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Selecting Strategies For Managing Environmental Risk
Knowing how to manage environmental risk can help you close deals on
impacted properties.
BY STEPHEN F. HILFIKER
It all started with the Love Canal. William T. Love, a 19th century
entrepreneur, decided he was going to build a city from scratch. His plan
was to generate hydroelectric power from the Niagara River. He built a
mile-long canal, ran out of money and abandoned the project.
The Hooker Chemical Company and other companies used the canal
between the 1920s and the 1950s as a toxic waste landfill. It sold the
property for $1 to the Niagara Falls School Board in 1955. A school and a
residential community were developed over the Love Canal.
Numerous health problems accumulated and prompted Congress to
pass the Comprehensive Environmental Response Compensation and
Liability Act of 1980, better known as Superfund.
Superfund imposed strict, joint, several and retroactive liability for pollution on
property. This essentially means that the federal government could find
almost anyone involved with the property, at any time, liable for
remediation costs regardless of fault.
This law, and similar state laws based on the same principles, have made commercial
real estate transactions far more complex over the last two decades. Numerous court cases have exacerbated the impact of these rules, making impacted properties difficult to finance and sell.
Over time, things always seem to balance out. We are approaching a balance between
environmental protection and economic progress based on recent
legislative amendments, increased risk tolerance, environmental
insurance, developing technologies and other risk management strategies.
Successful implementation of environmental risk management
strategies, in many cases, will enable you to cover risks so that you can
close real estate transactions on impacted properties. The purpose of this
article is to introduce several environmental risk strategies to assist you
with your primary objective: closing transactions. One of the primary
hurdles to clear on the way to the closing table is financing for the buyer.
Lender liability and financing
Several court cases, such as U.S. vs. Maryland Bank and Trust in 1986, and the Fleet Factors Case in 1990, made liability for remediation costs a significant
concern for lenders. Lenders had deep pockets, but in most cases did not
contribute to or exacerbate contamination that existed on their collateral
properties.
Congress passed the Asset Conservation, Lender Liability and Deposit Insurance Protection
Act of 1996, an amendment to Superfund, to define permissible activities
that lenders could perform without violating their secured creditor
exemption. The act essentially states that as long as the lender behaves
as a lender and does not get involved in management of the operation, they
will not be found liable for contamination that exists on properties used
to secure loans.
The Asset Conservation Act provided some relief in that lenders are not as concerned
about liability as they once were. However, the security of loans is still a
risk for lenders if the collateral property is impacted. Diligent
assessments and plans to either maintain, restore, or insure property
value are typically required by lenders and buyers to go forward with
impacted property transactions.
To identify and quantify environmental risks, diligent environmental assessment services
should be performed. Once the risks are defined, the following strategies
can be employed to manage them.
Environmental management (maintain value)
Investigating past and present environmental quality provides a good baseline. Requiring sound environmental management practices reduces the potential for
future releases. All purchasers/lenders should consider environmental
management practices to control future environmental quality.
Environmental management plans are designed to prevent pollution.
Storage, handling and disposal practices are outlined in detail.
Containment and spill response are critical elements of the plan.
The Florida Department of Environmental Protection (FDEP) has used
this approach in regulating petroleum and dry cleaner sites. Cleanup
programs were established to provide financial assistance for eligible
facilities with existing problems (Not all sites are eligible.).
Florida administrative codes require secondary containment and
compliance with waste management principles. Financial responsibility
must be demonstrated. These rules and programs have offered a solution
to existing concerns, and a method to prevent future concerns. On a much
smaller scale, we can use the same approach when evaluating each
property.
Cleanup programs (restore value)
The most regulated facilities are dry cleaning, petroleum and industrial facilities that utilize hazardous substances or generate hazardous waste. Florida,
and many other states, have created petroleum and dry cleaning solvent
cleanup programs that are funded by industry-based taxes.
The programs are designed to protect the environment by funding
assessment and remediation at sites that are eligible for the programs.
All of the programs are now closed, with the exception of the Petroleum
Contamination Participation Program, which requires FDEP knowledge of a
pre-1995 discharge.
Determining if a petroleum or dry cleaning site is eligible for cleanup funding and, if so,
identifying how and when funds may be made available is critical to risk
management.
Properties that are ineligible for the petroleum or dry cleaning programs, hazardous
waste sites, industrial facilities, and other potentially impacted
properties, may be eligible for Brownfield Redevelopment Act incentives.
"Brownfields," in general terms, are potentially contaminated properties.
Local governments can declare any property or group of properties to
be designated Brownfield sites. By following the procedures established in
the Brownfield Redevelopment Act, property owners can take advantage of
numerous regulatory and economic incentives provided through local, state
and federal governments.
The incentive for government is to return underutilized/abandoned properties to the tax
base. The incentives for property owners include tax credits, low interest
rate loans, money based on the number of employees working on the
redeveloped property, and permitting leniency or waivers.
Florida Statutes Section 376.308(5) provides some administrative
immunities from FDEP- mandated assessment and remediation services on
properties that are eligible for the cleanup programs. Owners of
properties that are eligible for the cleanup programs are not compelled to
assess or clean up contamination on the eligible site until the property
reaches priority status based on the hazard ranking scoring system set
forth in the rules.
Chapter 376 offers no immunity for third-party lawsuits based on off-site migration
of contaminants. So for properties that are eligible for cleanup programs,
off-site migration and potential claims associated with third-party
liabilities represent the greatest concern for purchasers and lenders.
Off-site migration of contaminants is a source of liability that is
very difficult to manage. A diligent assessment of the extent of off-site
migration and/or an environmental insurance policy to protect against a
third party lawsuit are typically necessary to adequately manage these
concerns if off-site migration of contaminated groundwater is extensive.
Environmental insurance (insure value)
The environmental insurance market has emerged in the last few years.
Environmental insurance is a very valuable tool that can be used to bring
complicated transactions to a close. Decisions involving impacted
properties have no financial basis unless the exposure associated with the
impact can be determined.
Environmental insurance can be used to quantify risks. The cost of premiums and
deductibles can be included in the economic equations for investors and
lenders to base decisions. There are several types of insurance that can be
used to close impacted property transactions.
- Cost Cap/Remediation Cost Overrun Insurance. The cost of remediation can now
be fixed based on these insurance policies. Using a remediation cost
estimate and factoring in the cost of insurance, the potential exposure can
be determined.
- Remediation Warranty Insurance. This insurance protects owners against discovery of
contaminants (new discoveries) after completion of remediation or after a
remedial action plan has been approved.
- Lender/Purchaser Policies. These policies provide coverage for lenders
against default by a borrower caused by pollution conditions discovered at
the site after closing. The policies can usually be extended to purchasers.
These policies pay the lesser of the outstanding loan balance or the
cleanup costs.
- Real Property Transfer Liability Insurance. These policies provide coverage for third
party or government-imposed cleanups when they are required after
closing.
These descriptions are very general and the policies can be
more or less extensive depending upon the needs of the insured or the
site-specific conditions that create the need for the insurance.
Determine actual value
Impacted properties have reduced value. If the environmental impact can be quantified, the value of the property - including the impact - can be appraised. Decisions regarding the purchase price, loan amount, loan-to-value, resale potential and overall credit
decisions can be based upon the adjusted value after investigating and
quantifying the risk.
If lending decisions were made using corrected values from the outset, foreclosure
pressures would not be as extreme because the outstanding balance would
be less than the actual property value. A sale of impacted property based
on corrected values is feasible. Numerous investor groups are affiliated
with remediation companies and actively pursue impacted properties
based on adjusted values.
Diligent assessment, remediation cost estimation and appraisal services will
generally be necessary to quantify the risk. The costs of these services,
and the reduced value, may damage the interest of all parties to the
transaction, but this approach should provide a more realistic baseline to
value.
Indemnification
Indemnifications and warranties will always play a major role in real estate transactions. Seller indemnification and escrow of cleanup funds still may be the
easiest and most practical method to transact property. But there are
some flaws to this approach, primarily for the buyer.
Purchaser risks include the solvency of the seller, the scope of the indemnification, resale
considerations and the uncertainty of the overall cost of cleanup. For
sellers, the federal government is typically not part of the transaction,
and that small piece of legislation called Superfund that created this
regulatory stew may not consider the resources of the country to be
indemnified.
Each property has its own set of circumstances, including the potential for pollution,
eligibility status, extent of pollution, concentration and location of
contaminants on the property, site specific hydrogeology, types of
adjacent and nearby property land uses, financial security of the
borrower, potential to insure against site specific risks, value of the
property and intended future land use of the subject property.
All of these and other factors should be considered when preparing
an effective risk management strategy for impacted properties.
Steve Hilfiker is an environmental consultant, Florida-licensed mortgage
broker and Florida-licensed real estate sales person. He is president of
Environmental Risk Management Inc. (ERMI), a property assessment and
remediation firm based in Naples, Fla., and First Environmental Mortgage
Inc. (FEMI), www.envmort.com, a licensed mortgage broker business in
Naples. He is also president of the Florida Environmental Assessors
Association. He can be reached at 1-888-ENV-MGMT or 1-888-ENV- MORT.
This article was previously published in the July 2000 Issue of Commercial Mortgage Insight.
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