For sale: environmental due diligence pays off for retailers.

Many retailers are finding sale/ leasebacks to be a good strategy for freeing up capital while ensuring the long-term use of property.

Both owned and ground-leased properties may be eligible for sale/ leaseback, even before construction is complete, and properties may be sold individually or combined in a portfolio and structured as either a private placement or a 144A public offering.

The key to ensuring that a property's environmental condition will pass muster in a sale/leaseback is both to conduct appropriate due diligence during the acquisition process and to assemble the necessary documentation following acquisition.

In connection with a sale/leaseback, the environmental condition of a property will be scrutinized by the purchaser and lender and, in a 144A transaction, by the Wall Street rating agencies. Increasingly, lenders are requiring borrowers to adhere to the new ASTM Phase I due diligence standard, ASTM E1527-05.

While this standard was developed to provide the basis for certain liability protections under the federal superfund law, it also formalized a more rigorous environmental assessment than might have been conducted under the previous standard.

Retailers anticipating a future sale/ leaseback should consider meeting this standard at the time of acquisition to avoid the costs and potential risks of having to fill in gaps in the environmental report later.

Conducting a thorough environmental assessment of the property is only half the battle in developing environmental information for purchase and subsequent sale/leaseback.

Once environmental issues have been identified, the next step is to quantify costs, determine the timeframe to complete remediation, and plan the sequencing of the remediation with construction.

The subsequent buyer and its lender must have comfort that regulatory closure is achievable within a reasonable period of time, that the project can be developed and operations continue without interference, and that there are no health risks or other liability for which an owner or foreclosing lender could be responsible in the event of default by the tenant in sale/leaseback.

Where contamination is believed to exist but presumed not to be extensive, often a retailer or its developer will budget money for cleanup rather than conducting subsurface testing to better quantify the extent of the contamination.

It is important then to document that the contamination was addressed during construction and in compliance with any reporting and regulatory closure requirements. This level of documentation is not necessarily something a buyer who planned to hold property would make the effort to assemble, but it is critical to complete the environmental picture for parties to a sale/leaseback.

Note that in order to accomplish sufficient "wrap-up" of environmental concerns, it may be necessary to involve an environmental consultant at some point during the construction phase.

Finally, retailers need to be aware of a relatively new concern that is receiving increasing attention from regulatory authorities. The issue is vapor intrusion--the potential for certain hazardous materials in the soil and groundwater to seep up through the foundation of a building and pollute the indoor air.

Historically, most state agencies typically did not examine this issue when granting regulatory closure for contaminated sites. Now, not only are states and the federal EPA looking at this issue in the context of newly-discovered releases, but some states (e.g., New York) are re-opening sites that had already received regulatory closure where the agency believes more scrutiny of the vapor intrusion potential is warranted.

In light of this concern, retailers would be well-advised, particularly where they wish to "flip" the property in a sale/leaseback, to ensure that their consultants address this issue as part of the due diligence exercise, and propose mitigation where necessary to ensure that a future health risk will not arise as a result of vapor intrusion.

Note that vapor intrusion concerns can arise as a result not only of releases on the retailer's property, but also from contamination migrating onto the property from an off-site source.

Conducting thorough environmental due diligence is doubly important when the purchaser intends to do a sale/leaseback.

SUSAN PHILLIPS, MEMBER EMPLOYMENT LAW PRACTICE, MINTZ LEVIN COHN FERRIS GLOVSKY AND POPEO, P.C.