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A site used by an auto body shop came up for sale. The buyer, a clothing retailer looking to build its fourth boutique in the area, wasn’t aware of some potentially harmful chemicals used in the site’s former life. About three-quarters of the way through the deal, one of the site inspectors developed what appeared to be an allergic reaction. The site was contaminated because of some of the chemicals the body shop used years earlier for paint and enamel work. The deal was off. The retailer wanted nothing to do with the site and was angry by what it deemed was a blatant lack of disclosure. The seller wasn’t aware that environmental insurance could offer protection when cleanup and pollution issues arose. In this case environmental insurance could also have helped save the deal. Environmental insurance can be a valuable tool in successfully closing real estate transactions. In many cases a buyer can purchase insurance to head off problems concerning possible pollution conditions that may exist on the property. And for sellers, insurance can offer protection in the event that they are pulled into a case related to the time when they owned the property. Since environmental insurance is a “claims made” policy — in other words, once the policy is in effect, the holder is covered no matter when the underlying event occurred — they would be covered even though they sold the property. Many attorneys, however, know very little about environmental insurance. Knowing where to turn on trickier issues can help any attorney close a deal. This is not to minimize the difficulties that environmental issues can create. Superfund sites, brownfield land, environmental legislation — all can create seemingly insurmountable obstacles arising from environmental liabilities. Faced with them, you are probably well advised to use a specialist to help you and your client identify the optimum environmental insurance solutions. THE ABCs The basic coverage most environmental insurance policies provide includes pollution cleanup; indemnification for third-party claims for bodily injury, property damage, and cleanup costs; and coverage for legal defense costs resulting from claims. When attorneys seek to include environmental insurance as part of their real estate transaction, basic coverage is usually provided in some form to one or more of the transaction parties, including, especially, the lenders. In many cases the lender requires this insurance in order to provide the loan or mortgage. From the lender’s point of view, if some pollution condition arises requiring cleanup or that creates a liability for bodily injury, the lender wants to know that the borrower can pay for the problems and avoid defaulting on the loan. In addition, the lender is often added to the policy to further secure those protections for the lender’s interests. Of course, the parties often have to negotiate specific policy terms. For example, if a site is known to have a certain type of pollution, such as a chemical used in the dry-cleaning process, but the levels of that pollutant are below state cleanup standards, a policy might be a good idea. The policy could ensure that if the levels of the chemical rise unexpectedly and require cleanup, the policy would cover the costs. RESEARCH AND PLANNING There are many reasons to explore the use of environmental insurance as an integral element in a real estate transaction. Many think of the most obvious — either large, severely contaminated sites or high-risk neighboring properties — but most don’t immediately consider other factors, like historical usage (the human activities that have occurred at the site) or low-risk tolerance (buyers who don’t want any exposure to financial loss), on the part of the buyer or the seller. Even fewer think of the smaller transactions that make up the vast majority of deals done today: the middle market. Although the prevailing idea is to incorporate environmental insurance only into larger transactions or to use it for severely contaminated industrial sites, there are many middle-market real estate transactions that could have been made more profitable or been saved altogether had insurance been considered. For instance, a small commercial real estate developer might specialize in properties constructed more than 10 years ago with purchase prices in the $2 million to $10 million range. This developer might be looking at buying a neighborhood shopping strip that has a dry-cleaning establishment. But because of the high risk of contamination from the dry cleaners, lenders are balking at providing any money for the deal. That’s when environmental insurance can protect sellers, buyers, and lenders in the event that regulators order a cleanup or a neighboring property makes a claim about migrating pollution. These kinds of situations are rarely considered candidates for environmental insurance. Identifying deals where insurance can help takes careful consideration and involves discussion and coordination with representatives of both the buyer and seller, as well as with third-party constituents. In contrast to other forms of “standard” insurance policies, insuring a building against fire, for example, is simple: All you need to know is whether the value is accurate and the premium makes fiscal sense. Environmental insurance requires an in-depth analysis of known and unknown pollution potential at a site. The policy can be specifically tailored to provide the precise coverage needed down to specific types of contaminants or even specific portions of a property parcel. There are very few environmental insurance brokers in the country. Working with a specialist can be beneficial, not just financially but also in terms of saving time — facilitating negotiations with constituents involves knowing how to “speak their language.” Specialists bring expertise, relationships with insurers and insurance brokers, and an ability to perform a complex analysis of each transaction’s risk scenario. ENGINEERING THE CONTRACT Determining the appropriate level of risk transfer — the risk of financial loss to an organization that is transferred to the insurance company — for a particular transaction can be the key to whether or not a deal will work. Some apparent environmental liabilities will require full transfer of risk to the insurer. In many other complex situations, however, only part of the risk needs to be transferred, and, in still other situations, alternatives must be considered. The standard elements to consider are as follows: • Third-party liability (legal responsibility to others caused by bodily injury or property damage arising from pollution and the concern of resultant financial loss)

• On-site and off-site cleanup (demands by environmental regulators to bear the cost to clean up pollution on the owned site or to pay for the cleanup of neighboring properties that had been contaminated by pollution emanating from the insured location) • Known conditions and remediation requirements (pollution that is known to exist on the property and whether it is necessary or may sometime become necessary to clean up the pollution) • Policy limits, retentions, and term options (the amount of insurance, the deductible on the policy, and the number of years the policy will be in effect — up to 20 years in some cases) Each of these elements must be carefully weighed to determine the right mix for each circumstance. In addition to the basics, many buyers will also require that environmental reports be prepared and specific remediation plans be put in place before finalizing the agreement. Negotiating the policy can take time and energy. After all, one size does not fit all in environmental insurance, and certain underwriting restrictions and capacity limitations on the insurance will mean compromises in the policy language and, ultimately, the coverage. Purchasers of insurance must be willing to sometimes cede some ground and take more limitations and restrictions, or pay a higher premium or agree to a higher retention level and certain coverage triggers. Though seemingly a standard transaction, structuring the insurance policy is more of an art than a science. Structuring the policy usually begins with an in-depth environmental review and analysis. This requires coordinating with the engineering staff, insurers, and regulators. An on-site inspection may also lead to some engineering recommendations, such as known condition remediation pacts (agreements to clean up pollution that have been reached by regulators and/or others before the sale), action-level triggers (the level of contamination that, when reached, triggers regulators to order a cleanup), and individual contaminant exclusions or limitations (the insurance policy stating specifically what types of losses it will not cover or will only provide partial coverage for). DONE DEAL? Anyone who has been through several real estate transactions involving environmental insurance knows that you hold your breath toward the end, but frequently “something comes up” and the deal is off. Potential deal-killer issues almost always arise, and having the right transaction team to guide you through a restructuring of the deal is critical. In the same vein, having someone to help you with the insurance policy refit is also necessary. In certain cases potential insureds will have to take on more risk, cede more capital in terms of premium, or even evaluate alternative coverage solutions, such as forming their own insurance company to cover specific types of risk. An environmental insurance policy, much like a mortgage on a property, does not renew on a regular basis. For better or for worse, that means it is likely there for the life of the property, long after the deal is done. Once the ink on the deal is dry, it is vital to keep the lines of communication open and be in regular contact with the individual parties regarding the status of the property. Lenders, for example, always want to know the value of, and liabilities to, the asset underlying their loan. Any new developments must be communicated, and in the case of negative developments, a plan for remediation and risk adjustment must be formulated — fast. This sometimes happens when a property was insured while it was used for one use, such as industry, and then moved into another use. Examining the importance of environmental coverage means making sure all parties involved realize the financial benefits of using insurance as a tool in structuring a real estate transaction. I hope this rough guide to the insurance placement process can help with some of the basics. Structured correctly, insurance can help attorneys in successfully closing more of their middle-market real estate deals.


John Butler heads PBC Environmental, the wholesale environmental insurance specialty practice of Hub International Ltd. in New York.

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