Today's uncertain economy presents a host of challenges to businesses nationwide. Many creditworthy borrowers in the commercial credit market see both direct and indirect effects of the economic situation. The direct consequences include the lack of available capacity or an increased cost of borrowing, while indirectly many clients might be required to provide broad-based indemnity agreements that include environmental indemnity where environmental issues have the potential to exist.
Depending on the credit risk of the indemnitor, indemnitees might require an evergreen letter of credit (LOC)-or cash-as an additional backstop. However, an LOC may not be as cost effective as it once was and posting cash as collateral is not recommended as the best use of funds. Additionally, many indemnities survive the satisfaction or forced termination of the agreement, and these obligations could exceed the amortized balance of the loan or the market value of the property. Accordingly, environmental obligations under an indemnity agreement could remain in perpetuity much like environmental liabilities recognized under the Federal Comprehensive Environmental Response and Liability Act (also known as the Federal Superfund Act) and other state laws.
In contaminated or potentially contaminated property transactions where it's unclear whether the scope or duration of environmental conditions is a significant risk factor, environmental insurance is a cost-effective tool that provides added value to both borrowers and lenders-a tool that agents and brokers should have at their disposal.
Ensuring Financial Recovery
Lenders benefit by transferring any credit risk to the insurance carrier, which typically poses little default risk. An environmental insurance policy also can be written in lieu of an environmental indemnity, so if there is a covered claim, financial recovery from a well-rated insurance carrier is more efficient and assured than from a potentially asset-strapped borrower. Viewed from the other side, borrowers also benefit by alleviating the need for personal and corporate indemnities. Borrowers can use the insurance to obtain interest rate relief on a loan or a loan portfolio.
Borrowers can work with their lenders and other strategic vendors to develop lending procedures to use environmental insurance for a single property or an entire portfolio of properties. Lenders, now one step removed from credit risk, should be willing to provide limited interest rate relief. Of course, it's vital to use a top-tier insurance company that exhibits financial stability, underwriting expertise and the ability to create customized solutions for a transaction problem.
Implementing the Strategy
There are certain key points to consider in using environmental insurance as a backstop or in lieu of an environmental indemnity. For example, the legal scope and duration of an indemnity may not be totally within the scope of the insurance policy's terms. Also, is the borrower implementing this strategy for a portfolio of properties or for a single site? When considering these and other issues, legal counsel skilled in environmental liability and environmental policies and an experienced environmental insurance broker should evaluate and discuss both the indemnity and the policy with borrowers and lenders to identify potential coverage gaps. Subsequent negotiations by the lawyer and the broker between the transaction parties and the insurance underwriter can better align the coverage with the intent and parameters of the indemnity.
First, it's important to determine the length of time required to amortize the loan and compare it with the duration of the indemnification and term of the insurance. The term of the indemnity may be indefinite or the term of the loan may be set further out than the term of the insurance. Most commercial loans are amortized over 10 years, not a problem in placing an environmental insurance program. Today carriers can issue policies of up to 10 years, with some restrictions. However, the question arises as to what to do thereafter. One solution is to negotiate renewal provisions in the environmental policies, although carriers are reluctant to provide this due to reinsurance treaty restrictions. One also can insert a covenant in the loan documents obligating the indemnitor to renew the insurance thereafter. However, there is no guarantee that insurance in the same form and scope as the original policy will be available or affordable in the future. If the sunset provision of the indemnity or the loan amortization period extends beyond 10 years and policy renewals cannot be obtained, the transaction parties and the lenders must agree in advance that after the policy term expires, the indemnitor reverts to the primary source of financial recovery.
There may be gaps between the scope of the indemnity and extent of coverage. Typically, policies provide defense costs for all insured, but not for fines for knowing non-compliance. Such gaps can be bridged through additional endorsements. For example, fine payment by the policy can be added if the penalties did not result from the insured's knowing act or omission.
The typical pollution legal liability (PLL) or environmental impairment liability (EIL) policy will respond if the indemnity provides for both governmental and third party claims for cleanup, bodily injury or property damage arising from pre-existing pollution conditions. However, if the loan requires the indemnity to cover consequential damages arising from pollution conditions, such as business interruption or development delay damages, endorsements must be added. A "soft costsobCrLf endorsement will cover additional fees for architects and professional services, renegotiation of leases, and additional real estate taxes and assessments due to project delays. A business interruption endorsement also can be added to cover lost rents due to pollution conditions. However, there may be other uninsured exposures, such as breach of representations and warranties by the indemnitor or acts of war or terrorism.
If there's a claim, environmental insurance policies require that all insured locations must be "scheduledobCrLf onto the policy. It also is important to negotiate in advance that properties can be added and dropped from coverage, as properties are "flippedobCrLf to new buyers or new sites acquired.
PLL and EIL policies provide coverage only for unknown pollution conditions. Known pollution conditions are not typically covered.
Brokers should distinguish to their clients whether the policy provides only for pre-existing unknown pollution conditions (existing prior to policy inception but discovered during the policy term), or if it also provides for unanticipated new pollution conditions (such as releases or new contamination from site operations conducted after policy inception).
Also, because PLL and EIL are claims-made and not occurrence-based policies, claims for damages must be both discovered and noticed to the insurer during the policy term. Even if the pollution event occurred and is discovered during the policy term, there is no coverage if the claim is not made to the carrier until after the policy termination or expiration.
Required Underwriting Information
To properly underwrite environmental risk, brokers must present the following documents to the prospective carriers:
o The most recent environmental reports, including Phase I and II environmental site assessments, groundwater monitoring reports or any subsurface investigations, lead and/or asbestos surveys, etc.
o A draft and final copy of the loan documents, including all exhibits. Brokers must work with the clients and carriers to ensure the direct and indirect provisions of the loan are satisfied. The direct provisions include any insurance requirements; the indirect provisions include the indemnity obligations of the borrower.
o Any transaction documents, such as purchase and sale agreements, indemnity agreements, legal land use restrictions and any contracts affecting environmental liability issues of the property.
o Full disclosure by the borrower on the historical environmental issues of the covered locations. This should include details on any fines or penalties received, as well as consent decrees or deed restrictions, if any, imposed on the site.
o The most recent audited financial statements (actual or pro forma-whichever is applicable).
o Application. All carriers require an application sometime during the application process. Brokers and clients should work with appropriate legal counsel in completing the application.
Excellent Primary Collateral Value
Environmental insurance has excellent primary collateral value to ameliorate credit risk. Parties can agree that the indemnitee seek coverage for claims first from the insurance policy, then pursue the indemnitor if there is a coverage gap, policy termination or expiration. Word documents to establish a clear procedure for order of recovery and possibly incorporated in the policy wording.
PLL/EIL policies typically require prior written consent of the company before assigning interest. Lenders will want a mortgage insured assignment endorsement to ensure the insurer will waive this requirement and assignment will proceed to the mortgagee/insured if the mortgagee forecloses on the property.
The mortgagee/indemnitee must be a named insured on the policy, with direct access to the liability limits and the ability to make a claim. If the indemnitee is an additional insured only, he must first go to the named insured (likely the indemnitor) to tender a claim. The indemnitee/mortgagee should also be careful that the PLL/EIL limits of liability are not shared with multiple parties-or, if so, that limits be set among the parties or the portfolio of properties to protect the indemnitee against the liability limits being eroded by others' claims.
With careful legal and business planning, environmental insurance is a valuable tool to overcome the obstacle of today's financial market.

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Using Environmental Insurance to Overcome Credit Risk

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