On October 21, the New Jersey Department of Environmental Protection (NJDEP) published a Proposed Rule that would, among other things, amend the Administrative Requirements for the Remediation of Contaminated Sites, N.J.A.C. 7:26C, to require prospective purchasers of real property conducting pre-closing environmental due diligence to immediately notify the NJDEP and the record owner upon the discovery of a previously unidentified discharge of hazardous substances. If promulgated, the Proposed Rule would mark a momentous shift in reporting obligations—which were previously understood to not extend to prospective purchasers performing environmental diligence—and would add a new level of uncertainty to those operating in New Jersey’s real estate market.
Due diligence is an ordinary part of every real estate transaction. It enables a prospective purchaser to gain critical insights into, among other things, the condition of a property and the potential risks associated with acquiring that property. Under the New Jersey Spill Compensation and Control Act (Spill Act), parties that acquire real property subject to a discharge on or after September 14, 1993, may be shielded from liability for additional cleanup and removal costs if they can satisfy four factors: (1) The entity acquired the property after the discharge occurred, (2) the entity did not know and had no reason to know that any hazardous substances had been discharged at the property, (3) the entity did not discharge the hazardous substances and is not in any way responsible for the discharge, and (4) the entity gave notice to the NJDEP upon actual discovery of the discharge. See N.J.S.A. 58:10-23.11g(d)(2). This is traditionally known as the “innocent purchaser defense,” and it creates an additional incentive for prospective purchasers to perform environmental due diligence sufficient to satisfy the level of investigation required by the second Spill Act factor above. This level of investigation is statutorily defined as “all appropriate inquiry,” which is itself defined to mean “the performance of a preliminary assessment, and site investigation, if the preliminary assessment indicates that a site investigation is necessary.” Ibid.
Prior to the Proposed Rule, it was generally accepted that a prospective purchaser performing due diligence (which can, but not always does, include invasive sampling) need not report the discovery of contamination to either the property owner or any regulatory authority. Additional steps were often taken to guarantee this result in cases where invasive testing is being performed, including contractually limiting the circumstances under which the results of diligence were provided to the current owner and prohibiting the involvement of New Jersey licensed site remediation professionals, which arguably have an ethical obligation to report any discharge to the NJDEP. See N.J.A.C. 7:26I-6.10. But it appears that the NJDEP now seeks to upend that paradigm, with a potential chilling effect on New Jersey real estate transactions.
If the amendments in the Proposed Rule are promulgated, any person conducting pre-closing environmental due diligence who discovers a previously unknown discharge will be required to immediately notify the NJDEP and the record owner of a property. That reporting requirement would extend to, among others, the prospective purchaser and the environmental professionals engaged by the purchaser to perform the diligence. While the prospective purchaser would not be liable for the cleanup and removal costs of the discharge unless and until it acquired the property, the seller would immediately have knowledge of the discharge and that discharge would be reported to the NJDEP (which would open a new case for that discharge). In the end, the seller would be left to take any steps necessary to investigate and remediate the discharge absent the purchaser agreeing to take them on following closing.
The potential chilling effects are obvious. Prospective purchasers want to understand the environmental condition of a property to protect themselves from (or at least understand) potential future liabilities following closing. Sellers have been amenable to allowing that diligence where it does not increase their own liability exposure, i.e., where disclosure of the results of such diligence can remain limited to those parties involved in that potential transaction. By requiring reporting, not just to the owner but also to the NJDEP, the Proposed Rule makes the risk of increased seller exposure almost unavoidable. At a minimum, this will undoubtedly shift negotiating leverage by giving a prospective purchaser power to extract concessions from a seller that will otherwise be stuck remediating a site after the discovery of a new discharge, potentially without any liquidity to cover the cost. In the long term, that increased exposure could, among other things, deter sellers from allowing environmental diligence, which would, in turn, deter prospective purchasers from acquiring property in this state, as they may no longer be able to protect themselves through adequate diligence. As the real estate capital markets struggle to gain traction, a policy like this could slow things down even further.
Regardless of the economic impact, if the Proposed Rule is promulgated, sellers and prospective purchasers in New Jersey must exercise even more caution in carrying out real estate transactions and related diligence.
For more information on environmental due diligence, the Proposed Rule, and the innocent purchaser defense, please contact the authors of this article.
