Transferring Polluted Properties
Close and trusting relationships among all parties is the single most important factor for the success of a real estate transaction involving an environmentally contaminated — or “brownfield” — property.
In the best of these transactions, the underwriter has good relationships with brokers, underwriters, clients and vendors, said Christopher Alviggi, business development leader, Alliant Insurance Services Inc., a Newport Beach, Calif.-based specialty insurance brokerage firm.
“You want to make sure everybody’s interests are aligned before you close. That will make claims settlement easier, post-close.”
And loop in the regulators, said Randall Jostes, chief executive officer, Environmental Liability Transfer Inc., an environmental liability buyout company. “If they’re included early in the transaction process, they’ll clearly communicate their expectations.”
Different states have different environmental standards and regulations, and different types of properties are subject to different federal regulation. To sort out the regulatory requirements, Jostes said, “we need relationships with federal and state regulators as well as other trusted parties: brokers, carriers, buyers and sellers. They all have their own jurisdictions and expectations.”
The circle of trusting relationships also extends to the consultant that performs the Phase I Environmental Site Assessment — the first step in environmental due diligence that identifies potential or existing environmental contamination liabilities — said David Rieser, head of the Environmental, Regulatory & Redevelopment Law practice at Much Shelist.
“Hire a reputable consultant,” he said. “A great deal depends on the quality of the people who do the work.”
A careless assessment could miss things such as underground storage tanks, which are prone to leaks, “weird pipes you can’t understand” and an unexplained patch of fresh cement — any of which should trigger further investigation, Rieser said.
Those problems could kill the deal or change its terms, since liability for problems on a property transfers with ownership.
Phase I Environmental Site Assessments also include reviewing public documents, such as government databases, building permits and historic fire maps. They create a safe harbor against liability from contaminations.
Demand for Phase I assessments boomed after enactment of the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA), which holds a buyer, lessor or lender responsible for remediation of hazardous substance residues, even if a prior owner caused the contamination.
Risk Transfer Strategies
The National Brownfield Association estimates that $2 trillion of real estate in the United States is devalued due to the presence of environmental hazards — an enormous opportunity for those who can unlock the properties’ redevelopment potential, said Jostes.
The money to be made is legendary: Think Manhattan’s Meatpacking District, the exorbitant neighborhood of young hipsters and boutique-lined streets whose name is the sole relic of its gritty past.
Every kind of property is game for redevelopment, each with its own possible contaminations and risks, said John Wasilchuk, account executive and environmental specialist, Lockton.
Abandoned residential buildings, for example, may have mold, asbestos or lead that require remediation. They may have housed meth labs, leaving behind chemical waste that may be reactive and toxic to human health and the environment, since meth cooks — unlike the fictional Walter White — tend not to be meticulous housekeepers.
Defunct gas stations may suffer petroleum contaminations in soil and groundwater from leaky underground storage tanks, and old agricultural sites could leave fertilizer, pesticide and herbicide contaminations behind, especially at points where the chemicals were stored, loaded or unloaded.
“Even if the indemnifier’s parent company is highly rated by Moody’s or A.M. Best, do we have the financial backing of the parent, or is it limited to the assets of the limited liability company?” — Matt O’Malley, president, North America environmental insurance business, XL Group
Between developers’ appetite for brownfield properties as the economy recovers and strict environmental regulation, the robust pollution legal liability market is “a huge enabler” of brownfield development, said Jim Vetter, environmental risk, insurance and solutions expert, managing director, Marsh.
Traditional pollution insurance will cover unknown contaminations that emerge post-sale, but not known contaminants, many of which buyers, sellers, insurers and regulators should be aware of from the due diligence studies, said Wasilchuk.
Along with “workhorse” pollution legal liability products, transactions also lean on the resurging remediation cost cap insurance market, said Vetter. Although many buyers and sellers still “play hot potato” with known cleanup liabilities through transactional methods, such as indemnification, purchase price adjustment and escrow accounts, they also look to environmental liability buyouts.
In these transactions, a third party assumes ownership in perpetuity of a property’s known environmental conditions in exchange for payment. The buyout company takes on responsibility for remediation and liability.
Among the advantages, said Jostes, is that such arrangements free property owners to concentrate on their core business while the buyout company “owns” and neutralizes the relationship with regulators, which can be adversarial with property owners.
The Power of Indemnification
In some cases, said Mary Ann Susavidge, chief underwriting officer, XL Group, sellers don’t want buyers to perform due diligence and will sell a property only on a “buy as is, where is” basis.
Lacking an appetite for environmental risk, banks often require a Phase I inspection, but buyers that finance the purchase themselves may still accept those risks for a desirable property, either stand-alone or bundled in a portfolio.
“If the property is so desirable, and if the buyer feels it’s educated enough about potential risks, it becomes a ‘don’t ask, don’t tell,’ situation,” Susavidge said. “If they poke around, state or federal regulations may force them to take corrective action.”
For example, the Industrial Site Recovery Act (ISRA) may pertain to New Jersey properties, where certain types of operations trigger a requirement to perform an environmental investigation that may not be required in other states.
“If the new entity wants to add the property to its portfolio, it might be motivated to take on the perceived risk. It’s a risk management choice,” Susavidge said.
A buyer forewarned of likely contamination may negotiate a reduced price, said Cathy Cleary, executive underwriter, XL Group, who is also an environmental attorney. She looks at a laundry list of contractual items that make a strong indemnity for buyers and sellers. It may come in the form of a purchase and sale agreement, or a separate indemnity agreement.
For example, who is responsible for investigation of any environmental issues and subsequent cleanups? If there are claims, how are they made, and who pays? What kind of protection is the buyer getting for future environmental liability obligations, and how long will the indemnity last?
Are there monetary caps on the indemnity — say, for the first $2 million only? Are there retentions before the indemnification pays? If contamination migrates to or from another property, who is responsible for the cleanup? Who is responsible for bodily injuries in the community? Property claims? Third party claims?
Most important is the financial strength of the indemnifier. A seller that is a limited liability company raises a red flag, said Matt O’Malley, president, North America environmental insurance business, XL Group. “Even if the indemnifier’s parent company is highly rated by Moody’s or A.M. Best, do we have the financial backing of the parent, or is it limited to the assets of the limited liability company?”
Quantify the Risks
Ann Viner, general counsel and director of environmental risk management, WCD Group, said brownfield risk management is like a three-legged stool composed of the contract, the insurance, and properly scoped schedule and budget.
All three are best managed by quantifying the property’s environmental risk, she said, which is separate and distinct from a qualitative “guestimate” based on the kind of contamination and historical outcomes of similar properties.
Quantifying the risk is relatively easy in transactions involving a single property, said Marc S. Faecher, senior vice president at TRC, a risk management, engineering, and construction management organization.
With a single property, he said, “you know where the property is located and what its issues are.”
However, he said, portfolios of real estate that blend desirable and impaired properties across primary, secondary and tertiary markets require more detailed analysis. Portfolios likely involve sites facing a variety of issues, and apportionment of responsibility between buyer and seller can be complicated.
“You need to analyze what ultimate cleanup costs would be and what cash flow impacts would be. You need to analyze when the liability would hit and deal with structuring remediation programs to reduce liability over time,” Faecher said.
Experienced consultants aim for a cost risk with a 95 percent degree of confidence, said Viner.
To quantify risk, the consultant develops data inputs for a risk modeling program, then runs iterations based on various scenarios. A lower confidence level can produce a spread of several million dollars in estimated cleanup costs, but a good quantitative analysis will identify the driver for the low confidence level, such as PCBs in the sediment.
Once aware of what information is missing, the consultant can obtain additional data on that driver. Using the new data, a risk modeling program produces a closer estimate of likely remediation costs.
“We know more about what remediations are called for, how much they’ll cost and how long they’ll take,” Viner said. “We can define better contract terms, better and more specific insurance coverage. Quantifying risk helps all three legs of the risk management stool.”