Law and the Environment

Will New ASTM Standard for Assessing Vapor Intrustion Wreak Havoc on Phase I Environmental Site Assessment Process?

Sitting at a Starbucks at in Dallas, Texas, I'm looking North at a Chevron-branded station owned by TETCO.  This is clearly noted on the sign with regular gasoline at $3.19 per gallon.  Clearly I am sitting downhill from the station, and if my client were buying the shopping center, my first suggestion would be testing the groundwater to see if the underground storage tanks containing various grades of gasoline or diesel below the gas station/convenience store have leaked and contaminated the property--under the Starbucks.  When I visit this site after dropping my daughter at school, I see the capped groundwater monitoring wells.  I would venture a guess that the hundreds of people who walk over or park on top of them have no idea what they are?  The two charming elderly women sitting outside the women in front of me have no idea that their may be gasoline and diesel 10 or 20 feet below their feet.  In reality, they probably have no reason for concern.  But a new standard for assessing risk from vapors from soil and groundwater may create havoc for real estate developers and banks.

Thinking about these issues is no different from any day in the office as an environmental lawyer.  (The "office" having grown with laptops, Blackberries, and cell phones to be about anywhere I am, ergo sitting in Starbucks with my T-Mobile connection blogging about an environmental issue--the mobile environmental lawyer.) Tanks leak.  Piping leaks.  People drive off and pull of the hose dispenses or otherwise spill fuels.  This is nothing new and has been going on for decades.  What is new is an ASTM standard for assessing the risk that those chemicals in the soil and groundwater are turning into vapor and getting into a building?  Could this new standard wreak havoc on the Phase I environmental site assessment process?  Could it be that I'm breathing benzene as I sit here typing this message?

It's actually unlikely.  My toxicologist friends working who work with me to assist clients in advising clients who remediate contaminated sights say it is highly unlikely in most instances.  In fact, they tell me it is when you fill up your car that you get your biggest shot of benzene--a known human carcinogen. 

So why the ASTM standard for assessing these risks if in fact they are so unlikely?  In the environmental regulatory world I live in as a corporate environmental lawyer since I graduated from Harvard Law School over 20 years ago, the regulatory agencies have begun to focus on these issues.  Yes, primarily in California, where all environmental regulatory programs tend to start (California has enacted and will be implementing a climate change greenhouse gas program before the Congress passes a bill), and the Texas environmental agency has not really tackled this issue and does not necessarily require that it be assessed.  Reportedly, the California agency is going back to sites closed under old rules that did not require vapor intrusion analysis and requiring that the sites be re-examined.  EPA has issued guidance documents on the subject of vapor intrusions and how to test for it.

As regulatory agencies and scientists begin to look at vapor intrusion into buildings, these issues have come up in real estate transactions in many parts of the country.  Real estate developers, real estate investment trusts, and banks then start to ask questions and the environmental lawyers and environmental consultants that work for them in their transactions start to ask questions.  Is vapor intrusion a problem?  What are the concentrations of chemicals in buildings that may arise from human sources in the ground (in soil and groundwater)?  Do such concentrations present a risk to people who work, live, visit these buildings?

The new ASTM standard is titled "Standard Practice for the Assessment of Vapor Intrusion into Structures on Property Involved in Real Estate Transactions" (E-2600-08). Roger Smith of Weston in Dallas provided this summary of the Standard.

The standard provides for a tiered approach to assessing and mitigating vapor intrusion conditions (VICs):

Tier 1

– Screening Level Assessment conducted with information typically gathered for a Phase I ESA (current and previous property use, location relative to potential sources, etc.) to decide if a potential vapor intrusion condition (pVIC) is present. It would make sense to include a request for a E 2600-8 Tier 1 VI screening level assessment along with the standard ASTM E1527 Phase I ESA. Since the assessment is based to a large degree on information gathered for the Phase I, there should be little additional cost associated with the screening levels assessment.

Tier 2

– Screening Level Assessment conducted by comparing information typically gathered in a Phase II ESA (soil and groundwater analytical data) to risk-based concentrations (look-up values) to decide if a pVIC is present. The Tier 2 VI assessments will mostly likely be requested whenever a standard Phase II ESA is requested. Since this is comparison to look-up values, there should be little additional cost associated with the Tier 2 screening level assessment.

Tier 3

– Vapor Intrusion Condition Assessment using modeling, soil gas samples, sub-slab vapor samples (from within buildings), and/or indoor air samples to decide if a VIC is present. This would be conducted when it has been determined that a pVIC is present that could affect current or future development on the property. The least expensive approach is likely to be modeling using existing data. This is typically a very conservative approach that may overestimate the risk of a VIC. If additional sampling is needed, the cost for conducting a VI assessment would typically be less than the cost for a Phase II assessment of the property.

Tier 4

– Vapor Intrusion Mitigation by building design, institutional controls, or engineering controls (removal of source, barriers, or mitigation systems). The scope and cost would be highly variable for Tier 4. For new construction, all three options are available. For existing construction, you are typically looking at the options for engineering controls.

The Standard is dense and may cause insomnia for even an environmental lawyer or consultant, but it does have potential implications for real estate transactions.  While it is not a part of the Phase I Site Assessment Standard which is used on almost all commercial real estate transactions, it is an add on to this standard.  It may in time become a standard practice to evaluate soil vapor intrusion.

If this happens, it may raise new issues and confusion in the commercial real estate market.  Banks will be unfamiliar with it and may be skiddish about chemical vapors and buildings.  What we need is to try to educate the real estate and banking industry about these issues.  While it will take time, it may be important not to scare off buyers and banks over vapor intrusions.

First, real risks may be rarely found.  The concentrations necessary to create a risk to workers in office buildings and industrial or warehouse settings are probably going to be rare.  People may need to work in buildings for 20 or 30 years, which is rare these days.  For residences, the concentrations are probably rarely going to raise a concern.  Second, for new buildings a vapor barrier can be constructed to prevent vapors from entering structures.  For old buildings, steps can be taken to vent the vapors.

Environmental assessments have become a standard practice in the real estate industry.  If vapor intrusion assessments become more commonly a part of those assessments, we need to be sure they don't become a source of undue alarm.  As commercial real estate faces the collateral damage of the subprime mortgage debacle, we need to take care that a new environmental concern and potential risk does not hamper transactions and the health of the market.  Understanding the scientific realities and real risk analysis is the first step in this process. 

Valero Settlement in Excess of $200 Million with EPA over Clean Air Act Issues Demonstrates Importance of Envirionmental Compliance Assessment, But Also Environmental Disclosure Due Diligence

In a case demonstrating the critical value of appropriate environmental due diligence into not only the potential for liability for releases of contaminants, pollutants, and hazardous substances into soil and groundwater, but the environmental management systems and environmental compliance of target companies in mergers and acquisitions, Valero agreed to a settlement by which it would pay a multi-million dollar penalty and over two hundred million dollars to install air pollution control equipment.  Valero purchased the refineries in question from another company in 2005.  In mergers and acquisitions, particularly those involving refineries, the potential costs to address air emissions issues are enormous.  Thus, extreme care should be taken in evaluating the compliance status of the refineries with New Source Review, Prevention of Significant Deterioration, Title V Permitting, the Clean Air Act and the regulations promulgated under the Act, and similar state statutes and regulations.  Care should also be taken to ensure that any emission offsets that are or may be required are available for purchase and that the cost of the emission reduction credits is understood.

The value of environmental disclosure due diligence can be demonstrated by this case.  Reviewing the prior company's disclosures and the internal controls used to identify and value environmental capital cost expenditures, predicted future potential expenditures, and environmental liabilities, coupled with the environmental compliance assessment, would allow the acquiring company, and if analyzed and reported properly to them, management and the board of directors, to adequately evaluate the acquisition and its impact on the disclosures that may be required under securities laws to shareholders at the time of acquisition or subsequent to acquisition, if the impact of the environmental liabilities or capital costs of the target company would be material to the acquiring company.

In the context of today's voluntary reporting on environmental and sustainability issues, public companies should take care in terms of the statements that are made regarding environmental compliance or management systems and efforts to protect the environment.  The acquisition of new companies or facilities could affect how the accuracy of those statements are perceived.

For more discussion of these issues please review my previous posts on Environmental Disclosure, the SEC case against Ashland regarding environmental disclosure, and Environmental Corporate Governance.

WASHINGTON, Aug. 17 /PRNewswire-USNewswire/ -- The Department of Justice and the U.S. Environmental Protection Agency have reached an agreement with Valero Energy Corp. that provides for a $4.25 million penalty and $232 million in new and upgraded pollution controls at refineries in Tennessee, Ohio and Texas that were formerly owned by Premcor Inc. The state of Ohio and Memphis-Shelby County, Tenn. have also joined in today's consent decree and will receive a portion of the civil penalty.

The agreement requires new pollution controls to be installed at refineries in Port Arthur, Texas; Memphis, Tenn.; and Lima, Ohio, that, when fully implemented, will reduce annual emissions of nitrogen oxide by more than 1,870 tons per year and sulfur dioxide by more than 1,810 tons per year. The new controls will also result in additional reductions of carbon monoxide, volatile organic compounds and particulate matter from each of the refineries. These pollutants can cause serious respiratory problems and exacerbate cases of childhood asthma.

"This Consent Decrees continues the commitment of the Department of Justice to assure that all refineries in the United States are in compliance with the Clean Air Act, said John C. Cruden, Deputy Assistant Attorney General for the Justice Department's Environment and Natural Resources Division. "This settlement, which was done in conjunction with state and local governments, requires new pollution abatement equipment, reduces air pollutants by a significant amount, obtains a meaningful penalty, and secures important environmental projects for the impacted communities."

"Valero committed to spend more than $200 million  in upgrades, which will reduce emissions of harmful air pollutants by several thousand tons per year," said Granta Nakayama, assistant administrator for EPA's Office of Enforcement and Compliance Assurance. "Today's settlement is good news for people living near these refineries; local residents will be able to breathe easier knowing that the air in their communities will be cleaner."

The settlement requires an additional $1.6 million to be spent on the following projects serving the Port Arthur, Texas community:

$1 million to support a local health center serving under and un-insured residents of the Port Arthur area, for the diagnosis and treatment of asthma and other respiratory illnesses that may be caused or exacerbated by air pollution. A mobile air monitoring van for the Local Emergency Response Commission. "Shelter-in-place" air control systems at the Booker T. Washington Elementary and Memorial 9th Grade Center schools to detect, isolate And filter air pollution that may result from emissions in the Port Arthur area. A project to replace existing high-emitting water heaters with new low-emission water heaters in low-income residences in the Port Arthur area.

Additional supplemental projects will be performed in the communities near the Lima and Memphis refineries, such as the installation of equipment on municipal diesel trucks and buses to reduce particulate and ozone-forming emissions, and the installation of new equipment to control wastewater treatment plant odors. Projects to further reduce "fugitive" and unregulated emissions from refinery equipment are also being undertaken at each of the three refineries covered by today's agreement.

This settlement is part of the EPA's national effort to reduce air emissions from refineries. Through federal settlements such as the one reached today, approximately 84 percent of domestic refining capacity is now operating under pollution reduction agreements. Including the settlement with Valero, 89 refineries located in 26 states across the nation are now under agreements to address environmental problems and to invest over $4.7 billion in new pollution control technologies.

The three refineries covered by today's settlement produce more than 650,000 barrels of oil per day, representing nearly four percent of domestic refining capacity in the United States.

The refineries were previously owned by Premcor and purchased by Valero in late 2005. In June 2005, before Valero acquired Premcor, a similar settlement was reached with Valero that addressed the refineries it owned at that time. Under that agreement, Valero committed to spend at least $700 million at 14 refineries nationwide.

Today's agreement was lodged in the U.S. District Court for the Western District of Texas and is subject to a 30-day public comment period and final court approval. A copy of the consent decree is available on the Department of Justice Web site at http://www.usdoj.gov/enrd/Consent_Decrees.html.

U.S. Environmental Protection Agency

CONTACT: U.S. Environmental Protection Agency, ENRD +1-202-514-2007, EPA+1-202-564-4355, TDD +1-202-514-1888

Web Site: http://www.usdoj.gov/

Climate Change Due Diligence: A New Aspect of Environmental Due Diligence?

           Now that California and six western states and ten northeastern states have passed laws and entered into regional programs to limit greenhouse gas emissions, the United States is entering a carbon-constrained economy.  Nine or more bills have been filed in Congress.  As companies enter into mergers and acquisitions, the potential costs of large carbon footprints at facilities or companies being acquired is becoming a significant concern.

            Not only the regulatory costs of potential emission reductions or offsets, but the “license to operate” may in jeopardy.  The case of TXU and it’s attempt to gain permitting for eleven coal-fired power plants demonstrates that the public and many legislators may prevent the construction of large greenhouse-gas-emitting facilities. The Wall Street Journal reports that Mirant, a utility that just emerged from bankruptcy, is facing limits on its profitability as a result of carbon regulation in the northeastern states.

            Many investment companies looking to acquire facilities in Europe are evaluating greenhouse gas emissions and the allowances and credits that have been purchased to ensure the ability to continue operating.  In the US, some companies have begun entering contracts to secure carbon credits to offset expected limits on greenhouse gas emissions.

            As we appear to be moving to increasing constraints on carbon dioxide and other greenhouse gases here, the need to begin conducting greenhouse gas evaluations and considering the ability to reduce emissions or the availability of offsets will begin to be a significant part of environmental due diligence.  It will become critical to evaluate not only compliance risks arising from carbon emissions, but also the very the value of facilities and companies being acquired.

Corporate Directors and Environmental Corporate Governance Part IV: Evaluation of Financial Disclosure by the Target in an M&A Transaction May Avoid Risk and Yield Benefits in the Negotiation of the Deal

In mergers and acquisitions, I have found that when one can show the target company has a week environmental financial disclosure process and week internal controls, a significant potential advantage may arise for the acquiring entity.  On the other hand, failure to identify these weaknesses can prove problematic for the acquirer after closing the deal.  As a result, for the appropriate M&A transaction, a review of the environmental disclosure policies, processes, and internal controls can yield valuable information for the acquiring entity and protect it from future risks and liabilities.

In the context of what I’ve been discussing in the Environmental Corporate Governance area, it is important for directors and management to ensure that the company considers environmental disclosure issues in each acquisition with potential material environmental risks and liabilities, both to manage risk and to consider the opportunity to identify the true value of the target company. 

A.  Review for Understanding and Negotiating Value or Other Concessions

The first issue is the extent to which the target has properly accounted for loss contingencies under Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies.”  One should review lawsuits, demands, and other potential claims to attempt to assess whether the financial statements have adequately reserved for such claims.  Moreover, the policies and processes, if any, the company has in place for identifying, valuing, adjusting, and reporting FAS 5 claims can be reviewed to better understand if the internal controls are adequate.  After the SEC enforcement case against Ashland (discussed in another post on this blog), it is critical that the review and adjustment of the reserve estimates received from the environmental manager or staff be rigorous and documented.

As for asset retirement obligations (AROs) and conditional AROs under Statement of Financial Accounting Standards No. 143 “Accounting for Asset Retirement Obligations” and Financial Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations”, again a careful review of what has been accounted for and the policies and procedures that have been established and how they have been implemented can shine significant light on the value of the company and its potential liabilities, as well as its FAS 143/FIN 47 internal controls.

The other key is to try to do this early.  Deals are somewhat like basketball games, the ability to obtain and process information has to conclude within a period of time, often a very short period of time.  The other side may hold out in terms of providing information or making documents available or allowing access to sites that need to be assessed.  The “four corners” or “stall game” can “run the clock out.”  Pressure builds to close the deal as one approaches the closing date.  For environmental lawyers armed with financial disclosure expertise, time is one of our many challenges.

Another point to keep in mind is that the due diligence process has to be tailored to the deal in terms of what is the nature of the buyer’s goal in making the acquisition, how will environmental issues play into this acquisition strategy,  what type of company or asset is being acquired, what is the market in terms of how many other potential buyers are out there, and is it a buyer’s or seller’s market.

There are a variety of tools that can be used in the deal, and some or all of these may be helpful in certain transactions, but not in all of them.  The point being one must chose the weapons for each deal to fulfill the goals of the buyer.  One advantage to this approach  is that the environmental due diligence plan and process will hopefully match the business strategy of the client in making the acquisition, pricing the acquisition, and then dealing with environmental compliance, management and disclosure issues after closing.  What liabilities or costs will the acquiring entity have to address post closing?  Will this arise two years after acquisition as the new assets or company is reviewed in the acquirers environmental audit process or through review of these issues in the context of the financial disclosure review?  What if the financial auditor determines the new assets or company does not have adequate internal controls or accounting for environmental?  Will a situation arise where the acquiring entity must restate its financials as a result of the acquisition?

It is important to begin with traditional environmental due diligence—identify risks, costs, liabilities, then use this information and more advanced environmental due diligence to identify potential AROS/ CAROs or loss contingencies.  The traditional due diligence will lead to discussions with the other side and then to internal control/lack of knowledge of environmental disclosure requirements with the seller’s environmental manager and then the accounting staff. 

In some deals, the target and its financial accounting people often do not have a good understanding of the environmental accounting issues, so knowledge can become power if the other side seems uneducated and unprepared to deal with a close review of their reserves for FAS 5 and accounting for FAS 143/FIN 47.  Of course this will vary with the size of the seller.  Smaller companies are often like shooting fish in a barrel—they have little expertise in accounting for environmental liabilities and few controls in place to address the issues.  Bigger companies may be more sophisticated, but it is likely you may be able to poke holes in their accounting, reserves, internal controls, etc. 

This is true with respect to both FAS 5 and FAS 143. Do not underestimate how the other side underestimates their loss contingencies just because FAS 5 has been around awhile.  Accounting for FAS 143 and FIN 47 may be practically non-existent or poorly documented and justified. 

Typical purchase and sale agreement contain representations regarding compliance with Generally Accepted Accounting Standards (GAAP).  Some agreements call for price adjustments for liabilities not properly addressed in the financial statements under GAAP.  These GAAP provisions may provide useful tools both for rooting out failure to account for costs, liabilities, and retirement obligations, and for arguments for adjusting values in the transaction.

Whether a price reduction or other advantage can be gained in a transaction, depends on the acquirer representatives and how bad they want the deal.  Issues may have to be considered “material” either in the SEC sense or the deal sense.  With a party wishing to take a strong stand on negotiating price, the value of the environmental financial review can often greatly support price negotiations.  The overall sense of the deal drives environmental negotiations—that is, if the buyer is looking for a price reduction, then environmental issues can be a mechanism to attempt to achieve that end. 

What is important is to go into the deal with an education of the corporate or transactional lawyers and client that this is potentially a useful tool.  In my experience, it arises after the fact through the environmental lawyer educated about financial disclosure issues raising concerns and failure to account or account accurately for environmental issues. 

B.                 Environmental Due Diligence to Protect the Acquiring Entity

The other side of the coin is the need to protect the acquiring entity.  US Liquids (discussed in another post on this blog) and its directors found the company in a criminal enforcement case after acquiring waste management companies that were accused of criminal violations of environmental statutes.  The drop in the stock price found the not only the company, but the directors as well in a shareholder lawsuit.  To add further injury, the Fifth Circuit Court of Appeals ruled the directors were not covered by the director and officer insurance.

The Ashland case reveals issues the SEC identified that caused them concern in an enforcement action over environmental reserves and disclosure.  Taking care to understand the target’s practices at the environmental estimation level and the review by management could avoid future problems and identify accounting changes that need to be implemented after closing.

Thus, the value of conducting due diligence into the environmental financial disclosure practices of target companies in M&A deals provides a potential two-fold advantage:  (1) further vetting of the value and environmental practices of the target company, and (2) protecting the acquirer from potential problems if the target’s practices are far less robust then the acquirer and avoiding future restatements or identified weaknesses in future financial disclosure and auditing.  Corporate boards and management should ensure that their acquisition teams are conducting environmental disclosure due diligence in the appropriate cases where environmental risks and liabilities may be significant.

Corporate Boards and Environmental Corporate Governance Part III: Acquisitions and Environmental Compliance, Management, and Disclosure Due Diligence and Integrating the Acquired Entity or Asset Into the Corporate EMS System

As a continuation of this series on the Environmental Corporate Governance, it is important to consider the governance issues arising from mergers and acquisitions.  Environmental, health, and safety due diligence is vital in acquisitions.  A critical issue identified is the need to integrate the new employees and company or asset (plant, facility, etc.) into the EHS management system and integrity system of the acquiring company.  Failure to do so may have significant consequences.

The first step is to ensure that the appropriate due diligence is conducted.  This must be a message from the board and management on down to those involved in the acquisition.  Due diligence now consists of three parts:  (1) review of the company’s and its assets and facilities compliance with laws and regulations, (2) review of the environmental management system of the company, and (3) review of the policies, processes, and internal controls (where appropriate) for accounting for and disclosing environmental liabilities and asset retirement obligations.

Review of the target’s compliance with environmental laws and regulations and potential environmental liabilities is fairly standard.  More and more consideration of the systems in place to ensure compliance and risk reduction is occurring.  What is now becoming more clear is that the evaluation of the target’s environmental financial accounting and disclosure may be a critical issue for the acquiring entity.

The US Liquids case discussed in another post, shows that the acquisition of entities that not only have poor compliance histories, but also the failure to account for the risks and liabilities by the target and then the new owner can have significant consequences on the acquiring entity and its board of directors.  The stock price fell and trading was stopped when a criminal investigation was announced of the facilities that had been acquired.  The directors were sued and the insurance company successfully argued that the environmental exclusions in the director and officer insurance policies excluded the claims and no coverage was available for either defense costs or liability.

The details of these issues will be addressed in a future post, but areas like asset retirement obligations under the Financial Accounting Standards Board’s (FASB) Financial Accounting Standard (FAS) No. 143, Accounting for Asset Retirement Obligations, and its subsequent interpretation of this standard, Interpretation No. 47 (FIN 47), Accounting for Conditional Asset Retirement Obligations, have created opportunities, but also pitfalls for acquiring companies.  Care should be given in evaluating the AROs as well as the more traditional reserves for claims and loss contingencies under Financial Accounting Standard No. 5, Accounting for Contingencies, or AICPA Statement of Position 96-1, Environmental Remediation Liabilities (“SOP 96 1”). 

An interrelated issue with the review of policies, processes, and practices is the need to ensure that the target company understands how these three “Ps” compare with its own.  Management, directors, and environmental VPs and managers must understand the importance of integrating the new employees and facilities immediately into the acquirer’s EHS management system and to ensure that no tolerance was provided for deviation.  Some employees would not be able to survive the transition—they simply would refuse to comply with the new system and would quit or be terminated.

Immediate imposition of the new system and review of performance and deviations was seen as critical.  Failure to do so immediately was viewed as likely to result in a very difficult process of trying to integrate the new people and facilities in the future.

Management and boards of directors should consider that the integration of new companies or assets through mergers or acquisitions requires a process-based approach.  The compliance status and environmental liabilities is just one part of this process.  Understanding the environmental management systems is critical, particularly after the Baker Panel Report regarding the explosion that killed and injured so many people a the BP refinery in Texas City, Texas.  The third leg of due diligence is the review of environmental accounting and disclosure in financial statements and any reports filed with the SEC if the target is a public company. 

The key point is understanding that the rigor of the related processes of the acquiring company must be compared with and harmonized with the target before and then after closing.  Otherwise, the buyer may find not only existing conditions that lead to environmental liabilities after closing, but potentially practices that lead to lawsuits and enforcement actions and even financial restatements months or even years after the deal is done.

Affect of “As Is” Provisions in Real Estate Contracts on Fraud Claims for Failure to Disclose Environmental Conditions of Property

            Commercial real estate transactions generally occur in the context of a contract containing an “as is” clause.  The objective of such a clause is to avoid any liability of the seller after the transaction for defects in the property.  Since real estate sales present the risk of the buyer acquiring not only the land, but liability for any contamination or pollution thereon, as is clauses present questions of how they affect environmental liability of both the seller and the buyer, and whether the buyer may return to the seller if environmental surprises spring up in the days, months, or even years after the sale.  This latent environmental risk often arises as a primary issue in real estate transactions, and, where not discovered at the time of the sale, often results in litigation over the meaning of the contract and to what extent the seller is relieved of environmental liability for the property.

            As is provisions are usually contained in a long section of the purchase and sale contract, and often also contain what are referred to as  “waiver-of-reliance clauses.”  These clauses are designed to address an element of fraud or misrepresentation, namely that the buyer relied on any representation, or,  in some cases, the failure of the seller to disclose known material information. 

            Of course, real estate transactions almost always involve at least some form of investigation of the potential environmental risks associated with the property in the form of Phase I or Phase II Environmental Site Assessments.  The typical real estate contract will contain a due diligence period in which the potential buyer is permitted to conduct the investigation it feels necessary to evaluate the property, usually including the ability to conduct a Phase I, and, where the environmental consultant who performs the Phase I recommends a Phase II to actually conduct testing of the property, usually soil and groundwater testing.  The contract often states that the buyer must conduct this investigation and determine whether it wants to proceed with the transaction or not—if electing to proceed then this is often described in the contract as the basis for the client being satisfied there are no defects in the property, whether environmental or otherwise.

             Real estate contracts are often drafted with these types of “boiler plate” provisions.  Unfortunately, the strategy for drafting a particular real estate contract and the environmental assessment that is conducted may not be best exercised with a standard approach or language.  With respect to the contract language itself, in particular, the buyer may not want to accept that the seller may fail to disclose or misrepresent the environmental conditions of the property. 

            The Texas Houston Court of Appeals recently provided an illustration of this contracting practice and reviewed the case law in Texas on the application of as is and waiver of reliance provisions. In Warehouse Associates Corporate Centre II, Inc. v. Celotex Corp., (192 S.W.3d 225 (Tex. App.—Houston [14th Dist.] 2006)) the plaintiff learned the hard way that a standard as is contract may not provide the seller protection from fraud committed against the buyer.  The The Houston Appellate Court preserved protections for buyers, but only in limited circumstances.

            However, another area of perhaps more importance is statutory environmental liability.  An open question not discussed by the appellate court is whether as is provisions provide any relief for sellers from statutory environmental liability in Texas.

            The facts of the case involved a buyer who purchased a property that was the site of a former shingle manufacturing plant—where, unknown and intentionally withheld from the buyer, asbestos was used in the process and buried in the ground.  The contract provided that the property would be sold on a “where is, as is” basis, “with all faults,” imposed no obligation on the seller to provide documents or records relating to the property’s condition, but allowed the plaintiff to inspect the property for 60 days and to terminate the contract for any reason based on its sole discretion within that period.  If the buyer proceeded to close, the buyer would accept the property and assume all liability for owning, using, or possessing the property, including any liability imposed by local, state, or federal environmental laws or regulations.

            The seller produced only a portion of an environmental report to the buyer that discussed asbestos in the buildings, but did not discuss asbestos in the soil or its use in the manufacturing process.  The part that discussed asbestos use in the manufacturing process was not disclosed to the buyer.

            Moreover, during the inspection period, a contractor excavating soil on the property discovered what appeared to be raw, friable asbestos buried below the surface of the property.  The contractor’s employee contacted the director of environmental affairs for the seller, and was told to backfill that area of the property and not to perform any other excavation in the area. 

            The environmental consultant engaged by the buyer to conduct a Phase I Environmental Site Assessment did not ask the director of environmental affairs about asbestos and no mention of the buried asbestos was made.  When asked about the materials used in the manufacturing process, again asbestos was not mentioned.  The consultant also conducted a Phase II Environmental Site Assessment and collected soil samples from the property; however, no asbestos testing was performed on the samples collected.

            After the closing of the purchase and sale, the buyer engaged a contractor to remove the slabs from the property.  In doing so, the buried asbestos was discovered.  Extensive sampling determined that asbestos contamination was widespread and reached to 13 feet below the surface.  As a result, the buyer filed suit under theories of common law fraud, negligent misrepresentation, statutory fraud under Section 27.01 of the Texas Business and Commerce Code, and sought rescission of the contract, punitive damages, and attorney’s fees. The seller counterclaimed, and both parties filed motions for summary judgment. 

            The trial court granted summary judgment against the buyer as to its claims, and granted the seller attorney’s fees of two million dollars for fees and various costs.    The buyer appealed the summary judgment and dismissal of its claims.

            In reviewing the applicable case law on these issues, the Houston Court of Appeals considered two prior Texas Supreme Court decisions, Prudential Insur. Co. of Amer. v. Jefferson Assoc., Ltd. (896 S.W.2d 156 (Tex. 1995)) and Schlumberger Technology Corp. v. Swanson (959 S.W.2d 171 (Tex. 1997)) as to the application of the as-is and waiver-of-reliance language in real estate contracts to exclude inducement by fraud and activities of the seller that impaired, obstructed, or interfered with buyer’s inspection of the property.  The appellate court concluded that the Prudential exception survives the later Schlumberger Supreme Court opinion. 

            These cases that have come before the Texas Supreme Court over the years raise two competing concerns:  on the one hand, an interest in allowing parties to enter into agreements that finally resolve all issues between them, and on the other hand, a desire to prevent fraud in real estate transactions. 

            The first case reviewed in some detail by the court was Prudential.  The Prudential case set out two exceptions to the “as-is” and “waiver of reliance” language in contracts.  The first is where the buyer is induced into entering the contract by a fraudulent misrepresentation or concealment of information by the seller. The second exception is where the facts show that the seller impaired, obstructed, or interfered with the buyer’s inspection of the property.

A.                 Inducement by Fraudulent Misrepresentation or Concealment of Information

            The defendant seller in the Warehouse Associates case argued that even where the facts showed fraud, the as-is and waiver-of-reliance language can be enforced.  The defendant relied on the Supreme Court’s decision in the Schlumberger case.  In that case, the Supreme Court attempted to avoid fraud to a point.  However, in the end, it concluded that the facts of the particular case warranted upholding a release of liability based on the specific facts of that case.  In that case, the issue involved a settlement of the disputed value of an asset or commercial project.  Because the waiver of reliance was directed at the dispute over value, the appellate court upheld the waiver as a matter of law and would not permit the buyer’s claim of fraud.

            In the Warehouse Associates case, the Houston Court of Appeals did not agree with the seller that the Schlumberger case stood for the proposition that waiver-of-reliance provisions voided any claim that the buyer fraudulently induced a buyer to enter a sales contract.  Rather, the Houston Court pointed out that the Schlumberger case stated that the Texas Supreme Court was resolving apparent divisions in prior cases and establishing the rule of law in accordance with a forty-year-old case that it would refuse to enforce fraudulently induced “waiver of reliance provisions.”  This was considered to be consistent with “the great weight of authority, the Restatement of Contracts, and the views of eminent legal scholars.”

            The court also noted that the Prudential opinion recognized other situations in which the as is or waiver-of-reliance provisions would not apply based on the totality of the circumstances.  Several possible factors were identified.  The first would be where the sophistication of the parties were in question or where one or more were not represented by counsel.  The second was whether the contract arose in an arm’s length transaction.  Third, the relative bargaining power and whether the contract was freely negotiated were identified as a significant issue.  Finally, and one of importance to practicing attorney’s, is whether the as is or waiver-of-reliance provision rose to the level of an important feature of the negotiations or whether it was simply part of the boilerplate in a form real estate contract.  This latter issue is important, since most real estate attorneys or their clients maintain forms that are used in most of their transactions.  As is and waiver-of-reliance provisions usually are standard provisions inserted into contracts.  Showing which provisions are actively discussed and which were not, may be an important part of future environmental fraud cases.

            In the Warehouse Associates case, the seller attempted to turn these factors against the buyer and argued that because the buyer was represented by counsel in an arm’s-length transaction, the waiver of reliance provision should be enforced and the fraudulent-inducement exception should not be applied.  The court rejected this position.  The court believed that where the jury had found that in fact the seller had withheld material information and fraudulently induced the buyer to enter the contract, the waiver-of-reliance provision should not be enforced.  It must be kept in mind that the Schlumberger case involved a disputed claim over the value of the asset, and this is what the waiver-of-reliance provision was designed to address in a settlement agreement.  This is different than a real estate transaction, where the buyer is simply attempting to ensure that it identifies and evaluates any environmental contamination or condition.   The buyer often is at a disadvantage of not knowing of environmental conditions known to the seller that are not readily discoverable by performing an environmental site assessment.

            One issue that arose is whether the buyer should have known of the buried asbestos.  The court ruled that information regarding the buried asbestos was concealed from the buyer and that it was not clear to even an environmental expert that asbestos had been used at the former manufacturing plant.  The court also rejected the argument that the buyer was charged with all information in the public record, for example records in the files of a governmental agency.

            Finally, the court did not adopt the seller’s argument that the fact the buyer engaged in its own inspection of the property for environmental conditions, Phase I and Phase II environmental site assessments, the fraudulent-inducement exception did not apply.

B.                 Impairment of Inspection

            The impairment-of-inspection exception to the as is and waiver-of-reliance provisions was not applied by the court in this case.  As a first step in deciding whether to apply this exception, the court stated that it analyzes the “impairment-of-inspection exception separately from the fraudulent-inducement exception.”  The court ruled that the property was open for physical inspection and testing.  The failure to provide information is not perceived to meet the exception, but only conduct that impairs, obstructs, or interferes “with the buyer’s exercise of its contractual right to carefully view, observe, and physically examine the property.”

            The court’s rational of the decision is important.  The opinion supports the ability of sophisticated parties to enter into contracts in which statements of the seller cannot be relied upon so that the exception does not swallow the rule of permitting as is transactions.  In particular, the court noted that the parties were sophisticated and represented by counsel in “an arm’s length commercial transaction in a way that allocated the risk of discovering adverse property conditions entirely to the buyer, and the parties placed the burden of inspecting the property for such conditions entirely on the buyer.”  Thus, the court appeared to leave the issue of concealment of information to the fraudulent-inducement exception, and concluded that obstruction of access to the property is the key to successfully invoking the impairment of inspection exception.