Expert Commentary

Environmental Risk in Retail: Exposures and Solutions

Alan Bressler examines the environmental risks in retail operations and presents the relevant risk transfer products designed to mitigate these exposures.


Environmental
October 2002

For many years, state and federal environmental enforcement was largely targeted at heavy industry, particularly those that were resource intensive or generated significant waste streams. With the passage of tough environmental legislation in the 1980s, such as the Comprehensive Environmental Response Compensation and Liability Act (CERCLA or Superfund) and the Resource Conservation and Recovery Act (RCRA), and the implementation of regulations designed to bring such industries under stricter compliance, state and federal environmental regulators began to focus their enforcement efforts on other types of business and even nonprofit entities. Universities, hospitals, cities, and counties did not escape the consequences of toughened regulations and increased environmental scrutiny. The retail industry has been no exception.

While environmental risks typically associated with retail operations pale in comparison to, for example, a petrochemical plant, these exposures and the liabilities they create can have a deleterious impact on earnings, growth, and expansion, and impair the public’s overall perception of the company as a good corporate citizen. In the current environment, it makes sense for retailers to consider the pitfalls, understand the exposures, and develop risk management practices and programs that address this evolving exposure. Just look at the recent explosion in mold-related litigation to see how environmental liability can affect virtually all industries.

Environmental risks associated with the retail industry generally fall into one of three categories:

  • Site acquisition, development, and construction
  • Store operations
  • Strategic transactions, such as mergers and acquisitions

Here are some of the common environmental risks associated with each category, and the relevant environmental risk transfer products designed to mitigate these exposures.

Site Acquisition, Development, and Construction

As do most businesses engaged in the acquisition and development of real estate and construction of improvements on the site, retailers face a variety of environmental risks associated with this process. While retailers that knowingly acquire and develop sites with known or suspected environmental contamination face the greatest risks, any retail organization buying or leasing property must understand the exposure, develop an effective due diligence process, and manage environmental risk.

Most real estate acquisitions include environmental due diligence, whether due to a lending requirement or simply as part of an organization’s “best practices.” This process usually begins with a Phase I environmental site assessment (ESA) in accordance with the American Society of Testing & Materials (ASTM) E1527 standard.

In such an ESA, the property’s historical uses are investigated, regulatory databases are searched for environmental violations or enforcement actions at the site or neighboring facilities, visual inspections are conducted, interviews are performed with landowners, tenants, or other individuals with knowledge of the site, and other qualitative environmental assessment data are gathered. (It is instructive to note that, in a Phase I ESA, no soil or groundwater quality data is gathered.) The intent of a Phase I ESA is to determine, from review of available records, interviews, etc., whether “recognized environmental conditions” exist that merit further investigation.

Where “recognized environmental conditions” are identified in a Phase I ESA, typical protocol is for the environmental engineering firm performing the work to recommend further assessment, usually in the form of a Phase II ESA. The Phase II ESA usually involves soil and/or groundwater sampling from a limited number of areas identified to be likely sources of contamination in order to perform a more quantitative assessment of any impact to soil and groundwater.

Some of the pitfalls of relying on a “data only” approach to environmental due diligence for real estate acquisition include:

  • Studies performed in the last decade have indicated that as many as 40 percent of all Phase I ESAs, even if property performed in accordance with ASTM standards, fail to detect existing contamination.
  • Recourse against an environmental consulting firm for failing to detect contamination may be limited by contract terms, the ability to demonstrate negligence, and/or the financial condition of the consultant and its insurers.
  • Phase I ESAs are merely a snapshot in time. Environmental regulations and conditions change over time, often after closing on the site.
  • Data is information; it doesn’t transfer risk.

A few retail organizations are undeterred by environmental contamination at all except for the most severely impacted sites. In fact, savvy organizations, in general, may use the arbitrage created by environmental uncertainty to their competitive advantage in terms of land acquisition cost. When their preferred location is driven by proven demographics, these organizations have developed a number of innovative ways of managing environmental risk to acceptable levels.

Brownfield approaches that incorporate risk-based cleanup standards present an evolving example (see IRMI Expert Commentary, Brownfield Redevelopment: A Risk versus Reward Proposition). In fact, Brownfield cleanups that incorporate large building slabs surrounded by vast areas of asphalt parking may be an ideal integration of cleanup and redevelopment at certain sites. Environmental insurance also has proven to be an excellent tool for managing the risks associated with these types of retail developments, including:

  • Cleanup Cost Cap for “capping” the cost of cleaning up known pollution conditions
  • Pollution Legal Liability for transferring the risk of cleaning up unknown preexisting pollution conditions, third-party claims, and other related exposures

For most retailers, though, real estate acquisition is contingent on a “clean” Phase I ESA (i.e., one which does not identify any “recognized environmental conditions”). Based on this evaluation, the site is acquired and readied for development.

A number of cases have clearly pointed out the pitfalls in relying purely on a Phase I ESA to identify preexisting environmental conditions at real estate development sites. Unearthing of buried tanks or drums is not uncommon. The spreading of unknown soil contamination across (or worse, off) the site during grading activities has been documented. There are even a few cases in which, during dewatering of a site in an area where the groundwater table was high, contaminated groundwater from an adjacent site was drawn onto the site undergoing development.

To compound the problem, the process of reporting, investigating, and, if necessary, designing and performing a cleanup of the newly found contamination is a seemingly endless journey that can delay a project for months. These delays have a cost. To organizations that depend on strong seasonal sales, these costs can be more than merely “significant.”

Many organizations—retail or otherwise—rely on seller indemnifications to fund the cost of remediation when unknown preexisting contamination is discovered during real estate development. These indemnifications have their own shortcomings.

  • Perfecting on the indemnification may be difficult, if not impossible, either due to insolvency of the indemnitor or disputes over the scope of the indemnification agreement.
  • Even if the indemnification agreement can be perfected as pertains to the actual cleanup costs, the agreement may expressly except third-party liability claims, economic damages, or both.
  • The time that it takes to perfect an indemnification may be costly. To retailers and the developers they engage, time is money.

Even when unknown preexisting environmental contamination is not found during development or construction, the process of site improvement, itself, can introduce environmental risk. Stormwater runoff has become a major environmental issue in the context of real estate development projects. Failure to obtain appropriate permits, and failure to comply with the management and reporting requirements of the permits, can result in substantial civil fines and penalties. While much of this risk is uninsurable (a few Pollution Legal Liability (PLL) insurers may offer limited coverage for civil fines and penalties), it is not unmanageable. Developing and consistently following proper permitting procedures and their requirements, as well as the retailer’s own best practices above and beyond permit requirements, will mitigate the risk of civil penalties from stormwater runoff.

Aside from the stormwater management risk, virtually all of the environmental exposures a retailer will face during the site acquisition and development process can best be addressed through a properly tailored Pollution Legal Liability program. (When the site has known contamination, a Cleanup Cost Cap, as described above, may also be invaluable.) Pollution Legal Liability coverage transfers the following risks associated with the site acquisition and development process:

  • Cleanup of unknown, preexisting pollution conditions (this section can also act as a remediation “warranty” against regulatory reopeners after cleanup of known conditions) both on and off the site
  • Third-party claims alleging bodily injury or property damage, including diminution of property value and natural resource damages, both on and off the site
  • Delay in project completion caused by previously unknown environmental contamination, which results in continuing soft costs
  • Loss of income due to delay in opening

(For a more detailed description of the array of coverages available in Pollution Legal Liability insurance products, see the IRMI Expert Commentary, The U.S. Environmental Liability Insurance Market—Reaching New Frontiers.)

Using Pollution Legal Liability insurance as a tool, retailers who acquire and develop sites can take the environmental risk and cost uncertainty out of the acquisition and development process as well as out of its budget.

Store Operations

Pollution Legal Liability coverage can also play an important role in managing the environmental risks associated with retail store operations. Environmental risks arising from retail store operations generally fall into one of two categories:

  • Nature of products/services sold
  • Store maintenance

Retail operations that store and sell significant volumes of paints, solvents, chemicals, petroleum products, fertilizers, pesticides, automotive batteries, and similar products obviously have a higher degree of environmental risk due to their operations than do greeting card stores. Compared with more resource or waste-intensive industries (such as petrochemical or forest products), it would be a fair statement to say that retail, in general, does not face the same level or type of environmental risk as heavy industry.

It is not unusual for certain types of “big box” retail establishments that stock and sell a wide range of products to have lawn, garden, and even automotive servicing departments. These types of stores obviously face a higher degree of environmental exposure than than do retailers specializing in clothing, most consumer durable goods, etc.

In addition to the typical exposures related to the storage of herbicides, pesticides, fungicides, etc., from the lawn and garden section, these stores typically sell a wide variety of paints, thinners, and other chemical-based products. The potential for long-term, gradual spills/releases of these products generally is obviated by the fact that they are stored above ground level and such releases would be discovered each day. Nonetheless, developing proper training and education, policies, and procedures for store employees is a critical component in managing this risk.

For example, the store should include, as part of its new employee orientation (for all new employees working in these departments, at minimum) do’s and don’ts related to storage, stocking, and disposal of partially opened/broken bags of fertilizers, pesticides, herbicides, etc. This will mitigate the risk of untrained, new employees improperly disposing contents of any broken bags or containers improperly.

In addition to dry or durable goods and other merchandise, some retailers have automotive service departments and sell gasoline to customers. While the types of automotive services offered often are limited to tire, battery, and oil change operations, these retailers face fairly significant environmental exposures, for example:

  • Underground storage tanks (USTs) that contain gas or diesel fuel for customer use
  • Waste batteries sent to recycling facilities
  • Used oil sent to recycling facilities

In addition to developing management practices that address proper filling of the tanks and dispensing of gas or diesel fuel, retailers should be aware that federal regulations require evidence of financial assurance for the ownership/operation of all underground storage tanks over 110 gallons capacity. The financial assurance test may be met by a balance sheet test, a surety mechanism, or an insurance policy. While many retailers may have balance sheets that meet the test, environmental insurance is an inexpensive alternative that can keep the company’s performance from being jeopardized by either cleanup costs or claims alleging releases from USTs.

For waste batteries, waste oil, spent solvents from parts washers, etc., best management practices should include qualifying and auditing transportation vendors and the treatment, storage, disposal, and/or recycling firms to which the wastes are transported. Beyond controlling this risk by establishing and consistently following these procedures, Non-Owned Disposal Site (NODS) coverage is critical for managing this long-term risk, because, as under federal regulations, the wastes retailers (or any entity) generate remain their responsibility from cradle to grave. NODS coverage, available under PLL policies, provides two basic scopes of coverage:

  • NODS first-party coverage—covers the insured’s liability as a “potentially responsible party” (PRP) under Superfund and/or state equivalent regulations to contribute to the cleanup of the NODS itself
  • NODS third-party coverage—covers the insured’s liability associated with third-party claims, alleging bodily injury and/or property damage from pollution conditions attributable to an insured’s waste products that have migrated beyond the NODS site

Store maintenance is another area where retailers often overlook environmental risks. Even though building maintenance in the retail sector may seem innocuous, most environmental exposures related to these activities are likely to be excluded by the pollution exclusion in the Insurance Services Office, Inc. (ISO), commercial general liability (CGL) insurance policies.

Consider, as examples, the following routine maintenance activities and related risks.


Maintenance Activity/Issue Exposure
Painting
  • Volatile organic vapors from paints and thinners
  • Disposal of paint and/or thinner-soaked rags and brushes
Floor stripping Volatile organic vapors from stripping compounds
Fluorescent light tube replacement Long-term disposal liability for tubes and ballasts containing mercury
Renovations Disturbing/releasing asbestos or lead-based paint in older facilities
Stormwater system maintenance Exceedances/violations of stormwater permits resulting in civil fines/penalties.
Improper roof/plumbing maintenance Mold growth and release of mold spores

Even though some states have restrictive interpretations of the pollution exclusion in ISO CGL policy forms, retailers should be aware that that these types of losses may not be covered under the majority of standard CGL forms. In addition to control and mitigation of these risks by implementing of best practices for training and educating maintenance staff through an Environmental Management System (EMS), Pollution Legal Liability coverage is the tool of choice for protecting retailers against these, and other, maintenance-related risks.

Toxic mold, an environmental exposure that has been evolving rapidly in recent years, is one area of store maintenance in which retailers would be well advised to pay extra attention. Most mold claims are related to either improper building design/construction means and methods, or improper maintenance. Examples of improper building maintenance that can foster mold growth include poor roof maintenance and unbalanced heating, ventilating, and air conditioning (HVAC) systems. In either case, long-term exposure of cellulose-based building materials to damp, humid, and dark conditions is a direct cause of mold growth.

Mold is a potentially serious exposure for retailers. While it is true that worker exposure is covered under state workers compensation benefits and the related insurance policies, for large retailers that are self-insured for workers compensation, these costs can be substantial when a mold condition spirals out of control in a store location.

Since the vast majority of exposure that might occur to store patrons and other third parties is short-term in duration, the likelihood of mold-related claims by third parties may be somewhat less than that of worker exposure. Bad publicity from media reports that scares patrons from shopping at a particular location may be more costly to retailers than actual mold-related third-party claims. It is important to note that a growing number of CGL and excess liability insurers are excluding mold claims from coverage via specific manuscript exclusions.

For more information on the general coverage issues associated with mold, under both traditional CGL or umbrella products and environmental-specific liability policies, see IRMI Expert Commentary, Mold: The Newest Environmental Hazard.

Retailers face two industry-specific concerns regarding mold exposure and coverage, beyond the traditional third-party bodily injury risk. First, property damage to owned property caused by exposure to toxic mold is likely to be excluded by certain standard exclusions in commercial property policies (e.g., dampness, humidity, etc.), and is clearly excluded by CGL policies. While Pollution Legal Liability products can cover certain toxic mold exposures, finding coverage under any product for mold damage to inventory (or any other first-party personal property) is difficult, if not impossible. Second, for those retailers who own buildings (and those otherwise responsible for damage to the building under certain lease terms), finding coverage for mold cleanup costs is difficult at best. At worst, in most states, a lack of remediation standards (and none are currently coded as law at the federal level) for mold leaves coverage for cleanup costs is an extremely gray area.

By and large, though, most environmental exposures associated with building maintenance are related to routine cleaning operations like floor stripping, painting, etc. Because stores can act as a huge confined space for volatile organic compound vapors, retailers should establish best practices related to these operations. Examples include conducting these operations after hours, keeping locations well-ventilated, and using low odor stripping products.

Finally, special precautions must be taken during renovations of retail establishments in older facilities, especially those built prior to 1979. Prior to this date, many commercial buildings in the United States were constructed with asbestos-containing building materials and/or lead-based paint. In many instances, retail locations, especially larger mall facilities, have undergone extensive abatement of these materials. For those retailers that are unsure whether their facilities contain such materials, some limited bulk sampling of suspect materials (e.g., drywall, ceiling grids, floor tile and mastic, etc.) by a qualified environmental consulting firm can confirm or deny their presence. If the materials exist, an operations and maintenance (O&M) program should be developed and implemented that specifically addresses procedures, ranging from renovation to light bulb changes and other activities that might disturb the materials. In cases where these materials are in poor condition and are potentially friable, complete abatement, or some other form of risk mitigation, is recommended.

Conclusion

While retail establishments typically do not face the range and magnitude of environmental risks faced by heavy industry, exposures do exist. State and federal environmental enforcement efforts increasingly are targeting less resource-intensive industries. Increased litigation and public awareness regarding exposures, such as toxic mold, have raised the stakes for virtually all industries.

In this environment, it makes sense for retailers to review their acquisition, development, and construction strategies, as well as their operations and facilities best practices and maintenance procedures. As with other areas of risk management, an ounce of prevention can go a long way toward mitigating serious financial loss. Environmental insurance remains the product of choice for transferring catastrophic environmental risks that are either unforeseeable or for which prevention can only go so far.


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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