Agency File Reviews for CRE Lenders – Are They Part of Your Phase I ESAs?

An “agency file review” is a common industry term describing a search and review of files maintained by a local, state, or federal regulatory agency for properties within its jurisdiction. Agency files usually contain information about remediation efforts, current property status, details on soil and groundwater contamination, correspondence with regulators, no further action (NFA) letters, and other types of background documentation on a property. For commercial real estate lenders, agency file reviews are an important part of the Phase I ESA process for loans on commercial properties, as they can fill in the gaps from other components of the investigation. Communicating with your environmental consultants will help you determine whether or not agency file reviews are included in your Phase I scope and when they should be.

ASTM Clarification of Agency File Review Language

The American Society for Testing and Materials (ASTM) is an international leader in the development and delivery of voluntary consensus standards. The ASTM E1527-05 Standard Practice for Environmental Site Assessments: Phase I ESA Process outlines the guidance for conducting an environmental site assessment on a commercial property with respect to the range of contaminants within the scope of Comprehensive Environmental Response, Compensation and Liability Act (CERCLA).

For the next revision to the standard, the ASTM subcommittee of the Phase I Task Group on Agency File Reviews has drafted proposed revisions to clarify when file reviews should be conducted and to provide guidance for environmental consultants in exercising professional judgment and making decisions about whether agency files are reasonably ascertainable. This language is currently nearing the end of the balloting process along with other proposed revisions to E 1527-05.

Although, in general, agency records are commonly reviewed as part of environmental due diligence, there is widespread variability on exactly when they are done. Factors such as the distance to regulatory offices, the ease of file access and review, and the associated costs can impact the decision on whether to include the review in the Phase I investigation or to conduct it as a follow-on, and separately priced, investigation. Under the new revisions, the environmental professional is asked to document and comment on the significance of those limitations, if the file review is not conducted. The revised language also allows consultants to review files and other records from an alternative source (e.g., interviews with regulatory officials, on-site records, and records maintained online). Consultants must include their opinion on the sufficiency of the information that was obtained from the alternative source in their report if they go that route.

EDR conducted a survey in January 2012 in support of the ASTM E 1527 subcommittee of the Phase I Task Group on Agency File Reviews to determine the state of industry practice of environmental professionals who visit agency offices to review files as part of a Phase I ESA investigation. The findings indicate that 32% of the time EPs “always” visit agency offices to conduct file reviews as part of their Phase I, 28% visit “very often,” 33% visit “occasionally” and 7% “rarely”.
As a lender, it is important to be clear as to whether or not your Phase I scope will include a file review. The ASTM clarification of the file review language will likely evoke better communication between the lender and their environmental consultant about the inclusion of agency file reviews as part of the Phase I process moving forward.

Importance of Agency File Reviews

The results of the survey suggest that, in general, environmental professionals do see value in completing an agency file review as part of the Phase I or in a follow-on investigation on the target or adjoining properties, assuming these properties have issues that could impact a loan. Agency file reviews cover items that may have been missed or have slipped through the cracks on a Phase I ESA, adding that much more protection to the financial institution that is extending a loan on a commercial property. These agency files can offer a deeper level of investigation of a property, usually beyond the detail provided by a database.

The survey results also revealed wide variance in both the pricing practices for agency file reviews and the level of effort involved. Environmental consultants reported that pricing for file reviews is generally included in the fixed cost of a Phase I ESA 55% of the time. Given the variability in the frequency with which agency file reviews are conducted, it is important that lenders get in front of their consultants and ask if file reviews are being completed as part of the Phase I scope of work. Concerning turnaround time, agency file reviews will sometimes add time to the delivery of the Phase I report, depending on various outside factors (mentioned below).

According to Michael Tartanella, Environmental Risk Manager – VP at Capital One Bank:

“We do not want to extend our due diligence time frame from our standard 2-3 weeks to the 4-6 weeks that some file reviews may require. We look at agency file reviews as separate, post-Phase I endeavors. We feel the “reasonably ascertainable” aspect of the Phase I industry is a pillar, especially for banks. We require our standard due diligence to be completed in this reasonably ascertainable time frame (15-20 days) because all of our internal pre-closing time frames and milestones are based on this basic aspect of the industry. We don’t believe that a Phase I was ever meant to be an all-exhaustive, all-inclusive document but rather constitutes “all appropriate inquiry into the previous ownership and uses of the property consistent with good commercial or customary practice”.

While there are a few factors affecting turnaround time, such as the physical location of state agencies, availability of information, and ease of accessibility, the ASTM clarification to the standard for performing agency file reviews in a Phase I should help take the burden off of consultants and allow them to better conduct file reviews in a timely manner. The inclusion of language supporting consultants to use other sources besides state agencies and to provide opinions on the necessity of file reviews will only help compress the turnaround time on Phase I ESA with file reviews for lenders moving forward.

EDR Insight reached out to three industry experts, two commercial lenders and one environmental consultant, to determine the perceived value of agency file reviews and the overall awareness is of the agency file review process.

Concerning whether consultants routinely do file reviews for their lender clients, Holly Neber, President of AEI Consultants, stated “We provide agency file reviews within our standard Phase I ESAs for our lender clients because we feel that a review of agency files is necessary to fully evaluate and identify potential environmental concerns”. According to Neber, lenders with internal or outsourced environmental risk management teams tend to be more aware of the importance of agency file reviews as part of their standard scope of work than those without specific environmental risk management groups within their institutions. Neber also mentioned that AEI finds that lender clients appreciate being notified up front “when an area has unusually long turnaround times to access file information, such as sites in Illinois or Southern California”.

Weighing in from a lender perspective, Tartanella believes that agency file reviews are an extremely valuable part of the due diligence process at his institution. “We have realized tremendous value from many agency file reviews. In many scenarios, we have been able to address our concerns about recognized environmental conditions (RECs) with the information that was obtained via the file review. In other scenarios, we realized that the issue was not resolved and required a further investigation via a Phase II ESA”, says Tartanella. According to Mary Schulz, Vice President of Environmental Risk at GE Capital Franchise Finance, “File reviews are a key component to our environmental due diligence process.” Though Schulz mentions that agency file reviews are clearly not appropriate in all circumstances (e.g., when a use of concern predates regulatory programs, then pursuing a file review is not feasible), she has found that “they resolve approximately 50% or more of issues that arise due to adjacent or nearby uses that occurred during the regulatory period and that have the potential to impact the subject property.” According to Tartanella, separate agency file reviews are not part of his institution’s standard Phase I scope of work, however, he believes that if the Phase I “has detailed a potential REC or issue that requires further investigation, then a separate and distinct additional investigation (file review) is appropriate”. If a file review is appropriate, Tartanella says that the “deal clock essentially stops or is extended” while investigation of the issue ensues. However, in that situation, “all parties involved recognize the need for the additional due diligence (and associated time) based on the results of the Phase I,” stated Tartanella. To Schulz’s and Tartanella’s point, lenders need to make sure they are communicating with environmental professionals so they are able to understand why file reviews may not be appropriate in all situations.

Questions Lenders Should Ask Their EPs

Since the draft agency file review language uses the word “should” (as opposed to “shall”) in directing environmental professionals to consider a file review, the environmental consultant has the flexibility to exercise professional judgment as to whether a review is necessary. Opening a dialogue with environmental professionals is key to understanding the need for a file review when working on a loan for a commercial property. There are various questions that lenders should ask consultants up front about whether or not they are conducting file reviews (and about the justification if not completing one), whether or not pricing and turnaround time for the Phase I will be affected, and if they are aware of the new ASTM language revisions that affect the Phase I ESA scope. Based on the draft language discussed above, EPs must document the justification for not conducting a regulatory file review and provide a statement as to the sufficiency of information if an alternative source is reviewed, rather than reviewing the actual file. “A review of agency files is not always necessary based on the nature of site use, but in the cases where it is critical to the findings of a Phase I, lenders need a heads-up at the beginning of the due diligence process”, says Neber.

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Given that agency file reviews are not routinely conducted by all environmental professionals on every Phase I ESA, it is up to those at financial institutions to ensure they’re protecting themselves and their institution by understanding the importance of file reviews as a supplement to the Phase I process, and communicate clearly with environmental consultants to ensure that the scope is mutually understood. Though Tartanella believes the completed Phase I should dictate the necessity of a further investigation (file review), others believe it should automatically be part of the scope of a Phase I. While the debate continues, lenders should continue to educate themselves on the importance of agency file reviews, ask questions of their associated EPs, and determine whether or not they believe that file reviews are necessary for a particular target property.

NOTE TO READERS:
EDR Insight wishes to thank Pat Coyne for providing peer review of this Technical Brief, as well as Holly Neber, President of AEI Consultants, Michael T. Tartanella, Environmental Risk Manager – VP at Capital One Bank, and Mary E. Schulz Vice President—Environmental Risk at GE Capital Franchise Finance, for their valuable contributions.