17 Feb 2012

Ordering Environmental Due Diligence

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In Lippy v. Society National Bank, 88 Ohio 3d 33, a 1993 case, the bank had referred a borrower to an environmental consultant to perform an environmental site assessment. The consultant failed to note serious contamination, the borrower suffered damages and the borrower sued the bank for negligence. The borrower prevailed against the bank, in that the appellate court found that the bank breached its fiduciary duty to the borrower. The case raises the issue as to how a lender should obtain a site assessment when the borrower is purchasing property.

There are three common approaches to ordering an environmental assessment when the borrower is purchasing a property. Each has some drawbacks:

1. Allow the borrower to obtain their own environmental assessment. Then the consultant must give reliance to the lender. Unfortunately, the borrower (and in some cases it’s the seller that places the order) often selects the consultant by lowest cost. The site assessment then may be delayed or deficient, the consultant may not be insured, and it is very common for the consultant to limit reliance on the study to the fee charged – which may be a limit of $1,500 when the consultant’s errors may cost the lender hundreds of thousands. In addition, once the borrower produces the report, it is wise to have it reviewed by the lender’s advisor, and the low-cost report now takes longer and costs more than a report by a more reputable company would have cost at the beginning.

2. Some lenders maintain a list of qualified consultants and refer the borrower to the list. In this manner, the lender knows that they should receive a reasonable work product upon which to base their lending decisions. The problem is twofold. One, some bank officer must qualify each company on the list, and stay on top of all substantive changes in that consultant’s company. Failure to note that consultant’s insurance has been dropped, qualifications have changed, or some key person has left the company, all may result in a breach of the fiduciary duty to keep up the list of qualified companies. Second, the thousands of environmental consulting firms will barrage the bank officer with requests to be placed on the list. In addition, must some be minority companies? Must some be woman or veteran owned? Must some be in the locale where the loans are made? This duty becomes onerous.

3. One national bank merely ordered and made the borrower pay for a report for the bank’s sole use. The borrower was not allowed to rely on the report and if the borrower/purchaser wanted the innocent landowner defense, they would have to order a separate (second) report!

The approach we recommend is to give any purchaser a choice – by use of a written acknowledgement form. The borrower/purchaser may order their own site assessment, subject to certain quality conditions; the consultant will give reliance to the lender; and the lender’s consultant must review the report. As an alternative, the borrower may ask the lender to order the site assessment report. If the lender orders the report, the borrower must waive any liability on the part of the lender and acknowledge that if the report is deficient; their sole recourse is against the consultant. The consultant must give full reliance to both borrower and lender.

It is important to note that there are many loans where a borrower is purchasing property but a lender does not require a full Phase I environmental site assessment. In this situation, if the borrower does not obtain a Phase I, the borrower will not have any legal protection against cleanup liability. Yet the borrower will pay for the lender’s limited due diligence and may not be aware that they are not being protected. The lender needs to prevent misunderstanding by giving appropriate notice to the borrower, along with the opportunity to order a full Phase I.

Please contact Yeoman Group if you would like a sample acknowledgment form for your use.

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