Introduction

Many individuals on the business or legal side of transactions involving the transfer of real property understand the primary purposes of performing Phase I environmental due diligence: (1) gain information on the environmental conditions of a property; (2) establish defenses to liability under the Comprehensive Environmental Response, Compensation and Liability Act, or “CERCLA”; (3) secure lending; and (4) obtain insurance.

Most of these individuals also are familiar generally with the CERCLA defenses parties seek to establish by conducting environmental due diligence: (1) Innocent Purchaser Defense; (2) Bona Fide Prospective Purchaser defense (also applies to tenants); (3) Contiguous Property Owner defense; and (4) Lender Liability  defense.1

Notwithstanding this understanding, environmental attorneys often receive the question: What is a REC, anyway? Simply stated, a REC, short for “Recognized Environmental Condition,” is the terminology used by the environmental consultant in its Phase I Report to identify a particular, potential environmental impairment on the property. The impairment may affect the use or value of the property, the ability to obtain financing, and the availability of the purchaser’s defense to CERCLA liability. As such, identifying RECs goes to the heart of why environmental due diligence is being performed.

Types of Recognized Environmental Conditions - RECs

First, let’s try to muddy the environmental waters in which you’ve started to swim by telling you that there are two sets of definitions of “RECs” currently in use. This is because USEPA recognizes two different ASTM due diligence standards as being adequate for establishing CERCLA defenses. For the moment, USEPA allows use of both the 2005 and 2013 standards (ASTM E1527-05, and ASTM E1527-13, respectively). In our experience, while both standards are allowed by USEPA, many consultants now use the new 2013 standard.2

So, for purposes of today’s discussion, let’s look at ASTM E1527- 13, which recognizes three types of RECs: the original REC, “Historical RECs,” and “Controlled RECs.”

Definition of Recognized Environmental Condition

ASTM E1527-13 defines a REC as “the presence or likely presence of any hazardous substances or petroleum products in, on, or at a property: (1) due to any release to the environment; (2) under conditions indicative of a release to the environment; or (3) under conditions that pose a material threat of a future release to the environment.” The definition is very broad, is  used as a “catch all” and is sometimes interpreted differently by different consultants. Some important points to remember are as follows:

  • Central to the definition of a REC is the occurrence of a  “release” whereby hazardous substances or petroleum have  entered on-site or off-site soils or groundwater or some  other media. Naturally occurring chemicals or substances  would not be properly identified as a “REC.”
  • Parties want to be informed about RECs so they can  address them in negotiating a purchase contract; however,  there are additional environmental concerns that are  not necessarily addressed that are not within the scope  of an assessment meeting the requirements of ASTM  E1527, such as asbestos or lead in buildings, adequacy of  existing operational permits, or on-going compliance with  environmental regulations. If the parties want these nonscope items addressed as part of the Phase I, they should  be specifically requested (see discussion below regarding  Business Environmental Risks). Even when so requested, the  consultant may report his findings separately rather than  identifying these non-scope items as RECs. If a condition is  present, but not identified as a REC for any reason, make  sure you don’t ignore it in the Purchase & Sale Agreement.  Neither the risk nor the liability of a condition goes away  merely because it is not a REC.
  • Petroleum contaminants are included in the scope of  conditions that could be RECs, even though petroleum is  not covered by CERCLA, and therefore liabilities associated  with petroleum releases are not protected by CERCLA  defenses.
  • Testing protocols change over time. Underground Storage  Tanks (“USTs”) that were removed in the past may not  have been tested to the degree necessary to satisfy  some consultants. Accordingly, do not be surprised if  the consultant identifies a former UST as a REC, even  though past testing suggests either that the former UST  never leaked, or that the adjacent soils were adequately  remediated. 

Definition of Historical Recognized Environmental Conditions (“HREC”)

The new ASTM Standard defines a Historical Recognized Condition (“HREC”) as “a past release of any hazardous substances or petroleum products that has occurred in connection with the property and has been addressed to the satisfaction of the applicable regulatory authority or meeting unrestricted use criteria established by a regulatory authority, without subjecting the property to any required controls (for example, property use restrictions, activity and use limitations, institutional controls, or engineering controls)”. Within the definition of HREC are several critical phrases:

  1. “has been addressed to the satisfaction of the applicable regulatory   authority;”
  2. “meeting unrestricted use criteria established by a regulatory  authority;”  and
  3. “without subjecting the property to any required controls.”

In practice, what these three points mean are:

  1. A No Further Action (“NFA”) Letter or No Further Remediation (“NFR”) Letter or similar letter (or Administrative Order) has been issued by the state agency, acknowledging the past contamination has been abated to the satisfaction of the applicable state agency;
  2. The property can be used for any lawful purpose, including residential;
  3. There are no related deed restrictions, environmental land use covenants (“ELUCs”), restrictions on groundwater use, prohibitions on excavation, or any requirements for paving, capping, encapsulation, vapor barriers or other physical means of minimizing exposure to contaminants in soil or groundwater.

In summary, HRECs are conditions which occurred or existed in the past, but have been addressed to the satisfaction of the state, and the property can be used as if it were never contaminated (no type of deed restriction or engineered barrier needed). Generally, few environmental risks are associated with HRECs. However, as noted previously regarding former USTs, they may be reported as a HREC even though the test protocols used at the time of removal were more lenient than current technology. In such instance (as well as others), notwithstanding that the state has signed off with an NFR, and the consultant has identified the condition (favorably) as an HREC, there may  be latent or residual contamination associated with former USTs that could impact the transaction.

Definition of Controlled Recognized Environmental Conditions (“CRECs”)

The new 2013 ASTM Standard defines a Controlled Recognized Environmental Condition (“CREC”) as “a recognized environmental condition resulting from a past release of hazardous substances or petroleum products that has been addressed to the satisfaction of the applicable regulatory authority (for example, as evidenced by the issuance of a no further action letter or equivalent, or meeting risk-based criteria established by regulatory authority), with hazardous substances or petroleum products allowed to remain in place subject to the implementation of required controls.”

An example CREC would be a historic leak or spill that has been remediated to something less than “clean,” so that the property may not meet residential or “unrestricted” use criteria. In this case, the “control of the REC” is the engineered barriers or institutional controls (such as a prohibition on use  of groundwater) on which the NFR letter is premised: the use restrictions in place and often recorded in the deed or otherwise memorialized. It should be noted that the identification of a CREC does not imply that the control put in place has been evaluated for effectiveness or adequacy.

Like HRECs, CRECs may have the approval of a state agency. Unlike HRECs, however, CERCs by their nature are associated  with contamination that remains on site. Thus, CRECs may affect development. CRECs may also require some type of ongoing  due care or mitigation to ensure the continued validity of a NFR letter issued by the state when a site has been satisfactorily remediated, and will likely require maintenance and oversight to ensure the Bona Fide Prospective Purchaser defense.

Definition of De Minimis Conditions

Per the ASTM Standard, a de minimis condition is defined as   “a condition that generally does not present a threat to human health or the environment and that generally would not be the subject of an enforcement action if brought to the attention of appropriate governmental agencies.” This can include areas of minor staining or spills below reportable quantities. De minimis conditions are not RECs or CRECs, and generally don’t pose risks that need to be addressed in purchase agreements involving  only real property.

Definition of Business Environmental Risks (“BERs”)

Because the goal of the ASTM standard is to establish the due diligence needed to satisfy a defense to CERCLA liability, it only requires consideration of historic releases of chemicals onto a property. However, as mentioned, there are a host of other potential environmentally related concerns that could exist   with regard to a property. The ASTM standard discusses the limitations on its scope and notes that parties to a transaction may wish to have these non-scope items evaluated as well. The ASTM standard refers to these non-scope items as a Business Environmental Risk (“BER”) defined under the ASTM standard as “a risk which can have a material environmental impact on the business associated with the current or planned use  of [a property].” BERs include issues or conditions such as the presence of asbestos, lead-based paint, radon, mold, wetlands, OSHA issues, regulatory compliance issues, and endangered species or cultural/archaeological issues. These need to be considered on a site-specific basis to determine whether it is desirable to have the environmental consultant include these issues in the scope of work, so that they too will be evaluated  in the course of the Phase I investigation, and addressed in a purchase agreement. For example, in an asset purchase, the buyer typically is interested in knowing whether asbestos is present in buildings being purchased. The buyer may not be interested in the seller’s regulatory compliance if the building will be used for a different purpose. In contrast, if the buyer is purchasing the on-going business, it may be prudent to expand the scope of the environmental site assessment to include a regulatory compliance investigation.

Frequently Asked Questions

Q: So if there are no RECs, HRECs, or CRECs, is the real property  okay?

A: Yes, for purposes of establishing the basis for CERCLA defenses; however, an environmental consultant’s determination that there are no RECs, HRECs or CRECs doesn’t necessarily mean there is no risk at the property, that there are no costs associated with environmental conditions when developing or operating a property, or that a site can be freely developed without consequences. For example, there may still be de minimis conditions or BERs associated with the property. Further, where RECs, HRECs and CRECs are identified they should be addressed in deal negotiations and the purchase agreement/lease.

Q: So if there are RECs, HRECs or CRECs, what do I do?

A: Ask your environmental lawyer. Really.

The identification of a REC, HREC or CREC can affect your transaction in a number of ways:

  • Conditions identified as RECs, or CRECs are not entitled  to the innocent purchaser defense (because, of course, by  virtue of reviewing the Phase I, the purchaser or lender now  has knowledge of them).
  • Conditions identified as RECs, HRECs or CRECs do not  preclude the use of the bona fide prospective purchaser  defense at a site, or the contiguous property owner  defense. However, due diligence only establishes  the defense. To maintain the defense, after property  acquisition, the purchaser must take “due care” regarding  the RECs, HRECs or CRECs, which can include taking  (at the purchaser’s expense) a response action or doing  remediation, performing other mitigation, and complying  with institutional and/or engineering controls.
  • Conditions identified as RECs, HRECs and CRECs should  be specifically addressed in the purchase contract/lease;  consideration must be made as to whether seller will  indemnify for liabilities associated with the conditions,  whether there are ongoing or post-closing costs or  obligations associated with the conditions, whether  conditions should be remedied pre-closing or post-closing,  and how, when, and who should pay for them.
  • Lenders are wary of RECs, HRECs and CRECs, so be  prepared to address them with the lender; lenders usually  require an assessment of the risks these conditions present  to the borrower’s ability to repay a loan, the effect of  conditions on the collateral, and potential liability for the  lender in a foreclosure situation should it need to manage  the property or take steps inconsistent with CERCLA’s  lender protections.
  • Generally insurers won’t insure RECs, HRECs or CRECs  unless the coverage is specifically negotiated, because they  are known, existing conditions.
  • Be mindful of who commissioned the Phase I report  and who prepared it. Two consultants viewing identical  conditions may reach differing conclusions as to whether  a condition is to be identified as a REC, HREC or CREC,  or identified at all. A Phase I Report should be carefully  reviewed by the purchaser and its legal counsel, and should  be considered as only the starting point in evaluating  what conditions need to be addressed in the purchase  agreement.

Conclusion

This primer is intended to assist in understanding the   difference between RECs, HRECs, CRECS, BERs, and de minimis conditions. A Phase I report is the starting point for identifying environmental risks that may bear on a property transaction. Understanding the Phase I conclusions likely will impact the terms of the deal, from purchase price and insurance, to indemnities, escrows and post-closing obligations.