Foreclosing Banks Increasingly Using Environmental Insurance For Sales Risks

As the nation slowly lifts itself out of the effects of the Great Recession, lenders are beginning to increase the pace of foreclosures on commercial properties. The volume of foreclosures is likely to significantly increase during the next few years as the loans that were originated during the height of the credit bubble become due. With real estate pricing averaging 50% below the peak of 2007, many borrowers simply will not be able to refinance their loans.

We have a number of posts in our “archived” section about the heightened risks that lenders face during workouts and foreclosures, and we encourage readers to review those posts. By way of a quick summary, though,  the secured creditor exemption of CERCLA and RCRA provide a safe harbor to lenders who do not participate in the management of a borrower’s operation. However, the scope of the liability protection is less clear when a bank forecloses on a property.

After foreclosure, the federal secured creditor exemptions require a lender to take commercially reasonable steps to sell the property. Unlike the EPA lender liability rule that was vacated by a federal court in 1994, the CERCLA and RCRA statutory language does not contain a “bright line” test for what constitutes commercially reasonable steps to sell foreclosed collateral. The lender cannot reject a “bona fide” offer but who really knows what that means when real estate prices are 50% below peak values and many of the interested buyers are only interested in acquiring property at rock-bottom prices.

In addition, many states have their own secured creditor exemptions that may not only have more specific instructions on what constitutes commercially reasonable efforts to divest foreclosed property but also have limits on how long a lender may hold title without being deemed to not taking commercially reasonable steps to sell the property. Not surprisingly, the acceptable time periods vary by the state. And then there are those nasty local ordinances that are imposing new maintenance obligations on lenders that take take title to abandoned property.

Because a lender will not know if it has satisfied the secured creditor exemption until after it has been sued and a court has ruled on the issue, we advise our lending clients to act as if they the secured creditor exemption is not available and to make sure they take steps necessary to assert the CERCLA and/or state landowner liability protections such as the innocent landowner and bona fide prospective purchaser’s defenses. This means that the lender will have to do a phase 1 and comply with the post-acquisition appropriate care or due care requirements. It is also often advisable to include an environmental compliance component to the due diligence to make sure the lender does not inadvertently find itself subject to fines and penalties for violations of environmental laws.

For these and other reasons, foreclosing lenders are motivated to sell properties as quickly as possible. One tool that lenders are increasingly turning to to maximize their return and minimize liability is to combine the phase 1 with an “as is” sale coupled with an assignable environmental insurance policy. The lender will not indemnify the buyer and the seller has to agree to a hold harmless provision along with a waiver of all rights under environmental and common law. The “as is” contract nature of the contract allows the lender to avoid later breach of contract claims in the event the property turns out to be contaminated as well as not have to reflect any liability that could be associated an indemnity on its books. The environmental insurance softens the impact of the “as is” nature of the contract. In addition, the lender will agree to have the policy assigned in exchange for no discount in the purchase price.

In the deals we have seen, the insurance  generally has only been available for suspected environmental conditions based on historic use of the property such as a strip mall that had dry cleaner in the past. The insurance is not generally available  to cover known conditions. However, there are some indications that some insurers may be more willing to work with lenders and purchasers to fashion some coverage for known contamination to satisfy the increased demand for this product as the volume of foreclosures increases. Of course, having a good understanding of the known condition or  enrolling in a state voluntary cleanup program with an approved cleanup plan or a state dry cleaner/UST program along with transacting parties who are flexible with their demands is crucial to successfully implementing this risk management strategy.



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