Environmental Due Diligence for Lenders

Article excerpt

This article considers the basic components of environmental risk management, the various factors considered by most lenders, and the information needed to facilitate the closing of the transaction. Although loans may be secured through various means, the author focuses on transactions secured by real estate or real property.

Conducting environmental due diligence--whether a Phase I environmental site assessment or Phase II subsurface study--is the mainstay of the environmental consulting industry. Much of this due diligence is conducted on behalf of either a lender or a purchaser and, in almost every instance, is done to obtain a financing decision. However, consultants generally have little understanding of how the lending industry uses the data they collect. What they do see is the variability in how each lender applies policy, procedures, and use of the consultant's work product. Lenders can ensure receiving the information they need to fulfill their due diligence requirements by making their wants known to the consultant.

Due Diligence Ensures Collateral

Each institution administers loan policy a bit differently, although with the same goal of due diligence. Generally, due diligence is required when a loan is supported by real estate or real property. This way, in the event of a default and subsequent foreclosure, the institution can sell the real estate or property and repay the debt. In such instances, the real estate or real property becomes the collateral. Loans also may be secured by personal guarantees, accounts receivable outstandings, inventory, marketable securities, and other non-real-estate or non-real property, and these may even be cross-collateralized with real estate or real property.

Let's take a closer look at the lending process and the varied approach by some lenders, followed by some suggested "do's" and "don'ts."

Varied Due Diligence Objectives

Each party in a real estate loan transaction has its own reason for conducting due diligence, but all share the objective of executing the transaction:

* Lenders need to be informed of the borrowers' known and potential liabilities to measure their ability to repay in the event funds are diverted for environmental purposes. Moreover, lenders need to ensure that the collateral is marketable at a value exceeding the loan amount in the event of default.

* Borrowers may desire to make an informed decision or establish an "innocent purchaser defense" (1) for new purchases, or they may be compelled to perform due diligence by their lender for reasons cited above.

* The consultant, who may be retained by a borrower or a lender, conducts due diligence for any of the reasons above.

On top of meeting the needs of borrowers and lenders, the consultant must contend with varying degrees of risk tolerance and lender experience, as well as differences in due diligence policies.

Loan Criteria

A lender provides funds to a borrower only after being assured that a loan can be repaid and that there are sufficient assets or guarantees pledged to cover the loan amount in the event of default. Therefore, lender environmental policy and procedures should be integral to the credit, asset, collateral, and foreclosure analysis process.

Environmental Credit Review

The primary focus of the environmental credit review is to identify the potential, or known, environmental liabilities that could divert the borrower's cash flow to address environmental problems. Liabilities may include:

* Expenditures for engineered controls to prevent unacceptable exposure.

* Third-party agreement transfer of environmental cleanup liability to the borrower.

* Strict joint and several liability (for example, PCB cleanup under TSCA or RCRA liability--large quantity generator sites with incomplete or ongoing cleanups).

* Legal claims for cleanup nr other damages, such as replacing a municipal drinking-water well. …