Environmental Insurance To Protect the Interest of Lenders

Even with the advent of statutory “safe harbors” that protect lenders from becoming liable for pre-existing environmental contamination, lenders worry about the costs of cleaning up properties. Simply put, lenders worry about whether their collateral (e.g., a manufacturing facility or a Brownfield site slated for redevelopment) is really worth what they think it is given the potential environmental liabilities.

Discussion of any business situation that presents issues of risk and liability quickly leads to consideration of insurance. Through insurance one may convert all sorts of unknown potential future liabilities, including environmental liabilities, to a known premium payment. However, many lenders and property owners have discarded environmental insurance as a viable solution to the problems of environmental liability. Historically, environmental insurance has been both expensive and limited, or ambiguous, in its coverage. Now may be time for reconsideration. Environmental insurance policies have evolved to the point where they are very effective risk management tools.

There are two different types of environmental insurance policies that are typically used to protect the interests of lenders. The first is “Pollution Legal Liability” (“PLL”) insurance that runs to the benefit of the property owner and covers legally required investigation, defense, and remediation costs associated with previously unknown historic and/or future contamination. Lenders rely on these policies to ensure that environmental conditions will not have a material adverse affect on a borrower’s financial stability if the borrower is forced to perform a cleanup. Lenders can also be named as additional named insureds on these policies so that coverage running to the benefit of the lender is in place in case the lender is ever forced to foreclose on the real property.

In a recent transaction the lender was making a loan to an entity that was acquiring a large manufacturing plant. Even though the bank was not taking a security interest in real estate associated with the plant, the lender was concerned that potential clean-up costs associated with historic contamination could have a significant and adverse effect on the borrower’s ability to repay the loan. In this case, the lender’s concerns were addressed when the seller of the manufacturing plant and the borrower agreed to cooperate and purchase environmental insurance policies designed to respond to historic contamination. The policies provided approximately $20 million in limits.

The second kind of environmental policy used to protect lenders is called a “Secured Creditor” or “Lenders” policy. Some of these policies are designed to pay the outstanding loan balance if the borrower defaults and environmental contamination exists on the collateral property. In other words, these policies allow lenders to avoid foreclosing on contaminated properties. Instead of pursuing a foreclosure, the insurance pays off the loan balance and the insurer obtains the lender’s foreclosure rights. Policies with this coverage are often referred to as “Loan Balance” policies. In some instances, the lender’s coverage is structured to pay the lender either the loan balance or the cost of cleanup, whichever is less. These policies are often referred to as “Lesser Of” policies.

As of the time of the writing of this article, one major insurer had just pulled its Loan Balance policy from the market and is instead offering Lesser Of coverage. While other carriers have expressed a commitment to continue to offer Loan Balance policies, it will be interesting to see what the future brings. It is important to note that both Loan Balance and Lessor Of policies provide lenders with protection from claims for bodily injury or property damage.

In another example, the borrower’s window of opportunity to acquire a “downtown brown” (i.e., potentially contaminated) property was set to expire before the borrower could meet the bank’s environmental due diligence requirements. Instead of passing on the deal, the bank had the borrower pay for a Secured Creditor policy which allowed the bank to close on the loan even though some of its standard environmental due diligence requirements had not been met. In exchange for a one time premium payment of approximately $22,000, the insurance policy covered the entire loan amount (approximately $14 million) for five years. In the end, the lender was comfortable and the borrower acquired a terrific urban location for redevelopment.

Environmental insurance underwriters and brokers have seen the volume of deals closing with the benefit of environmental insurance increase in the last twelve to eighteen months. This increased deal flow is also confirmed by the fact that Goulston & Storrs is now routinely asked to evaluate whether an environmental insurance coverage proposal makes sense in light of the details of a particular transaction. Many of our clients are increasingly aware that:

• Environmental insurance can sometimes be used in lieu of recourse environmental indemnities and/or costly Phase II environmental investigations.

• Secured Creditor policies are often utilized in large securitizations (e.g., portfolio transactions) and have been looked upon favorably by the rating agencies.

• Pursuing a borrower for recovery of environmental costs when they default on a loan can jeopardize the status of additional loans that borrower may have with the bank – making a bad situation worse. Secured Creditor policies often waive all rights of subrogation against the borrower except the right of foreclosure (meaning the insurer will only look to the value of the secured property and will not pursue the borrower for recovery of losses), thereby aiding in the prevention of additional defaults.

A number of states have adopted incentive programs designed to encourage lenders to make loans that are secured by industrial or previously contaminated properties. For example, the Massachusetts program is known as the Brownfields Redevelopment Access to Capital (“BRAC”) program for environmental insurance. The BRAC policies utilize standard, pre-negotiated forms issued by AIG Environmental. This standardization means that policies may be obtained quickly, with very favorable pricing. Any lender qualified to do business in Massachusetts may participate in the program and obtain BRAC Secured Creditors insurance.

Lenders take note – all BRAC policies, including Secured Creditor policies, are currently eligible for a state subsidy of the lesser of 25% of the insurance premium or $25,000. Since the borrower typically pays for environmental insurance, these subsidies can be a terrific and concrete way for a lender to show its willingness to cooperate with and help a borrower.

Environmental insurance can be an extremely useful tool for satisfying a lender’s environmental concerns, accommodating a borrower’s concerns about due diligence costs and personal guarantees, and getting a deal closed. It is important to note, however, that policy language can change from deal to deal and is often manuscripted to fit a particular transaction. Accordingly, an environmental insurance policy, like any other legal contract, should be reviewed carefully to verify that anticipated coverages are, in fact, available. It is also important to note that pricing and long term financial stability can vary widely from insurance company to insurance company. Used properly, environmental insurance can provide savvy lenders and borrowers with a competitive advantage.

For more information, please contact: William M. Seuch 617.574.4041 wseuch@goulstonstorrs.com

This article should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer concerning your situation and any specific legal questions you may have.

Environmental Risk Resources Association

Environmental Insurance To Protect the Interest of Lenders