When you are selling a business, a buyer will typically require a Phase 1 Environmental Report as part of their due diligence process. This is a pretty standard process if you are either selling the real estate along with your business, or leasing the real estate to the buyer.
What is a Phase 1 Environmental Report?
The assessment will usually be conducted in two ways:
- By visiting the site and conducting interviews; and
- By conducting a review of external documents with various agencies.
The assessor is looking for two distinct types of potential environmental risk:
- Risk of potential contamination from onsite land use; and
- Risk of contamination that may be caused from offsite sources such as adjacent property, utilities, or underground pipelines, wells, etc.
The buyer requires a Phase 1 environmental report primarily to support the deal's financing requirements since the real estate would be used as security for the financing. This is typically a non-issue for you, the seller, unless there are major problems with the site — i.e., asbestos, oil leaks, PCPs. If there are problems, the buyer may order a Phase 2 report, back out of the deal completely or most likely look for a haircut on the purchase price to "allow for the correction of the issues identified."
You can manage the Phase 1 by attending the site visits and by identifying issues beforehand so you can craft a risk mitigation plan. This will save you a few dollars if there are actually any problems. Also, remember that the buyer will most certainly look for seller indemnifications in the purchase and sale agreement against any previous environmental liabilities, so you are going to carry this risk anyways. Therefore, why get a haircut on the purchase price? The use of a Phase 1 is often used by some buyers as a technique to drive the purchase price down, so beware.
The Onsite Visit
The assessor will first conduct an onsite visit and staff interviews. The point to this visit is to:
- Identify any above and below ground storage tanks to see if there is potential for leaks — even if there are no leaks present, this is an almost automatic low to moderate risk identified as there is always the potential for leaks.
- Vegetation review, ponding of water and general erosion — if the vegetation around the site is looking a bit sad or there is erosion around it, the assessor will likely note as an area to follow-up.
- Existence of asbestos, polychlorinated biphenyls (PCBs) which could come from leaks in electrical transformers for example, mold, ozone depleting substances (ODS), lead, urea formaldehyde foam insulation (UFFIs), etc. All of these are pretty nasty contaminants which likely would trigger an immediate Phase 2. The good news is that if the building was constructed after 1982, the chances of finding any of these nasties decreases considerably. If you are aware of them, have a containment and mitigation plan already in place before the Phase 1 occurs. Don’t assume the Phase 1 won’t find or identify this — it will, it’s part of the checklist.
- Existence of any chemical storage — again this is an automatic low to moderate risk, even if there are no leaks evident. Be ready to show that you have secondary containment in place.
- Existence of transformers, piping, air conditioning, elevators or other mechanisms that may leak any contaminant fluids
The Offsite Review
For the off-site review, the assessor will likely conduct a number of regulatory enquiries to assess if there is exposure to contamination from other sources by reviewing the following:
- If there are above or below ground tanks, then the relevant Tank Management Association may be contacted to ensure these are registered.
- The federal or state energy board will be contacted to determine if there are any oil or gas wells or pipelines within the general proximity of the site that may represent a contamination risk.
- The city or town health services board may also be contacted to see if there are any outstanding complaints or orders against the owners of the real estate regarding any contamination.
- Aerial photographs going back a few decades may be ordered to see if the site had any previous land uses that are subject to potential contamination (think gas stations 40 years ago).
Don't Be Alarmed if a Buyer Requests One — It's Par for the Course
When you are preparing your business for sale, especially if you intend to package the real estate in the transaction, don’t be surprised if a Phase 1 Environmental Report is commissioned. It is almost a given that it will, so don’t panic. The key is to be prepared and conduct your own process prior to the assessor visiting the site.
Identify as many of the potential issues noted above as you can beforehand and put a plan in place to solve the problem(s). This goes a long way to giving you some bargaining leverage with the buyer in the event the Phase 1 Environmental Report is used as ammunition to drive a haircut in the purchase price.