The Phase I Process: A Powerful Pawn in the Environmental Toolbox.
The term "Phase I" is thrown around quite a bit in the environmental industry; most people 'in the know' think they have a fairly good sense of:
What the term actually means;
What it is meant to accomplish;
What protections it provides; and, just as importantly,
What protections it doesn't provide.
But a little knowledge can get you in trouble, especially if what you think you are accomplishing and protecting yourself against in your 'Phase I' process is not manifested in the actual end-product that arrives in your inbox, or lands on your desk.
Think of the Phase I in a business transaction as the pawn in a chess game; overlooked by many and considered inconsequential, but to people who really know how to play the game, a very powerful tool indeed to accomplish your goals.
So, when a Phase I finds its way into your business situation, the question becomes:
Am I doing enough environmental research to make an informed decision;
Am I doing the right environmental research to make that decision; or
Am I allowing too much research by another party that will hurt me in the end?
Before we answer those questions, let's first determine what typically gets you in the Phase I game to begin with.
When does the need for a Phase I actually arise?
There are a variety of potential triggering events for when a Phase I might be ordered by one or more of the parties in a business scenario; some of the more common occurrences are:
Financing Real Estate (typically a purchase or refinance);
Buying or selling real estate;
Lease commencement or termination (typically commercial/industrial);
Securing local approvals for site development/redevelopment;
Quantifying environmental liability associated with pending, or ongoing, litigation or an insurance claim or defense; and/or
Regulatory permit filing, compliance monitoring or rectifying an environmental violation.
Let's assume one of the above bullets puts you in the 'Phase I' game. The next, very important question is: what type of environmental assessment do you actually need? Before we answer that question, let's get a more basic question out of the way.
What tasks actually constitute a Phase I?
By definition, a Phase I is a non-intrusive, first-blush, look/see and records research exercise — it does not include sampling of the soil, groundwater, air or the like — those tasks are associated with what is termed Phase II work —which follows the Phase I process in certain deals, if it makes sense to move onto the next step. However, some Phase I's actually do include limited sample collection, which is antithetical to what I just stated the definition of a Phase I is — hold that thought — more on that discrepancy later. The four basic, qualitative tenets of a Phase I are as follows:
Task No. 1: A Site Inspection, to identify any existing or potential red flags on the subject parcel (both interior and exterior areas) — preferably the inspection is accompanied by an individual with knowledge of the site — if not, many times said individual will complete a Questionnaire, the answers to which would be incorporated into the final report;
Task No. 2: A Review of Regulatory Databases & Records, to identify if the site owners and/or operators are listed as having prior or current environmental permits, violations or regulatory issues of some sort;
Task No. 3: A Review of Historic Site Use, to identify if the site historically was utilized for any purposes that might presently pose an environmental risk (e.g., the site is currently a bank branch, but was formerly the site of a gasoline service station in the 1960's, or a manufacturing plant in the 1920's); and
Task No. 4: A review of Neighboring Site Use, to identify if any adjoining, or proximate, neighboring sites may be adversely impacting the subject parcel — this review is accomplished as part of the three tasks above — namely, when assessing the subject site, you are also assessing whether neighboring sites have the ability to affect the subject site in a negative environmental manner.
In a very general sense, those four tasks encompass what a typical Phase I should include. But the devil lies in the details — what exactly do you do, and how much research do you perform, under each of those four headings?
For instance, under Task No. 2 above, the regulatory database/records search task will depend heavily on how many different databases you actually review (on the local, county, state and federal levels), the search distances for each (i.e., The subject site and all sites adjacent? All sites within a quarter-mile? All sites within one mile?) and whether those searches are strictly online, or if they entail actually sending Open Public Records Act (OPRA) letters to various regulatory bodies, and/or if actual, in-person file reviews at the various agencies are included — each of these tasks can skew the level of research/information culled, and time/cost expended significantly. Also, with respect to Task No. 3 above, regarding historic site use, there are a variety of helpful historic resources that can be tapped (e.g., Historic aerial photographs — dating back to circa-1930, historic fire insurance maps — dating back to the late 1800's, historic city directories — dating back to the early 20th century, historic topographic maps — also dating back to the early 1900's, and the like) — depending on how many resources are secured and ultimately reviewed, the time, cost and value of the data culled can vary significantly.
The same holds true for Task No. 4 above, the more resources that are reviewed regarding neighboring parcels, the more complete picture of overall environmental risk can be secured, but the flip side is the additional cost and time associated with garnering 'more and more data.'
The result can be a bit of a wild west scenario, whereby two Phase I's on the same property, although each includes the four primary tasks above, might not really be comparable at all, simply because of the level of research undertaken under Tasks 1 through 4 above can vary wildly.
And who gets to decide what the right amount of Phase I-related research is good enough? The answer depends on who is ordering, or demanding the Phase I. Is it the bank, or borrower, in a financing deal? The buyer, or seller, in a transaction? The landlord, or tenant, in a lease negotiation? The defendant, or plaintiff, in a litigation? The insurer, or insured, in an insurance claim? Each party has different goals, and may, and usually does, desire a different type and level of research in the Phase I process.
It can get quite messy.
To that end, if you, and your environmental team are on top of your game, and better understand the Phase I pieces and mechanisms than your counterpart, you can move, or attempt to move, the Phase I review process closer to your end game goals than that of the opposing party, whomever they may be. If you take anything away from this article, it should this point — use the Phase I process to achieve your goals to the maximum extent possible, because it can commonly provide the base, or foundation, information and data for subsequent, increasingly complex and expensive environmental decisions moving forward.
General types of Phase I documents.
There are several Phase I formats that summarize the four tasks enumerated above, along with environmental studies that don't quite rise to the level of a Phase I, and others that are a bit more than a Phase I; each is described briefly below.
These are not-quite-considered a Phase I:
These studies are actually not Phase I's, since they do not meet the four criteria for a Phase I above, but nonetheless are commonly used as an alternative to a Phase I, to give the end user a sense of potential environmental risk at a lower price/quicker turnaround than a traditional Phase I. The most common "Non-Phase I's" follow.
Regulatory Database Search: This is essentially just Task No. 2 of the Phase I process. Yet many times, banks, for lesser-sized loans, or less risky end-uses, will forego a full Phase I and simply order a database search to save the borrower loan-related costs. The idea is to identify known red-flag issues quickly and inexpensively.
Technical Peer Review: This is essentially a technical review of a prior Phase I that may be outdated/stale (most Phase I reports are considered stale within 6 to 12 months of issue), or completed by a firm not approved by the end-user for one reason or another.
Environmental Site Inspection: This is essentially just Task No. 1 of the Phase I process — it quickly identifies readily observable environmental risks/red flags at a physical location in a minimal amount of time and at a reduced cost, but it does not address historic use and/or regulatory listings, if any.
Historic Site Review: This is essentially just Task No. 3; many times a Client is comfortable with the current use of the site (say a bank branch location) but suspects the site might have been used for more environmentally challenging purposes in the past (say, a gasoline service station in the 1960's/1970's, or as part of a larger industrial plant 75 years prior) — it is quite common for sites to be developed, razed, redeveloped and razed again, multiple times, especially in urban areas. These long-past uses commonly result in remnant soil and/or groundwater contamination beneath the ground that would never be suspected, based upon current use. These limited historic reviews can sometimes give a quick/inexpensive look/see to determine if any potential red flags lie hidden below the ground.
As you can see, the tasks above are usually parts of a Phase I; if the results are favorable, Clients will either stop there and accept the results, or proceed to a full Phase I, and re-purpose the findings above into the final report.
The following are basic Full-Phase I Studies:
ASTM E1527-13 Phase I: The most comprehensive type of 'full' Phase I is a version that meets what is termed All Appropriate Inquiry (AAI) and satisfies Innocent Purchaser (IP) defenses under federal statutes. Now there are material exceptions and carve-outs to these definitions and it is best to converse with your counsel if trying to meet all AAI/IP protections. But given that caveat, the Phase I typically utilized to meet these criteria is an ASTM E1527-13.
To make sense of what should be included in a standard 'Phase I', enter the American Society for Testing and Materials (ASTM), formally known now as ASTM International. ASTM, founded in 1898, is essentially an international standards organization, which develops and then publishes voluntary consensus technical standards for a wide variety of items and industries (the standards they have compiled number in excess of 12,000). The people at ASTM decided back in 1997 to apply their knowledge and expertise to the environmental Phase I process, adding Phase I's to the 12,000+ standards that ASTM maintains. ASTM does not enforce its standards; however, many governmental bodies, and private companies, owing to ASTM's well-known reputation, reference the applicable ASTM standards in statutes, regulations, policies or guidance documents.
In 1997, ASTM determined what they believed should be included in a standard, comprehensive Phase I; ASTM designated a Phase I meeting this 1997 criteria as an ASTM E1527-97 Phase I. It became the baseline for what a Phase I was. Over the ensuing years, as the environmental industry changed and matured, ASTM amended and upgraded the Phase I requirements several times — in the years 2000, 2005 and 2013. Thus, the current (as of 2020) ASTM Phase I standard is now referenced as an ASTM E1527-13 type Phase I, since the 2013 upgrade is still the most recent version provided by ASTM.
Some federal regulatory agencies, such as the United States Environmental Protection Agency (EPA) have essentially adopted the ASTM E1527-13 to satisfy its 'Phase I' AAI/IP criteria; many banks also use this type of Phase I as their de facto requirement for larger/more complicated deals.
NJDEP Preliminary Assessment (PA): Some states, such as New Jersey, have developed their own version of the Phase I; since many of our clients do work in New Jersey, we'll talk a bit about this. The New Jersey's Department of Environmental Protection (NJDEP) developed a type of Phase I that they term a Preliminary Assessment (PA), which they have determined must be completed to meet AAI/IP criteria. The PA is similar to an ASTM E1527-13 Phase I, but not identical; therefore, if you wanted to meet both NJDEP and EPA criteria for a Phase I, it would have to be a modified/combined Phase I to meet both PA and ASTM E1527-13 criteria. Again, this is both a technical and legal issue to discuss with your counsel and environmental consultant for any particular project on your plate.
Other Phase I Types — All the Rest: There are a slew of alternate Phase I documents on the market that include all four of the primary criteria, but do not necessarily go to the length of research under Task Nos. 2, 3, and 4 above to fully satisfy the AAI/IP criteria. These Phase I's are still comprehensive in breadth and will usually identify the same 'red flags' the more comprehensive Phase I's do, but accomplish same at a quicker turnaround and lesser price. For this reason, many banks like to use these reports, since it will allow them to make an informed environmental decision, but save their borrowers some transactional fees. Many times, these less comprehensive, albeit full Phase I’s can be upgraded to PA and/or ASTM E1527-13 Phase I reports simply for the differential in price. However, it is important to understand that fully compliant IP-type Phase I reports only protect the party relying on the report for environmental issues the Phase I process didn't find, not for the issues that are found and identified in the report. This is a common misconception among parties relying on a Phase I. This important fact can be discussed in greater detail with our firm and your chosen counsel, if need be.
These are a bit more than a Phase I — they include some limited testing/Phase II tasks:
As stated above, a Phase I does not include any intrusive testing, unless it does. Some Phase I's (especially by certain banks and more sophisticated Buyers) will morph some limited Phase II-types sampling/assessment tasks into the Phase I process, usually to get quicker answers on risk issues that are surely going to be detailed in the Phase I, and to save some money re-mobilizing to the site more than once.
Some typical Phase II-related tasks that are commonly bundled with the Phase I process are:
Ground penetrating radar (GPR) or magnetometer sweeps, looking for potential underground storage tanks (USTs), septic systems or other buried appurtenances;
UST precision testing (if one or more known tanks exist onsite)
Potable well testing (if an onsite well is used for drinking or other purposes);
Septic system suitability testing (if a subsurface septic disposal system is utilized onsite);
Bulk building material testing for asbestos containing material (ACM);
Lead based paint (LBP) chip sampling;
Mold assessments;
Wetland and/or flood hazard assessments;
Radon testing;
Indoor vapor intrusion (VI}-related volatile organic (VO) testing (both inside buildings, and sub-slab, if suspected); and the like.
Who gets to decide what type of Phase I is undertaken?
Usually the person requiring you to undertake the Phase I gets to choose the type of Phase I you will be performing. And the options run the gamut. Below is a basic primer.
Banks.
When making loans, typically banks will want to ensure the underlying real estate asset upon which the loan is largely secured is worth what the appraisal says it's worth.
Since most appraisals have a caveat stating their valuation assumes no environmental set-offs/liabilities, the bank will need to determine if there is, in fact, a liability associated with environmental issues that must be taken into account (i.e., deducted from the valuation). The Phase I is the first step in that environmental liability assessment process. Depending upon what the Phase I reveals, the bank may reject or modify the requested loan terms, require some additional Phase I-related work, implement targeted Phase II sampling work, establish an environmental escrow for post-closing tasks (see our May newsletter for an accompanying article on bank escrows) or some combination thereof.
Financial institutions typically have an internal policy dictating what type of Phase I is required for each type of loan; some bank policies are basic, other are quite detailed. Usually the type of Phase I the bank requests is based upon the size (dollar amount) of the loan and the use of the property (e.g., office building, day care, gasoline service station, dry cleaner, apartment building, etc.). To that end, the bank may have Phase I requirements that range from the most comprehensive, exhaustive studies, to abbreviated versions. Many banks even have environmental reviews (for smaller and/or less environmentally risky loans) that are somewhat less than a full Phase I — namely, a regulatory database review (i.e, Task No. 2 above), to give a rudimentary sense of environmental risk.
Also, many banks have an approved list of environmental consultants (similar to approved appraisers), whereby they will only accept an environmental report from one of their approved firms on the list. At times, if you already have a Phase I in hand, these banks will accept a report from a non-approved firm, but in that instance, it would typically be peer reviewed by a bank-approved firm, at an added cost. Sometimes this makes economic sense; sometimes not.
Buyers & Sellers.
Owners performing Phase I's prior to listing a property for sale is not as common, but is undertaken by parties desiring to identify potential 'red flags' before putting their property up for sale. They will conduct a preemptive Phase I to determine what might come up in a Buyer's Phase I report. Then the Seller has time to strategize with their counsel, broker and environmental consultant to make easy fixes and how best to address more complicated environmental issues, if same exist. It can be a smart strategy, and allows a Seller to get ahead of the environmental curve. The balancing act in doing this preemptive work is not to find and create an environmental problem for the owner that might not have been found otherwise...sometimes this is easier said than done.
Buyer’s Phase I work is commonly dictated by the bank they choose for financing; however, if it is a cash deal, the Buyer can determine what level of due diligence will best meet their appetite for environmental risk. This is usually a discussion with counsel and the consultant to weigh/address environmental pros and cons of the various levels of due diligence.
Tenants & Landlords.
Phase I's are commonly used by landlords and tenants to establish 'baseline' conditions upon entering into a lease; this will assist in clearly spelling out the existing environmental risks in place prior to tenant operations — to apportion liability should issues arise during the tenancy. It also can be used as a gauge when compared to a lease termination audit — again, to apportion costs should any environmental risks have occurred due to the tenant’s operation (or conversely, to prove they were not due to the tenant's operations). Many times (and preferably, to lessen disputes), these pre- and post-lease Phase I audits (terms, conditions, costs) are memorialized in the formal lease agreement.
Regulatory.
Due to certain regulatory statutes, mandatory Phase I audits are required when property is sold, bankruptcy is declared a lease terminates (this is especially true in New Jersey) or an environmental violation exists/regional contamination is discovered (and source(s) are being identified). Usually the regulatory agency will dictate the nature and type of Phase I assessment (usually under a different name - in New Jersey this Phase I document is called a Preliminary Assessment, or PA, as discussed earlier).
Litigation & Insurance Claims.
In litigation matters, either defendants or plaintiffs will commonly conduct a Phase I as an early step in determining potential culpability for a contamination issue that is subject to dispute; typically, in this setting, the extent of the Phase I scope is usually on the comprehensive end of the spectrum. It can also be used by insurers or insureds as a first-step/baseline setup to quantify/assign responsibility in insurance policy claims and coverage disputes.
Development Approvals.
During site development/redevelopment, the governing body may require an environmental assessment of the parcel. Many times, this document takes the form of an Environmental Impact Statement (EIS), which is not really analogous to a Phase I; it focuses on the environmental effects of a planned use, versus identifying existing environmental risks/liabilities. However, a Phase I is usually undertaken for project financing purposes, and many clients attempt to use, or re-purpose/modify the Phase I into an EIS, to save costs. Less sophisticated towns/counties/agencies are sometimes more amenable to accepting a Phase I in the stead of an EIS, but they really are different documents, used for different purposes (although there is an overlap in information in each type of report).
Essentially, once you determine the universe you are in, you can best strategize with counsel and your consultant on the type of Phase I and the depth of research needed to satisfy the parties to the transaction.
In Summary.
The Phase I process is usually the first step in determining environmental risk. And as can be seen from the summary above, a relatively simple Phase I process is not always so simple, and you may have the ability to mold and manipulate the contents of the document to best suit your end-goals.
If you’d like to discuss any of the items described above in greater detail, or wish to tailor a Phase I to your particular needs or business situation, contact Glenn Brukardt at glenn.eikon@gmail.com or 908-813-2323, ext. 36.
In many cases, it is much easier to make changes at the beginning of the environmental process, than trying to turn the train after it has left the station.