Brownfield Redevelopment:
A Risk versus Reward Proposition
December 2000
The number of abandoned industrial sites across
America in need of environmental remediation continues to grow. With local governments
striving to curb urban sprawl and eliminate inner-city decay, and with the development
of recent legislative and regulatory initiatives, these “Brownfield” sites offer
an opportunity for redevelopment. This article explains how environmental insurance
and innovative risk management tools help reduce the risk and uncertainty surrounding
these projects.
by Alan
J. Bressler and John A. Hannah
Marsh,
Inc.
Shifts in the U.S. economy in the years following World War II created a
dilemma for American cities and communities. Many older, noncompetitive, and
underperforming factories required significant modernization. From the late
1950s through the 1980s, these facilities were relocated to the suburbs rather
than attempting to update them for a number of reasons: lower taxes and utility
costs, changing labor needs and demographics, and the availability of less costly
land. This resulted in the closing of large numbers of industrial facilities
in cities across America. Subsequently, technological innovations and the shift
to a more service-oriented economy further eliminated the need for industrial
plants.
In the 1980s, the dawning of the country's most significant environmental
regulations complicated, increased the risk, and ultimately limited the sale,
reuse, or redevelopment of these sites. Many seriously contaminated industrial
facilities were, or are being, cleaned up under the Comprehensive Environmental
Response, Compensation, and Liability Act of 1980 (CERCLA) or Superfund. CERCLA
created the concepts of strict, retroactive, and joint-and-several liability
for remediation of environmental contamination.
Even where industry preferred to be near the city, CERCLA and a growing wave
of federal and state environmental regulations often made it cheaper to build
on "greenfield" areas outside urban centers. In time, many such sites blighted
neighborhoods. Factories shut down, local economies suffered, and tax bases
eroded. Other local businesses also were devastated by the economic downturn,
contributing to the decay of communities.
Many smaller commercial sites—such as former gas stations, dry cleaners,
automotive repair shops, and even vacant land where disposal activities occurred—remain
abandoned to this day. City governments acquired some of these sites through
legal means, such as tax lien foreclosure or condemnation, and were faced with
the question of how to put these sites back into productive use while protecting
human health and the environment. In the 1990s, these sites were named "Brownfields."
The U.S. Environmental Protection Agency (EPA) defines a "Brownfield" as:
abandoned, idled, or underused industrial and commercial facilities where
expansion or redevelopment is complicated by real or perceived environmental
contamination.
A recent U.S. General Accounting Office study concluded that there are over
500,000 Brownfield sites in urban, suburban, and rural areas of the United States,
and estimated that the environmental cleanup and redevelopment costs could exceed
$650 billion. With growing pressures on corporate earnings, the wave of mergers
and acquisitions, and utility deregulation, industry has been forced to close
or sell underperforming or nonperforming facilities, and noncore and stranded
assets, creating new Brownfield sites every year.
Evolution of the Brownfields Market
Since the mid-1990s, evolving attitudes, continuing economic evolution and
expansion, and innovative approaches are turning Brownfield sites into opportunities.
Concern over urban sprawl, economic drivers, and the need for sustainable infill
development prompted an opportunity to reuse and redevelop these areas. The
remediation of these sites can help a city or community reinvent itself, breathe
life into a depressed area, increase tax revenues and related services, create
jobs, and improve the quality of life.
New legislative and regulatory initiatives spurred this activity. The Asset
Conservation Act of 1996 gave lenders protection against environmental liability
in the normal course of debt-financing activities. The Taxpayer Relief Act of
1997 gave favorable tax treatment to environmental remediation costs. The EPA's
Brownfields Redevelopment Initiative provided funding for assessment of sites,
a previous major cost barrier to entry, and to capitalize revolving loan funds
for site cleanup activities.
State Voluntary Cleanup Programs (VCPs) are one of the most significant regulatory
initiatives. Currently, about 44 states have passed some form of VCP or Brownfields-type
legislation with industrial cities instituting some of the most progressive
programs. Among their many provisions, these laws have allowed for risk-based
cleanup based on intended reuse or redevelopment, and remedial liability relief
for innocent parties voluntarily agreeing to clean up sites. They typically
offer "no further action" (NFA), "no further remediation" (NFR), or "certificate
of completion" (COC) letters documenting completion of any required remediation
and providing (conditional) release from further cleanup requirements. By factoring
in the future use of the site, cleanup can be conducted to less than pristine
standards.
The level of required cleanup depends on a number of factors, including type
of contamination, media involved (e.g., soil or groundwater), and human and
ecological health risks. Intended reuse has become a driving factor in determining
cleanup standards. For many projects, the cleanup methodology is integrated
with the redevelopment, such as an asphalt cap providing both parking areas
and an impervious barrier to contain contaminated soil and prevent contamination
from leaching into groundwater.
Risk and Uncertainty: Barriers to Brownfield Redevelopment
A number of barriers to successful Brownfield transactions and redevelopment
remain; most revolve around risk and uncertainty. Examples of these risks include
the following.
- Third-party or "toxic tort" liability risks
- Regulatory risks
- Timing risks
- Financial exposures
Many such risks are intertwined, such as the risk of regulatory "re-openers,"
which could require additional cleanup after the VCP remedial effort has been
completed. This constitutes both a regulatory and financial risk. These risks
are discussed in more detail below.
Toxic Tort Risks. Site owners, sellers, buyers,
developers, and contractors all face risks from exposure to soil or groundwater
contamination on or emanating from the site. These claims may involve allegations
ranging from on- or off-site bodily injury, to property damage from off-site
migration, to diminution of property value at adjacent sites.
Regulatory Risks. These are of greatest concern
to firms that own and wish to sell or redevelop their sites, buyers who transact
in or redevelop Brownfields, and to some extent, contractors engaged in the
actual cleanup and development work. Again, regulatory re-openers could result
from an EPA-mandated cleanup broader than that approved under a state VCP or
changing state regulations imposing more stringent cleanup standards to already
remediated sites.
Memoranda of agreements (MOAs) signed between EPA regional administration
and some state regulators (approximately 15 to date) have mitigated some of
this risk. However, the MOAs contain exceptions to these enforcement "passes."
Due to strict eligibility requirements, they largely address sites that would
be unlikely to face federal CERCLA enforcement actions even in the absence of
the MOA.
Waste generation and disposal during remedial actions and undiscovered preexisting
contamination are other regulatory risks. Most state VCPs have incorporated
limitations on remedial liability to innocent purchasers to a degree sufficient
to encourage Brownfield redevelopment, but they do not eliminate regulatory
risk altogether.
Timing Risks. Intertwined with financial risks,
these involve delays in development and opening that may occur due to discovery
and required cleanup of unknown preexisting contamination during remediation
or construction activities. Not only are profits at risk, but "soft" costs,
such as loan interest, may continue during such delays. Not all timing risks
are related to environmental conditions. Failure to pass zoning for intended
future use or to secure permits for development activities may cause other timing
risks.
Financial Exposures. Lenders remain cautious
about providing debt financing on properties with known or suspected contamination,
even with the added clarification provided in the Asset Conservation Act. The
contamination might impact the borrower's ability to repay the loan, the loss
of collateral value, and the potential for remedial and toxic tort liability.
Owners who redevelop their own sites and buyers who purchase sites for redevelopment
face financial risks ranging from underestimating cleanup costs, to the cost
of undiscovered preexisting contamination, to toxic tort liability. The insolvency
of an indemnitor is a financial risk faced by both parties.
Many finance, regulatory, liability, and timing risks are being addressed
through innovative arrangements by a burgeoning cottage industry of Brownfield
development firms. Some firms provide equity funding, others trade an equity
position for funding and executing environmental or redevelopment consulting
and remediation activities. Traditional methods of dealing with these exposures
have included reductions in the purchase price to offset anticipated environmental
risks, indemnification agreements, escrow accounts, letters of credit, trust
funds, and similar funding mechanisms. These methods lead to protracted, often
heated negotiations over indemnification terms and the need to maintain reserves
on balance sheets for transactions in which a company's real intent was to cleanse
itself of the liability in addition to the asset.
Evolving Insurance Market Addresses Brownfield Risks
Innovative ways of managing Brownfield risks are available to meet the needs
of parties involved in reuse and redevelopment opportunities. Environmental
insurance products now play a critical role in many transactions. The following
four main products are particularly beneficial to parties involved in Brownfield
purchases, sales, ownership, reuse, and redevelopment.
- Pollution legal liability
- Cleanup cost cap
- Secured creditor programs
- Owner-controlled environmental insurance programs
These products are discussed below.
Pollution Legal Liability (PLL). This cornerstone
product for fixed-site facilities is designed to transfer the risks of cleanup
costs for unknown preexisting or new environmental conditions, third-party "toxic
tort" liability (bodily injury, property damage, and diminution in value), transportation
and disposal of waste materials from cleanup activities, and loss of income/extra
expenses caused by pollution conditions. PLL, which each insurer gives a different
name, can protect the seller by backing up the indemnification given to, or
received from, a buyer. It can also protect sellers from third-party liabilities
resulting from their interest in the divested property. PLL can protect the
seller from changes in regulations or new regulations that impose new liability
for cleanup.
PLL can protect the Brownfield buyer from: cleanup costs or tort liability
incurred if a seller becomes insolvent and cannot fund its indemnity; third-party
liability and cleanup costs from other unknown preexisting environmental conditions;
and the risks of waste materials generated and transported during cleanup. It
can also replace lost of profits associated with delays in opening and fund
continuing soft costs incurred during development due to environmental conditions.
Once the development is up and running, PLL can continue to provide risk transfer
for cleanup of new environmental conditions, third-party liability, and even
loss of income and extra expenses caused by pollution conditions. PLL also gives
an increased comfort level to lenders that environmental cleanup costs, third-party
liabilities, and certain timing risk won't adversely affect a borrower's inability
to repay a loan.
Cleanup Cost Cap. This coverage, introduced
in the mid-1990s and also known as "Remediation Stop Loss," is used to manage
the finance risk associated with unexpected cleanup cost overruns. The policy
pays for costs in excess of the estimates contained in a remedial action plan
(RAP), plus some buffer layer, usually 10 to 20 percent of the budget estimates,
which acts as a deductible. Some arrangements include coinsurance once the cleanup
costs exceed the budget estimates plus the buffer layer. The policy responds
when cleanup costs exceed the RAP estimates plus the buffer due to the discovery
of more contamination than was expected, additional types of contamination discovered
in the area of concern, or off-site cleanup costs for known pollution conditions
in the area of concern that have migrated.
Cleanup cost caps can be used to hedge the finance risk Brownfield developers
face from cleanup cost overruns. Owners who redevelop their own sites and developers
who purchase these sites find this coverage valuable for its direct financial
protection when cleanup cost estimates are exceeded. The product can also be
structured to provide contingent coverage for an owner who reacquires remedial
liability should the buyer become insolvent and fail to complete the cleanup.
Like PLL, a cleanup cost cap provides an extra level of comfort to lenders.
Secured Creditor Programs. These programs are
gaining acceptance among both traditional lenders and nontraditional sources
of debt financing—on a portfolio and single-loan basis and as a tool to manage
risk in securitization of loan pools. In the context of Brownfield financing,
secured creditor programs protect lenders from loss of principal loan balance,
cleanup costs, or third-party liability.
Two forms of the product exist. In the traditional product, the policy pays
for the lesser of the principal loan balance outstanding or the cleanup costs
when a loan default occurs and pollution conditions exist on the property used
as collateral. A more recent version provides for the repayment of the principal
loan balance only in the event of the default and pollution condition triggers.
Many lenders prefer this coverage form since foreclosure of the property is
not a requirement, and most lenders would prefer not to enter the chain of title
due to environmental regulations. Secured creditor programs give the lender
assurance that, at worst, the principal loan balance will not be jeopardized
due to borrower default and contamination to collateral.
Owner Controlled Environmental Insurance Programs
(OCEIPs). Like traditional owner controlled insurance programs (OCIPs),
OCEIPs protect project owners from third-party liability due to the operations
of all contractors on a project. OCEIPs can be written as stand-alone programs
or in conjunction with a traditional OCIP's commercial general liability (CGL),
auto, workers compensation, and other insurance coverages. In an OCEIP, both
contractor's pollution liability (CPL) and environmental professional liability
(environmental errors and omissions) are combined to protect the project owner
from third-party environmental claims due to the operations of all contractors,
or the acts, errors, or omissions of all consultants and environmental engineers
on the project.
The program covers the owner as primary named insured, and each contractor,
consultant, or engineer is added to the policy as an additional insured. Coverage
for third-party claims for bodily injury, property damage, or cleanup costs
is provided for all parties. The program also covers cleanup costs on the project
site for the owner due to the operations, acts, errors, or omissions of these
firms, as the owner is considered a third party relative to the negligence of
the contractor or consultant.
As respects both the remediation and construction portions of the redevelopment
process, an OCEIP is an excellent tool for managing the risks associated with
Brownfields redevelopment. More so than in traditional OCIPs, the quality and
consistency of coverage for the owner is vastly enhanced by an OCEIP. Unlike
CGL, auto liability, or workers compensation insurance, where most contractors
and engineers have Insurance Services Office, Inc. (ISO), or ISO-type standardized
policy forms, every insurer that offers CPL and environmental E&O has its own
manuscript policy form.
In the absence of an OCEIP, the project owner is faced with widely varying
degrees of coverage and exclusionary language when relying on additional insured
status under the contractor's, consultant's, and engineer's policies. Like traditional
OCIPs, there are typically significant cost savings to the OCEIP approach; these
increase with the size of the project. The following diagram is an example of
how PLL, a cleanup cost cap, and an OCEIP may be integrated to form a solid
wall of protection for those redeveloping Brownfield sites.
|
Project Action
|
Phase I, II
Remedial Design and Development of Cleanup Plan
|
Remediation of Site
|
Property Transfer, Redevelopment, and Continued Use
|
|
Insurance Reaction
|
|
Pollution legal liability for cleanup of undiscovered preexisting
pollution, third-party liability, waste transport/disposal, and project
delay and soft costs
|
PLL as Post Remediation Warranty Insurance added for the buyer to
protect against regulatory "re-openers"
|
|
Cleanup cost cap policy added
|
Pollution legal liability for cleanup of unknown preexisting, new
conditions, third-party liability, regulatory "re-openers," and loss
of income/extra expense for owner
|
| Owner controlled pollution/professional
liability wrap-up |
These four products have the ability to mitigate many, if not most, of the
regulatory, liability, timing, and financial risks faced in Brownfields transactions,
reuse, and redevelopment. There is currently a tremendous amount of flexibility
in the environmental insurance market, as well as adequate capacity, which allows
these products to be customized to address the needs of most Brownfields-related
risks. Of course, to make financial sense, a Brownfields developer still must
have a detailed understanding of local real estate market needs, capacity, and
drivers, as well as a ready source of debt and/or equity financing. At the end
of the day, these are still real estate development transactions subject to
all of the normal business risks associated with sites where no known contamination
exists.
Conclusion
With local governments striving to curb urban sprawl and eliminate inner-city
poverty and decay, and with the development of recent legislative and regulatory
initiatives and innovative risk management tools, the market for Brownfields
redevelopment has never been stronger. While environmental insurance is not
the panacea for Brownfield risk, it has become a valuable tool that can eliminate
enough uncertainty to encourage many projects to proceed.
Reuse or redevelopment of these sites is one of the most important issues
facing cities and communities today. Brownfields initiatives are gaining momentum
across the country, and environmental insurance is right there, helping to pave
the way.
Alan Bressler is a senior vice president
of the Marsh Environmental Group. As a member of the Group's Corporate Client
Development practice, his responsibilities include setting and executing corporate
strategy for sales and delivery of environmental products and services, acting
as a corporate technical resource, developing new environmental product and
service offerings, and training and education. Mr. Bressler was one of the nation's
first insurance brokers to specialize in the environmental insurance market
and now has 12 years' experience in environmental risk management, insurance,
and strategic consulting for major industry. He received a BS degree in Risk
Management and Insurance from Florida State University. Mr. Bressler can be
reached at Alan.Bressler@marshmc.com.
Opinions expressed in Expert Commentary articles are those of the author and are
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