Grand Plan: A Sample Scenario
Your plans are made. The premise is set for your business and you embark upon site location. Lo and behold, you come across a vacant corner lot located in the middle of a commercial zone. Negotiations begin and before you know it, a letter of intent is executed and due diligence begins.
In a perfect world, professionals are engaged through proper legal channels — you include architects/engineers, your preferred broker at NFP, environmental consultants and your good friend who happens to be a commercial real estate broker for Avison Young. Legal works with your environmental consultant to formulate a scope of work that will lay the foundation for a Phase 1 Environmental Site Assessment. The consultant raves about their vast insurance program and how very well insured they are, then sends a final scope of work to you, the buyer, for execution.
Unfortunately, you and legal do not discover until after the fact 1) consultant has strong limitation of liability and liability is limited to cost of engagement, 2) no third-party reliance can be made upon Phase 1 and 3) Ground Penetrating Radar will not be utilized. Furthermore, the scope did not include a Freedom of Information Act request and failed to satisfy the minimum requirements for “all appropriate inquiry.”
Due Diligence
The environmental consultant deploys personnel and limited equipment to site in order to commence Phase 1. Draft report comes back relatively clean with a few minor issues such as soil staining and patches of dead weeds. Presumably the consultant will note in the summary and conclusions that soil staining is a recommended environmental condition, and that in their professional opinion further investigation is warranted. However, you elect not to pursue subsurface testing as suggested by environmental consultant.
Your broker reminds you that a duty to defend by the insurer is much broader than duty to indemnify, and notes that most of our clients purchase pollution liability insurance because it prefunds litigation expenses arising from contamination on, at or from the insured location (job site). This insurance is designed to provide coverage for discovery of previously unidentified contamination, tort liability (third-party bodily injury and property damage) arising from pollutants and legal defense. You elect not to purchase pollution legal liability cover as presented by NFP. Due diligence concludes and closing occurs.
Development
The planning board approvals are received, and you now morph from buyer to developer. Lender negotiations begin and a term sheet is executed. The bank agrees to provide your development team a 70% LTV “loan to value” contingent upon 1) a clean Phase 1, 2) execution of lending and environmental indemnity agreements. Funds are transferred to development team, and dirt starts moving.
Surprise
Work comes to a screeching halt when a backhoe discovers a tank of heating oil, until you and the contractor and your environmental consultant meet with representatives from the state environmental protection agency to formulate a remedial action plan.
While the merits of a remedial action work plan are discussed and negotiated, carrying costs such as interest expenses, property taxes and legal costs accrue. To complicate matters further, you personally executed an environmental indemnity agreement with lender, which obligates the developing entity, its members and partners plus the trust and estates of the individuals to defend and indemnify lender for loss caused by environmental conditions on or at the site.
State representatives sign off on remediation proposal presented by consultant and now you must present findings to your lender for approval and final sign off.
Assuming the lender has its own set of professionals review reports and opine on proposed remedial methods, you can proceed with remediation and development. You’re unhappy but not surprised when you receive an invoice from the lender for services rendered in response to the discovery of the tank and proposed remediation. Remediation proceeds as planned and you receive a No Further Action letter from state regulators. Development is completed.
True Cost of Risk
The project is now complete and fully rented/leased. However, the discovery of unknown contamination during capital expenditures, aka CAPEX, stopped development temporarily and added unanticipated costs to development budget.
When looking at the true cost of environmental risk, one should consider quantifiable versus unquantifiable risks. For example, quantifiable risks are:
- Remediation costs, true cost to clean up property to standard in line with proposed use — “how clean is clean.”
- Carrying costs such as interest expenses, real estate taxes and engineering/design fees post remediation.
- Requests for reimbursement from a lender in response to engaging in house and external environmental consultants to review data and corresponding remedial action plans • Permit and application fees.
Unquantifiable risks include:
- Legal costs to negotiate remedial action plan
- Legal fees for the defense of lender in response to remedial action
- Tort liability arising from discovery and remediation of known contamination (third-party bodily injury or property damage claims)
- Potential liability arising from damage to groundwater or other natural resources
Conclusion
With proper due diligence and utilizing professionals entrenched in brownfield redevelopment projects, many of these risks are transferable to potential insurers or can be mitigated through contractual indemnification obligations. However, it cannot be stressed enough that environmental indemnity agreements can be punitive and oftentimes flow through the entities to the individuals, the estates and potential heirs. Understanding the breadth of potential obligations that could be put on you as the buyer/developer aids NFP in identifying risks that are insurable and uninsurable with an ultimate goal of providing clients balance sheet stability utilizing environmental insurance.