FEATURE ARTICLE, JULY 2005

TOOLS FOR MANAGING ENVIRONMENTAL RISK
How can a purchaser, lender, tenant or seller protect itself against the potential threat of environmental contamination and the associated liabilities of a commercial real estate transaction?
Sandra Fitzpatrick

Fitzpatrick

The introduction of the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) and later restructured by The Superfund Amendments and Reauthorization Act of 1986 (SARA), as well as various state environmental statutes, created direct burdens on real estate title conveyancing that have significantly affected the title insurance industry. Of primary concern is the risk of an environmental “super lien” being filed against the real estate for reimbursement of cleanup expenses that take priority over all existing liens.

In the 1980s, lenders looked to title insurance for protection against any environmental risk that would attach to their interest should a borrower default on its loan. Under the ALTA policies, there were no express exclusions for environmental matters. For a short time, several title insurance underwriters provided superlien coverage but only insured the lender that the lien of its mortgage would not lose its priority to a superlien as the result of a cleanup or hazardous waste released, spilled or discharged onto the insured premises on the date of policy. In January 1987, title insurance underwriters abandoned this coverage as the risk was too great and the policies clarified that environmental matters were not covered.

In 1987, the ALTA 8.1 endorsement was introduced to give lenders coverage against environmental protection liens that are of record at the date of policy. It was also designed to disclose any state statute in effect at date of policy that may impair the priority of the insured mortgage. This coverage remains in effect today.

The basis for a title insurance policy is a title search of the public land records prior to its issuance. It was determined in 1986 by at least one state insurance commissioner that the risk of loss could not be eliminated by a careful examination of the title records since environmental liens may arise subsequent to the effective date of a title insurance policy and filed in a variety of records which may not be in the normal course of a title search. The risk that a lien may be recorded or other defects created in the future is a casualty risk.

As part of the due diligence process for commercial real estate transactions, a major concern is the environmental condition of the property. The ALTA 8.1 only provides that a notice of enforcement or a notice of a defect, lien or encumbrance has been recorded in the public records. The coverage is afforded to a lender for any loss that may happen as a result of lack of priority of the insured mortgage. The endorsement includes a limitation that it is only effective if the land is used for residential purposes. The risk is greater for commercial properties and requires specific approval.

 How can a purchaser, lender, tenant or seller protect itself against the potential threat of environmental contamination and the associated liabilities not addressed by the ALTA 8.1? Environmental insurance is available from a property/casualty underwriter to satisfy these concerns and facilitate smooth closings.

The growing concern about hidden environmental contamination has resulted in environmental site assessment insurance. Today, several insurance companies are now offering a variety of insurance products designed to address specific concerns and in essence, transfer the potential risk of environmental liabilities to a commercial underwriter. The most common include coverage for pollution legal liability, lenders, cleanup cost cap and environmental finite risk programs.

The Pollution Legal Liability policy is designed to insure anyone with a financial interest in commercial real estate — owner, buyer, lender or tenant. There are 16 areas of coverage offered from which an insured can create a policy designed to meet or exceed closing requirements, including:

• On-site cleanup of undiscovered contamination, pre-existing or new conditions.

• Off-site cleanup of contamination migrating from the insured site.

• Payment of third-party claims for bodily injury and property damage.

• Supplemental environmental automobile liability.

• Owner’s spill liability.

• Business interruption insurance.

Policies are written on an individual property or portfolio basis with minimum policy limits of $1 million, a deductible of $10,000 per occurrence, and terms of 1-10 years. The policy is assignable to a subsequent owner within the policy term.

These policies are usually written on a “claims made” or “discovery” basis, meaning that the contamination must be discovered during the policy period, and the insured must provide written notice of the claim or contamination to the insurer during the policy period. The claims-made limitation is important because contamination is frequently discovered many years after it occurs. Some policies provide that the insured may purchase an extended reporting period that provides the insured with an additional period in which to notify the insurer of claims arising prior to the policy’s expiration.

Policy benefits include the warranty of environmental condition, an alternative to environmental indemnity and/or escrows, guarantee of successful remediation, and acceleration of transaction negotiations.

The Secured Creditor Impaired Property policy was designed to protect lenders from environmental liabilities that might arise during the loan workout and property disposition process. Coverage is available for a policy term that exceeds the actual length of most commercial real estate loans up to 20 years.

Several rating agencies have issued reports indicating that the use of environmental insurance may help obtain a better credit enhancement in certain commercial mortgage-backed securities (CMBS) transactions.

On properties that need to be remediated, the Cleanup Cost Cap policy insures against cost overruns on the remediation plan. This policy is designed to address the risk and gives certainty to the total project cost and can be used as an alternative to setting up an escrow based on remedial estimates. The costs of this insurance varies according to the size of the project, amount of retention held by the insured, scope of contamination and time for remedial completion.

On urban properties that were once classified as brownfield and remediated, the insurance benefits provide a guarantee that the remediation is successful, cleans up the reputation of the property, satisfies tenants’ and future investor’s requirements, and converts a closed facility into a productive operating facility.

In today’s sensitive environment, companies have recognized the importance of maintaining a responsible management program for their business operations. The Environmental Protection Program (EPP) combines risk transfer and funding mechanisms with environmental consulting to meet the financial and risk management objectives of the insured. The right environmental insurance coverage not only provides a company with protection but also preserves corporate assets, net income, public image and reduces the potential for liability claims.

By utilizing both the ALTA 8.1 and environmental insurance programs the prospective purchaser, tenant and/or lender can maximize their coverage and feel secure about their investment in commercial real estate.

Sandra Fitzpatrick, MCR, is vice president of sales for LandAmerica’s Commercial Service offices in Fairfield, Connecticut, and Summit, New Jersey.

©2005 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.