FDIC Issues Updated Guidelines for Environmental Risk Programs
 
March 6, 2007
 

For many prospective purchasers, the threat of incurring liability under a variety of environmental laws for cleanup of environmental contamination is a significant consideration in acquiring certain real estate. The potential for environmental liability also exists for lending institutions, which may be directly liable for cleanup of contamination on real property collateral. Even where real property is not used as collateral, lenders may be adversely affected by environmental contamination in situations where a borrower is sued for sizeable cleanup costs and consequently cannot make payments on a loan. In an effort to reduce the risks of environmental liability for lending institutions, the Federal Deposit Insurance Corporation (FDIC) recommends that institutions maintain an environmental risk program to help evaluate the potential risks of environmental contamination and liability associated with real property collateral. The critical elements that should be incorporated into an environmental risk program are set forth in the FDIC’s updated November 2006 “Guidelines for Environmental Risk Programs.”

The FDIC issued these new guidelines in response to the Environmental Protection Agency (EPA) All Appropriate Inquiries Rule (AAI Rule), which took effect on November 1, 2006, and sets forth the specific requirements that a prospective purchaser of real property must follow in order to qualify for certain defenses to liability under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). Under CERCLA, present and past owners of property, among others, may be held strictly liable for the cost of cleaning up hazardous substances on property. Congress amended CERCLA in 2002 to establish certain defenses to cleanup liability, one of which applies to new owners of property. One such defense, referred to as the bona fide prospective purchaser defense, allows a person to purchase property with the knowledge that the property is contaminated without being potentially liable for the cleanup of the contamination. Generally, the defense requires the prospective purchaser to adhere to a series of standards and practices, and prior to purchasing the property, undertake “all appropriate inquiries” into the previous use and ownership of the property.¹ The standards and practices that are necessary to meet the requirements for “all appropriate inquiries” are reflected in the FDIC’s “Guidelines for Environmental Risk Programs.”

Before an institution implements an environmental risk program, the FDIC suggests that the board of directors review and approve the proposed program and designate an officer knowledgeable in environmental matters to implement the program. The crucial elements that should comprise an environmental risk program include staff training, written policies and procedures for the institution to follow in evaluating environmental risks, performance of an environmental risk analysis during the loan application process, performance of a structured environmental risk assessment when possible environmental concerns are implicated, monitoring of the borrower and the real property collateral, specific language in the loan documentation to protect the institution, and an analysis of the extent of the institution’s involvement with the borrower’s operations, including foreclosure.

The FDIC Guidelines stress the importance of performing a structured environmental risk assessment in cases where potential environmental concerns are implicated in an application, interview, or visual inspection of property. This more detailed assessment may involve interviewing previous owners of the property, researching past uses of the property, inspecting the property and neighboring sites, and reviewing company records to determine whether hazardous materials were previously used or disposed of on the property. Based on the specific risk characteristics of the transaction, an institution may decide to require a borrower to perform a property assessment that conforms to the standards and practices of the EPA AAI Rule. Compliance with the AAI Rule will help protect the borrower from CERCLA liability if the borrower meets the requirements of the bona fide prospective purchaser defense. The decision to require an environmental evaluation that meets the AAI Rule should be made on a case-by-case basis.

Institutional environmental risk programs are subject to review by FDIC examiners. The failure of an institution to develop or comply with its own environmental risk program will subject the institution to criticism and corrective action by the FDIC. Given the potential adverse consequences of both environmental liability and FDIC corrective action, institutions should devote considerable time and effort to the creation and observance of an environmental risk program.

For more information, e-mail Meredith Cody at meredith.cody@hklaw.com or call toll free, 1-888-688-8500.

¹ After November 1, 2006, prospective purchasers must comply with the requirements of the AAI Rule, or follow the standards set forth in the ASTM E1527-05 Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process, to satisfy the standards for conducting all appropriate inquiries.