Effectively Navigating Environmental Liability Risk

Those involved in commercial real estate transactions are often confronted with environmental issues before and after the purchase of a site. Environmental issues can range from exposures associated with lead paint or asbestos in older buildings set for demolition to contaminated soil or groundwater associated with historical operations from on- or off-site sources. Insurance is often selected to manage those environmental liabilities.

Emerging environmental issues that are increasingly becoming more common include the risks associated with indoor air quality or long-term sustainability of energy efficiency to meet “green building” standards.

Best practices involve buyers and lenders requiring qualified environmental site assessments (ESA) of any property being acquired. Two of the most common ESAs are in the form of a “Phase I” environmental report, which requires physical inspection of sites, along with historical research of all prior operational exposures at and/or adjacent to the site. If the Phase I report identifies contaminates of concern (COC) or recognized environmental conditions (REC), then a Phase II report would be required. That involves further investigation and sampling of air, soil and/or groundwater, which involves installing temporary or permanent sampling wells on the site.

The ESA will confirm one of three conditions: no known environmental issues; known environmental issues that could be associated to future environmental claims, but further investigation is required; or known environmental issues that must be immediately addressed and will require reporting to the regulatory agency.

After Phase I or II has clearly identified known environmental conditions (COC or REC), regardless of whether claims have been filed, there are significant liabilities at risk. At that point, buyers, sellers and lending parties often disagree on many contractual terms regarding ownership of the liabilities. Therefore, insurance is relied upon to manage the known and/or unknown environmental liabilities.

Since passing the Small Business Liability Relief and Brownfield’s Revitalization Act of 1995 and subsequent federal amendments, the success of buying and selling environmental contaminated real estate has significantly increased. Regardless of whether the environmental issues are actual and/or perceived, the management of future known and unknown environmental liabilities must be addressed. “Qualified” environmental insurance products to support those known and unknown environmental liabilities have become one of the most cost-effective methods of managing this environmental risk.

The increased need for environmental insurance first began in the early 1980s with the implementation of federal legislation associated with the National Environmental Policy Act, Clean Air Act of 1970 and 1972, Resource Conservation and Recovery Act in 1980, and Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA, or also known as the Superfund Act). All of those laws and regulation created new environmental liabilities.

The laws and awareness of environmental exposures, as well as the liability arising from the exposures, quickly became a big issue with insurance companies, which found themselves paying for environmental defense and cleanup costs under business general liability policies. Consequently, the industry quickly responded in the mid-1980s by adopting the “absolute pollution exclusion” that became a standard on all commercial general liability policies. That was the genesis of the environmental insurance industry.

Transactions involving environmental liabilities of any form tend to be complex and require dedicated environmental law, engineering and insurance brokerage experts. The process is collaborative and, in most cases, the environmental insurance broker is responsible for making sure all parties are working together to manage the environmental risk, which generally requires environmental insurance as the final backstop.

Negotiating and purchasing an environmental insurance product is unlike the purchase of traditional commercial insurance coverages (auto, general liability, property, workers’ compensation). There are a limited number of carriers that will underwrite environmental insurance products, and all companies have their own “unique” policy forms.

Selecting the right professional environmental risk management team is critical to the success of not just environmental insurance placement but also to the long-term management of the environmental risk. The team members should include:

• An environmental attorney who has at least five years of “transactional/real-estate” experience.
• An engineering/consulting firm with first-hand knowledge and relationships with state and federal regulatory agencies.
• An environmental insurance broker who has experience with conducting other environmental related transactions and has quality relationships with the primary environmental underwriters (i.e. AIG, XL, ACE and Zurich).

While environmental risk management involves the basic elements of “identify, evaluate, review and finally implement,” all members of the team hired to manage an environmental risk solution should be actively involved in working with the environmental insurance underwriter to negotiate manuscript policy coverages, terms, conditions and definitions that are consistent with the purchase/sell agreements.

The greatest challenge is ensuring that the insurance placement supports the contractual indemnity obligations between the buyer and the seller, plus any requirements of the lender and/or the regulatory closure strategy established by the environmental consultant.

The risk of exposure to environmental liabilities continues to increase, as does the demand for service specialization. Often, the insurance expertise needed to manage an environmental risk varies and is highly detailed. But environmental issues should not be underestimated or thought of as a routine venture.

Stakes are high, and missteps can cause delays and difficulties that can run-up costs and consume a long period of time. Due diligence is needed in assembling the right team to do the job and represent a client and its objectives accurately and effectively.