The below article was published in the Journal of Building Survey, Appraisal and Valuation Volume 6 Number 4.
Environmental liabilities can have a huge impact on the value of a property and their remediation can come at significant cost. This is not just an issue confined to the due diligence process at acquisition: landlords and tenants of leased property may also find themselves lumbered with expensive and unforeseen dilapidations liabilities, sometimes years down the line. This article sets out a number of case studies, providing examples of real-life scenarios which serve to outline the need for a thorough and pro-active approach.
Building surveyors have long been alert to the presence of invasive species and asbestos – but they need to also be aware of broader contamination issues (albeit at a basic level) and know when the specialist input of an Environmental Consultant is required.
Anne Johnstone is a Partner at Malcolm Hollis based in Glasgow with responsibility at a national level for the Environmental service. Anne has experience in a broad range of environmental specialisms including due diligence, contaminated land investigation and risk assessment, remediation, environmental permitting and ecosystem services assessment. She has also provided expert witness services to clients in relation to contaminated land liabilities. Anne’s clients include top UK pension funds, private equity firms, corporations and public sector bodies. She is a member of the Investment Property Forum and Chair of the UK Environmental Law Association (UKELA).
Why building surveyors need to be aware of environmental issues
If they are not properly defined and understood, environmental liabilities can have a huge impact on the desirability – and therefore, value – of a property. Having an understanding of environmental issues is, therefore, crucially important. Building surveyors need to be aware of the basic issues and to be able to recognise when specialist input from an environmental consultant is needed – essentially, any time you see something on site that you are not sure about. Building surveyors need to be very careful about commenting on environmental liabilities, as their professional indemnity insurance may not cover them for this kind of advice.
Phase I Environmental Assessments
It’s likely that, if a building surveyor has come across the work of an environmental consultant at all, it will usually be in the form of a Phase I Environmental Assessment.
A Phase I Environmental Assessment sets out the environmental consultant’s opinion regarding the level of contamination risk associated with a particular site and identifies other potential environmental liabilities that may need further investigation.
When are they needed?
A Phase I is needed when a site is going through the planning process, either to demonstrate that it is suitable for its intended use with no further assessment, or to form the basis of further phases of work to address unacceptable risks highlighted by the Phase I.
Phase I Assessments are also required during transactions. They can be:
- prepared on behalf of the vendor and provided to potential purchasers; or
- instructed by a purchaser, using their choice of consultant to advise them.
These reports may be appended to deeds of sale and can form the basis of indemnities between the various parties involved in a transaction.
Phase I Assessments– an overview
The typical scope of a Phase I is as follows:
- Desk-based research of the site history through examination of historical maps.
- Search of an environmental database regarding records of pollution incidents, landfills etc.
- Written searches of the local authority Environmental Health department and Planning department.
- Research of the geology and environmental setting through examination of geological maps, hydrogeological maps and other publicly available information such as borehole logs.
- A site visit to review current (and evidence of previous) operations and assess the potential for ground contamination to have occurred (although the client may specifically request a desk-based assessment, i.e. no site inspection).
- Review of previous reports.
Once all of this information has been gathered, the environmental consultant will carry out a systematic evaluation of potential environmental liabilities. There are three basic elements to the assessment approach:
1. Potential for ground contamination or hazardous substances to exist on the site (historical or current);
2. Environmental context (sensitivity to groundwater, rivers, land use etc.); and
3. Assessment of significance – based on a combination of the first two elements and consideration of the client’s requirements, for example where a change of use is proposed.
The general principle is to establish whether there are contaminant linkages between what environment professionals term the source, the pathway and the receptor. Put simply the Source-Pathway-Receptor model identifies:
- Source – where the pollution can come from
- Pathway – how the pollution can travel through the environment
- Receptor – who or what could be affected by the pollution
From there the level of risk to the receptor will be assessed as a result of exposure to the source, or hazard.
It is important to note that the risk ranking in an environmental report refers to contamination risk only, and that other environmental liabilities such as flood risk, invasive species or presence of deleterious materials such as asbestos may be identified. For that reason, surveyors should beware of reporting the risk ranking in isolation in their reports.
Surveyors should also check the report’s caveats. Various high-level, lost-cost options are available in the market which can be useful as tools for things such as an initial screening of a large portfolio. However, if that’s all that is carried out, this can cause problems during negotiations because, although they identify potential risks, they give no indication as to what the significance of those risks are. It is akin to producing a building survey report without including any cost information.
As well as identifying the significance of risks, a good environmental report should both outline problems and – where possible – propose solutions. Ideally the consultant should try to resolve issues as far as possible before finalising the report. If that’s not possible, the consultant should be clear about why their risk ranking is not deemed ‘low’.
Such reasons might include:
- the site has been flagged by the regulators for further inspection or action;
- an issue has been identified that may require a significant amount of money to be spent in order to resolve; or
- contamination is present and although unlikely to manifest itself as a risk, could cause a price chip during a future sale as a result of the buyer’s perception and attitude to risk.
Case Study 1 – City Centre Office
This site comprised a Georgian building with a 1980s extension. It was located in the City of London and was occupied by a retail unit on the ground floor and offices on upper floors. Historical site uses had all been commercial and the site appeared to be low risk in all respects. However, during the site inspection evidence of former underground storage tanks was noted in the basement. Further investigation uncovered important documentation detailing the decommissioning of the tanks (thus removing the ‘source’), which had a combined capacity of 144,000 litres and had been used to store fuel for the building’s back-up generators.
This is a good example of the benefit of comprehensive due diligence and a thorough review of existing documentation. Surveyors should be aware that environmental liabilities can exist even in situations which, on the face of it, seem unlikely.
Case Study 2 – Former Landfill Site
A building survey carried out at a light industrial estate indicated evidence of subsidence. Possible gas vents were also noted during the survey. A review of historical maps indicated that the site had previously been a landfill. Regulatory searches confirmed that gas protection measures were incorporated during construction – therefore breaking the pathway between ground gas in the soil and users of the site. It was therefore possible to conclude that the site was low risk. Without this information, the site would have been ranked as medium or high risk.
This case illustrates the importance of conducting searches and the material effect they can have on the risk ranking.
Flood Risk Assessments
Contaminated land legislation has been around for nearly 20 years. Many clients now feel comfortable in dealing with contamination risk – in that they have a sense of what the scale of the problem might be and can come up with ways of managing it, either by steering clear of brownfield sites, chipping the price or putting indemnities in place. However, flood risk is a much bigger unknown – and, arguably, an increasingly common problem. Flood risk issues can take time to assess fully and can (and do) scupper deals.
There are a number of different types of flood risk:
- risk of flooding from rivers or the sea;
- risk of pluvial or surface water flooding;
- risk of groundwater flooding.
Surveyors should be aware that a Phase I will give only a very basic indication of whether there’s likely to be problem – in which case rapid communication to the client is essential, because further stages of investigation can be protracted and may well involve further, specialist input.
For river/sea/surface water flooding, a hydrologist will be able to do some analysis of publicly-available information on a timescale of a week or so. However, for a proper site-specific risk assessment, a topographic survey is necessary as well as requesting information from the regulatory authorities, which can take up to 6–8 weeks to obtain – hence the need to flag up suspected flood risk issues as soon as possible.
For groundwater flooding, it is very difficult to assess the risk because the available information does not define risk – it just states whether groundwater flooding is possible or not. Therefore, other lines of evidence – such as waterlogging on a site, evidence of water ingress in basements or damp floor joists – need to be considered in light of whether a high water table could be the cause. Waterlogging and dampness of this kind will be readily apparent to a surveyor during the site inspection.
The default assumption surveyors should make is that flood risk may be an issue on any site. The Environment Agency, SEPA and Natural Resources Wales all publish flood maps which can be used to make an initial cursory check.
Dilapidations and environmental issues
Dealing with contamination in dilapidations negotiations is challenging. Even if contamination is present on site it is nevertheless highly unlikely that a statutory breach will exist. The precise wording of a lease is key: many leases, particularly older ones, are silent or ambiguous as regards to contamination liability. New leases should include clear and detailed clauses regarding environmental liabilities. For landlords such clauses should not discharge contamination liability on dilapidations release, whereas tenants should seek to exclude liability for historical contamination.
It is also often difficult to establish exactly when, and where, contamination occurred, and the direct cause, particularly on sites with long industrial histories. The presence of contamination on a site does not always make it unsuitable for use, but the site’s value can be negatively impacted. However, determining the loss in value is problematic.
This uncertainty could be avoided by benchmarking the condition of the site at lease entry otherwise tenants may find it difficult to be released from this liability upon surrender. This would serve to set a standard for clean-up at lease surrender (similar to a Schedule of Condition). Not “clean”, but back to an agreed baseline, whatever that may be. However, to be robust, this requires intrusive investigation, which is unlikely to be commercially acceptable during lease negotiations.
There is also a great deal of environmental regulation with which tenants must comply – particularly during their occupation – such as oil storage regulations and waste regulations. Non-compliance would amount to a breach of covenant but, more often than not, needs to be picked up during the lease in order for the landlord to pursue the tenant to remedy any breach of covenant. This is where interim remedies come into play.
One option available to both landlords and tenants is to conduct audits at regular intervals throughout the duration of the lease. What constitutes a “regular” interval is likely to be determined by the length of the lease and the level of risk associated with the tenant’s activities. Audits provide a paper trail of what has happened at a site; they ensure compliance with statute and encourage best practice. They also provide protection in the event of a pollution incident and reduce the risk of devaluation of an asset.
Standard clauses allowing the landlord the right to re-enter a property in order to carry out repairs (often known as Jervis v Harris clauses) are unlikely to give landlords the right to conduct intrusive investigations whilst a property is let. However, there is no reason why environmental inspections cannot be carried out in the same way as other inspections and there is existing case law supporting this approach both in England and Scotland.
The following examples highlight the importance of monitoring and understanding what is happening on a tenanted site:
Case Study 4 – Abandoned Site
In this case the landlord owned a number of industrial properties, one of which was tenanted by a galvanising company. The company had occupied the site for around 10 years and operated under a permit. The landlord unexpectedly received a letter from the regulator informing them that, as a result of non-payment of fees for the permit, the regulator had inspected the site and found it abandoned. As they could not track down the former tenant, it was their view that the landlord was responsible for clearing the site.
Upon inspection, large quantities of hazardous chemicals were found at the site. The disposal costs were estimated at around £500,000 – costs not covered by the landlord’s insurance and which therefore had to be borne by the landlord in their entirety.
Case Study 5 – Fly-tipping
The “Polluter pays” principle is particularly difficult to apply in the case of fly-tipping, for obvious reasons. Under The Environmental Protection (Duty of Care) Regulations 1991, regulators will consider a landowner (or the person responsible for managing the land) to be liable for the cost of removing fly-tipped waste. On a leased site, responsibility for clearance is likely to come back to the wording in the lease.
In 2014 waste was dumped on vacant commercial land and inside industrial units in a spate of fly-tipping in Essex. Unbeknown to the owners or their agents the culprits cut locks and removed obstacles such as fences and boulders in order to gain access. The owners were subsequently served with notices and ordered to pay tens of thousands of pounds to remove the waste. The regulator warned them to be vigilant and to regularly check vacant land or units for signs of fly-tipping as their liability would continue to lie with them, regardless of already having paid out.
Case Study 6 – Hexavalent Chromium
Hexavalent chromium is a known human carcinogen. Exposure occurs via inhalation, ingesting it in food or water or by direct contact. Hexavalent chromium compounds were widely used in a number of industrial processes including electroplating, stainless steel production, leather tanning and wood preserving. Oxides of chromium were also used as pigments to brighten white paint. Some parts of the UK have a significant legacy of hexavalent chromium contamination from disposal of the waste products from industrial processes to produce chromium compounds.
In this case a tenant carried out works without first notifying the landlord. They excavated a hole in their yard to install a new interceptor, spreading the excavated material across the yard area. When it rained, the puddles turned yellow-green – a clear indication of hexavalent chromium contamination. Due to the acute human health risk the yard had to be isolated and then surfaced in concrete (to break the ‘pathway’), at some considerable expense, for which the tenant was liable.
This case demonstrates that tenants should not carry out work without their landlord’s consent. However, this was a site that hadn’t previously been investigated – so the landlord was none the wiser either. Therefore it is important that no excavation works should commence without first considering what might be disturbed. This is especially relevant on industrial sites where contaminants may be present from previous, but long-forgotten processes. Also, where material is excavated it should be isolated in a stockpile, rather than spread over a large area. Controlling the waste in that way will reduce clean-up costs considerably, where contamination is subsequently identified.
Other types of ‘contamination’
There are other types of “contamination” beyond the presence of hazardous substances in soil or groundwater beneath a site that can represent significant financial liabilities if they are not managed or controlled properly. Asbestos and Japanese Knotweed are prime examples – and ones which a building surveyor should be alert to on-site.
Another specific environmental issue that has a direct connect to the condition of a building is mould. In recent years there has been a growing focus on mould and the potentially damaging effects on health from exposure to spores. In the USA, toxic mould exposure is known as “the new asbestos”. The number of claims in the UK so far is small compared to the US, but those that have proceeded have not been straightforward. The liability has been as likely to fall on the tenant as the landlord given the importance of factors such as how the building is used.
Importantly, providing commentary on mould is not currently part of a standard Phase 1 report. Further, as something that can only be done by someone who has carried out an inspection it is an issue that falls firmly within the remit of the surveyor carrying out a building inspection.
The scale and prominence of the issue in the US means this is something that is likely to come increasingly to the fore in the UK. It will be important for building surveyors to get clarity on whose responsibility this is and the extent they have to provide comment within their own scope of work.
Contamination risks can present real hazards that demand potentially expensive remediation and may have a severely detrimental effect on a site’s value. However, this is not always the case: sometimes a perceived risk is actually far less serious than it might at first seem – and such poor perception can still have serious commercial consequences. This is where an experienced environmental consultant, and a good report which clearly identifies both the risks and their significance, can make a positive difference.