Environmental insurance: Enhancing and adding value to business transactions

Abstract

Business transactions come in three forms: simple, complex or impossible. Impossible equates to a transaction that has been abandoned because one or both parties sees no potential gain—financial or otherwise—in completing the transaction. Providing such a compact definition for complex transactions is not as simple. Complex transactions often involve negotiation. As we all know, negotiated transactions usually require a sacrifice of either time or money, often both. These sacrifices usually results in reducing the value of the transaction. It also creates inefficiency because of the amount of time it takes to sort through all the options, negotiate, and renegotiate. The bottom line is that the key component that makes a transaction “complex is the willingness of either party to assume or agree to taking on risk. In the world of environmental risk, these factors are often exacerbated by a level of uncertainty that accompanies environmental liability. It's not hard to imagine the complexity of dealing with an environmental liability and, from a business owner's perspective, the following concerns are common: For a known environmental condition, what is the total cost of cleanup? What's the guarantee that costs won't exceed what is allocated? What if regulations change? What if the cleanup technology does not work in the time frame allowed‐which may be deal sensitive? What if another environmental condition is found that was not previously identified? If another party indemnifies my company for the cost, what is the value of that indemnity...will they be around five, ten, or even twenty years from now? Or, from a lender's perspective: How can we lend on property that has no or negative collateral value? For unknown conditions, what level of due diligence is enough? If an environmental nightmare is discovered, could it have been identified sooner? How much time and money can be spent studying a transaction before the research cost and time reduce the potential opportunity? As a lender, will the borrower remain sound if an environmental condition is discovered? If a condition is discovered, what collateral exists to secure the loan balance? The question must be asked: Is fear of environmental risk stifling growth and market expansion for developers, lenders, or growth companies? And, what conditions of sale exist in a transaction to address unknowns, and risks that parties to a transaction would be willing to accept. Equally important, is ensuring that an organization has evaluated environmental risk for new conditions alongside other exposures faced in the business operations. Implementing loss control measures to help minimize risk, as well as examining what risk can be assumed and what should be transferred are strategic, sound business practices. This is where environmental insurance comes into play. Environmental insurance offers a critical mechanism by which to remove environmental risk from the transaction table. By moving risk out of the negotiation to a third‐party insurer, environmental insurance can increase efficiency and bring about successful completion, whether the transaction is a merger or acquisition, a securitization of a loan pool, a lending commitment, a redevelopment project, environmental disclosure, or satisfaction of regulatory obligations. Through the use of numerous examples, the authors will try to illustrate the value provided by today's environmental insurance market in business transactions. After twenty years of development, the insurance contracts have proven meaningful to many transactions and continue to be written to meet the needs of individual insureds.