The Why and How of Environmental Risk

By John Berteau, Associate General Counsel

For banks, environmental risk management addresses concerns about the present by looking into the past and gazing into the future. A good environmental risk policy looks to the past to identify existing environmental liabilities before making loans secured by commercial real estate—to prevent either the bank or the borrower being held liable for cleaning up someone else’s environmental mess.[1] This same policy will also evaluate onsite operations to determine potential future liability and weigh the potential risk for the bank. Practically speaking, much of environmental risk for banks involves assigning liability with regards to the two main pieces of environmental legislation: RCRA and CERCLA.

Pronounced “WRECK-ruh” (RCRA), the Resource Conservation and Recovery Act addresses the disposal of hazardous waste, and the regulation of Underground Storage Tanks (USTs). USTs are most often used to store gasoline and diesel at filling stations, and are frequent sources of environmental contamination. Although established by federal law, state agencies regulate UST activity, including the cleanup of environmental contamination. RCRA contains no liability protections, so when making loans on UST sites, banks often require indemnification from sellers for any past environmental contamination discovered onsite after the transaction.

Pronounced “SIR-kla” (CERCLA), the Comprehensive Environmental Response, Compensation and Liability Act, authorizes actions in response to environmental contamination. In CERCLA terms, contamination includes things like paints, pesticides, and chemicals. Generally, the businesses most likely to be CERCLA concerns are dry cleaners, auto repair shops and manufacturers. Luckily for banks and borrowers, CERCLA contains liability protections provided that the borrower conducted “all appropriate inquiries.”

“All appropriate inquiries,” is an EPA standard used to evaluate a property’s environmental condition and assessing potential liability for any contamination. The standards by which environmental assessments are conducted are published by ASTM International, and a borrower generally conducts “all appropriate inquiries” by having an ASTM E1527 Phase I Environmental Site Assessment conducted on their property.

For most banks, this is where having a structured environmental policy fits in, because Phase I ESAs are expensive and are not required by federal regulation or state law. In 2006 the FDIC indicated in an Institutional Letter that banks should maintain an environmental risk program in order to screen potential collateral properties for environmental contamination, but this is to protect the safety and soundness of the bank’s collateral. The FDIC guidance addresses environmental risk management in very general terms and leaves it up to banks to come up with specific policy requirements based on each bank’s own appetite for risk. For many loans, particularly those of a lower dollar amount or on certain property types, banks do not require Phase I ESAs and evaluate environmental risk onsite using other methods.

A good first step in evaluating environmental risk is completing first portion of the ASTM E1528 Transaction Screen Questionnaire (TSQ). The instructions on the TSQ indicate in several places that the E1528 does not comply with “all appropriate inquiries,” so this is not used for protection from CERCLA liability, it is used to determine if the risk onsite for environmental concerns is low enough to proceed with the loan without conducting more due diligence onsite.  The first portion of the TSQ is generally filled out by the borrower and the lender while visiting the property being screened. The TSQ contains roughly 40 questions such as “is the property used for an industrial use?” and “are there currently and pits, ponds or lagoons located on the property?” which help to identify any potential environmental concerns onsite.

The second component of the TSQ is done after reviewing standard environmental databases maintained by federal, state, and tribal offices. The databases contain information about the subject property and properties within a one-mile radius of the subject property. Properties that have been identified as having environmental contamination will be listed in these databases, as will properties that are registered with the state (such as UST sites and hazardous waste generators) that have not reported any contamination. This helps to identify past environmental concerns offsite that might not be obvious given the present status of the site, as well as concerns related to surrounding properties. The second component of the TSQ which requires a review of databases is often split from the first component of the TSQ, and is considered a second or “higher” level of environmental due diligence.

If a TSQ and/or database review indicates potential environmental concerns, the next step is generally to have a Phase I ESA conducted onsite by an environmental professional. A Phase I ESA includes a physical inspection of the site, interviews with the property owner and other appropriate individuals, a review of standard environmental databases maintained by federal, state and tribal offices within one mile of the subject property, and a history of the property back to 1940 or first developed use. A Phase I ESA includes a wealth of information on the property and usually includes a site map, site photographs, aerial photographs, historic Sanborn fire insurance maps, and a flood zone map. The typical cost of a Phase I ESA starts around $2,000 and a typical turnaround time is 2-4 weeks.

Should your Phase I ESA reveal suspected environmental contamination onsite, the ESA may recommend Phase II testing. A “Phase II” is a custom-tailored environmental site assessment that includes laboratory testing of samples of soil and/or groundwater taken from the property.  The scope of a Phase II is determined by the findings and recommendations of a Phase I ESA.  The costs of Phase II testing vary greatly, but are commonly between $1,000 and $10,000. A typical turnaround time on Phase II Soil and Groundwater testing is 2-3 weeks.

Should your Phase II testing reveal environmental contamination above acceptable limits, “Phase III” remediation will likely be required. A Phase III is a remediation plan generally created by an environmental professional and approved by a federal or state governmental agency (depending on the type of contamination). The costs associated with Phase II remediation ranges from tens of thousands to millions of dollars, and the length of time required for Phase III remediation is determined by the extent of the contamination onsite. Remediation projects may range from months to years.

[1]Environmental risk polices often exempt 1-4 family residential properties from environmental screening because of the low risk.


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