September 1, 2006
Itís Simply Poor Due Diligence
Are you placing time bombs in your files?

I recently received a phone call from an occasional banking client that had put herself in a bit of a jam. The client was in the process of financing an old light industrial site in a re-developing urban area of Denver. The client, who for the purposes of this article will be referred to as Ms. Jenkins, had bought in on a sales pitch from a representative of a prominent national regulatory government agency database firm. The pitch was basically, "Make your environmental due diligence cheap and easy by ordering one of our computer reports." The so-called "desk-top review" had apparently been originally developed in response to limited Fannie Mae refinancing requirements of existing loans. However, the database company had unilaterally expanded this product as a broad offering to the marketplace to be used with new loans and began promoting its wholesale use in the lending community. Letís take a quick look at the desk-top review product and then weíll get back to Ms. Jenkinsí dilemma.

This so-called desk-top review product included 1) a radius map report that ostensibly contains all of the regulatory activity reportings for the subject property and the surrounding area per the requirements set forth in the ASTM 1527E 2005 Standard; 2) a Fire Insurance Map abstract ostensibly reporting historic use of the subject property; 3) an historic city directory abstract ostensibly addressing the subject property and the immediately surrounding area; and 4) two proprietary databases ostensibly reporting previous property and area use by dry-cleaning establishments and manufactured gas plant databases. The proprietary databases are not included in the new ASTM 1527E 2005 Standard.

This computer model product results in a cover sheet that designates the property as either being a) high risk; or b) low risk. Ms. Jenkinsí dilemma was created when the desk-top report designated her property as being "high risk". Ms. Jenkins did not realize at the time that the high risk designation generated by the computer model program, may well have saved her monumental headaches for herself and her borrowers on future loans.


Ms. Jenkins desk-top review report had designated the subject property as high risk based upon two immediate area government agency database reportings. The primary concern addressed a former chemical distribution company located approximately one-half block northwest of the subject property, with a secondary issue concerning a former gasoline station located adjacent to the chemical company site. Ms. Jenkins, now faced with a "rush" situation, proceeded with a Phase I Environmental Site Assessment, and thatís when my phone rang.

Ms. Jenkins explained the situation, and I assured her that I was basically familiar with the desk-top review program and it had fundamental flaws that frequently result in false "highs" as well as false "lows". Wasting time with the desk-top review had further complicated Ms. Jenkins loan as she was no short of time in which to complete the due diligence process by the closing date. In fact the inspections period in the Buy/Sell Contract was expiring imminently. Immediately sympathetic to my clientís dilemma, I agreed to meet her and her borrowers at the site the following morning.

Upon arriving at the site, Ms. Jenkins provided me with a copy of the desk-top review report. I looked at the two sites at issue; I first noted that both sites were clearly down-gradient from the subject property, thusly, minimizing any risk of contamination of the groundwater beneath our subject property site. I then examined the database records and ascertained that the chemical company site had completed clean up activities in August, 1996. I then was also able to quickly determine from the database information that the former gasoline station site was listed as a "closed file" indicating the completion of removal and remediation activities to the satisfaction of the appropriate regulatory authorities. I was able to tell Ms. Jenkins that I did not believe either site presented any significant environmental risk to her loan transaction, but that I would further investigate these two reportings as well as the other area reportings during the conducted Phase I activities. In fact, further investigation subsequently corroborated my initial site observations and determinations.

Ms. Jenkins mentioned that although there appeared to be a significant amount of data in the report, that it appeared to be somewhat broad and cryptic. As I reviewed the report with her and we discussed the contents, we noted Fire Insurance Map review verbiage as being " illegible due to poor film quality; further finding illegible; or an unidentified structure". Also, an area of discomfort in the report was the inclusion of several pages of historic city directory listings covering a broad area surrounding the subject property. However, only two listings of the subject property, in 1976 and again in 1986, were included in the report. This is far short of any industry standard historic review included in past or present approved environmental protocols. The subsequent Phase I investigative activities conducted by EARC resulted in city directory listings extending back to 1928, as well as Fire Insurance Maps indicating former single family and mixed retail and single family use of the two subject property lots extending back to the 1920ís.

Beyond the erroneous findings based on computer generated data, I was further professionally concerned with on-site issues, such as potential asbestos issues as the development plans included extensive renovation of the interior of the subject property building. Also, as characteristic of the older area, there was the potential of an underground storage tank that could have possibly provided heating oil to the subject property buildings in prior years.


In this case, the computer generated "high risk" designation created problems for the banker as well as the borrower during the loan process. Additionally, by the time the Phase I report was completed, even on a rush basis, the inspections period in the Buy/Sell Contract had lapsed, leaving the borrower with few options in dealing with any genuine problems on the subject property. Fortunately, the loan proceeded toward closing with the bank absorbing the costs of the desk-top review and agreeing to finance the cost of the Phase I. Most importantly the bank, despite the problems, moved quickly enough not to lose the loan. However, Ms. Jenkins was further concerned with the possibility presented by the other side of the proverbial coin. What if the desk-top review had indicated "low risk" when there actually was a problem. As Ms. Jenkins readily conceded, had the report reflected a "low risk" designation, she would have simply placed the report in her files and proceeded with closing the loan.

Ms. Jenkins conjecture presented an extremely valid point of concern. I explained to her that EARC utilizes the government agency reports provided by the same company that had created her dilemma and that within the previous 60 days; the report had failed altogether in reporting an existing landfill on a banking clientís single family subdivision loan. Remediation of the landfill was still in progress and the landfill activities were the subject of regulatory agency liens and citations. Only three weeks before, EARC had also received another report from the same firm that did not include a significant BFI landfill southerly adjacent to a clientís potential development parcel. Despite EARCís repeated complaints regarding the database firms mapping system over the previous several months, no apparent action had apparently been taken to remedy the situation.

Possibly the worse case scenario for a lender, is to have simply placed an inadequate desk-top review product in the files that designated an asset as being "low risk" based on a computer generated data dump with no professional evaluation. I have personally dealt with banks and lenders for the past 18 years. I am personally aware that my clients are presently competing for loans in a market place that has never been more competitive. I also realize that the temptation is great to simply buy-off on a cut-rate priced product that claims to make environmental due diligence quick and easy without ever having to leave the desk. In reviewing your internal environmental risk management policy, it is wise to keep in mind that "if the borrower is protected, the bank is too." You can only protect your borrower and the bank with a sound environmental due diligence policy based on the industry standards as previously and presently set forth in the ASTM Standards and most recently in the EPA guidelines. The "desktop review" has never been a part of any EPA or ASTM approved or recommended protocol for due diligence and should not be used for any practice involving new loans.


In the case of the quick and easy desk-top review, keep in mind that every time you place a low risk report in your file, you may well be placing a time bomb in the filing cabinet. When that time bomb goes off and your borrower looks at you because a landfill exists on his property and his development plan is in ruins, imagine how you will feel when you place the desk-top review report in front of that borrower, he looks at the "low risk" designation based on nothing more than a computer dump with no professional evaluation, and asks, "what were we thinking?"

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