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Environmental ghosts.

EVERY COMPANY, LARGE OR SMALL, has to answer to environmental laws. An environmental catastrophe--whether it be a massive spill like the Exxon Valdez or a small accidental discharge from a processing plant--can spell disaster if a company is uninformed and unprepared. More than ever, risk managers are aware of the multitude of environmental disasters that can disrupt a company's entire operation.

A problem that has surfaced in recent years stems from federal Superfund and state laws that place the greatest potential liability on the property owner. These new laws have made it crucial for risk managers to protect their companies from environmental risk when considering the purchase of commercial property. A company can inherit a set of environmental unknowns--or ghosts--when it buys commercial property or acquires another company. Sometimes it takes years for these ghosts to appear, but when they do, although they are invisible, they cannot be ignored.

Environmental ghosts can range from an abandoned underground storage tank that was "forgotten" until its contents seeped into a nearby water supply, to illegally dumped cleaning solvents or chemicals behind a building.

Once the buyer takes legal control of the property, state and federal laws usually force the new owner to shoulder at least some of the cleanup costs of any environmental problem that exists on the property, regardless of the owner's role in causing the contamination. In some states, under certain circumstances, the current owner is held solely responsible for past environmental blunders.

Who Pays?

Until recently, prospective property owners could do little to protect themselves from liabilities associated with sudded environmental problems. These liabilities can easily cost hundreds of thousands, or even millions, of dollars.

Although environmental liability is complex, it boils down to deciding who is to blame for an environmental problem and who will pay to clean it up. It is no surprise to risk managers that the federal government has placed the burden of proof on commercial property owners and operators. Unfortunately, clouds of obscurity begin to form when determining which business or property owner will share in the costs of cleanup. Who pays for past environmental problems that surface after property has changed hands? What happens when the original polluter is no longer in business? The answer to this multimillion-dollar question lies in both federal and state legislation.

While the federal government spearheaded cleanup legislation, many states not only enforce it but add a legal layer of their own. This has resulted in liability and costs ranging widely from state to state; many states go well beyond federal laws for the extent of cleanup as well as the severity and speed of enforcement procedures. In total, more than 100 state laws affect liability and cleanup costs.

When considering a property purchase, the risk manager should first reduce environmental risk on the property and then manage the amount of risk that remains. It is crucial to determine the amount of risk present in the prospective property, for instance, by conducting a phase I environmental assessment. However, if the buyer wants to get an idea of the risks and risk-reduction possibilities without the full-blown phase I, an environmental transaction screen or pre-phase I assessment can alert the buyer to possible environmental problems. The screen includes a records review, a visual inspection of the property and a query of the current owner regarding possible hazards.

Assessment Decisions

How does the risk manager decide between a transaction screen and a phase I? The transaction screen is favored by companies that do not want a complete phase I because of time and financial restraints, but would nevertheless like to quickly review the property. The best reasons to perform a transaction screen are lower costs and expediency. There are lower costs because the buyer or financial institution is doing the screen as opposed to an evinronmental consulting company. It is in the interest of the lender to quickly inspect the property; this will speed the transaction.

The transaction screen can be performed by the risk manager or other managers, who are trained to properly administer it. Many banks are training their employees to perform the screen. Maximum efficiency is another reason to opt for a transaction screen.

When possible problems are uncovered during the screen, the purchasing company would be well advised to do a complete phase I assessment. Risk managers should keep in mind that a screen may overlook a potential problem that a phase I could potentially uncover. The screen is also limited to a certain type and size of property. For instance, a multimillion-dollar gasoline refinery would probably be too large for a transaction screen, while a five-year-old, three-story office building would probably qualify.

Continuing Efforts

After these tests are completed, negotiations with the seller should address the future welfare of the property and potential buyers. If indications of severe problems exist, the buyer can proceed with a more extensive environmental study, a phase II, or can abandon the deal altogether after determining that the risks and costs are too high. Any problems found should be used as bargaining chips to not only lower the price of the property, but also to get the seller to share the remediation costs and legal liability. The final option is to eliminate from the transaction that portion of the property that is causing the problem.

Yet, even when no apparent problems are found, the future is not risk-free. Property transfer insurance will cover the remediation costs of undetected problems at time of purchase. Like other types of insurance, this coverage and its costs depend on the condition of the property, the deductibele and the types of risks covered. Most of the companies now offering this environmental insurance require a phase I assessment and, in most cases, the costs are incurred by the property's buyer.

There is no national standard or rating agency for phase I assessments; some insurers have established their own phase I standards and will accept work only from select environmental consultants. Research shows that some environmental consulting firms miss as much as 40 percent of existing contamination.

State Laws

Coverage of state laws is another consideration in choosing environmental insurance. Some insurance policies cover Superfund legislation only, while others include state and local laws. More than 70 percent of all environmental problems come under state jurisdication; therefore, inclusion of state laws in environmental coverage is critical.

Because this type of insurance is new, many companies are testing various lengths of coverages, limits and premiums. For instance, many lending agencies are interested in policies that cover the property until the end of its mortgage, but three-year policies are also available. The premium is usually based on a percentage of the purchase price and is paid upfront in a three-year policy.

In the future, it appears that banks will be major players in this trend-setting insurance market. Some banks have indicated that insurance will soon be required on commercial property transactions above a certain dollar value, and that the coverage will be administered in much the same way as title insurance. The banks hold the purse strings for most transactions, so property buyers' compliance is a given. As need dictates and insurance companies gain feedback from customers, policies may be extended to cover a broader range of environmental problems.

Paul K. Freeman is president and chief executive officer of ERIC Group Inc., an insurance company in Englewood, CO.
COPYRIGHT 1992 Risk Management Society Publishing, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Title Annotation:environmentally related but hidden aspects of commercial property; includes related article on what to ask when purchasing property
Author:Freeman, Paul K.
Publication:Risk Management
Date:Feb 1, 1992
Previous Article:Clearing the air on the Clean Air Act.
Next Article:Asbestos abatement.

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