ENVIRONMENTAL CONTAMINATION AND POLLUTION INSURANCE
By Gregg A. Nathanson, Esq1


Ten years ago, purchasers avoided contaminated property like the plague. Times have changed. Today, someone who buys contaminated property can take several steps to manage or practically eliminate the risk of environmental liability.

Traditional Methods of Allocating Risk

Many traditional methods of allocating risk in a real estate transaction apply to the allocation of environmental liability. For example, the purchaser's "due diligence" investigations of the property should include performing a Phase I environmental site assessment of the property to determine whether further inquiry is required. If there is evidence of one or more recognized environmental conditions, then a Phase II subsurface investigation should be performed.

In addition to performing due diligence, the representation and warranty provisions of a purchase agreement can and should allocate environmental liability. For example, the purchaser may request a "straight" representation and warranty that the property is in full compliance with all environmental laws. The next best scenario is for the seller to represent and warrant that, "to the best of their knowledge, after diligent inquiry," the property is not contaminated. On the other hand, the seller would prefer to limit the representation and warranty to the best of the seller's knowledge "without independent inquiry," or to those environmental problems actually caused by the seller. Better still, the seller would prefer to make no environmental representations or warranties whatsoever, and insist on selling the property in "as is" condition.

In addition to representations and warranties, the purchaser will want the purchase agreement to contain a broad seller indemnification regarding environmental matters. The seller will want to avoid any indemnity. The parties may mutually agree that the seller's indemnification will be limited in a number of ways. For example, the indemnity may terminate after a fixed period of time; it may apply only after a minimum "basket" amount of environmental damage is suffered by the purchaser; or the seller's maximum environmental liability may be "capped".

If the parties are motivated to close the transaction before they have fully addressed environmental issues, the purchaser may require the seller to place a portion of the sale proceeds "in escrow". These funds could be drawn upon to remediate the property, or collateralize the seller's environmental indemnity of the purchaser regarding potential third party personal liability or property damage claims or remediation.

Finally, the parties may negotiate a reduction in the purchase price in consideration for an agreement by the purchaser to assume some or all of the seller's environmental liability. Unfortunately, considering the potential enormity of environmental liability, sometimes simply deciding

Baseline Environmental Assessments

In 1995, Michigan enacted sweeping environmental legislation intended to permit buyers to avoid liability for existing site contamination. This law requires buyers of contaminated property (called a "Facility") to perform a baseline environmental assessment ("BEA"). The BEA establishes a "baseline" for existing contamination, and considers the purchaser's proposed future use of contaminants at the site. To avoid environmental liability, the purchaser must disclose the results of the BEA to the Michigan Department of Environmental Quality ("MDEQ") and to any subsequent purchaser or transferee. In addition, the buyer may petition the MDEQ to review the BEA and request a written determination of the buyer's exemption from liability. In other words, the MDEQ will tell the buyer, in writing, that they will not have environmental liability.

Even if MDEQ determines that the buyer is generally exempt from environmental liability, the buyer will still have certain statutory "due care" obligations with respect to existing contamination. For example, the buyer may not do anything to exacerbate existing contamination. In requesting a written determination of nonliability from the MDEQ, the buyer may also set forth their proposed due care activities, and ask the MDEQ to approve those activities, in writing, as well.

Reasons for Obtaining Pollution Insurance

There are a number of circumstances when traditional contractual provisions regarding allocation of risk, coupled with a BEA, still are not sufficient to protect against environmental liability. Here, the parties should consider obtaining pollution insurance.

The biggest and most obvious reason for obtaining pollution insurance is to quantify economic uncertainty. The purchase and sale of real estate is a financial transaction, and the transaction may not make good economic sense after considering potential environmental liability. Sometimes the amount of the potential environmental liability may well exceed the purchase price of the property. Other times the seller may not be receiving proceeds sufficient to cover the cost of any environmental clean-up. Finally, it may be difficult or impossible to quantify the amount of potential environmental liability. The purchaser may prefer to limit their risk by paying (or causing seller to pay) a fixed insurance premium, rather than face open-ended environmental liability.

A second reason to obtain pollution insurance relates to timing. Often the parties will want to complete the transaction before the property has been fully remediated. It may not make economic sense for the purchaser to wait 6 months or longer until the property is clean, before going forward. Pollution insurance may facilitate closing the transaction by providing assurances from an independent third party insurer that the property will be remediated to acceptable levels, on a timely basis.

In addition to issues of time and money, pollution insurance is an extremely flexible product which can be tailored to meet the varied interests of the parties. Pollution insurance can be responsive to a unique set of circumstances that surround the transaction. Buyers, sellers, lenders, tenants, contractors and regulatory agencies each may be involved with the contaminated property, and pollution insurance may offer certain benefits and opportunities for just about everyone involved.

Types of Pollution Insurance

There are four basic types of pollution insurance currently available: clean-up "cost cap" property coverage; pollution legal liability insurance; owner controlled insurance; and secured lender coverage.

Clean-up "cost cap" property coverage. This type of environmental insurance provides the insured with a cap on the total cost to remediate known contamination. For example, if a remedial action plan suggests that the site can be remediated for $500,000, then the insurance may apply a cost buffer (or deductible) of $100,000, and provide the insured with anticipated exposure of $600,000. If total remediation costs exceed $600,000, insurance will make up the difference, up to the total amount of the policy. The insured is permitted to "cap its costs". This type of insurance covers substantial cost overruns encountered when cleaning up known contamination. The insurance can facilitate a purchaser's decision to assume certain environmental risks associated with buying contaminated property. Why? Because some independent (and presumably solvent) third-party insurance company is going to assume the risk of clean-up cost overruns.

Some environmental contractors will agree to assume environmental clean-up liability for known contamination associated with the site, for a fixed fee. In exchange for an up-front guaranteed fixed price, the environmental contractor will perform all work necessary to remediate the site and even obtain a government approved closure. Under these circumstances, the environmental contractor usually purchases clean-up cost cap coverage, to ensure that they have the resources to clean up the property if substantial unanticipated cost overruns are encountered. While the cost of a fixed cost, guaranteed remediation contract is not cheap, the benefits can be significant. A party who may otherwise have unlimited environmental liability can be freed from many or all of those liabilities in exchange for a current lump sum payment. The cost usually equals the estimated remediation cost, plus a premium to cover cost overruns and the contractor's profit. The remediation guaranty is usually assignable to subsequent parties, including purchasers and lenders, thereby facilitating the sale or refinance of the property.

The parties may also purchase environmental remediation insurance which protects against unknown but existing contamination, which is later discovered on the property. This insurance may also cover unknown contamination that migrates onto the property, as well as spills or accidents which first occur during the policy period. In many ways this is analogous to traditional casualty insurance coverage (i.e., coverage against loss due to a fire which occurs during the policy period).

Pollution Legal Liability Insurance. Pollution legal liability insurance protects against third party liability claims arising from environmental matters. Third party claims include off-site bodily injury, property damage, and clean-up costs caused by contamination which came from the subject property. Suppose the purchaser buys property that was once contaminated and later cleaned up. The purchaser may fear that some of the contamination seeped into the groundwater, then migrated off-site into the neighboring dairy farmer's water supply. The purchaser's business could not withstand potentially enormous environmental liability if, for example, the neighbor's cows drinking the water start dropping dead. This type of policy protects the insured against catastrophic unknown environmental liability.

Pollution legal liability insurance also includes protection for environmental liability relating to transportation and off-site disposal of environmental contaminants. In addition, pollution legal liability insurance may cover business interruption and diminution in value due to pollution conditions. The insurance product can be tailored to meet the insured's specific liability concerns based upon the environmental contaminants, property and business involved.

Owner Controlled Insurance Program. Owner controlled insurance is a type of "wrap-up policy" that addresses all of an owner's insurance needs regarding an entire project, including environmental liability. Instead of worrying about the adequacy and policy limits of insurance obtained by each contractor, the owner can obtain one policy that wraps up or includes general liability, property damage, contractor claims, worker's compensation and professional liability, along with environmental liability associated with remediation, pollution legal liability, and off-site transportation and disposal. This type of policy guarantees cohesiveness of coverage. It can simplify and streamline coverages and claims procedures. The owner will enjoy a greater degree of control over job-related insurance costs. Owner controlled insurance can assure that the owner is always the named insured and protected against depletion of limits of coverage on contractors' policies. Owner controlled insurance may even provide economies of scale which can ultimately decrease overall insurance premiums.

Secured Lender Coverage. The fourth type of pollution insurance is designed to protect secured lenders. Few banks want to make loans secured by contaminated property. The value of the collateral is diminished if the property is contaminated. Also, if the owner/borrower is required to expend significant resources cleaning up the property, these are resources which otherwise could have been used to capitalize the business or pay borrower expenses, including debt service. Finally, if the borrower defaults, the bank does not want liability for environmental conditions relating to foreclosed property.

Secured Creditor Impaired Property Insurance is specifically designed to protect commercial lenders. The insurance coverage is triggered if the loan is in default, and an on-site pollution condition is discovered. The policy will pay the lender the lesser of the outstanding balance of the loan, or cleanup costs. The policy is not triggered until and unless there is an event of default by the owner/borrower. Secured lenders may also obtain pollution insurance coverage against liability for third party bodily injury, property damage, and claims for clean-up costs resulting from on-site pollution conditions. These types of pollution insurance policies can provide secured lenders with a form of additional collateral in the event of a default associated with contaminated property.

Conclusion

Pollution insurance can be a valuable risk management tool to limit potential environmental liability. It can supplement the traditional methods of allocating risk in a real estate transaction, including proper due diligence, representations and warranties, indemnifications, placing funds in escrow and reducing the purchase price. It can also supplement obtaining a BEA and written determination of nonliability from the MDEQ. Despite their best efforts, however, the parties cannot always avoid or prevent environmental liability, or reduce the severity of environmental losses. Under these circumstances, the parties may choose to purchase pollution insurance to transfer the risk of certain environmental liabilities to an independent third party insurer. The policies can be tailored to accommodate the insured's specific concerns. In sum, when facing potentially large environmental liability, for clean-up or possible third party claims, the parties should consider pollution insurance as a way to help control their environmental liability.

The information contained herein does not attempt to give specific legal advice. For advice in particular situations, the services of a competent legal advisor should be obtained. This article is the exclusive property of Couzens, Lansky, Fealk, Ellis, Roeder & Lazar, P.C., and no reprint or other use of the information contained herein is permitted without the express prior written authorization of Couzens, Lansky, Fealk, Ellis, Roeder & Lazar, P.C.

© 1999 Couzens, Lansky, Fealk, Ellis, Roeder & Lazar, P.C. All Rights Reserved.

Reprinted with permission from Building Business & Apartment Management (April 1999), publication of the Building Industry Association of Southeastern Michigan.

1. Gregg A. Nathanson is a shareholder with the law firm of Couzens, Lansky, Fealk, Ellis, Roeder & Lazar, P.C. in Farmington Hills, Michigan. Mr. Nathanson maintains a transactional practice with emphasis on real estate, environmental and corporate matters. Mr. Nathanson is a frequent speaker at Michigan State Bar and Institute of Continuing Legal Education programs, and he has published articles on various topics in real estate law. Mr. Nathanson also chairs the Michigan State Bar Real Property Law Section Committee on Residential Transactions. He may be reached at (248) 489-8600; or by E-mail at gnathanson@couzens.com.

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