Insurance Structuring real estate transactions with environmental liabilities

The presence or possible presence of environmental contamination complicates virtually every real estate transaction.

On one hand, the seller/landlord wants to walk away from unknown environmental liabilities as soon as his/her interest passes.

On the other hand, the buyer/tenant is understandably reluctant to assume potential liability for undiscovered pollution resulting from activities that occurred before he/she gained an interest in the property.

Difficulties arise by virtue of the inherent limitations of traditional risk identification and allocation measures. Even the most thorough Phase I and Phase II site audits may fail to reveal all contamination, and even the most inescapable contractual indemnity may be rendered worthless when the cleanup costs exceed not only the value of the property but also the indemnitor's financial resources.

So how does one save a transaction that is about to fall apart because of the environmental risks facing both seller and buyer? A carefully crafted environmental insurance policy may be the answer.

Environmental insurance can benefit purchasers, sellers, lenders, lessors, lessees and other potentially responsible parties. It can bolster or replace environmental indemnities, assist in the procurement of financing for contaminated property, and lower a developer's risk in acquiring and developing known contaminated property.

While the premiums for environmental policies can be substantial, an environmental insurance policy can provide important benefits: (1) the insurance company providing the environmental insurance policy will, in all likelihood, have a solid financial backing compared to a corporate or individual indemnitor; (2) insurance companies are regulated under federal and state law; and (3) California courts generally favor the insured whenever there is a dispute concerning coverage.

A number of large, well-known insurers provide environmental insurance: the American Insurance Group (AIG), Zurich-American Insurance Co. (through its Steadfast subsidiary) and Kemper Environmental (part of the Kemper Group). Many smaller companies have also carved out a niche in the environmental insurance field.

No matter which insurer you choose, all environmental policies are similarly structured and contain three essential elements: (1) coverage for unknown and/or specified known pollution events; (2) conditions for coverage; and (3) exclusions to coverage.

Regardless of the specific coverage, environmental insurance is generally written on a claims-made or "discovery" basis. This means that the policy will cover only those claims that meet two requirements:

The claim is brought against the insured or the contamination is discovered by the insured during the policy period; and the insured provides written notice of the claim or contamination to the insurer during the policy period.

Most environmental insurance policies offer a combination of the following types (not an exhaustive list) of insurance.

These policies generally include coverage for cleanup of the insured property for both a voluntary cleanup and/or a regulatory ordered cleanup for unknown and, in some circumstances, known contamination and the cost of cleanup for contamination which occurs after the policy goes into effect. Coverage extends to third parties for bodily injury or property damage.

These policies may also include more specialized coverage such as loss of income or loss of rents resulting from a pollution condition and/or loss of value to the insured property resulting from a pollution condition.

These policies provide coverage only to a lender. Two actions will trigger coverage under these policies: the borrower defaults on the loan and the property is contaminated.

Once coverage is "triggered," the insurance policy will pay to the lender the lesser of the remediation costs or the outstanding loan balance.

This form of coverage combines traditional environmental insurance with self-insurance. The insured and the insurer first agree on an estimated cost for cleaning up known contamination.

The insured then agrees to a large deductible or a self-insured retention , the "stop loss" amount. The insurer bears the risk of all cleanup costs in excess of the "stop loss" amount, up to the policy limit.

Regardless of the policy the parties chose, each policy will require expert negotiation on behalf of the insured to meet the insured's specific needs.

Customized policies can provide valuable and economical protection because coverage can be tailored to certain properties or to specified risks.

For these reasons, every party who is contemplating the purchase of an environmental insurance policy must carefully review: the scope of coverage provided; policy limits and deductibles; policy term definitions; conditions and exclusions; conditions of policy cancellation; and, the insurer's identity and financial standing.

Such an evaluation must be performed before the policy is purchased.