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Secured Creditor Environmental Insurance:
Another Means Of Protecting Collateral From Environmental Risk

By Peter Tester, Lindquist & Vennum PLLP

Banks and other lenders are understandably wary when a customer walks in seeking a loan for what is viewed as an environmentally risky business or for the development of once-contaminated land (so-called Brownfield deals). Many lenders shy away from such loans because of the risks to the value of collateral and/or a borrower’s ability to repay a loan due to environmental contamination. Even lenders willing to consider such loans require extensive due diligence designed to weed out loans that are simply too risky, and where a loan is to be made, adjust rates upwards to reflect the increased risk. These steps have undoubtedly helped lenders avoid potentially “problem” loans. However, even when such precautions are taken, if contamination occurs in the future or if past contamination is discovered after the loan has closed, a lender may still face a partial or total loss of collateral (the usual dilemma facing a lender is to forego foreclosure or to foreclose, remediate the property, and seek recovery of the cost of remediation from the borrower). To protect lenders and borrows prospectively, after a loan has been made, the insurance industry has developed a relatively new product: secured creditor environmental insurance.

Secured creditor environmental insurance protects lenders and borrowers from financial loss where contamination is found and must be cleaned up by paying either the outstanding loan balance when a default occurs and an environmental condition exists or the cost of environmental cleanup, usually whichever is lower. These policies also provide protection from direct third-party liability claims, including liability for cleanup costs, bodily injury, or property damages from contamination. The benefit of these policies is that they are essentially a warranty that the site assessment or other due diligence is correct. If it is not correct, the insurance pays for the cleanup, the owner has a clean property, and the lender has marketable collateral. The ease of mind that future impacts to the property that cannot be foreseen will be covered, and protection from potential third-party property damage or liability claims will be assured, should allow more loans to be made.

The typical application for secured creditor insurance requires information on current, past and intended future use of the site, copies of any environmental examinations, assessments, reports or data on this site, and copies of any environmental indemnification or hold harmless agreements between the borrower and a related entity. The applicant must also identify any facts or circumstances that can be reasonably expected to result in a claim against the company or borrower for environmental cleanup, or bodily injury or property damage arising from the release of pollutants into the environment. Standard exclusions include those for civil or administrative fines, penalties or assessments, liability of others as a result of a contract or agreement, actions arising from or attributable to intentionally known and willful or deliberate noncompliance, and for intentionally illegal acts or omissions if the insured knew that pollution conditions would result.

Secured creditor policies are available from a number insurance carriers, including AIG Environmental, Kemper Environmental, and Zurich-American to name just a few, and are available for individual loans and groups of related loans that are pooled and sold on the secondary market. The policies have been available for over five years and are just now beginning to be used with some regularity, but their use has been generally limited to larger institutions.

A recent survey by the industry group Environmental Data Resources, Inc. (“EDF”), out of Southport, Connecticut, shows that less than 10 percent of respondents were using secured creditor insurance. These are almost exclusively large institutions. At the same time, over 50 percent of respondents indicated they could foresee greater reliance on property environmental insurance; for major lenders, environmental insurance may soon become as common as title insurance for certain commercial real estate transactions. According to the EDF survey, the principle reasons that financial institutions have not required the purchase of environmental insurance is the limited experience with such policies due to the newness of the product, its expense, and bank policies that don’t rely on environmental insurance at all. Looked at from the other side, the purchase of secured creditor insurance was most common because of the property type involved, because no other environmental due diligence for the property was performed, or because the due diligence identified an issue of potential concern. Smaller lenders, including community banks, can also profit by these policies as it can reduce the amount of time that must be devoted to investigation of the condition of the property. The policies also can increase business opportunities that lenders were once unwilling to get involved with or were simply unaware of.

The major rating agencies, such as Standard & Poor’s and Fitch & Moody’s, all have experience with environmental insurance and site assessment as a requirement for underwriting certain collateral. Some of the agencies will accept environmental insurance in lieu of environmental site assessments depending upon the size of the loan and its rate.

The cost of environmental insurance can be very reasonable, even when compared to the usual costs of a preliminary site assessment, which can run as much as $2,000–4,000 per site. Environmental insurance also has the advantage of being relatively quick to obtain, and this quick turnaround tends to help both borrowers and lenders.

In sum, secured creditor environmental insurance is another tool that lenders and borrowers can utilize to overcome the concerns of unanticipated cleanup costs and fears of unforeseen liability from contaminated property. 

ABOUT THE AUTHOR

Peter Tester is a partner in Lindquist & Vennum’s St. Paul office. He focuses his practice on environmental, land use and energy law. He can be contacted at 651-312-9216 or by e-mail at ptester@lindquist.com.

This article is only a general summary for informational purposes and does not constitute legal advice. Consult a qualified and experienced insurance advisor for your specific situation or particular questions.

riskVue | The webzine for risk management professionals
October 2003