Environmental Liability Risk Transfer: its time has come

Real Estate Weekly, June 21, 1995 by Stephen A. Silverman

The Problem

For some time, the SEC and the accounting profession has required that public companies disclose to investors the potential liability which the company has to remediate property owned (or formerly used) by the company from pollutants. The disclosure requirement is a problem to many companies, as often the potential amount of the cost of remediation (even when the amount is unknown) is an impairment to the company either in a public offering or the obtaining of borrowed funds in a financing.

However, until recently, there have been only the choices of continuing the reserves (and attendant disclosure) or completion of the remediation. Neither choice has been a desirable prospect. The first doesn't solve the problem. Commencement of remediation requires the use of important capital, has an unknown cost and often can take years. Sometimes, in the process of remediation of property from known contaminants, other previously unknown contaminants are discovered and must be remediated at the cost of additional time and money for completion of the project.

The problem has resulted from the requirements in CERCLA (the Superfund law) and other federal and state environmental statutes, which impose upon the potentially responsible party (PRP) the absolute obligation to bear the cost of the cleanup of the property, which obligation continues even if the property is sold to a third party. Since a new owner also has exposure under the statutes to complete the remediation, the PRP gains little in a sale unless there is the assurance of the completion of remediation by the new owner.

The problem is compounded by the fact that the cost of remediation is very often uncertain. Sometimes estimates have varied by many times the original estimate.

Holding the property creates its own problems and continued "pain and suffering" to the management of the company. There is usually a significant dollar cost to continue to hold property. There are always continuing costs. Those costs always include property taxes and insurance, but many times an abandoned plant site requires a reasonably significant number of non-productive employees for maintenance and security. Perhaps most important is the time of the company's management in continuing to ponder the problem.

Companies most effected by environmental contingent liabilities include many Fortune 500 chemical, oil, gas and transportation firms. Most have disclosed liabilities of more than $100 million, and some, like Monsanto and Arco, exceed $1 billion. In total, it is estimated that companies are carrying close to $100 billion of contingent liabilities - a staggering number of illiquid assets.

The Solution

ELRT solves all of these problems. Simply stated, ELRT is the transfer of the liability for remediation (the cleanup itself) to a third party in a manner which assures the PRP that the remediation will not only be commenced, but actually completed. Since the original PRP continues to have the exposure of liability for the cost of the cleanup, to eliminate the dreaded establishment of reserves and/or footnote disclosure in its financial statements, the obligation of any third party must be such that it is satisfactory not only to the PRP, but to its auditor. The method which has been successfully utilized is the obligation of a third party enhanced by commercial insurance to protect against not only known contaminants, but unknown contaminants as well.

Environmental Liability Risk Transfer has been developed by Remediation Capital Corporation (RCC) and Environmental Liability Acquisitions, Inc. (ELA) both of San Francisco. A few other companies have also made efforts to accomplish similar structures.

History of the Development

One recent insurance industry estimate is that more than 80 percent of all of the dollars paid by insurance companies related to claims for environmental pollution is for defense costs; a minuscule 20 percent or less has been expended to do actual cleanup.

This reflects the attempt by the industries who created the claims and those who have willingly or unwillingly insured against the claims, a crude effort at risk transfer. Hundreds of millions, if not billions, are now being spent trying to push this liability from one party to another. Yet the cost to our society and to our economy remains. The hundreds of millions spent on defense do not remediate a single barrel of pollution.

Until now, Environmental Liability wasn't anyone's "Business"; dozens of companies are engaged in remediation. That isn't the issue. For the companies in the United States discussed here which own real estate, not one has the opportunity to make toxically polluted real estate a profit center. Many managers will ponder the size of the loss related to the property, while for years others will be concerned about how his or her management of the problem will be evaluated by a superior, but none of these managers can show a profit to the bottom line by the management of problem. The best result which management can achieve is reduction of the loss.