Environmental Liability: New Insurance Policies Can Help Protect Investors against Unseen Risk
Dunn, Jim H., Journal of Property Management
As president of the property, management company that has been selected to manage a property that contains asbestos that is not going to be removed, how do you protect your company and the owner from potential liability? Any claim for illness caused by the asbestos may not occur until 20 or more years from now.
As manager of a shopping center that has a dry cleaner as a tenant, how will you pay for cleaning up contamination caused by that tenant? How will you deal with the expense of cleaning up pollution caused by someone dumping contaminated material on your property?
If one of the properties you manage has to undergo remediation, what will be your recommendation to the owner and lender as to how they, as well as your company, can be protected from any liability created by the cleanup process?
Buyers most often attempt to negotiate an indemnification agreement from the seller on environmental issues. Does this agreement also cover the lender and management company? The Environmental Protection Agency (EPA) does not recognize indemnification agreements and starts its chain of liability with the current owner, lender, and, under some circumstances, management company. What assurance is there that the entity giving an indemnification agreement will be financially capable of paying a claim years down the road? Is a reserve being set up by the seller to cover this liability? If the seller does that, how is it treated on the financial statement or balance sheet and how is that looked upon by its lenders?
The Growing Problem
The issues and considerations surrounding environmental liability are myriad and are unlikely to improve any time soon. A national study published in 1991 estimates that by the year 2020, an additional 43,616 sites will be added to the current list of 37,500 for a total of 81,116 sites potentially in need of remediation. The study, published by the Waste Management Research and the Education Institute of the University of Tennessee, estimated that 30 percent - 24,335 sites - will require remedial action.
The report further estimates that the total number of sites not covered by federal cleanup funds will be from five to 15 times greater than the current National Priorities List - EPA's list of sites identified for long-term remediation. Costs, not including discovery, will typically reach $1 million per site.
Is It Worth the Risk?
Given the increasing number of sites and the rising costs of remediation, what is the most cost-effective method to protect against the possibility of an environmental contamination claim? The options are few. Many buyers and sellers - but not lenders - rely on a Phase I audit. Phase I is a historical review of a property's ownership and use. Typically, environmental databases are searched for potential contamination that may have occurred within a half-mile radius of the property. Any property uses that might have caused contamination are then researched specifically.
Yet how accurate are the Phase I audits? Last year the New York Law Journal reported that a new survey of 33 environmental engineering firms nationwide found that 21 percent of Phase I reports "have either overlooked serious environmental problems or have so neglected to document a property's history that a realistic understanding of the dangers of contamination is impossible."
The second option is to have a Phase II or Phase III audit conducted. Each of these is progressively more thorough - and more expensive - than the Phase I. While this reduces the risk, it does not eliminate it. Furthermore, an audit does not guarantee there is no contamination nor does it pay for remediation should contamination he found.
What does offer protection and payment are environmental risk liability insurance policies, which protect property owners, managers, and lenders against environmental liability in real estate transactions. Environmental risk liability policies protect the insured against liability from laws that obligate them to remediate the property. …