For decades, Bankers have utilized environmental indemnifications in their loan documents as protection from environmental liabilities. Then in the mid 1990’s Phase I / II… environmental site assessments were added as another layer of defense for a Bankers lender liability exposure on real estate transactions.
In basic terms, environmental indemnifications and Phase I’s have been used as a way for all concerned parties to feel content with addressing potential environmental exposures on financial transactions.
Today, we know the problems created by this mindset and the fact that environmental indemnifications and Phase I’s are a very cursory way of addressing environmental exposures. Especially when you consider that environmental liabilities tend to be a severity vs frequency issue.
As countless Banks have experienced, when it comes to environmental liabilities, a client’s environmental problem can become the Banks problem. That’s why it’s crucial for banks to have a financial assurance mechanism (Bond, Letter of Credit, Environmental Insurance, Monies in Escrow…) in place to backstop the inability of a borrower to meet environmental indemnifications.
Environmental financial assurance mechanisms also help to reduce the reputational risk associated with environmental liabilities for Banks.
When it comes to environmental liability insurance as a financial assurance mechanism, three often overlooked benefits offered in environmental liability insurance policies are:
1. Defense Costs: Environmental liabilities are relatively new and very litigious. Even if you do nothing wrong, you can still get named in a suit and must expense legal fees. Environmental insurance policies cover defense costs.
2. Claim Management: All policies come with specialists to assist you in handling a claim. Who is in charge of communications, public relations, emergency response, government compliance, financial management, third party claims for bodily injury, property damage, natural resource damages….?
3. Third Party Liabilities: The majority of the time the cost to clean up the environmental problem/s is far less than the associated claims that come in from third parties for bodily injury, property damage and business interruption.
Environmental Coaching Guide for Bank Professionals
1. Bankers must first understand what a “Pollutant” is? If you look at a loan document, they generally describe a Pollutant as smoke, vapors, soot, fumes, acids…. However, due to the way our courts and insurance companies have responded to lawsuits and insurance claims, environmental Strategist® (eS) has developed the following simplified definition: a “Pollutant” is a material, substance or product that gets introduced to an environment for other than its intended use or purpose.” In other words, something that ends up where it does not belong can be a Pollutant. eS have examples where fresh water, milk, cheese, fruit, beer and more have all been defined as a “Pollutant”.
2. Every commercial client a Bank works with is impacted by environmental exposures. What is their financial assurance mechanism?
3. eS research has determined that fewer than 50% of Phase I Site Assessments are accurate. Also, environmental due diligence (Phase I, Phase II…) as part of meeting the innocent landowner or lender liability defense only protects the real estate owner or bank from the government. Impacted non-governmental third parties can still file suit.
4. Banks, besides being cognizant of the environmental exposures impacting their collateralized properties, need to consider neighbors of collateralized properties. When a Phase I Site Assessment is conducted to investigate who neighbors are that could have contamination going onto a subject property, environmental engineers do a minimum of a 2-mile radius search. Third party contamination coming onto a bank collateralized property could impede the property owner’s ability to service their loan. Under Federal law the property owner is ultimately responsible for the environmental condition of their property regardless of who caused the contamination. Environmental insurance policies can protect property owners if third party contamination comes onto their property.
5. What about bank loans for client’s that lease / rent their facility to third parties? Lease / rental agreements contain “environmental indemnifications”. What if a tenant experiences an environmental liability in the facility or a third-party vendor (HVAC contractor, Repairman, Landscapers…) contaminates the facility? Without a financial assurance mechanism in place, contracts that contain environmental indemnifications may not be worth the paper there written on.
6. Additional environmental exposures impacting bank loans may include but are not limited to: Vapor intrusion, Storm water runoff, Natural resource damages, Easements that cross collateralized property, New construction & remodeling on collateralized properties, Sick building syndrome, Mold, Legionella….
Bankers not proactively addressing environmental exposures may find their profits at risk when a borrower discovers they have an environmental liability. Coaching up Bankers how pollution insurance can protect them from the gaps created by environmental indemnifications in contracts and site assessments will drive the sales of your insurance products.
Environmental Liability Insurance Coverages for Banks to Consider
Simply due to their business model, every Bank is impacted by environmental exposures. Therefore, consideration needs to be given to the economies of scale afforded with environmental liability insurance versus self-insuring.
Environmental Impairment Liability (EIL)
EIL is for Banks susceptible to economic loss caused by pollution that actually or allegedly originated from owned or collateralized properties. Sometimes referred to as Pollution Legal Liability (PLL), this coverage is for those who own, operate, lease, or have any other insurable interest in real property and/or the operations. Coverage can be written in a variety of ways addressing unknown preexisting conditions or new conditions. Coverage can include third party bodily injury and property damage along with business interruption and extra expense, on and off-site cleanup costs, legal defense expenses, non-owned disposal sites, transportation and more. EIL can be offered on multiyear terms. Most EIL policies cover above ground storage tanks up to a certain size. You can cover multiple locations on a single policy.
Lender Liability Coverage (LLC) / Secured Creditor Coverage
As so many Banks have learned, when it comes to environmental liabilities, a client’s environmental problem can become the Banks problem.
To address the potential environmental liabilities faced by a Bank’s operations, there is a risk transfer product called Lender Liability Coverage (LLC). LLC enables Banks to shield assets by protecting collateral and insuring for environmental liabilities arising from collateral properties. LLC fills gaps created by traditional environmental indemnifications, due diligence….
LLC provides collateral value protection in the event of a loan default and a newly discovered pollution event at the covered location/s. When this occurs, LLC can pay the lesser of the outstanding loan balance and extra expenses or the estimated cleanup costs. LLC can be used on a single transaction or on a portfolio basis. Coverage is offered on multiyear policies that can run up to the term to maturity of the insured loan. LLC offers the ability to assign interest to a successor lien holder. LLC allows Banks to be more competitive on loans they would once be forced to pass-up due to environmental uncertainties.
Property Transfer Coverage
When buying or selling property there can be unknown preexisting environmental conditions. Since environmental due diligence (Phase I, Phase II…), cannot guarantee uncovering all potential environmental liabilities, insurance companies have created property transfer insurance. This coverage protects the new owner or any party with an insurable interest, against unknown environmental conditions that may be discovered during the policy period, that were not caused by the new owner.
This coverage not only helps to keep the property at its maximum value, it will assist the purchaser in being able to secure the necessary financing to complete their transaction. You can cover multiple locations on a single policy.
Mergers, Acquisitions & Pollution Protection (MAPP)
Key to any acquisition is the correct valuation and effective due diligence and MAPP operates as a backstop against issues due diligence or valuation processes may not be able to identify.
As a financial assurance mechanism for M&A’s, pollution liability insurance has become part of “Best Practices”. Representation & Warranties (R&W) insurance is proving its value for M&A’s much the same as pollution liability insurance has.
R&W insurance is designed expressly to provide insurance coverage for the breach of a representation or a warranty contained in a Buy / Sell Agreement, in addition to or as a replacement for all or most of the seller’s contractual representations and warranties.
MAPP delivers a cost-effective way to transfer R&W and pollution liabilities to a financially stable third party.
Brownfield Redevelopment Insurance
Today, more than ever, Federal, State and local governments are creating incentives for redevelopment of Brownfield sites. These are properties that due to actual or perceived contamination are sitting idle or underutilized. Through Brownfield redevelopment these properties can be cleaned up and put back on the tax rolls.
The basic purpose of this insurance is to protect the owners, purchaser or investors against known or unknown environmental conditions. Brownfield redevelopment insurance can be structured in a variety of ways. Besides the financial assurance mechanism, contractor’s pollution liability, transportation, off-site disposal, cost cap insurance, post remediation coverage and much more can be addressed. The important thing to remember about Brownfield redevelopment coverage is that it is customized for each project.