“Using Environmental Insurance in Deals with Environmental Risk”
Inside Counsel 09/30/15 By Michael S. Mostow
In transactions involving property that is or may be contaminated, the environmental questions typically boil down to 1) Is this property contaminated, and if so, how contaminated? 2) What will it cost to clean up this site to appropriate levels? and 3) Which party will be liable for these costs and any resulting claims? Phase I (non-invasive) and Phase II (invasive) investigatory work is usually performed to answer questions 1 and 2, and negotiations regarding cleanup cost allocation, indemnity, and purchase price reductions address question 3.
But sometimes a third party — an insurance company — can shoulder the environmental liabilities, and, depending primarily on the property’s future use, Phase II investigation may be unnecessary and even undesirable.
Environmental liability insurance goes by many names. Combine some number of the words “pollution,” “liability,” “environmental,” “impairment,” “remediation,” and “protection” and you will undoubtedly end up with the name of a policy offered by a carrier. Nevertheless, all policies share the same general characteristics. Depending on which “coverages” are purchased, the policies may insure against losses arising from 1) new releases (post-policy inception), 2) pre-existing releases (pre-policy inception), 3) third-party claims (government and private party), 4) remediation costs for contamination discovered after the policy is in force, 5) property damage (such as diminished property value), 6) bodily injury (think toxic tort), and 7) legal fees associated with the foregoing. Other coverages, like business interruption, may be available as well.
Environmental insurance is property focused; it covers the insured for exposure related to contamination at or migrating from a specific property or properties. (Contractors pollution liability insurance covers an insured for environmental releases arising out of the insured’s actions, but that’s a separate topic.) The coverage is claims made and reported, meaning that, to be covered, a claim has to be made against the insured and reported to the carrier during the policy period. Policy periods max out at ten years, but renewals and reporting extensions are usually available. Policy limits of liability are typically between $2 million and $20 million, but higher limits may be arranged, and deductibles generally range from $25,000 to $1 million and up, depending on the circumstances. The premium is paid once, at policy inception, as opposed to annually.
Critically important is the fact that policies are negotiable. Environmental insurance is a terrific tool to transfer risk, but — no surprise here — insurance carriers prefer to collect premiums and, if possible, deny coverage when a claim is made. Therefore, parties who are considering environmental insurance should reserve several weeks prior to the closing to negotiate the best terms possible with the insurance carrier. Restrictions on or elimination of exclusions, limitations on the carrier’s right to terminate the policy, narrowing the representations the insured makes in the application, and other customizations are available, but an insured has to negotiate the policy like it would any other contract. Take a policy off the shelf and you will be leaving coverage on the table.
In a purchase and sale transaction, the parties are typically concerned with environmental costs arising from historic (pre-closing) releases. Environmental insurance covering losses arising from pre-existing conditions can address this concern. Which coverages to obtain will depend on the terms of the transaction. The breadth of the coverages will also depend on the known risks posed by the properties to be transferred. Even if the parties know of contamination, odds are unasserted third-party claims concerning such contamination can be covered.
There is a push-pull between the breadth of coverage and the knowledge the parties have regarding the property to be covered. Insurance policies cover parties from unrealized risks. Parties that know of contamination may obtain coverage from third-party claims arising from that contamination, but parties that don’t know of contamination may obtain third-party claims coverage and remediation coverage — coverage for the remediation of the discovered contamination regardless of a third-party claim — if that contamination is discovered during the policy period. Therefore, parties contemplating the use of environmental insurance should consider how the insurance might fit into the overall deal, including how much, if any, Phase II data should be collected.
As noted in a previous column for this series, sellers of potentially contaminated property may be loathe to allow the buyer to perform Phase II testing on the seller’s property. From the buyer’s perspective, if the deal dies as a result of the Phase II data, the buyer has lost its deal transaction costs up to that point. But for the seller, the loss may be much greater. At a minimum, the seller now knows of the contamination, and any future deal will have to account for the contamination, likely via a price reduction and possibly a promise to indemnify the buyer from environmental claims. Worse, state law may require the seller to notify the authorities regarding the contamination, and remediation obligations may follow.
Environmental insurance may serve in lieu of a Phase II investigation. This is particularly true if the property to be acquired is going to be operated as is. In that case, there is no need to investigate the environment. The owner of a manufacturing facility would not voluntarily take Phase II samples of its site, and that reasoning remains valid despite the change in the ownership of the site, or in the stock of the company that owns the site. The buyer is purchasing a going concern. On the other hand, if potentially contaminated property is being sold for redevelopment, Phase II testing is more appropriate, and insurance may play a significant, but more limited, role.
The terms of the deal, the future use of the property, and other factors inform the type of environmental insurance that may be useful to the parties. Tailored through negotiation, environmental insurance can serve in lieu of an indemnity, to back-stop an indemnity, to avoid Phase II work, and to reduce other environmental risks.