(April 12, 2024) - Wyatt Kendall and Brian Remler of Morris, Manning & Martin LLP discuss how the commercial real estate industry can prepare for transactions involving properties potentially affected by PFAS.

Much has been written about the continued challenges facing the commercial real estate industry at the start of 2024, including high interest rates, imminent debt maturities, and ballooning insurance costs.

But there is another issue looming just as large over the industry this year — the proposed designation of certain per- and polyfluoroalkyl substances, or "PFAS," as hazardous substances under the federal Superfund law, the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA). When this designation occurs, it will touch nearly every commercial estate transaction and wreak havoc on many.

PFAS, also known as "forever chemicals," are a group of man-made chemicals specifically designed for their stable and repellant qualities, which cause them to be highly persistent in the environment. Because of these qualities, a wide range of industries have used PFAS over many decades in a variety of ways, including in clothing/fabrics, cleaning products, non-stick cookware, cosmetics, paints, food packaging, and fire-fighting foam.

For years, PFAS avoided the scrutiny of state and federal regulators, in part due to the difficulty in accurately testing for PFAS and the absence of studies confirming their impact on human health and the environment.

That has all changed, however, as scientific understanding of PFAS has developed rapidly in recent years. Studies now indicate that PFAS are toxic, nearly indestructible, and essentially ubiquitous in the environment because of their widespread historical use. In fact, due to extensive migration via air, surface water, and groundwater, PFAS have even been identified in locations as remote as Antarctica.

Because of these significant findings, state and federal regulators now have PFAS squarely in their crosshairs and have already proposed or enacted new PFAS regulations ranging from manufacturing bans to drinking water standards. However, no proposed regulation is more significant to the commercial real estate industry than the federal EPA's proposed designation of certain PFAS as hazardous substances under CERCLA, which EPA expects to finalize as soon as this month.

A recent multi-billion-dollar class action settlement between PFAS manufacturers and water suppliers illustrates how far-reaching and costly federal regulation of these constituents can be. Although the settlement will provide water suppliers with $10.5 to $12.5 billion, many anticipate this sum will be inadequate to compensate suppliers nationwide for costs needed to comply with newly issued PFAS federal drinking water standards.

This expectation results from PFAS' ubiquity and persistence in the environment, and it acknowledges that many water suppliers will not know the full extent of PFAS impacts until they expand testing and treatment in response to federal regulation.

While EPA's proposal to designate PFAS as CERCLA hazardous substances would bring different consequences, those consequences would be similar in scale and would rock the commercial real estate industry.

A foremost concern is that finalizing a CERCLA designation for certain PFAS would subject property owners to strict, joint and several liability for any of those PFAS identified on or migrating from their property (subject to certain liability defenses). Such an outcome could expose property owners to significant cleanup costs or other liabilities.

Lurking behind these liability concerns, however, is the reality that EPA's proposed designation will create significant transactional risks, thereby complicating and increasing the cost of real estate deals moving forward.

Phase I environmental site assessments (Phase I ESAs) are performed in connection with nearly all commercial property acquisitions, financings, and re-financings. The Phase I ESA standard currently in effect (ASTM E1527-21) provides that PFAS do not fall within the required scope of a Phase I ESA unless they are ultimately listed as "hazardous substances" under CERCLA.

Therefore, if EPA moves forward with the hazardous substance designation for certain PFAS, every Phase I ESA, and in turn nearly every real estate and financing/refinancing transaction, will involve some consideration of PFAS.

The significance of this outcome to the commercial real estate industry cannot be overstated. Existing property owners who previously acquired or financed a property using a prior Phase I ESA that did not identify any issues and did not include an evaluation of PFAS may find themselves in the unfortunate situation of "holding the bag" on a property at which PFAS are now identified as a concern by a buyer's or lender's environmental consultant.

Such an outcome could kill or complicate a transaction, prevent a party from financing/re-financing or selling a property, and/or significantly decrease a property's or a portfolio's underlying value. Of further concern to current owners, there is also potential for sites previously cleaned up and closed to be "re-opened" by regulators to evaluate and, potentially, clean up PFAS.

In terms of future acquisitions, prospective buyers would need to factor potential PFAS impacts into all pre-purchase environmental due diligence activities, likely leading to increased costs, extended due diligence/closing timelines, and extensive negotiations of transactional documents.

If potential PFAS impacts are ultimately confirmed through environmental testing (which is likely given their prevalence in the environment), owners or developers could face significant and costly environmental investigations and cleanups, potential go-forward liabilities, and/or other tenant, investor, and lender headaches.

Developers may also need to factor potential PFAS impacts into underwriting, particularly when planning for soil disposal and construction dewatering required for their development plans.

Some in the commercial real estate industry may think they are immune to PFAS issues simply because of the nature of their real estate or loan portfolio holdings. Such a view would be misguided, however, as PFAS impacts have been confirmed to be expansive and touch nearly every real estate product type, not just large manufacturing facilities. Take for example your standard strip retail center or grocery-anchored shopping center.

The Florida Department of Environmental Protection recently conducted a state-wide study investigating PFAS at drycleaners undergoing state-funded cleanup, including sites at retail centers. PFAS were detected at nearly every dry-cleaning site, likely the result of PFAS leaching from clothing and/or detergents.

Studies have also linked PFAS with many other property types, including car washes and fast-food chains. So while one may think PFAS are only associated with larger manufacturing and industrial properties, PFAS may actually come into play at retail strip centers, shopping centers, car washes, restaurants, and mechanic shops, among many other property types.

Given the significance of EPA's impending designation, those in the industry should not wait to begin evaluating how PFAS might affect their current holdings and future deals. Anticipating PFAS issues will help minimize risks, costs, and general friction for all parties involved in a real estate transaction. This should generally include taking the following steps:

•Discuss PFAS issues before kicking off environmental due diligence: Buyers should determine their consultant's approach to evaluating PFAS risks before embarking on environmental due diligence activities — for example, will potential PFAS presence be considered a Recognized Environmental Condition ("REC") in all circumstances, or will REC determinations be limited to findings indicative of a likely exposure risk or on-site source area? A consultant's familiarity with how state regulators are addressing PFAS may result in a more nuanced discussion of PFAS risks. While these conversations may not be needed as a matter of course for all transactions, they should be had for sites with higher PFAS risks.

•Evaluate potential PFAS risks before testing: Given the ubiquity of PFAS in the environment, property owners should proceed with great care before testing for PFAS as any testing will likely yield PFAS detections, even at properties with minimal historical PFAS usage. If a potential PFAS risk is identified, parties should first research regulatory and other information regarding known regional or offsite PFAS impacts. Performing this additional research on the front end may eliminate the need for or limit the scope of any PFAS sampling.

•Test with an eye toward the end-game: If sampling for PFAS is needed, buyers should first consider their options to address any PFAS impacts that may be detected. They should then structure any testing to maximize utility and minimize the likelihood that follow-up events will be needed. Pertinent considerations include distinguishing potential on-site sources from regional ambient/background concentrations, assessing the most pertinent exposure scenarios, factoring in any state-level requirements or guidance, and tailoring an appropriate suite of constituents to analyze. Buyers may also want to consider testing for types of PFAS that are not currently regulated under CERCLA but may be regulated in the future.

•Take advantage of available liability protections and contract around PFAS: When dealing with PFAS issues, buyers should take extra care to ensure they qualify for the bona fide prospective purchaser liability defense under CERCLA and similar defenses provided by certain state laws. Buyers will also want to ensure that, after closing, they take certain reasonable steps to avoid exacerbating any PFAS issues and jeopardizing their liability protections. Depending on jurisdiction and site-specific factors, enrolling in a state voluntary cleanup/brownfield program to attain formal closure for on-site PFAS impacts may warrant consideration.

•Factor PFAS issues into development plans and budgets: Setting aside potential liability concerns, PFAS should also be factored into a developer's plans and budget. PFAS may come into play in connection with import/export of soils, construction dewatering, and water permitting. Additionally, many landfills have already begun requiring sampling for certain PFAS constituents before accepting materials, and the number of such landfills will likely continue growing as regulation increases. Developers should be prepared for increased soil disposal costs and/or less readily available disposal options. Further, when developers need to import soil for their projects, they may need to consider sampling imported soil for PFAS or obtaining sufficient information to confirm that the soil to be imported is from a "PFAS-free" source.

•Contract around PFAS risks: Finally, given the rapidly changing regulatory environment surrounding PFAS and the sharp rise in PFAS-related lawsuits, parties should consider how potential PFAS risks could be allocated contractually. Depending on the nature of the transaction and potential for PFAS issues, this could include, among other provisions, indemnities, releases, and post-closing cleanup/escrow agreements to mitigate potential exposure to PFAS risks.