If your institution does commercial real estate lending like mortgage services, the Phase I environmental site assessment (ESA) is a critical element of your overall risk management program. The Phase I typically involves a review of property records, a site inspection, and interviews with current owners and occupants, as well as local government officials and nearby property owners.
Soil sampling may or may not be part of this due diligence phase, but you should still retain a qualified and experienced environmental professional to perform the Phase I. Environmental professionals are subject to rigorous industry risk management standards, and are experienced in spotting red flags, such as past contamination either onsite or at adjacent or nearby properties that may warrant additional scrutiny.
Not sure if the proper use of a Phase I ESA is a critical piece of your CRE lending due diligence? One recent high-profile case highlights why it should be. The owners of a commercial property applied for a multi-million-dollar mortgage. After conducting its normal due diligence, the lender approved the loan and disbursed the funds.
However, shortly after closing the EPA investigated the site, and radioactive readings were discovered. Ultimately, the EPA determined the property had legacy radioactive contamination due to an adjacent property’s prior use as a hazardous waste dumping site. The agency demanded cleanup, and the borrower ended up defaulting on its loan due to the expense.
Although the bank had retained an environmental consulting firm to conduct a Phase I ESA as part of its normal due diligence, the firm’s review failed to uncover the historical record of the adjacent property, and also missed the fact that the subject property was once part of a larger parcel that included the contaminated property. When the borrower defaulted on the loan, the lender sued the consulting firm for malpractice. Unfortunately for the bank, the court threw out the lawsuit due to a three-year statute of limitations. (For a deep dive into the specifics of this case, check out Schnapf Environmental Law’s excellent discussion.)
Bottom line, when properly utilized the Phase I is a crucial tool for uncovering potential environmental risks, such as property contamination. Here are some tips for getting the most out of your Phase I:
While mistakes can always happen, a more thorough review of the property may have meant the difference between taking a pass on a risky CRE loan, and absorbing millions in loan losses.