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Purchasing Real Estate: Due Diligence
School officials authorized to purchase real estate for their schools are often eager to put pen to paper after finding reasonably priced property. A real estate purchase agreement should, however, be carefully scrutinized before signing to ensure that the agreement provides the school with an opportunity for adequate due diligence. Purchasing property without performing due diligence could result in significant liability for the school.
Environmental Due Diligence
The federal Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) and Michigan’s Natural Resources and Environmental Protection Act (NREPA) impose liability for environmental contamination, which may include contamination clean-up costs. This liability extends not only to the party who caused the environmental contamination, but also to the party owning contaminated property, regardless of whether the owner caused the contamination.
Both statutes contain an “innocent landowner defense” that shields an owner of contaminated property from liability under the CERCLA and the NREPA if, among other things, the owner did not know or have reason to know that the real estate was contaminated when the owner purchased the real estate. To meet this standard, the owner must have conducted “all appropriate inquiries” before purchasing the real estate.
A Phase I environmental test examines the current and historical uses of real estate to determine whether those uses potentially contaminated the real estate (e.g., gas station, oil tank storage, dry cleaner). A prospective purchaser can often make “all appropriate inquiries” by conducting a Phase I test so long as the test does not identify potential contamination on the real estate.
If a Phase I test identifies potential contamination, and the school decides to proceed with the real estate purchase, then a Phase II environmental test should be conducted to determine whether contamination actually exists. A Phase II test generally analyzes soil, groundwater, and gases.
If a Phase II test reveals contamination, the innocent landowner defense will not apply. A school purchasing contaminated real estate may still avoid liability for that contamination if the school conducts a baseline environmental assessment (BEA) and discloses the BEA to the Michigan Department of Environment, Great Lakes, and Energy and subsequent real estate purchasers and transferees. Typically, a BEA requires a new owner to take steps to avoid exacerbating existing real estate contamination.
A clause that makes the school’s obligation to purchase the real estate contingent on the school’s satisfaction with the results of environmental and other testing should be included in a real estate purchase agreement. Moreover, the school should require the seller to indemnify the school from any liability for environmental contamination existing on the real estate on or before the closing date.
A real estate purchase agreement should allot sufficient time to conduct a real estate title search and allow the seller to cure any title defects that the search reveals (e.g., liens, easements, and deed restrictions).
The title search is initiated by ordering a title insurance commitment from a title insurance company. The title company will verify that the seller owns the real estate and will issue a commitment disclosing any recorded real estate interests of third parties (i.e., title defects). The title commitment should be thoroughly reviewed to ensure that a third party’s recorded rights to the real estate, if any, will not interfere with the school’s intended real estate uses (e.g., a telephone company’s easement for telephone poles through the middle of the real estate).
If the school is satisfied with the title commitment, it should require the seller to deliver a title insurance policy to the school at closing. A title company issuing such a policy will agree to reimburse the school for recorded title defects arising on or before the effective date of the policy but usually not for title defects that were located by the title company during its title search. In certain circumstances, the title company may also agree to reimburse the school for unrecorded title defects.
Other Due Diligence
Depending on the real estate’s characteristics, other due diligence may also be beneficial before closing. The due diligence process may include: (A) flood plain evaluations to ensure that the real estate is not located in a flood plain; (B) appraisals to ensure that the real estate is being bought for a fair price; (C) real estate surveys to ensure there are no unrecorded title defects (e.g., third parties with no recorded interest in the real estate who are using or encroaching on the real estate); (D) consideration of the availability of, or cost to extend, water, sanitary sewer, and other utilities; and (E) determining whether there is adequate stormwater drainage from the real estate.
Although due diligence requires extra work before a school purchases real estate, it is crucial for avoiding headaches and legal liability down the road. If your school is considering purchasing real estate, Thrun’s real estate attorneys are available to help.