When Contamination is Discovered Mid-Transaction: Legal Obligations and Smart Next Steps

Environmental due diligence is a key aspect of any commercial real estate transaction. In an ideal scenario, the buyer’s environmental due diligence will confirm (with a reasonable degree of certainty) that there are no contamination issues associated with the property, and this will allow all parties involved to move forward with confidence. Buyers can engage a California environmental attorney to assist with their due diligence—including conducting Phase I and Phase II Environmental Site Assessments (ESAs) as necessary—and they can rely on their legal counsel to ensure that they have the documentation they need.

But what if everything doesn’t go according to plan?

If contamination is discovered mid-transaction, this doesn’t necessarily mean that the deal is over. In fact, in this scenario, buyers (and sellers) may have various options available. With that said, decisions will need to be made, and, ultimately, buyers will need to decide whether moving forward with the transaction still makes sense in light of the newly discovered legal risks and financial considerations involved.

5 Options for Keeping the Deal on Track When Contamination is Discovered Mid-Transaction

To be clear, every situation is unique. Contamination can take many forms and present various risks. As a result, the options that are available in any particular case will depend on the specific circumstances involved. With this in mind, here are five non-exclusive examples of potential options for keeping a deal on track after contamination is discovered mid-transaction:

1. Renegotiating the Purchase Price (or the Property)

One option when contamination is discovered mid-transaction is to renegotiate the purchase price. If the buyer will have to cover the costs of cleaning up and remediating contamination that existed pre-purchase, it may make sense to have the seller cover these costs indirectly through a purchase price reduction.

Another option in this scenario is to renegotiate the property that is being purchased. If, for example, only a portion of the property is contaminated, it may make sense to exclude that portion of the property from the deal (including through legal subdivision, if necessary)—assuming that portion of the property isn’t necessary to achieve the buyer’s business goals.

In either example above, the parties will need to negotiate terms in the purchase and sale agreement that allocate the risk of future liability related to the contamination.  That risk may be retained by the seller (if the property is subdivided) or it may be assigned to the buyer (if there is a reduction in price). In either circumstance, there will be corresponding release and indemnity terms required in the PSA to ensure the future liabilities are clearly memorialized to prevent future litigation.

2. Placing Funds Into Escrow (or Delay Closing)

As an alternative to (or in addition to) reducing the purchase price for the property, the parties could also agree that the seller will place funds into escrow. If required or necessary cleanup and remediation efforts cannot be completed prior to closing, placing an estimate of the necessary funds into escrow can be a way to ensure that they will be available to the buyer when needed.

If the issue is minor and does not require reporting to a regulatory agency or significant remediation, but the buyer requires more certainty, then it may be possible to delay closing so that the parties can fully investigate and agree to a plan for mitigation, if any is required. The overarching point here is that the parties have the opportunity to be creative—and, if they still share a mutual interest in moving forward after discovering contamination mid-transaction, they can (and generally should) find a way to do so.

3. Negotiating Indemnification Rights and Other Contractual Protections

Negotiating indemnification rights and other contractual protections is a common way to shift liability risks between contracting parties. This, too, can be used either as an alternative to, or in conjunction with, the options discussed above.  

4. Establishing Status As a Bona Fide Prospective Purchaser (BFPP)

Buyers can also protect themselves from liability for contamination discovered mid-transaction by establishing their status as a BFPP. If a buyer conducts all appropriate inquiries (AAI) and takes the other steps that are necessary to qualify as a BFPP, it can avoid liability under CERCLA even if it is aware of contamination prior to closing. 

5. Obtaining Pollution Liability Insurance (if Possible)

Obtaining pollution liability insurance may be an option in this scenario as well. Insurers may be willing to provide limited coverage in certain circumstances where there is uncertainty regarding future liability or the extent of liability. Sometimes this will get a deal done – if a seller is unwilling or unable to alleviate all of the risk and if a buyer is anxious about the potential for future liability that remains uncertain, then a PLL policy may be able to bridge that uncertainty gap. This is an option worth considering when you are putting all of the options on the table.

When Is It Time to Walk Away?

While these can all be viable options for dealing with contamination discovered mid-transaction under appropriate circumstances, in some cases, it will make sense to walk away. Of course, this has its own set of legal and financial considerations—including the applicability of relevant contingency clauses, among others. Again, informed decision-making is critical, and prospective buyers should work closely with their legal counsel, lenders, investors, and any other pertinent parties to make sure this is truly the best option under the circumstances at hand.

IMPORTANT: Reporting May Be Necessary

As a final word of caution, it is important to note that when contamination is discovered at a commercial property, the contamination may need to be reported to the federal and state agencies promptly. Failure to report contamination as required can lead to steep penalties, and, if a deal hangs in the balance, these penalties could potentially impact the parties’ decision-making regarding the deal as well.

Request an Appointment with a California Environmental Attorney at Bick Law LLP

Have you discovered contamination mid-transaction during a potential industrial property sale in California? If so, we can help you make informed and strategic decisions, and we invite you to contact us for more information. To speak with an experienced California environmental attorney at Bick Law LLP in confidence as soon as possible, give us a call at 949-432-3500 today.