Picture this scenario: Soil testing reveals that perchloroethylene (PERC), a highly toxic chemical used in dry cleaning that causes cancer in humans, is present on the property that you’ve leased to four different dry cleaning tenants over the past 20 years. The PERC has polluted the groundwater, and the government is demanding that you undertake a costly cleanup. 

The good news is that you have legal recourse against the tenant or tenants that caused the pollution. The bad news is that you may not be able to determine exactly which of those tenants dumped the PERC. And that may leave you holding the bag for 100 percent of the cleanup costs.  

The moral: Landlords must have some way to monitor the environmental condition of the property so they can trace any pollution that occurs to the tenants who caused it. One effective method for establishing accountability, according to a veteran New Jersey environmental attorney, is to ensure your lease gives you the right to perform an environmental audit just before (or after) a high-risk tenant vacates the space. 

Performed systematically, environmental audits give you a snapshot of the property’s environmental condition at the moment each tenant moves out, enabling you to identify contamination and attribute it to the tenant that caused it. Result: You’ll be able to take immediate and proactive measures against tenants that cause pollution rather than having to chase after them years or decades later after you finally discover the damage. Here’s a look at the strategy and how to draft a lease clause to implement it.  

Negotiate Right to Conduct Environmental Audits

Commercial leases typically include language banning tenants from using or storing chemicals that are prohibited by state and federal environmental laws in the leased space. They also give landlords the right to sue for damages, as well as the right to perform periodic inspections to ensure tenant compliance with these restrictions. 

However, relying on use restrictions and inspection rights isn’t enough to protect you. Tenants may conceal the hazardous materials they use or introduce new toxic chemicals into the space at any time. That’s why you need to have a qualified consultant, engineer, or other expert perform certain kinds of testing, sampling, or other evaluations to uncover environmental damage. 

“Unlike periodic inspections, environmental audits aren’t a staple of commercial leases,” notes the New Jersey attorney. “Landlords must make a point of negotiating for environmental audit rights.”  

This may not sit well with all tenants. “While tenants generally appreciate a landlord’s long-term need to manage the environmental conditions of the property they own, undergoing an audit can be disruptive,” the attorney cautions. Accordingly, she suggests that tenants may push back on the issue. And if there are no clear audit protocols in place, they may seek to deny the landlord’s auditor access to the space. So, it’s imperative to reach agreement on environmental auditing before the lease is signed.

The good news is that you don’t necessarily need full environmental audit rights with every single tenant. Standard lease restrictions on use and storage of hazardous chemicals and periodic inspections should be adequate protection when dealing with tenants whose businesses don’t pose a high risk of environmental damage, such as a clothing store or an accounting firm. You should demand environmental audit rights only when leasing to businesses those that pose a high risk of pollution or environmental harm. Keep in mind that the list of high-risk businesses is longer than you might expect, including not just manufacturing industries but also dry cleaners, warehouses, medical offices, furniture makers, research labs, and marijuana and other agricultural growth operations. 

Strategic Pointer: Require all prospective tenants to give you a list of the chemicals and materials they intend to use or store on the leased premises. You can then use that list to determine whether you need environmental audit rights. 

Put 8 Protections in Environmental Audit Lease Clause

The other critical phase of the strategy is to ensure that the actual lease language gives you the protection you need to minimize risks of liability for the pollution that tenants cause. While each situation is different, like the Model Lease Clause below, your environmental audits clause should include eight key provisions. 

1. Landlord’s right to perform environmental audit before lease ends. Timing is crucial. The ideal time to perform an environmental audit is after a tenant vacates the space but before the lease expires [Clause, par. a]. Once a tenant departs, you know it has done all the damage that it’s going to do; and if the lease is still in effect, you may still be able to make maximum use of all your remedies under the agreement. 

Example: Surrender clauses typically require tenants to leave the premises in at least as good a condition at the end of the lease as it was when they moved in, save for ordinary wear and tear. If the clause is still in effect, the landlord will be in the position to claim that pollution on the premises discovered during the environmental audit constitutes a lease default.

Practical Pointer: If the tenant vacates on the day the lease ends or the post-vacate/pre-lease expiration window isn’t otherwise available, arrange for the environmental audit to take place as close as possible to the lease termination date, the New Jersey attorney advises. Then do your own walk-through inspection immediately after the tenant leaves and before the environmental consultant begins the audit to sniff out any obvious pollution or environmental damage that a lay person is capable of detecting. 

2. Landlord’s sole right to decide whether to do environmental audit. Having an audit right doesn’t necessarily mean actually having to use it in every single case. The important thing is having “sole discretion” to decide whether or not to go through with the environmental audit in each particular case [Clause, par. b]. If the tenant balks, compromise by agreeing to use that discretion “reasonably”; and if that’s still not enough, set out the specific factors you’ll use in exercising your reasonable discretion, such as the nature of the tenant’s business and how long it occupied the space. 

3. Clarification that choosing not to audit doesn’t relieve tenant of liability. If you make the decision not to exercise your audit rights, you run the risk that the tenant will seek to disavow any responsibility for pollution discovered after it’s moved out. In addition to claiming it didn’t cause the pollution, the ex-tenant may argue that forgoing the environmental audit waived your rights to hold it responsible for subsequently discovered environmental damage. 

To guard against this, the clause should say that your decision not to exercise your right to perform an environmental audit doesn’t affect your right to sue the ex-tenant for cleanup costs associated with the environmental damage the tenant caused [Clause, par. f]. 

4. Defined scope of environmental audit. Tenants may be reluctant to agree to an open-ended audit lest it turn into a fishing expedition. They may request that you insert language that defines the scope of the environmental audit and the kinds of tests and evaluations it will include. The exact details of the audit will depend on the nature of the space, the tenant’s use, and the environmental laws that apply [Clause, par. c]. 

5. Landlord’s right to select environmental auditor. It’s important for the auditor to have proper credentials and experience to do the job right. So, insist on having the right to select the environmental auditor at your sole discretion. If tenants insist on having a say in the selection process, specify the minimum qualifications a consultant or firm must have to be selected [Clause, par. d].

6. Clarification that tenant’s environmental liability survives lease termination. Environmental auditors may miss damage that was apparent at the time of the audit; or materials that an auditor concluded were harmless may later get reclassified as toxic substances or pollutants. In either case, you want to be able to sue the tenant notwithstanding the “false negative” results of the environmental audit performed at the end of its tenancy. So, specify that the tenant will remain liable for any environmental damage it may have caused while it leased the space regardless of what the auditor concludes and regardless of whether that damage is discovered after the lease expired [Clause, par. g].

7. Tenant duty to pay costs of environmental audit. The cost of an environmental audit of commercial property typically ranges from $3,000 to $10,000 depending on the property’s size and location, audit complexity, and other factors. Our Model Lease Clause requires the tenant to pay the full costs of the audit, but you may have to agree to cost sharing when negotiating with tenants that have strong bargaining leverage [Clause, par. e]. 

Another possibility is to structure cost-sharing on the basis of the audit’s findings. Thus, for example, tenants would pay a smaller or even no share when no environmental damage is found and a larger share if the auditor does discover pollution, particularly if it recommends further tests to follow up on the initial results. 

8. Tenant duty to put environmental audit expense money into escrow. The New Jersey attorney recommends that you require the tenant to put money covering the costs of the environmental audit into an escrow account that you hold. Specify that any funds left in the escrow account after the consultant’s fee, testing, and other audit costs are paid will be returned to the tenant; however, the tenant must pay any excess amounts if the money in the escrow account isn’t enough to cover the costs of the environmental audit. 

Expect tenants to push back on this point, the attorney warns. “This is an important protection on which you should stand your ground,” she adds. “If concessions are unavoidable, agree to a smaller escrow amount rather than giving up the escrow idea entirely.”