Main Street Monday — How The SBA’s Dry Cleaning Requirement Changes Impact Your Due Diligence Considerations

March 5, 2018

By Guest Contributor
Marshall Stanclift
Partner Engineering

Main Street Monday — How The SBA’s Dry Cleaning Requirement Changes Impact Your Due Diligence Considerations

Dry cleaners are a confounding conundrum in the world of commercial real estate. They generally rent on economical space but generate a lot of business and foot traffic for other establishments. They are considered not just profitable business models, but a critical anchor in a mixed-tenant commercial strip center.

Unfortunately, dry cleaners also pose a significant potential health risk to themselves and neighboring tenants. This is mostly due to historical use of a cleaning solvent called perchloroethylene (PERC), often causing a “dry cleaner headache” for property owners. First introduced to dry cleaning in 1931, demand for this highly effective cleaning agent increased throughout the 1980s and peaked in the 1990s when closed loop machines were introduced.

Unfortunately, PERC has been recognized as a highly toxic carcinogen. Worse yet, it is very mobile and heavier than water, which means contamination can occur in water beneath the site (potentially impacting local drinking water) or exposure to neighboring properties as it travels below pavement and spreads in the soil in all directions. It can travel vertically through vapors, which are dangerous both in the primary property, and potentially neighboring properties. This vapor intrusion can make cleanup very challenging and increase the liability of the property. Because of this, there is an increased cost of financing for historical dry cleaning sites due to the need for Phase II Environmental Site Assessments and potential remediation of solvent contamination, which can cost hundreds of thousands of dollars.

In 2007, California became the first state to phase out perchloroethylene, with legislation enacting a full ban by the year 2023.

Recognizing the environmental risk posed by dry cleaners, the U.S. Small Business Administration (SBA) has revised its environmental policy for these loans in its latest standard operating procedure. Here is the current language in the 2018 SOP 50 10 5 (J) pertaining to subsurface investigations involving dry cleaning facilities (changes from previous SOP in bold):
“…On-site dry cleaning facilities, which may have utilized Trichloroethylene (TCE) and tetrachloroethylene (PCE) and/or petroleum-based solvents in the course of their business operations may present significant clean-up costs if these contaminants have entered the soil, soil vapor and/or groundwater. Prudent lending practices dictate and SBA requires that any Property with on-site dry cleaning facilities, whether currently in operation or operated historically at the site, that did, do or likely used chlorinated and/or petroleum-based solvents undergo a Phase II ESA…Any soil and groundwater contamination and soil vapor intrusion must be addressed.”

For the immediate future (until and unless further revisions to the SOP are announced), there are two major changes to previous policy. One, the SBA now requires a Phase I Environmental Site Assessment and a Phase II Environmental Site Assessment for all properties currently or historically operating a dry-cleaning business, without consideration of a time frame or exceptions. Two, the SBA has added petroleum-based solvents as a recognized contaminant and soil vapor as a media to be assessed during a Phase II ESA. Taken together, these more stringent guidelines will require far more compulsory due diligence with little to no wiggle room.

The long-term impacts of this new policy are murkier. It is possible that there will be fewer SBA loans in the future, depending on risk appetite and due diligence budgeting. Conversely, there could also be an uptick in Phase II ESAs if the lender wants to make the loan and the borrower has enough collateral to afford the assessment. The SBA’s new policy is pretty air tight, making the effort to attempt going through appeals a poor choice. If a site has been a drop station and/or a green dry cleaner, there is a chance of not needing a Phase II, based on the available information and due diligence completed to determine the historical use.

Ideally, we prefer a world of professional judgement where all facts can be considered when doing a site assessment; nevertheless, dry cleaners are indeed a huge risk. To ensure that the lender and borrower have enough time to complete a Phase I and Phase II ESA concurrently, it is more crucial than ever to engage experienced consultants and Environmental Professionals that provide these services.

For current and future owners of dry cleaning establishments, sound environmental practices are the best advice for minimizing future risk. Alternative cleaning methods to solvents and PCE are currently available, as are “green” machine and cleaning processing systems. These are still effective methods of cleaning, while posing a far lower environmental or health threat. Beware that some older sites will still use PERC for spotting, making careful due diligence assessments in any transaction critical. Regardless of which solvents are used on site, it is best practice to get an annual audit of the facility from a consultant.