By Bret A. Stone and John R. Till
Most banks and financial institutions are loathe to admit it, but their portfolio of properties and loans include properties that are or may be environmentally impaired. If the borrower defaults on the loan, the bank will face the unsettling prospect of foreclosing on the contaminated collateral or even foregoing its security. In other cases, the bank may be a current or former owner of the property. Whatever the scenario, there are economical steps that should be taken now to protect the value of your collateral and avoid, or at least minimize, your institution’s potential liability. Indeed, the proactive identification of historical insurance assets could save you millions of dollars on attorneys, environmental consultants, and lost collateral.
II. Insurance Basics
Generally, liability insurance policies obligate insurance companies to two important duties. If you or your borrower are sued for a potentially covered claim, the general liability insurance company has a duty to defend that suit – i.e., it must pay for the defense of the case. In addition, the insurance company has a duty to indemnify the insured for liability up to specified limits for covered claims. Although insurance policies written today typically exclude coverage caused by pollution, that was not always the case. In the 1960s, liability insurance policies did not contain pollution exclusions. In the 1970s, however, the insurance industry started writing policies that contained an exclusion for pollution coverage, but the exclusion contained an important exception – the so called “sudden and accidental” exception. Under these policies, the insurance companies contractually agreed to provide coverage if the pollution was the result of a sudden and accidental event. After years of paying out claims, the insurance industry changed again in the mid-1980s and put in place what is commonly referenced as an “absolute pollution exclusion.” Under certain circumstances, even the so-called “absolute pollution exclusion” has been found by courts not to apply.
The change in liability insurance policies is particularly important because the old policies are typically “occurrence-based” policies, which never expire. They continue to provide coverage today for events that took place decades ago! Thus, an accident causing a spill of hazardous materials that occurred in 1970 continues to provide coverage today if allegations are made against the insured. Moreover, a “sudden and accidental” spill may trigger the insurance for every subsequent year of coverage where the property damage exists. Accordingly, the general liability insurance policies your institution had, or your borrower had, in 1971, 1972, and so on may each have an independent obligation to defend and indemnify against long tail exposures.
But this information is literally disappearing! Every time someone moves their office, files get discarded in the process. If these files contain old insurance policies, you could be throwing away millions of dollars in insurance coverage.
A. Case Study – Contaminated Collateral
Bank has a loan on property in an industrial area of town. Adjacent properties have known areas of contamination. Operations at the property have included manufacturing processes. Bank is concerned that Borrower may default on the loan leaving the Bank with the potentially contaminated property. Although as a mere lien holder Bank is exempt from liability as an “owner” of the property, in order to protect its security interests, Bank takes proactive measures to search its own records for evidence of liability insurance of Borrower in the event Borrower becomes insolvent. Bank also sends a request to Borrower for all insurance records. Insurance records reveal that Borrower has ample insurance coverage. One year later, Borrower defaults on the loan and files for bankruptcy. Prior to foreclosing on the loan, Bank sues Borrower to require Borrower to investigate and clean up the property and litigation costs including attorneys’ fees. Once remediation is complete, Bank forecloses on loan and takes property and its full value.
B. Case Study – Bank Owned Property
Bank held title of a commercial shopping center for a period of 10 years in the 1970s and 1980s. The shopping center included a dry cleaner and a gas station with an auto mechanic. Bank was later sued as a former owner of the property. Fortunately, Bank maintained accurate records of its liability insurance policies. In addition, the leases with the dry cleaner and gas station required that Bank be named as an additional named insured on the tenant’s liability insurance policies. Bank tendered the suit to its insurance companies, which agreed to defend the Bank in the lawsuit under a reservation of rights. The reservation of rights created a conflict of interest between the Bank and its insurance companies such that Bank was able to hire its own attorneys at the insurance companies’ expense. Bank eventually settled the case with indemnity dollars paid by the insurance companies.
III. Steps for Proactive Financial Institutions
In order to ensure that these valuable insurance assets are not lost and are available should the need ever arise, you should take proactive steps to identify and understand your institution’s historical insurance program as well as the historical insurance of your borrowers on commercial and industrial properties (at the very least, on any property where there was or is a dry cleaner, manufacturing plant, plating shop, printer, or auto mechanic). Banks may already have information on their borrower’s first party insurance (e.g., fire protection) for properties they lend on because the loan terms require it. In many circumstances, insurance was written as part of a package and the same insurance company wrote the third party liability coverage. Accordingly, financial institutions should pull together and analyze this information in order to understand the respective coverages before there is a problem. For the most part, the culling together of old insurance policies, claims files, and correspondence with insurers can be done internally. If professional help is desired, you can hire an attorney knowledgeable on issues of insurance coverage issues in environmental cases to analyze and report on their existing coverages, how they might be used to address past, current and future environmental problems, understand where you are missing insurance information, and be able to respond quickly and effectively in the event of a future claim.
The time to act is now, before those files are discarded. The people with the information about yours and your borrowers’ insurance programs are getting up in age. Even if you are not able to readily put their fingers on their old insurance policies, the people who handled insurance matters 20, 30, or 40 years ago may be a great help in identifying and securing information regarding these valuable assets. But don’t stop there. Once the old insurance policies are found, make sure that you understand their coverages and exclusions, have them scanned and backed up onto a disc for safekeeping, and begin the process of filling in any gaps in the historical insurance coverage programs.