Environmental insurance is a crucial tool for real estate professionals looking to maximize value for their clients in commercial transactions.
By Chris Alviggi, Managing Director, Environmental Practice Group Leader, NFP
The Amazon model, combined with the rippling impact of the COVID-19 pandemic, drastically changed the market for commercial real estate. With the newfound demand for industrial real estate in strategic locations near population centers, industrial sellers gained the upper hand when selling property previously considered undesirable. Purchasers, hungry for cheap industrial sites, often acquired property with limited due diligence on potential pollutants on the site.
Depending on how the previous owner used the site, there are many ways a site can become contaminated. When commercial real estate transactions commence, consideration should be given to the environmental conditions on-site and known contamination should be quantified and managed. For sites that present little evidence of contamination, environmental due diligence is often seamless, and transactions can close quickly. Other times, contamination is not adequately quantified, and additional testing is required to determine the best course of action to remedy the situation.
For real estate professionals who want to maximize value for their clients, environmental insurance is a vital tool in commercial transactions. The key to successful placements is understanding the intricacies of purchase and sales agreements. To reach a mutually agreeable outcome in a commercial real estate deal, it’s important to examine the impacts of contractual concessions on environmental insurance placements.
Naturally, sellers want to position their properties and potential environmental concerns in a positive light during the transaction. In addition, sellers aim to contractually transfer as much environmental liability to the purchaser as market conditions permit. While often, both parties can agree on material deal points prior to closing, this is not always the case. In this instance, environmental insurance provides a third-party conduit to this transaction and allows both parties an opportunity to transfer environmental risk to the prospective insurer.
Environmental Cleanup and Closure
Conducting due diligence for potential environmental pollutants is essential in any transaction. The first step in any environmental site assessment is to identify known contaminations. Depending on the findings, either party may agree to allow additional subsurface sampling to quantify the extent of known contamination.
Frequently, sellers are reluctant to allow purchasers to complete additional testing. In this instance, buyers’ knowledge is limited to information from previous transactions already in the public domain. When this occurs, pollution liability insurance can bridge the gap between “known” and “unknown” contamination and the intended future use of the property.
Conversely, if the seller allows for additional testing, the results of the investigation can raise new questions. These questions can be as basic as which party is accountable for cleanup and subsequent regulatory approvals. More complex considerations include assessing which party assumes risk from both a legal and financial perspective. Depending on the outcome and which entity maintains remediation liability, a well-designed environmental insurance plan can mitigate select financial risks for insureds.
Policy Structure
Depending on the specific transaction, insurance professionals may need to consult on which parties can access insurance. Most often, purchasers prefer to be listed first on any insurance policy. This provides the purchaser with additional protection, assuming basic environmental site assortments were conducted. Insurers tend to follow suit and provide the purchaser with the broadest possible risk transfer solutions to mitigate risk from unknown contaminants.
Policies can be expanded to include sellers as well. Depending upon the current state of environmental contaminants, including the seller on post-close insurance, this could aid in finalizing transactions and protect both parties. However, if the seller is unwilling to negotiate or denies responsibility, insurers may be limited in what coverage can be extended to the seller. Based on the particulars of attachable insurance, including open claims and breadth of coverage, insurers might not agree to expand insurance policies.
If insurers agree to grant coverage to both the buyer and seller, provisions should be made if additional pollution is discovered, including how the uninsured findings will be funded and how the costs will be allocated between the parties. Further consideration should also be given if additional parties are included for coverage and whether all parties are prepared to accept the potential dilution of policy limits. Both parties also need to agree on who is responsible for paying the premiums and deductibles, along with what conflicting protections are offered with severability of interests.
Environmental Indemnification for Real Estate Professionals
Environmental insurance policies are designed to provide indemnity and defense coverage for losses arising from pollution discovery on, at or from the property, regardless of whether the property is leased, owned, or rented. Environmental insurance can also include coverage for legal liability and contractual obligations.
Real estate professionals looking to mitigate environmental liabilities for their clients should consider how environmental liabilities are allocated in the contract. In many instances, open environmental conditions remain with the seller until the transaction is formally closed. Conversely, sellers can escrow funds, and buyers can assume remediation and closure liability before closing.
Liability from the recognized environmental conditions can be either retained by the seller or assumed by the purchaser. Insurers are receptive to wrapping around contracts where environmental liabilities shift with a few notable exceptions, such as when the contract of sale does not mirror the insurance intent. In these cases, insurers are reluctant to extend coverage to the seller or unable to have coverage equality amongst the parties, which can complicate transactions that require insurance to close.
Tertiary contracts can be included in environmental insurance policies if a named insured contractually assumes environmental indemnity obligations. Two examples of this are lending agreements and access agreements. In lending agreements, insureds who rely upon commercial debt to acquire property enter into environmental indemnity agreements with a lender. It’s important to note that these agreements can be joint and often include personal or corporate guarantors.
Access agreements, often executed during due diligence, allow third-party site access to investigate conditions on behalf of the purchaser. These agreements include indemnity obligations so accessors can compensate sellers for pollution-related losses resulting from their negligence. Both types of agreements contain broad environmental indemnity shifts and can be included for coverage in environmental insurance policies, but caution should be taken if dilution of limits occurs when additional parties become insureds in environmental insurance policies.
Working as a Team
Placing transactional environmental insurance cannot be done in a vacuum and often works best when done in conjunction with the client’s deal team, which includes legal counsel, environmental consultants, tax and title professionals, debtors, and other interested parties. Ensuring alignment between contracts of sale and prospective insurance policies is a daunting task. However, failure to differentiate between contract terms and insurance terms can lead to misunderstanding and painful claims adjustment.
Our team of experts at NFP is committed to helping you navigate the complexities of environmental liability exposure. Please reach for more guidance or assistance.
Disclaimer:
NFP Corp. and its subsidiaries do not provide legal or tax advice. Compliance, regulatory and related content is for general informational purposes and is not guaranteed to be accurate or complete. You should consult an attorney or tax professional regarding the application or potential implications of laws, regulations or policies to your specific circumstances.
Insurance services provided by NFP Property & Casualty Services, Inc. (NFP P&C), a subsidiary of NFP Corp. In California, NFP P&C does business as NFP Property & Casualty Insurance Services, Inc. (License # 0F15715).