Enviro Liability Has a ‘Special’ Place in Real Estate

July 16, 2013Articles Law360

"Reprinted with permission from the July 16, 2013 issue of Law360. Further duplication without permission is prohibited. All rights reserved."

Environmental attorneys involved in real estate transactions have learned, after years of court decisions, that “as is” provisions in real estate purchase contracts do not mean “as is” when it comes to environmental conditions. A recent decision again underscores this. The decision of the New York Supreme Court, Appellate Division in Revell v.Guido is the latest reminder to exercise caution in contracting regarding environmental liabilities.

The appellate court reviewed the sale of property in which a seller filled out a property information statement submitted to him by his real estate agent. The information statement asked for information about a number of things, including the condition of the septic system. The seller wrote “septic system totally new — leach field totally replaced — new 5,000 gallon holding tank.” At the conclusion of the form, the agent had set out that the form was “deemed reliable, but not guaranteed.”

It turns out that the statement on the septic system left out some interesting history.

The seller had several issues with the septic system before the property went on the market. Several years prior to the sale, the seller had been cited by the local government for improper performance of the system. He attempted to “fix” the system by adding additional tanks, but, in 2003, the system was again cited when pools of sanitary sewage were found on the property.

The New York State Department of Environmental Conservation became involved at that time. The DEC and the seller jointly worked out a redesign of the septic system, and the seller and his consultant worked on the final DEC-approved redesign. Unauthorized changes were made by the consultant in that design, and the consultant never certified the new system. The next year, the seller placed the property up for sale.

Two real estate brokers were the new buyers. They were savvy enough to insist on a disclosure statement being provided. They did, however, agree with the seller on an as-is clause in the sale contract. The property was sold as is, but there was a septic test condition, allowing the buyers to test the septic system. That provision stated that if the buyers did not test, they waived the condition. The buyers reviewed the statements in the disclosure, did not test the septic system and closed on the property.

The septic system failed again a month after closing.

The buyers and seller ended up in court. The buyers moved for summary judgment contending that the seller failed to disclose all of the prior issues with the septic tank.

Seller and Buyer Contentions

The seller obviously pointed the court to the provisions of the contract stating that the transaction was an as-is transaction. Indeed, the seller stated, the buyers had an option to test the septic system and had declined to do the testing.

Furthermore, the seller claimed that the disclosure could not be considered as a part of the contract. The contract contained a “merger clause” stating that the purchase agreement incorporated all of the final provisions of the contract and no additional communications could be considered to be part of that contract.

Next, the seller pointed out that the disclosure form contained a general qualification that “all information (was) deemed reliable but not guaranteed.” The seller contended that there was technically nothing wrong with what was stated on the form; there just were some items missing.

Buyers pointed out that it was not just the missing history of septic system problems. In fact, there were other relevant items missing, including a letter from the engineer who designed the new system stating that he had concerns about the system.

Also, buyers contended that the seller actively misled them in the disclosure statement. The buyers contended that when the seller was aware of a long history of failures and compliance issues with governmental authorities, it was misleading and fraudulent not to mention it.

What Did the Court Decide?

The court began by noting that New York follows the rule of caveat emptor in commercial real estate transactions — “buyer beware.” However, that rule does not apply to a seller who fails to disclose information if that failure is tantamount to “active concealment.” A buyer who asserts that it relied on false or concealing statements could assert a claim against the seller.

The court reasoned that the “totally new” statement in the property description was technically false. Many parts of the old system were still in place, like the pump station and two tanks installed in the first attempt to fix the system.

The seller had contended that the system had been replaced twice at great expense to him, and thus, in his opinion, the system was totally new. He contended that when he answered the question, he was only referring to the present state of the system. The court disagreed as it viewed the questionnaire as asking for more than the current state.

The court sent the case back to determine whether the buyers relied on these statements, whether that reliance was reasonable and if the buyers should have ascertained the facts on their own.

Lessons (Re)Learned

This opinion once more reminds us that full disclosure of conditions leads to fewer lawsuits. Recently, we were able to assist a client in obtaining summary judgment in an environmental cleanup case where concealment had been alleged. That institution had foreclosed on a site and arranged for sale.

Prior to its marketing, the institution had performed a soil removal and did not disclose that at all to any potential buyers. After closing, extensive contamination was found on site.

Our client was able to prevail on a motion for summary judgment because there were no provision for disclosures at all, there was no representation given about the condition of the site, and the institution had no knowledge of other problems. Nevertheless, the failure to be transparent and let the buyer know cost the client time, energy and attorneys' fees to get out of the potential liability. Instead, if the institution had just produced reports showing remediation, there would have been no suspicion that the institution knew more and that there were grounds for a lawsuit based on fraud and nondisclosure.

Lesson 1 is not to stop using the time honored in as-is provisions in contracts. Instead, it is to be upfront and transparent in the real estate dealings. It is easier to enforce an as-is clause if everyone knew about the conditions that existed before closing. That way, if someone attempts a lawsuit, there is nothing that makes the transaction look “suspicious.”

Lesson 2 relates to property disclosure laws. Most states have them and require sellers to prepare disclosure statements. In New York, property disclosure laws require disclosure of environmental matters in residential real estate transactions. The only penalty for noncompliance is a credit from seller of $500 to the purchase price.

We are told that some real estate lawyers advise clients to give the $500 credit rather than running the risk of making a material misstatement. The better course is to fully document everything you may know, so people cannot argue that you had something to hide.

Logical (and Possibly Sobering) Extension?

Environmental due diligence has been standard in business transactions for years. Although most commercial deals do not have an environmental disclosure statement, a form of that disclosure exists in most cases.

Parties have used ASTM standards to craft phase I audits involving environmental conditions. Under the ASTM standards, it is normal for consultants to ask sellers to fill out questionnaires as part of the due diligence process to aid in the preparation of the phase I report. This information is frequently attached as an exhibit to the phase I report.

The U.S. Environmental Protection Agency’s “All Appropriate Inquiry” rule provides a defense to the Comprehensive Environmental Response, Compensation and Liability Act environmental liabilities if the purchaser performs ASTM audits prior to purchase. As environmental questionnaires form a part of the foundation of the ASTM information obtained by prospective purchasers, the quality and accuracy of this information could have a direct impact on the purchaser’s ability to succeed in its environmental defense.

Consider what will be reviewed on the remand of the Revel case. Is the information materially misleading, and were the purchasers relying on this information? Apply it to a CERCLA defense case. Will we see the day when phase I questionnaires are reviewed to determine whether or not the purchaser asserting the defense has a reasonable right to rely on the statements in that questionnaire and whether or not the purchaser had to find out the facts on its own?

Sobering, and this serves to again remind us that, in the world of real estate, environmental liability has a “special” place.

"Reprinted with permission from the July 16, 2013 issue of Law360. Further duplication without permission is prohibited. All rights reserved."