Every real estate transaction comes with financial and business risks. But if the property being bought, sold or redeveloped is contaminated — or there is even the possibility of contamination at the site — that creates even more risks.
But while there are risks associated with contaminated properties, that doesn’t necessarily mean that the transaction should be abandoned. Instead, learning to mitigate and manage those risks will help make the transaction successful.
“Business owners should align themselves with good counsel and develop relationships with numerous advisers,” says Kenn Anderson, director of Aon Environmental Services Group, a division of Aon Risk Services Central, Inc. “The first is a lawyer well versed in real estate and contaminated property transactions. They should also be getting advice from an environmental consultant and consider transferring certain risks to an insurance company through environmental insurance.”
Smart Business spoke with Anderson about how to prepare for the risks associated with contaminated property and how to assess the benefits of environmental insurance.
What risks are associated with contaminated or potentially contaminated property?
The first and biggest risk is the fear of the unknown. Environmental consultants are well versed in looking at potential risks related to unknown or suspected contamination.
But when it comes to paying for and transacting the property, that risk of the unknown becomes more evident. Business owners might be worried about unknown contamination on the property or contamination already identified that turns out to be worse than originally thought. There are also possible risks and impacts after the transaction and cleanup have taken place. Third parties, such as neighbors or future occupants, could allege bodily injury or property damage related to the contamination.
What is environmental insurance, and how does it work?
There are two areas of environmental insurance used when transacting property. The first is the cost-cap, or stop-loss policy, which puts a ceiling on the actual cleanup costs of a site. It also helps against negligible risk — a risk that a business thought it could manage within the transaction dollars but then the cost for something such as a property cleanup got out of hand. This insurance typically costs between 10 and 25 percent of the limit that is purchased. So if someone buys a $1 million limit, it would cost between $100,000 and $250,000. While this is more expensive, parameters can be put around it, especially in larger transactions.
The second type, and one that is used most often, is environmental liability insurance. This is also referred to as pollution legal liability insurance, or environmental impairment liability insurance, which protects the buyer, seller or both parties against unknown risks in a transaction. This could be site cleanup related to a pre-existing condition, an unknown contamination, or new or future pollution conditions. Third-party claims for bodily injuries and property damages are also covered.
There is no typical cost for environmental liability insurance because it is usually based on the type of site, the length of coverage and the limits of liability purchased. Heavy industrial sites that are being transacted into another type of site, such as residential or mixed use, require more expensive premiums than if the site is going from heavy industrial to heavy industrial.
If the policy covers both the buyer and seller, one party will purchase it, while the other will be a named insured on the policy. A separate, side agreement is typically used to identify things such who pays what portion of the premium and who pays the deductible in the event of a loss.
Should a business owner purchase environmental insurance for any transaction dealing with contaminated or potentially contaminated property?
Business owners should look at it in all cases and at least evaluate the use of it, but it shouldn’t be purchased in every situation. It is a matter of looking at someone’s risk appetite, as well as the amount of the premium for the overall coverage being offered. It just doesn’t make sense in some transactions. The premium shouldn’t be compared to the purchase price or selling price of the property, but it should be determined if it makes sense for the individual deal.
Environmental liability policies can be purchased for up to 10 years of coverage, so if the buyer or seller is risk-averse, he or she needs to look at the premium being charged to determine if the insurance would make sense.
What are the benefits of preparing for issues related to contaminated property?
Environmental insurance has become a fairly practical tool for contaminated properties over the last 15 years. There has been an increase in frequency with real estate firms using the tool, and lawyers are becoming well versed in how to use this insurance to mitigate risks.
It helps bring certainty where there is often a great deal of uncertainty and mitigates some of those uncertainties for the buyer or seller. It could also bring certainty regarding financing or equity, or help answer some questions upfront. Environmental insurance can also help strengthen the sale price of a piece of property.
In addition, a lot of the timing with the transaction can be expedited by preparing for these issues. The process used to be very drawn out, and a lot of time was spent on negotiating environmental indemnities and buy/sell agreements in the transaction.
Today, business owners can expedite the process by employing legal counsel to make sure that those contracts are well negotiated and identifying some of the risks that are readily insurable and removing them from the table.
Kenn Anderson is director of Aon Environmental Services Group, a division of Aon Risk Services Central, Inc. Reach him at (312) 381-4226 or firstname.lastname@example.org.