Environmental Insurance: No Substitute For Testing

By Eric C. Rubenstein and Joanne S. Agrippina
 

Telecommunications In today’s fast-paced commercial real estate market, many investors and developers seek quick closings to take advantage of low interest rates. To expedite the financing process, they often purchase environmental insurance in lieu of performing environmental audits.

What many commercial real estate buyers may not realize is that the typical environmental insurance policy available today insures only the lender’s exposure to loss on the loan. It offers no protection to the buyer of the property for liability or any cleanup costs resulting from environmental contamination. These policies are likewise often replete with exclusions for items such as lead paint, mold and asbestos and the payment of claims is generally conditioned upon both a default on the loan and a finding of contamination.

Many lenders are willing to accept these policies in lieu of environmental testing because the policies enable a lender, after a finding of contamination and a loan default, to collect on the policy without having to either take control of or foreclose on the contaminated property. The contaminated property remains the problem of the owner, who may be subject to enormous liability (perhaps even criminal) and clean-up costs. The owner continues to bear the responsibility, even after paying the cost of the environmental insurance policy, which could be more than 1% of the loan.

Buyers may use environmental insurance as a means of obtaining lender clearance to close a transaction where the buyer knows or suspects that there is existing contamination and that the property will not pass the lender’s mandatory Phase I inspection. Rather than pay for the environmental audit and risk the lender’s rejection of the loan, buyers are paying for the environmental insurance and crossing their fingers.

Because the potential liability as well as the cost and expense associated with environmental contamination can be catastrophic to a property owner, it is important to realize that these policies are no substitute for environmental testing. Environmental insurance may have its place in a commercial transaction, but it should be utilized in conjunction with, and not as an alternative to, environmental testing.

Because it is true that environmental due diligence does have its limitations, environmental insurance should be considered a due diligence enhancement, not replacement. It may well be used to provide additional comfort to a lender or perhaps as an incentive to a lender to increase a borrower’s credit availability. There are even instances where an insurance policy alone may be appropriate, such as refinancing where environmental testing had been performed at the time of acquisition.

Environmental insurance policies are still relatively new and untested. It has been several years since the first of these policies were issued and the initial claims now are being made. It is will be interesting to see how the claims are handled and how such claims will shape the environmental insurance industry in the future. For the time being, owners must realize that insuring the lender’s interest may under certain circumstances be a good idea, but it will be meaningless to the buyer who has not protected itself from the enormous potential liability associated with environmental contamination.
 
Eric C. Rubenstein is a partner and Co-Chair of the Real Estate Department of Ruskin Moscou Faltischek, P.C., and can be reached at 516-663-6513 or erubenstein@rmfpc.aw-develop.com. Joanne S. Agrippina is an associate in the Real Estate Department, and can be reached at 516-663-6674 or jagrippina@rmfpc.aw-develop.com.

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