Due Diligence at Dawn Risky Business: Case Studies and Lessons Learned from Phase I Litigation

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Entering A Written Contract For A Phase I

01.01.2002

Thomas H. Davis Jr.

Facts

Exxon Corporation operated a gasoline station on the relevant property from November 1972 through September 1985, when Globe Oil Company purchased it. Globe Oil subsequently merged with Emro Marketing Company ("Emro"). Underground storage tanks ("USTs") that still contained petroleum remained on the property during the period of ownership by Globe Oil and Emro.

In June 1990, certain "Buyers" contracted to purchase the property from Emro to construct commercial lease space. The contract between Buyers and Emro included a representation by Emro that all of the USTs on the property had been removed.

That same month, Buyers verbally hired an environmental consultant (the "EC") to conduct a Phase I Environmental Site Assessment ("Phase I") of the property. The EC understood the terms of that verbal agreement to be that he would conduct a Phase I in accordance with the guidelines provided by the Federal National Mortgage Association ("Fannie Mae"), since Fannie Mae was financing the Buyers' purchase. Under these guidelines, the EC would conduct an on-site visual inspection of the property, a title search of public records and interviews with past owners to investigate the types of business conducted on the property in the past. Buyers, however, believed that the EC would conduct a more comprehensive Phase I using the then current American Society for Testing and Materials ("ASTM") Phase I standards.

Upon completing his Phase I, the EC issued a report to Buyers stating that the property was not a hazardous waste site and did not warrant Phase II environmental testing of soil and groundwater. The property sale closed in November 1990.

During site preparation by Buyers for the construction of commercial lease space, four USTs were discovered along with petroleum contaminated soil. During the Phase I, the EC was told by Emro, consistent with the contractual representation, that all USTs had been removed. Further, there were no pipes, islands or other visible signs to the contrary. Buyers promptly sued defendants Exxon Corporation, Emro and the EC. Buyers alleged that the EC was negligent for not using the more comprehensive ASTM standards and that, had he done so, he would have located the USTs.

Result

All parties participated in a comprehensive mediated settlement conference. The mediation was successful, and as a part of the settlement, the EC agreed to pay Buyers $22,000, 18% of the settlement total of $124,000.

Lessons Learned

Lesson 1: A written agreement is imperative to clearly identify the scope of services an EC agrees to perform. The written contract should include a clear expression of:

the work to be performed under the agreement;
the work that will not be performed (to the extent possible);
the information to be provided in the Phase I report;
the identity of the beneficiaries of the Phase I report;
a method for resolving contract disputes (e.g. mediation, arbitration, etc.); and
a limited liability provision.

Lesson 2: ECs should carry Errors and Omissions Insurance. Given the significant amount of money that is often spent in reliance on Phase I reports and the cost of defending an EC suit arising from an incorrect report, Errors and Omissions Insurance is essential. The cost of this EC suit exceeded many years of premium payments, not including the settlement payment. A case that goes to trial would cost substantially more.

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01.01.2002