the past few years. At first, potential environmental exposure chilled virtually every commercial real estate transaction, and forced development away from "brownfields" to the less risky "greenfields" in outer suburbia. Environmental consultants and a cottage industry associated with "Phase I Environmental Investigations" became de rigueur, albeit without much of a standard beyond caveat emptor. Then, in the 1990's, we witnessed a not-so-subtle change in the answer to the fundamental question of how clean is clean? That answer is now a function of the costs of an environmental cleanup, and the cleanup costs are a function of environmental risks posed to various populations deemed at risk with the prospective use of commercial real estate. The more stringent the cleanup requirements, the costlier the process, and the less likely the market will participate in brownfield purchases and developments. In response, risk-based corrective action models and proportionate share liability schemes have been developed in the states, indicating a paradigm shift in philosophy to determine cleanup criterion and costs. Cleanup values are now measured in terms of risk to populations associated with particular uses of real estate (residential populations, and workers' safety concerns in commercial and industrial uses), and, together with technical analyses of pathways to humans (air, dermal contact and groundwater). Risk-based corrective action standards have dramatically changed the calculus associated with environmental cleanups, making sensible expenditures both reasonable and effective, and warming the chill that traditional environmental law liability imposed on the commercial real estate market. Nonetheless, even with risk-based corrective action objectives and the more reasonable cleanup standards and conditions, it was still a risky proposition for a potential purchaser to invest in and own commercial property that has a history of commercial or industrial uses. In response to that risk, state and federal legislators have made additional changes in the environmental cleanup liability regimes. It is now possible that the current owner of contaminated property may actually escape environmental cleanup liability in some circumstances - although navigating those circumstances is not for the uninitiated. The following is designed only to introduce you to the fairly remarkable changes in the federal and state liability regimes that are available to prospective owners and adjoining owners of real estate. But, first, a little background:

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Background About our Environmental Practice Group Our regulatory lawyers focus on permits, compliance status and regulations involving Air, Water, Wetlands, Underground Storage Tanks, Financial Responsibility and Corrective Action. Indeed, we are remarkably conversant and experienced in the Clean Air Act, the Clean Water Act and Underground Storage Tank Regulations. We represent clients involved in regulated and permitted activities and enforcement actions associated with Air and Water. We have also negotiated and permitted a federally approved Wetland Mitigation Bank in the northern suburbs of Chicago. We have also negotiated Title V Permits and Federally Enforceable State Operating Permits for a variety of activities associated with the Clean Air Act. We have successfully represented clients seeking Variances and Adjusted Standards (Revised SIP Rules) in actions before the Illinois Pollution Control Board and USEPA. In addition, we continue to represent clients in enforcement actions initiated by the United States Environmental Protection Agency, the Department of Justice, various state environmental protection agencies and states' attorneys general. Additionally, Bill and other members of our environmental practice group focus on cleanup and cost recovery lawsuits by and on behalf of individuals, corporations and local units of government seeking costs or defending claims for costs in federal and state courts throughout the country. Our experience in Superfund and related administrative litigation and appeals in the federal courts (even appeals to the United States Supreme Court) is second to none. We respect the policy behind strong environmental programs, but advocate for our cilents to ensure that our clients are not unreasonably burdened. Finally, our practice group includes preeminent criminal defense lawyers. We recognize the remarkable criminal exposure in all aspects of environmental compliance - from permit applications, record keeping, monitoring and alleged violations. In short, we stand ready, willing and capable of handling our clients' environmental issues. If you have any questions for our environmental lawyers, please direct them to William J. Anaya, by phone at 312-8497109, and by electronic mail at: [email protected].

Federal Environmental Liability · CERCLA Since 1980, owners and operators of commercial real estate have become familiar with environmental cleanup liability statutes, especially, cleanup liability described in the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 ("CERCLA"), 42 U.S.C. §9601, et seq. The CERCLA model was ruthlessly copied by many of the states, including Illinois. Pursuant to the familiar model, a "potentially responsible party" is liable for "removal and remedial costs" incurred by "any person" following a "release" of a "hazardous substance1" at a "facility." See CERCLA §107(a), 42 U.S.C. §9607(a). The CERCLA model provides four classes of potential liability -- only two of which involve liability associated with ownership of real estate - the current owner and the owner at the time of the disposal of the hazardous substance. See 42 U.S.C.§§107(a)(1)-(2). The other two "potentially responsible parties" identified in the statute ("arrangers" and "transporters") pose environmental liability concerns for those involved in the sale, purchase or lending associated with a business -- to the extent that the business may incur environmental cleanup liability at another site. For our purposes here, we are only considering the liability associated with the purchase of property by an owner, and not potential environmental liability at sites not owned by our clients. · Environmental liability for "passive owners" of Real Estate Liability associated with current ownership is self-explanatory (if not unfair, especially when imposed without culpability), but not all prior owners have liability exposure even if the hazardous substance was present at the property during the prior owners' tenure. Liability for "passive owners" (the release occurred prior to ownership, and the passive owner sold the property to a third party in the interim) depends on which Circuit the owner lives in. See Nurad, Inc. v. William E. Hooper & Sons Co., 966 F.2d 837 (4th Cir. 1992) (finding the "passive" owner liable). However, in United States v. CDMG Realty Co., 96 F.3d 706 (3d Cir. 1996), the court the court held that finding "passive" owner liability would wholly negate the "innocent purchaser" defense, which, by its nature, applies only after a disposal. 96 F.3d at 715, 716. In addition, the Sixth Circuit held that "passive" migration is not a "disposal" which otherwise requires human intervention for liability. See United States v. 150 Acres of Land, 204 F.3d 698 (6th Cir. 2000). · RCRA Solid and Hazardous Waste Liability (with Citizens' Suits) In addition, while CERCLA generally excludes petroleum as a "hazardous substance"(see 42 U.S.C. §9601(14)), Congress provided environmental cleanup liability associated with petroleum and other "regulated substances" under the Resource Conservation and Recovery Act of 1976 (RCRA), Pub.L. No. 94-580, 90 Stat. 2795. See RCRA §§7002, 7003. Moreover, under RCRA, an individual or the government may seek injunctive relief (not cleanup costs per se, nor damages) against the person who contributed to a hazardous situation involving hazardous waste, regulated substances, or petroleum. See 42 U.S.C. §§ 6991,6992.

Environmental Liability in Illinois The Illinois Environmental Protection Act In Illinois, the State has authority under the Illinois Environmental Protection Act, Reconsidering Environmental Considerations 2006 | Page 2

415 ILCS 5/1, et seq., to recover statutory costs against a similar group of potentially responsible parties. See 415 ILCS 5/22.2(f). In seeking reimbursement under §22.2(f), the state may seek relief in an action filed before the Illinois Pollution Control Board or in the circuit court. Unlike the CERCLA model, there is no private cause of action under §22.2(f) of the Illinois Environmental Protection Act. See Chrysler Realty Corp. v. Thomas Industries, Inc., 97 F.Supp.2d 877 (N.D.Ill. 2000); Norfolk Southern Ry. v. Gee Co., No. 98 C 1619, 2001 U.S.Dist. LEXIS 10784 (N.D.Ill. 2001). However, a private citizen may bring an enforcement action against another person who violates the Illinois Environmental Protection Act (i.e., §§21(a) -21(w) but not pursuant to §22.2(f)). See Lake County Forest Preserve District v. Ostro, PCB 92-80, 1992 Ill. ENV LEXIS 551 (July 30, 1992); Chrysler Realty Corp. v. Thomas Industries, Inc., PCB 01-25, 2000 Ill. ENV LEXIS 743 (Dec. 7, 2000). And, in those cases in which a citizen plaintiff, acting as a private Attorney General, alleges and proves a violation of the Illinois Environmental Protection Act, the Illinois Pollution Control Board has held repeatedly that the Board has jurisdiction and authority under its enabling statute to order a person judged to have violated the Illinois Environmental Protection Act to clean the site and to reimburse the party for the cleanup expenses incurred by the private party. See: Lake County Forest Preserve District, supra; Chrysler Realty Corp., supra. In addition, the Illinois Supreme Court has held that a private party may institute a third-party derivative action against another party seeking indemnity, contribution, or some recognized relief under the same provision of the Illinois Environmental Protection Act at issue in an original action filed by the State of Illinois. See People v. Brockman, 143 Ill.2d 351, 574 N.E.2d 626, 158 Ill.Dec. 513 (1991); People v. Brockman, 148 Ill.2d 260, 592 N.E.2d 1026, 170 Ill.Dec. 346 (1992); People v. Fiorini, 143 Ill.2d 318, 574 N.E.2d 612, 158 Ill.Dec. 499 (1991); People v. N.L. Industries, 152 Ill.2d 82, 604 N.E.2d 349, 178 Ill.Dec. 93 (1992). However, note that the Illinois appellate court recently revisited the derivative action exception, and held that a defendant's tort claim against a third party was not an approved derivative action following an initial claim made under the Illinois Act. See NBD Bank v. Krueger Ringier, Inc., 292 Ill.App.3d 691, 686 N.E.2d 704, 226 Ill.Dec. 921 (1st Dist. 1997). All of this is, and has been generally known for some time. Clearly, state and federal agencies and, in certain instances, individuals may be entitled to reimbursement for the costs incurred in performing an environmental cleanup from "owners" of real estate in certain instances. So what is new? Exemptions From Environmental Liability 1. Exemption From Liability for Lenders and Fiduciaries It should come as no real surprise that Lenders and Fiduciaries were first able to convince Congress and the state legislatures to re-consider the onerous "current owner" liability standards that applied to them. On the one hand, Lenders were surprised to learn that the so-called "secured creditor" exemption within the definition of "Owner" in CERCLA is actually the source of environmental liability for Lenders under CERCLA (to the extent that a Lender "participates in the management" of the borrower's business). In any event, after various adverse court decisions, Congress enacted the Asset Conservation, Lender Liability, and Deposit Insurance Protection Act of 1996, Pub.L. No. 104-208, 110 Stat. 3009. with nine "safe harbors" for pre-foreclosure actions Reconsidering Environmental Considerations 2006 | Page 3

undertaken by Lenders. See 42 U.S.C. §9601(20)(F)(i)-(iv). Post-foreclosure, a lender will not be held to be an "owner or operator" so long as the lender does not participate in the management of the borrower's business, and so long as, after foreclosure, the lender sells, releases, liquidates, or otherwise conveys ownership in the property "at the earliest practicable, commercially reasonably time, on commercially reasonable terms, taking into account market conditions and legal and regulatory requirements." See 42 U.S.C. §9601(20)(E)(ii)(II). According to the statute, the lender may continue to operate the borrower's business, wind up the borrower's business, undertake response actions under CERCLA, or take any other measure to protect or prepare the property for sale or disposition. Id. Equally importantly, the Asset Conservation Act also added similar protections for fiduciaries. See 42 U.S.C. §9607(n). "The liability of a fiduciary under any provision [of CERCLA] for the release or threatened release of a hazardous substance at, from, or in connection with a … facility held in a fiduciary capacity shall not exceed the assets held in the fiduciary capacity." The exemption does not apply "if negligence of a fiduciary causes or contributes to the release or threatened release," or if the fiduciary is liable under the statute in any other capacity. In those instances, the fiduciary would have independent liability, and the accretion in exposure would likely not be attributable to the estate. Congress defined a fiduciary as: trustee, executor, administrator, custodian, guardians of the estate and guardians ad litem, receivers, conservators, committee of estates of incapacitated persons and personal representatives (but not trusts that were created as business trusts). 2. Exemptions From Liability for Prospective Purchasers and Adjacent Property Owners, and the USEPA's New "All Appropriate Inquiry Rule" Throughout the 1990's the U.S. Department of Justice and the U. S. Environmental Protection Agency tried to establish standards that would recognize the reality of environmental liability associated with so-called "brownfields" (contaminated sites that could have commercial viability if prospective ownership did not carry with it the risk of environmental cleanup liability). USEPA sought to establish standards that would provide no disincentive to prospective purchasers considering investing in brownfields based on the rational fear of environmental liability. After meeting with little success in trying to negotiate terms in separate proposed transactions, in January 2002, Congress enacted the Small Business Liability Relief and Brownfields Revitalization Act, wherein Congress provided exemptions for Prospective Purchasers and Adjacent Property Owners who are bonafide purchasers (as that term is defined under the statute). See 42 USC §9607(r) and 42 USC §9601(40). Briefly, to the extent that a prospective purchaser performs an "All Appropriate Inquiry" as that term and process is now described, a purchaser/owner may escape environmental cleanup liability if that purchaser/owner can show, by a preponderance of the evidence, that the material was present and released at the site before the purchaser owned the site. In addition to the performance of a pre-acquisition "All Appropriate Inquiry," the purchaser/owner must exercise post-acquisition "appropriate care" by taking "reasonable steps" to stop continuing releases and to prevent future releases. In addition, in the event of a cleanup or any other remedial activity at the property that takes place after the property is transferred to the purchaser, the purchaser/owner must cooperate with USEPA or other parties who require access to perform the cleanup work. Also, the purchaser/owner must agree comply with all land use restrictions imposed in connection with the cleanup at the property. Finally, if purchaser/owner gains a windfall (by Reconsidering Environmental Considerations 2006 | Page 4

buying the property at a depressed value due to contamination and having escaped cleanup liability as a "prospective purchaser" under the statutory exemption), the exempt owner's interest will be subject to a windfall lien for any cleanup costs incurred by USEPA or the state cleaning up the property. Note that the "prospective purchaser's" exemption is different than both the "third party and "innocent purchaser's" exemptions otherwise described in CERCLA. Remember that both the "third party" and the "innocent purchaser's" exemptions from liability are designed as a defense for unknown and undiscovered contamination that was not discovered even after performing an all appropriate inquiry under the circumstances. The "prospective purchaser" and "adjoining property owners'" exemptions recognize known contamination, and both are designed to show that known contamination was released at the property prior to the prospective purchaser's acquisition of the property. The reference to an "all appropriate inquiry" has been a part of CERCLA's environmental lexicon since 1986, initially spawning a national debate on what should constitute "an all appropriate inquiry," but eventually being reported as a set of investigative protocols in a national standard established by the American Society for Testing and Materials ("ASTM"), and known as the Phase I -- ASTM Standard 1527. We know that Congress and the United States Environmental Protection Agency apparently considered the ASTM Standard 1527 as inadequate for use in determining the data necessary to support the new "prospective purchasers" and "adjoining property owners" exemption because on November 1, 2005 USEPA published its final rule ("Standards and Practices for All Appropriate Inquiries; Final Rule"), 70 Fed. Reg. 66070; 40 C.F.R. Part 312. According to the new rule, the standards therein described shall become effective on November 1, 2006 - so there is time to incorporate those protocols into our commercial real estate processes in the correct instances. According to the new AAI Rule, the ASTM Standard 1527 - 97 is appropriate for preacquisition "due diligence" (i.e., to qualify as an innocent purchaser)ii , but in order to qualify as an exempt prospective purchaser and an exempt adjoining owner, an All Appropriate Inquiry is required in order to identify "conditions indicative of releases and threatened releases of hazardous substances or, at, in or to the subject property." The AAI Rule has ten factors to consider: a. The inquiry must be performed by an environmental professional (a defined and specifically qualified professional under the new rule). b. The inquiry must include interviews with past and present owners, operators, and occupants of the facility for the purpose of gathering information regarding the potential for contamination at the site. c. The inquiry must also include reviews of historical sources, such as chain of title documents, aerial photographs, building department records, and land use records, to determine previous uses and occupancies of the real property since the property was first developed. d. The inquiry must include searches for recorded environmental cleanup liens against the site that are filed under federal (District Court Clerk's Office), state, or local law (Recorders' Offices). e.

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government records, waste disposal records, underground storage tank records, and hazardous waste handling, generation, treatment, disposal, and spill records, concerning contamination at or near the facility. f. The inquiry must include visual inspections of the site and of adjoining properties. g. The inquiry must contain some analysis of the specialized knowledge or experience on the part of the prospective purchaser. h. The inquiry must also contain some analysis of the relationship of the purchase price to the value of the property, if the property was not contaminated. i. The inquiry must analyze commonly known or reasonably ascertainable information about the property, and j. The inquiry must included analysis of the degree of obviousness of the presence or likely presence of contamination at the property, and the ability to detect the contamination by appropriate investigation. USEPA's AAI Rule is remarkably different than the ASTM Standard 1527 Phase I protocol: 1. The AAI Rule has a definition of "Environmental Professional" that requires greater oversight and report certifications by senior engineers of Phase I investigations and, arguably, limits the universe of consultants that may be authorized to perform these assessments. 2. The AAI Rule expands the reporters' obligations to interview current and past-owners and occupants of a site. 3. The AAI Rule imposes affirmative requirements on the consultant to interview neighboring property owners in the case of abandoned properties. 4. The AAI Rule imposes the duty of the consultant to review historical sources of information dating back to the first use of the property for residential, agricultural or commercial/industrial purposes. 5. The AAI Rule requires the consultant to search for environmental cleanup liens recorded under any federal, state or local laws. 6. The AAI Rule substantially increases report drafting and documentation requirements imposed on environmental consultants, including obligations to document the extent of the review, identify "data gaps," and to provide opinions regarding the significance of data gaps on the identification of potential releases of hazardous substances. 7.

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tive purchaser to analyze the value of the property in relation to potential cleanup costs and the propriety of the sale price in relation to value without and without a cleanup, and to analyze the sophistication of the prospective purchaser. In addition, USEPA's AAI Rule establishes evidentiary standards in documenting compliance with the new rule, and specific analysis of gaps in information. The expected costs of compliance with the AAI Rule will be substantially higher than the current "due diligence" practice. Arguably, the benefit of acquiring "contaminated" property without the traditional environmental liability of a current owner will balance the additional costs incurred by a prospective purchaser or adjoining property owner. Clearly, the additional costs and the additional analysis required to qualify as an "All Appropriate Inquiry" under the new rule, involve analysis of value, obviousness of contamination and the sophistication of the prospective purchaser, because prospective purchasers involved in purchases of contaminated property may experience a windfall. That is, if the government remedies the contamination after closing, then the new owner (former prospective purchaser) would gain the benefit of the environmental cleanup without the risk of being required to pay for the cleanup. Congress considered that potential, and provided for a prospective purchaser windfall lien at 42 U.S.C. Section 9607(r). The presence of this potential windfall explains some of the additional analysis required in the new AAI Rule. Finally, in order to qualify as a prospective purchaser, and following the performance of an "All Appropriate Inquiry," the prospective purchaser/owner must: (i) exercise post-acquisition "appropriate care" by taking "reasonable steps" to stop continuing releases and to prevent future releases; (ii) must cooperate with USEPA or other parties that might desire future access to perform cleanup work; (iii) must agree to comply with any land-use restrictions imposed in connection with any cleanups, and (iv) must recognize that the property might be involved with EPA "windfall liens." Prospective Purchasers' Exemption in Illinois Illinois law provides its own version of the "prospective purchaser's" exemption, but not as clearly as the federal program. Specifically, 415 ILCS 5/22.2b provides that a prospective purchaser may gain a release from the State for environmental cleanup liability under the Illinois Environmental Protection Act if the prospective purchaser performs "response actions to remove or remedy all releases" at a property pursuant to an "approved response action plan" otherwise described in the statute. Interestingly, the "Agency may approve a response action plan under this Section, including but not limited to a response action plan that does not require the removal or remedy of all releases or threatened releases" if the person proves that (1) the response action plan will prevent or mitigate immediate and significant risks, (2) the future activities at the property will not "cause, allow, contribute to, or aggravate the release," (3) the plan takes into consideration the health concerns of those who will be present at the property, (4) IEPA gains irrevocable access to the property, (5) the person is financially responsible for cleanups, and (6) such other requirements as may be imposed by the Agency. In other words, the purchaser/owner could satisfy the foregoing requirements if the facts indicate that the problem is remedied by institutional controls (e.g., deed restrictions, and/or groundwater ordinances) and engineered barriers (pavement, and offsite agreements or easements with adjacent property owners consenting to the presence of the material).

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· Proportionate Share in Illinois

ARNSTEIN & LEHR LLP Chicago, Illinois 120 S. Riverside Plaza, Suite 1200 Chicago, IL 60606-3910 312.876.7100 phone 312.876.0288 fax Boca Raton, Florida 2424 N. Federal Highway, Suite 462 Boca Raton, FL 33431 561.322.6900 phone 561.322.6940 fax Miami, Florida 201 S. Biscayne Blvd., 4th Floor Miami, FL 33131 305.374.3330 phone 305.374.4744 fax Tampa, Florida 300 S. Hyde Park Avenue, Suite 180 Tampa, Florida 33606 813.259.9964 phone 813.259.9724 fax West Palm Beach, Florida 515 N. Flagler Drive, Suite 600 West Palm Beach, FL 33401-4323 561.833.9800 phone 561.655.5551 fax Hoffman Estates, Illinois 2800 W. Higgins Road, Suite 425 Hoffman Estates, IL 60195-5224 847.843.2900 phone 847.843.3355 fax Milwaukee, Wisconsin 7161 N. Port Washington Road Milwaukee, WI 53217 414.351.2440 phone 414.352.6901 fax www.arnstein.com

In addition, Section 58.9 of the Act (415 ILCS 5/58.9) provides that "in no event may the Agency, the State of Illinois, or any person bring an action … to require any person to conduct remedial action or to seek recovery of costs for remedial activity … beyond the remediation of releases … proximately caused by such person's proportionate degree of responsibility … that were proximately caused or contributed to by 2 or more persons." So long as the prospective purchaser/owner does not exacerbate or contribute to the known contamination at the property, that owner's environmental cleanup liability exposure under state law should be limited to the degree of their culpability, which in the case of a prospective purchaser will be none.

· The Illinois Site Remediation Program (the "SRP") In addition, the Illinois Environmental Protection Agency administers the Site Remediation Program described at Title XVII of the Illinois Environmental Protection Act. Specifically, either the current owner or the prospective purchaser may approach IEPA and gain a No Further Remediation ("NFR") Letter pursuant to the Tiered Approach to Corrective Action ("TACO") guidelines published by the Illinois Pollution Control Board. The effect of an NFR Letter is described at Section 58.10 of the Act (415 ILCS 5/58.10). Specifically, an NFR Letter "signifies a release from further responsibilities under this Act in performing the approved remedial action and shall be considered prima facie evidence that the site does not constitute a threat to human health and the environment and does not require further remediation under this Act, so long as the site is utilized in accordance with the terms of the No Further Remediation Letter." The NFR Letter protects not only the current owner/recipient of the NFR Letter, but also, the transferee, successor, assign and lenders of the current owner. Conclusion The environmental stimulus has remained the same in commercial real estate for the past two and one-half decades, but the methods and means of addressing that stimulus have changed significantly under state and federal law. In 2006, we have more tools and techniques than ever before to manage environmental risk for our clients. Those changes present alternatives and opportunities not previously available to our clients, but those alternatives create more complicated risks for clients and their lawyers. Now, more than ever, counsel must analyze the purchaser's objective in purchasing a commercial site, and depending on the risk and the expectation of the purchaser, counsel must be prepared to recommend alternatives that are consistent with the purchaser's strategy. Uninitiated counsel should take special care in making recommendations without assistance.

i Interestingly, "hazardous substances" does not include petroleum under the CERCLA regimen. That is, the single largest contaminant of concern at most commercial sites - petroleum - is specifically excluded (unless the petroleum products come within one of the exceptions to the exclusion or can be characterized as "hazardous waste"). See 42 U.S.C. §9601(14).

ii

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ASTM recently modified Standard 1527 (with Standard 1527-05), incorporating earlier standards. Standard 1527-05 should also be appropriate pre-acquisition "due diligence" as it has been historically applied.

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