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Impact of environmental compliance on real estate finance

June 2013 - From the Print Edition

Developed countries, though governmental, institutional or private actors, have slowly but steadily in the last two decades, embarked on a path actively promoting responsible development, both at home and through investments made into developing countries. Financial institutions, either commercial or investment banks or multilateral financial institutions have been and still are among the most important actors. On the one hand, their actions are driven from the inside, by their inherent need to limit their commercial risks and the exposure / damages generated by environmental law requirements or their potential non-observance by borrowers. On the other hand, their reactions are a response to claims that, in consideration of social responsibility, they should be considered responsible beyond their legal liability. In the recently released LMA real estate development facility agreement, these obligations are imposed expressly under Clause 24.11. Failure to observe relevant obligations, to maintain representations and warranties can trigger an event of default and entitle lenders to accelerate the loan.

Environmental law, in general, and environmental liability in particular are still developing areas, worldwide. In Romania, further to the country′s accession to the EU and implementation of EU legislation, we can no longer speak of lax or insufficient environmental regulations in place. We can speak, however, of the lack of experience of local authorities in dealing with specific industry aspects or changes, either legislative or technology-related.

Furthermore, it continues to be a distinction between mandatory environmental legal obligations, and "soft law" obligations, namely guidelines or recommendations that are generally observed but are not today in place as legal requirements. And even that line is not very clear, as we do not have today specific limits in the application, let′s say, of the precautionary principle.

When it comes to evaluation of any project from the perspective of its compliance with environmental obligations and standards, financial institutions look at three aspects: credit risks (the cost of environmental compliance, in light of the borrower′s ability to observe its obligations), security risks (valuation of assets is influenced by perception and public perception, positive or negative, may significantly influence the value of an asset taken as security) and liability risks (the possibility to be held responsible for the activities they finance). The first phase when such aspects are taken into account, and the most important, is upon the preliminary evaluation of projects: lenders normally perform environmental investigations prior to entering into the financing, trying to determine the existence of any pre-investment pollution and anticipate all environmental related aspects of the prospective development/investment.

In case of real estate developments, developers usually make such determinations themselves when developing within city limits, on decommissioned former industrial sites, but rarely do so when developing outside city limits or on former agricultural lands recently removed from the agricultural circuit and included within city limits. This is one of the situations where lenders need to evaluate carefully, as contaminated lands and contaminated water sources with nitrates from agricultural sources represents a significant problem, both at EU level and specifically in Romania, where local authorities have taken little actions in the sense of identifying, remediating or limiting the effects of such contaminations or at least, raising awareness on local problems. No bank would like to finance a "green residence project" located far from the noise and traffic of Bucharest, but where all underground waters are polluted with nitrates, together with all associates consequences. Another example are former animal farms decommissioned after 1990, where asbestos remains an unsolved issue in the roofs and walls of surviving buildings, and the remedial proceedings (obtaining of the necessary approvals from the relevant environmental protection authority) and costs might affect the economics of the project, the timeline of the proposed investment and loan draw-downs.

Attention should be paid not only to the potential borrower′s direct activity, but also to that of the entire chain of suppliers and/or subcontractors which will be used in the development process.

In some cases, the findings of such investigations can determine the separation of the proposed project into components, if environmental issues appear to be attached to one part of the project and lenders may decide to go forward only with the "clean" part of such project.

In the same time, although not a legal requirement, ignoring today the trend towards "greener", energetic efficient developments/activities might prove to be unwise both for the developer (who will have difficulties finding buyers or tenants, as the case may be) and for the lender (that will have increased credit and security risks).

After the successful completion of preliminary investigations, lenders and borrowers enter into negotiations on the financing costs (heavily influenced by the findings of the investigations) and on the financing documentations. The relevant sections of the financing documentation are definitions, conditions precedent, representations (relevant during the drawn-down phase) and warranties (relevant throughout the existence of the loan) and events of default.

While there are limited situations in practice where a breach of an environmental representation or warranty, can, on its own, determine accelerated repayment of a loan, attention should be paid upon the negotiation and drafting of representation and warranties, as well as to relevant environmental definitions. Usage of general terms, such as "appropriate measures", "generally accepted" practices may turn to be unwise for both lenders and borrowers. In the same time, terms such as "to the extent of its knowledge/belief", "after careful inquiries" or "or at any time thereafter" represent limitations /extensions of liability that both parties should carefully consider prior to accepting them.

Other clauses in the financing documentation shall be inserted depending on the approach taken by the lender: coverage for all gradual or historical pollution or just for accidental pollution. Depending on such decision, the need for and extend of insurance cover for environmental liability shall differ.

Adina Gutiu

Adina is an experienced real estate and environmental lawyer, with more than 10 years of practice in advising on real estate developments. Throughout her carrier, Adina has advices clients such as: Goldman Sachs International, Morgan Stanley, UBS AG, Citigroup Venture Capital International, OMV Petrom S.A., E.ON AG, Heitman International Sarl, First Title, Inveravante, Gran Via 2006, Global Emerging Property Fund, NEPI etc. She is a member of the real estate practice of Reff & Associates | Deloitte Legal, and heads the Environment & Climate Change practice of the same firm.

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