First Quarter 2008
Updated Phase I ESA May Be Required Prior to Acquisition of Property From Related Entity in Order to Qualify for CERCLA Liability Defenses
Holland & Knight Newsletter
Prospective purchasers of real estate are confronted with many critical issues when acquiring property, not the least of which is the potential for liability under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA or Superfund) if the property is contaminated. By qualifying for one of the three CERCLA defenses to liability prior to taking title to the property, prospective purchasers may have a defense to potential liability. These defenses include the bona fide prospective purchaser defense, the innocent landowner defense and the contiguous property owner defense. The defenses, which were included in the Small Business Liability Relief and Brownfields Revitalization Act (Brownfields Amendments of 2002), are generally referred to as the Landowner Liability Protections (LLPs).
The first step in qualifying for one of the LLPs is to conduct the requisite “all appropriate inquiries” into the previous ownership and uses of the property so as to determine whether hazardous substances were released at or on the property. The criteria that must be met in satisfying the “all appropriate inquiries” requirement are outlined in the Environmental Protection Agency (EPA) All Appropriate Inquiries Rule (AAI Rule), 70 Fed. Reg. 66,070 (Nov. 1, 2005). See 40 C.F.R. 312. Further, prospective purchasers must satisfy additional obligations post-closing.
Often, courts are called upon to determine whether prospective purchasers have adequately engaged in the requisite environmental due diligence necessary to qualify for one of the LLPs. Numerous cases exist in which courts discuss the adequacy of the “all appropriate inquiries” conducted by prospective purchasers. An important related issue is what due diligence is required when a prospective purchaser seeks to acquire property from a related entity, such as a general partner or limited liability company. Specifically, when an entity seeks to transfer its interest in a property to a closely related entity, does the latter have to conduct its own due diligence to qualify for one of the LLPs, particularly when the transferring entity has already done so?
Existing Case Law
While very few courts have addressed this issue to date, at least one recent case sheds some light on this issue. This case is Seven Springs LP v. Fox Capital Management Corp., 65 ERC 1475, 1476 (E.D. Ca. 2007). In Seven Springs, the Eastern District Court in California explained that a subsequent owner of contaminated property cannot “shelter” under the CERCLA defense of the former property owner without conducting its own due diligence into the environmental conditions on the property. Id. at 1477. The subsequent owner, Seven Springs, argued that it was entitled to assert the innocent landowner defense because the previous owner of the property, which owned 99 percent of the interest in Seven Springs, had already qualified for the defense. Id. Despite the fact that the subsequent and previous owner were closely related, the District Court pointed out that they were in fact two separate legal entities with separate rights and responsibilities. Id. Accordingly, the subsequent owner could not escape its duty to perform the requisite due diligence simply because the former owner had already done so. The District Court opined that, to allow a subsequent owner to simply rely on the conduct of a former owner without engaging in its own independent inquiry, would defeat the purpose of the defense. Id. While Seven Springs involved two closely related entities, the decision seems to indicate generally that one entity cannot shield itself under the defense of another entity without making its own independent inquiry into the environmental condition of a property.
Another relevant case is Chesapeake and Potomac Telephone Co. v. Peck Iron & Metal Co., Inc., 814 F.Supp.1269 (E.D. Va. 1992). The Seven Springs court cited this case in support of its conclusion that the subsequent property owner could not rely on the defense of the former owner because the two were not the same entities, but were in fact separate legal entities. See Seven Springs, 65 ERC at 1477. Generally, the Chesapeake decision suggests that even closely related entities must individually engage in their own “all appropriate inquiry” in asserting a defense to CERCLA. Id. at 1281. The following is a brief description of the facts in Chesapeake.
Zacharias Brothers, a Virginia general partnership composed of Edward Zacharias and William Zacharias, purchased a 12.5 acre parcel of property in 1973, subdivided the property into four smaller parcels and leased portions of the property to a battery-breaking business. The battery-breaking business caused significant environmental contamination on the property. Id. at 1280. After the battery-breaking business ceased operations on the property, Zacharias Brothers (the general partnership) transferred some of the property to the brothers and their wives, individually. Id. Zacharias Brothers, Edward Zacharias, William Zacharias and their wives were all named defendants in the CERCLA litigation. Id. at 1273.
The general partnership, Zacharias Brothers, asserted the innocent landowner defense with regard to two of the four parcels, arguing that the contamination on those two parcels must have occurred prior to the time the partnership acquired title to the property as a whole. The court rejected this argument, stating that the property was indivisible, and that the contamination from the battery-breaking business clearly occurred during the time when the general partnership owned the property. Id. at 1280.
Defendants Edward and William Zacharias, and their wives, asserted the innocent landowner defense separately from the Zacharias Brothers partnership. Id. The court explained that these defendants must demonstrate their entitlement to the defense by showing, among other things, that they had no reason to know of the contamination on the property. Id. The court concluded that these defendants could not make that showing and thus were not entitled to the innocent landowner defense. Id. at 1280-81. Specifically, the court found that Edward and William Zacharias individually knew there was contamination on the property because they were notified by the Virginia attorney general in a letter that was addressed to Zacharias Brothers. Id. at 1280. The letter was sent prior to the time that the property was transferred from the general partnership to the Zacharias brothers. Id. The court concluded that the two brothers, as individuals, were not innocent landowners, and neither were their wives. Id. at 1281. Even if they had not been told of the contamination by their husbands, the court explained that the wives should have engaged in the requisite “appropriate inquiry into the previous ownership and uses of the property consistent with good commercial or customary practice” prior to acquiring their interests in the property. Id. The record revealed that a question to their husbands or even a cursory investigation of the property would have revealed the existence of the contamination. Id.
The Chesapeake decision suggests that, regardless of how closely intertwined the entities may be, each is entitled to separately assert its own defense to CERCLA. However, each entity has to individually satisfy the requisite elements of the defense and engage in its own appropriate inquiry. The Seven Springs court cited Chesapeake for this proposition and ultimately concluded that Seven Springs should have engaged in its own independent inquiry if it wanted to avail itself of the defense rather than rely on the actions of the closely related former owner.
A case that is similar to Chesapeake is In re Hemingway Transport, Inc. v. Kahn, 174 B.R. 148 (Bkrtcy. D. Mass. 1994), which also involved claims brought under CERCLA. In Hemingway, the contaminated land at issue was purchased by Juniper Development Group (JDG), a general partnership composed of G. Whitten, C. Whitten and A. Whitten (Whittens). Id. at 156. JDG later transferred the property to the Olympia Nominee Trust (the Trust) of which JDG was the sole beneficiary and the Whittens were the trustees. Id. The court found that JDG and the Trust were separate entities. Id. at 172. Both JDG and the Trust, individually, asserted the innocent landowner defense. Id. The court found that because the Whittens had been alerted to the presence of contamination on the property, they as trustees of the Trust were not entitled to assert the innocent landowner defense. Id. However, the court also found that, while the defense was available to JDG, JDG did not satisfy the criteria necessary to avail itself of the defense. Id. at 173-74. In sum, the Hemingway decision suggests that closely related entities must individually engage in their own independent inquiry in order to avail themselves of CERCLA defenses.
Conclusion
While very few courts have addressed the question of the type of environmental due diligence that a party must engage in prior to acquiring property from a related entity, Seven Springs, Chesapeake and Hemingway suggest that closely related entities must each engage in their own due diligence in order to avail themselves of the defenses to CERCLA liability provided in the Brownfields Amendments of 2002.
The first step in qualifying for one of the LLPs is to conduct the requisite “all appropriate inquiries” into the previous ownership and uses of the property so as to determine whether hazardous substances were released at or on the property. The criteria that must be met in satisfying the “all appropriate inquiries” requirement are outlined in the Environmental Protection Agency (EPA) All Appropriate Inquiries Rule (AAI Rule), 70 Fed. Reg. 66,070 (Nov. 1, 2005). See 40 C.F.R. 312. Further, prospective purchasers must satisfy additional obligations post-closing.
Often, courts are called upon to determine whether prospective purchasers have adequately engaged in the requisite environmental due diligence necessary to qualify for one of the LLPs. Numerous cases exist in which courts discuss the adequacy of the “all appropriate inquiries” conducted by prospective purchasers. An important related issue is what due diligence is required when a prospective purchaser seeks to acquire property from a related entity, such as a general partner or limited liability company. Specifically, when an entity seeks to transfer its interest in a property to a closely related entity, does the latter have to conduct its own due diligence to qualify for one of the LLPs, particularly when the transferring entity has already done so?
Existing Case Law
While very few courts have addressed this issue to date, at least one recent case sheds some light on this issue. This case is Seven Springs LP v. Fox Capital Management Corp., 65 ERC 1475, 1476 (E.D. Ca. 2007). In Seven Springs, the Eastern District Court in California explained that a subsequent owner of contaminated property cannot “shelter” under the CERCLA defense of the former property owner without conducting its own due diligence into the environmental conditions on the property. Id. at 1477. The subsequent owner, Seven Springs, argued that it was entitled to assert the innocent landowner defense because the previous owner of the property, which owned 99 percent of the interest in Seven Springs, had already qualified for the defense. Id. Despite the fact that the subsequent and previous owner were closely related, the District Court pointed out that they were in fact two separate legal entities with separate rights and responsibilities. Id. Accordingly, the subsequent owner could not escape its duty to perform the requisite due diligence simply because the former owner had already done so. The District Court opined that, to allow a subsequent owner to simply rely on the conduct of a former owner without engaging in its own independent inquiry, would defeat the purpose of the defense. Id. While Seven Springs involved two closely related entities, the decision seems to indicate generally that one entity cannot shield itself under the defense of another entity without making its own independent inquiry into the environmental condition of a property.
Another relevant case is Chesapeake and Potomac Telephone Co. v. Peck Iron & Metal Co., Inc., 814 F.Supp.1269 (E.D. Va. 1992). The Seven Springs court cited this case in support of its conclusion that the subsequent property owner could not rely on the defense of the former owner because the two were not the same entities, but were in fact separate legal entities. See Seven Springs, 65 ERC at 1477. Generally, the Chesapeake decision suggests that even closely related entities must individually engage in their own “all appropriate inquiry” in asserting a defense to CERCLA. Id. at 1281. The following is a brief description of the facts in Chesapeake.
Zacharias Brothers, a Virginia general partnership composed of Edward Zacharias and William Zacharias, purchased a 12.5 acre parcel of property in 1973, subdivided the property into four smaller parcels and leased portions of the property to a battery-breaking business. The battery-breaking business caused significant environmental contamination on the property. Id. at 1280. After the battery-breaking business ceased operations on the property, Zacharias Brothers (the general partnership) transferred some of the property to the brothers and their wives, individually. Id. Zacharias Brothers, Edward Zacharias, William Zacharias and their wives were all named defendants in the CERCLA litigation. Id. at 1273.
The general partnership, Zacharias Brothers, asserted the innocent landowner defense with regard to two of the four parcels, arguing that the contamination on those two parcels must have occurred prior to the time the partnership acquired title to the property as a whole. The court rejected this argument, stating that the property was indivisible, and that the contamination from the battery-breaking business clearly occurred during the time when the general partnership owned the property. Id. at 1280.
Defendants Edward and William Zacharias, and their wives, asserted the innocent landowner defense separately from the Zacharias Brothers partnership. Id. The court explained that these defendants must demonstrate their entitlement to the defense by showing, among other things, that they had no reason to know of the contamination on the property. Id. The court concluded that these defendants could not make that showing and thus were not entitled to the innocent landowner defense. Id. at 1280-81. Specifically, the court found that Edward and William Zacharias individually knew there was contamination on the property because they were notified by the Virginia attorney general in a letter that was addressed to Zacharias Brothers. Id. at 1280. The letter was sent prior to the time that the property was transferred from the general partnership to the Zacharias brothers. Id. The court concluded that the two brothers, as individuals, were not innocent landowners, and neither were their wives. Id. at 1281. Even if they had not been told of the contamination by their husbands, the court explained that the wives should have engaged in the requisite “appropriate inquiry into the previous ownership and uses of the property consistent with good commercial or customary practice” prior to acquiring their interests in the property. Id. The record revealed that a question to their husbands or even a cursory investigation of the property would have revealed the existence of the contamination. Id.
The Chesapeake decision suggests that, regardless of how closely intertwined the entities may be, each is entitled to separately assert its own defense to CERCLA. However, each entity has to individually satisfy the requisite elements of the defense and engage in its own appropriate inquiry. The Seven Springs court cited Chesapeake for this proposition and ultimately concluded that Seven Springs should have engaged in its own independent inquiry if it wanted to avail itself of the defense rather than rely on the actions of the closely related former owner.
A case that is similar to Chesapeake is In re Hemingway Transport, Inc. v. Kahn, 174 B.R. 148 (Bkrtcy. D. Mass. 1994), which also involved claims brought under CERCLA. In Hemingway, the contaminated land at issue was purchased by Juniper Development Group (JDG), a general partnership composed of G. Whitten, C. Whitten and A. Whitten (Whittens). Id. at 156. JDG later transferred the property to the Olympia Nominee Trust (the Trust) of which JDG was the sole beneficiary and the Whittens were the trustees. Id. The court found that JDG and the Trust were separate entities. Id. at 172. Both JDG and the Trust, individually, asserted the innocent landowner defense. Id. The court found that because the Whittens had been alerted to the presence of contamination on the property, they as trustees of the Trust were not entitled to assert the innocent landowner defense. Id. However, the court also found that, while the defense was available to JDG, JDG did not satisfy the criteria necessary to avail itself of the defense. Id. at 173-74. In sum, the Hemingway decision suggests that closely related entities must individually engage in their own independent inquiry in order to avail themselves of CERCLA defenses.
Conclusion
While very few courts have addressed the question of the type of environmental due diligence that a party must engage in prior to acquiring property from a related entity, Seven Springs, Chesapeake and Hemingway suggest that closely related entities must each engage in their own due diligence in order to avail themselves of the defenses to CERCLA liability provided in the Brownfields Amendments of 2002.