FEATURE ARTICLE, APRIL 2007

MANAGING ENVIRONMENTAL RISKS FOR
BROWNFIELD REDEVELOPMENT
James Vetter

Brownfields — abandoned, idled or under-used industrial and commercial facilities that may have real or perceived environmental issues -— may represent significant opportunities for both sellers and potential buyers. For owners, these sites historically had been a burden, marring financial statements and draining cash flow. However, they are increasingly becoming a potential source of cash as a growing number of sites have become marketable.

Many prospective purchasers and developers now consider brownfields a more attractive option to traditional greenfields development because they can offer at least two significant potential advantages: location and price. Brownfields are traditionally close to town and work centers with easy commutes, and many are located on or adjacent to waterfront, which has prime development appeal. 

In addition, brownfields often are discounted due to real or perceived environmental issues. As a consequence, prime locations can be acquired at a significant discount compared to comparable greenfield sites. In light of those two factors, brownfields can offer a high-value end-use, an attractive development pro-forma and potential return on investment.

Financial Feasibility and the Pro-forma

Brownfield redevelopment projects are fundamentally a financial venture in which sellers and developers seek to maximize and realize a return on investment either by divesting or developing environmentally impaired properties in desirable locations. For a project to be successful, the owners and prospective purchasers need to understand and enable development of a realistic pro-forma to meet the project’s and developer’s basic financial goals.

The pro-forma is a capital budgeting process where revenues and expenses are cost accounted and forecasted over the life-cycle timing of the project.  Ultimately, this stream of costs must be discounted at a project’s cost of capital to determine whether the project is able to provide a positive net present value (NPV); that is, the time value of money of the expected revenues exceeds that of expenses using the cost of capital. The goal is to avoid projects with negative NPVs and to seek projects that maximize positive NPV.

One consideration with brownfield sites is how to manage cost uncertainty from environmental issues. Pro-forma development and the NPV outcomes are highly sensitive to cost assumptions and any related likely variances in them. Environmental outcomes can be a challenge to forecast both in terms of cost and time-to-closure. Historically, some development has not progressed as a result of these uncertainties.  Among other variables, an assessment and decision about a project’s viability and forecasted return on investment needs to consider:

• A full cost accounting of environmental risks for the project as related to purchase-and-sale agreement negotiation, field execution, and successful exit strategy;

• Potential variances that may occur in environmental costs and, importantly, their timing;

• Environmental issues that may affect site redevelopment plans, end-uses, and usable acreage calculations.

• Risk management processes used to minimize or eliminate variances, including proper contract negotiation, environmental insurance, subcontractor insurance requirements, field management practices, and exit strategy.

Including the results of a risk management assessment with the pro-forma development should provide adequate information for “go/no-go” decision making and help to maximize the total project return.

Risk Management Strategy

Most site acquisitions and developments focus on environmental issues at the acquisition stage. Typically, the first step involves environmental due diligence to identify and quantify environmental costs for inclusion in the pro-forma and as part of purchase-and-sale agreement negotiations. A successful environmental strategy, however, needs to consider the risks associated with each of the three phases of a brownfields project life-cycle:

Phase A: Acquisition

Risks and Needs:

Manage unknown and known risks from due diligence; provide greater certainty regarding pro-forma cost assumptions; provide assurance to seller for environmental matters; eliminate or limit need for indemnity and its legacy obligations; eliminate or limit assumption of risk by developer; or limit risk associated with transaction documents (such as PSA).

Phase B: Redevelopment

Risks and Needs:

Integration of costs and risk management with redevelopment plan; manage over-runs associated with remediating known conditions; facilitate or provide back up for cost collection under indemnity (amount and timing); limit impact from discovered conditions and third-party claims.

Phase C: Exit Strategy

Risks and Needs:

Eliminate or limit indemnity and costs to developer on exit, or provide assurance to other developers, homeowners or tenants.

A broad examination of risk issues along a project’s entire life-cycle will provide a more complete assessment of environmental issues and can help eliminate many of the surprises and considerations that may surface during redevelopment or when it is time to exit the property.             

Risk Management Tactics

A number of risk management tactics are available to address risks across the project life-cycle:

Purchase and Sale Agreements 

The first line of risk management defense is a purchase-and-sale agreement (PSA).  A wide variety of provisions and protections typically are woven into PSAs, including indemnities, representations and warranties, performance standards on disclosure, and cost allocation and purchase price adjustments. The selection of legal counsel with environmental experience on property transactions is a critical first step to create a PSA that may help to minimize a party’s potential exposure.

Third-party Liability Transfers 

In traditional transactions, the buyer and seller negotiate the allocation of environmental risks; brownfields transactions typically involve the assumption or apportionment of multiple and often complex risks. In many cases, neither party wants to assume environmental liabilities, preferring to leave the environmental issues to another party so they can focus on their own business core-competencies.

In light of these concerns, a number of environmental engineering and consulting firms have stepped forward with a solution.  These firms have moved beyond their traditional “time and materials” method of billing and have embraced “guaranteed fixed-price contracts” and “liability buy-outs.” Parties considering these arrangements should consult with legal counsel before proceeding.

Under a guaranteed fixed-price contract, the buyer or seller retains liability, but the consultant provides a single price to complete remediation and to achieve closure consistent with the intended development and project schedule. This provides cost certainty around environmental remediation costs.

In a liability buy-out, the consultant assumes environmental liabilities contractually from both the buyer and seller. A liability transfer agreement (LTA) is executed to complete the transfer of the environmental liabilities. The LTA provides for a transfer of risk contractually and can include the consultant assuming responsibility directly with regulatory agencies for outstanding orders and decrees.

This approach can be broader than a guaranteed fixed-price in that it includes both fixed-price for the remediation previously described as well as the assumption of associated liabilities, such as third-party bodily injury and property damage claims, and natural resources damages. This solution involves pre-funding the consultant’s liability at the time the transaction is completed.

Environmental Insurance

Various environmental insurance products often are utilized on brownfields to help manage an array of environmental risks across the entire project life-cycle for buyer, seller, and/or consultant.

A pollution legal liability (PLL) insurance policy can help to protect against adverse financial consequences related to the discovery of certain unknown conditions such as:

• Environmental remediation clean-up costs (on and off-site);

• Third-party bodily injury;

• Third-party property damage;

• Legal defense expense;

• Natural resource damage claims;

• Diminution in value (third party);

• Development soft costs due to delay;

• Business interruption

A PLL policy can offer some flexibility with respect to assignment or for adding multiple stakeholders, including buyer, seller and future landholders to help facilitate future sale and divestiture.

An environmental cost cap policy can provide protection against cost over-runs associated with known conditions. Known conditions are typically excluded from the PLL policy. During negotiations, the known conditions are identified, a cost is assigned for their cleanup, and responsibility is allocated in the PSA. The cost cap policy can then provide coverage for the following types of risks that often result in over-runs:

• Known contamination is greater in volume than expected;

• The degree of contamination is higher (soil that was expected to be non-hazardous turns out to be hazardous);

• Previously unidentified contaminants are discovered that affect treatment and disposal costs;

• The amount of time for remediation is longer than anticipated and increased variable and non-variable costs are incurred;

• The government agency mandates a change in remedy or a lower cleanup standard that increases costs

The most important aspect of cost cap is that it aids in providing a degree of cost certainty for the remediation of existing contamination. This is critical when forecasting expenses on the project is necessary to achieve projected margins

A significant amount of the cost uncertainty and other potential environmental exposures associated with brownfields often can be managed by a careful analysis of risks from acquisition through exist strategy, and by use of appropriate risk management strategies, including PSA negotiation, environmental insurance, guaranteed fixed-price contracts, and liability buy-outs. With the appropriate risk management mechanisms in place, brownfields may represent significant financial opportunities and alternatives both for developers and buyers and provide meaningful benefits to communities and society.

James Vetter is senior vice president in the environmental practice at Marsh.


©2007 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.