EVERY LENDING INSTITUTION and risk management professional should know that environmental risk is a part of everyday lending. Typically, a lender's environmental risk evaluation begins at loan origination with the ordering of a Phase I environmental report. Other lending personnel, including workout or special assets officers, also should be aware that environmental risk could impact an otherwise performing commercial real estate loan, as well as loans to manufacturing facilities and other operational facilities. Too often, such risks are discovered upon foreclosure.
Million-dollar cleanups and damages awarded to plaintiffs for environmental liability are commonplace. Following is a list of individual cases involving real estate that resulted in enormous financial damage:
* An award of $13 million for property damage due to contamination.
* A $6 million property now worth $3 million as a result of contamination.
* Awards of $4.75 million and $4 million to individuals for contamination.
* A $2.5 million award to an individual for contamination and subsequent damages.
What's significant about this list is that the real estate collateral is residential property
Residential Properties: Where Is the Environmental Risk?
A common misconception is that residential properties either pose no environmental risk or may present only minor issues with mold, radon, asbestos, or lead. Most lenders and risk management professionals are surprised to discover that environmental risk and its associated liability are not confined to commercial lending.
FDIC Makes No Distinction between Commercial and Residential Properties
The FDIC document "Guidelines for an Environmental Risk Program" states: "The potential adverse effect of environmental contamination on the value of real property and the potential for liability under various environmental laws are important factors in evaluating real estate transactions and making loans secured by real estate." (1) Federal banking regulators and their counterparts at the EPA and state agencies do not differentiate between commercial property and residential property when it comes to environmental liability.
Case Examples of Environmental Risk with Residential Properties
Financial institutions, third-party consultants, attorneys, and risk managers should take note that substantial environmental risk is not confined to commercial lending.
$3.75 Billion Residential Property Class Action for Local Gas Station Leak
In April 2010, approximately 75 residents in Frederick County, Maryland, filed a $3.75 billion lawsuit against multiple fuel companies. The suit alleges groundwater contamination at their residences as a result of gasoline leaks from a local gas station. (2) The lawsuit seeks $50 million for each resident in compensatory and punitive damages. Damages alleged include bodily injury harm due to exposure to gasoline and gasoline-related products. The theories of liability are numerous and broad enough to include negligence, strict liability of an abnormally dangerous activity, private nuisance, and trespass to land.
A local lender commonly extends credit to several borrowers in a single community, unintentionally concentrating the bank's loan portfolio in a confined geographic area. A 2007 Fitch Ratings report lists geographic region as the second highest variable for default. Did the members of the local bank's credit committee have guidance or concentration limits on geographic loan exposure? A logical supposition is that the lenders also were unaware of the potential environmental risk to this community.
$4.75 Million Awarded for Mold in a Single-family "Dream Home"
In 2005 the Mengs purchased their $900,000 dream home: a 5,900-square-foot luxury home with Brazilian cherry flooring, a wrought iron staircase, high ceilings, and three fireplaces. …