Running the Environmental Gauntlet: Can Your Site Emerge from the Government-Guaranteed Lending Review Process?

From the desk of David S. Coyne, Principal, Qualified Environmental Professional

“The risk of contamination is so minimal that no additional investigation is warranted.”

Consider the above statement – it’s definitive, and can bring closure to an environmental lending review. It almost certainly would bring a smile to the face of a lender, borrower or other stakeholder in a real estate transaction.  But the findings of an environmental investigation – just like a property appraisal or a structural-mechanical evaluation – aren’t always positive.  Sometimes detailed studies uncover unwelcome realities, and the need to perform further inquiry.

When loan approval criteria for government-guaranteed programs such as SBA financing only provide approvals for sites that are covered by the statement above – where no additional environmental evaluation is needed – it leaves a hugely important question in its wake.  What are the prospects for properties with known contamination? 

Lenders that are taking a borrower through the government-backed SBA loan process have many conditions to meet, and work hard to demonstrate the criteria for achieving a loan approval under these programs. These programs are popular because they offer rates and guarantees that are more attractive than the terms that banks can provide by themselves, and reduce the overall risk to the lender in the event of a mortgage default. Among the SBA’s many loan opportunities are the following two programs:

  • The 7(a) Loan program is targeted toward new and existing small businesses over a range of commercial activities. Companies eligible for 7(a) loans must be for-profit enterprises that operate, or will operate, in the United States and have invested existing equity in the business prior to applying for government-guaranteed financing, and have limited resources available for more conventional forms of private lending. An environmental due diligence screening process applies under this program, with the scope and extent of inquiry following a step-wise process that is a function of the site’s operational history.
  •  The 504 Loan program is available to not-for-profit community development corporations (CDCs) and targeted directly at real estate lending, for the purchase of land, buildings, and improvements that can include construction of new buildings and associated infrastructure. CDC/504 loans can also be made toward the purchase of machinery and equipment, and therefore often form a convenient financing package for companies seeking a facility or service-area expansion.   Since CDC/504 loans are defined by real estate and/or real property value, environmental assessments will almost always be required.

SBA guarantee programs proved very popular with risk-averse lenders during the post-recession recovery several years ago, and the SBA has seen increases in total loan amounts nearly every year since 2009. As the loans have become more substantial in size, the procedures for loan approvals and their administration have evolved in step with their more widespread application.  The SBA currently sets forth its environmental due diligence guidelines in its frequency-updated Standard Operating Procedure (SOP) 50 10 5.  The SOP’s current iteration, SOP 50 10 5(H), was issued in May 2015.  Under the SOP, SBA requires an environmental assessment of all commercial property used to collateralize or otherwise secure a program-applicable loan.  The depth of inquiry varies per property type, and follows an iterative process that begins with a comparison of the property’s NAICS code against SBA’s list of environmentally sensitive operations.   

If a facility’s NAICS code matches a list of environmentally sensitive operations provided in Appendix 4 of the SOP, then a Phase I ESA performed to the current ASTM Standard is automatically required. Lesser-scope, screening-level questionnaires and the SBA-specific RSRA process (Records Search with Risk Assessment) process can be performed on properties that do not fall under the NAICS categories, and the environmental review process can be concluded and submitted to SBA if the results of either study shows no need for further evaluation.  Similarly, if a full Phase I ESA does not identify any recognized environmental conditions which warrant further evaluation, the process can be considered complete and submitted for SBA review as part of the loan approval package.  However, any business environmental risks (BERs) – specifically, issues that are not RECs and don’t warrant further evaluation but could pose a risk in the future, such as open drains, or aboveground tanks without secondary containment – must be addressed to the consultant’s recommendation as a condition of loan approval.  In light of these requirements, the lender should be prepared to communicate the costs associated with addressing BERs, and should provide documentation to SBA that they have been completed.

If, through the completion of the Phase I ESA, recognized environmental conditions (RECs) which warrant a Phase II site investigation are found, the SBA will generally require that the owner or borrower carry out the environmental consultant’s recommendations for further study. If the findings of the Phase II do not reveal any site impacts requiring remedial action or posing an exposure or operational risk, the environmental review process can be completed and documented in the loan package as described above.  Appendix 5 of the SBA’s SOP states that “if at any stage of the Environmental Investigation SBA concurs with a lender’s recommendation that environmental risk has been sufficiently minimized and that no further investigation is required, the loan may be disbursed.”

At the end of the environmental due diligence process then looms a critical question for properties where impacts have been identified. Are there scenarios in which the SBA will accept an environmental risk at a property?

The likelihood of SBA accepting a site with environmental impairments that have not been fully characterized is generally low. However, there are conditions that allow for funding in certain circumstances, and are mainly driven by the extent to which the impacts have been studied, and if the impacts are being cleaned up.  The SOP guidance states that loan processing personnel must obtain field counsel or center counsel’s opinion as to the adequacy of an environmental investigation, and whether the risk of contamination has been ‘sufficiently minimized’.  Further the SOP notes that “loans may not be approved or disbursed if there is known contamination or ongoing remediation at the property unless the risks have been minimized to the satisfaction of the SBA loan processing personnel after consulting with and obtaining the concurrence of SBA field counsel or center counsel.”

The criteria for SBA’s approval of the loan disbursement in the presence of contamination is outlined in detail in Subpart B. III, Section G of the SOP and is generally limited to sites that have been adequately characterized and are undergoing cleanup under an agency-related remedial program. In general, the actions need to be far enough along as to define an absence of exposure pathways and a schedule for completion, and an assurance of continued responsibility for the remedial action to be followed to completion by a responsible party.  In addition, if a responsible party is engaged and committed to the completion of the site cleanup, the SBA will likely require that intent to be formalized in a written indemnification agreement.

Other options for loan approval for sites with contamination could include the documentation of cleanup funds from other sources, or the establishment of an escrow account to ensure adequate funds for the completion of a planned agency-guided program. Additional conditions in the SOP guidance also allow for consideration of loan disbursements in the presence of “minimal contamination,” where the contamination and the cost of cleanup are de minimis in nature in relation to the value of the property, or if the cleanup is projected to be completed within one year.  SBA approvals for contaminated sites may also be considered on an individual basis, under a generalized category subtitled “other factors,” which could include the application of environmental insurance or bonds.  Such factors would be reviewed for approval only by SBA’s environmental committee under special consideration. 

To take a larger perspective on the issue, it’s clear that most sites that would reach the stage of a Phase I ESA or a Phase II site investigation under this program would be properties that would have failed the earlier screening processes. By the nature of their operations, these sites would already pose a significant likelihood of the presence of environmental concerns. For this reason, it’s very important to have a clear understanding of the goals of the environmental review process beginning with the initial steps of the SBA review process.  An honest and clear understanding should be communicated among all parties – lender, borrower, and consultant – about the consequences of the environmental review process, and the realistic potential that the goal of an environmental assessment – specifically, the likelihood that “the risk of contamination is so minimal that no additional investigation is warranted” can actually be met.

Our team of experts is here to guide you in understanding and quantifying the characterization, cleanup strategies, and agency approvals  needed to pursue the approaches described above for the investigation and remediation of impaired properties.