An Ever-Evolving Approach to Environmental Risk Management

By Ezovski, Derek | The RMA Journal, April 2016 | Go to article overview

An Ever-Evolving Approach to Environmental Risk Management


Ezovski, Derek, The RMA Journal


I'm a sports fan, and I love watching my kids' games. One of my favorite activities in my so-called downtime is cheering on my daughter's soccer team. Nothing quite matches the thrill of watching a group of five-year-olds running in every direction. They are clearly having a blast and burning off a lot of energy. But that chaotic energy isn't always well placed or used in the most efficient manner.

Commercial real estate lending can seem similar at times. As a lender or risk management professional, you are pulled in many different directions on any given day. The clock is running, and as you work to close a hot deal, you worry about beating out the competition, pricing appropriately, applying rigorous credit analysis, and performing appropriate due diligence, including site visits and appraisals. All of this is happening while your client is breathing down your neck to get the loan to closing. No wonder you feel like you're running around in circles!

Environmental analysis is an important yet frequently overlooked component of any risk management program and one that borrowers rarely understand. But with a few adjustments, the environmental due diligence process can be repositioned as a service to enhance the borrower relationship and create lasting value over the long term. This article shares some hot trends in the environmental space as well as some best practices.

Why an Environmental Review?

There are several reasons why financial institutions involved in commercial real estate (CRE) lending should have a robust and well-considered environmental risk management program.

1. Lender Liability: The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA, also known as "Superfund") was enacted in 1980 as the federal government's solution to cleaning up sites contaminated by hazardous substances and pollutants. However, it really didn't make an impact on the banking industry until a decade later, when the U.S. Court of Appeals for the Eleventh Circuit handed down its ruling in the case of United States vs. Fleet Factors Corp (1990).

The court determined that, despite the statutory exemption for secured creditors that was included in CERCLA, a lender may be held liable based simply on having the opportunity to influence a debtor's business operations. With that decision, lenders were placed squarely in the crosshairs of liability for environmental contamination, forcing banks to be more aware of their role. This interpretation kick-started the development of environmental due diligence practices at commercial banks, a process that has trickled down over time to community banks and credit unions.

2. Risk of Default: Environmental reviews may seem like a nuisance when trying to close a commercial real estate transaction in 60 days, but you will be glad for this piece of risk management if the worst-case scenario arises and the loan ends up going bad. When the bloom is still on the rose, it is hard to think about a loan going into default, but it does happen. And if you are forced to foreclose, a clean property will be worth a lot more on the market than one requiring remediation.

Additionally, good environmental reports include information about adjoining-property risks. Standard due diligence includes a history of past commercial use and remediation that can highlight potential risks of secondary contamination of the subject property. Although you or your borrower may not technically be liable for contamination from surrounding commercial sites, it is still something that would need to be dealt with down the road if the subject property goes into foreclosure and ends up on the market.

On balance, you and your borrowers are both better off conducting environmental due diligence up front on the subject property.

3. Impact on Reputation: Few crises are more media-ready than an environmental cleanup. If your institution has a loan on the property, or if you had to repossess a property due to borrower default, your bank's name will also be dragged through the mud. …

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