Two commercial property owners find themselves responsible for decades-old environmental contamination because they failed to conduct proper environmental due diligence before their purchase and they bought short-tail, claims-made insurance policies with a claims-in-process exclusion that did not offer any protection against long-tail environmental claims.

1.  What are the issues?

Rarely can a commercial real estate purchaser look at a piece of property and know whether or not the property is contaminated, and, if so, whether the contamination will require an expensive cleanup. Many of the most persistent and difficult-to-clean-up environmental contaminants are measured in parts per billion, like one droplet of water in an Olympic-sized swimming pool or a pinch of salt in 10 tons of potato chips.

Under federal and state environmental laws, people who buy a contaminated property are strictly liable for the investigation and remediation of every molecule of environmental contamination on the property from the beginning of time, no matter how it got there and no matter how much it costs to clean it up, until they achieve regulatory closure.

If, however, a buyer can establish that he is a bona fide prospective purchaser, then he may be able to buy the property free and clear of such liability, provided that he meets certain conditions, such as not impeding remedial efforts and not aggravating the spread of contamination.

When it comes to insurance, briefly stated, there are two types of commercial liability insurance policies. A claims-made policy provides protection for claims made during the specified policy period. In contrast, an occurrence-based policy provides protection for claims that occurred during a policy period no matter when the claim is made. In the environmental context, occurrence policies may be stacked to provide a policyholder multiple years of coverage to pay for long-tail environmental claims.

2.  What happened to the hapless purchasers?

In Atlantic Cas. Ins. Co. v. Garcia, Case No. 2:15-CV-66, 2017 WL 67617 (N.D. Ind. Jan. 5, 2017), a federal district court held that the property owners’ claims under two short-tail, claims-made commercial general liability insurance policies were barred by the policies’ claims-in-process exclusion. Here are the facts.

In 2004, the Garcias (residents of California) bought property in Indiana. Because the Garcias failed to conduct any environmental due diligence, they did not know that the property had housed a dry cleaning facility between 1945 and 2000, that a site assessment around 1999 revealed that some of the tanks containing dry cleaning fluids were leaking and that the Indiana Department of Environmental Management ("IDEM") requested further testing that continued into 2004, the year the Garcias bought the property. The Garcias said they had no knowledge of the contamination until many years after their purchase.

In 2014, IDEM demanded that the Garcias conduct and pay for further investigation and remediation of the contaminated property. The Garcias sought coverage under two commercial general liability policies they purchased from Atlantic – one in 2009, the other in 2010.

The Atlantic policies were claims-made policies that contained a claims-in-process exclusion, which precluded coverage for losses or claims for damages arising out of bodily injury or property damage — known or unknown — that occurred or were in the process of occurring before the policies' inception date. The court held that the Garcia’s claim for coverage was barred by the plain language of the claims-in-process exclusion since the contamination that gave rise to the IDEM claim was in process prior to the policies’ inception.

3.  How could the outcome have been different?

Outside of doing environmental due diligence and buying the right insurance coverage, the outcome of the Garcia's case could have been different had the Garcias raised the affirmative defense that application of the claims-in-process exclusion rendered the coverage illusory.

Whereas an occurrence policy protects the insured against the financial consequence of an accident or other liability creating-event that occurs during the policy period, no matter when the claim is made–it might be many years later–a claims-made policy protects the insured against the financial consequences of a legal claim asserted against him during the policy period. Given that there must be some interval between a wrongful act and the claim arising out of it, a claims-made policy might seem illusory if its coverage were confined to claims made during the policy period arising out of wrongs also committed during that period and the period was extremely short. Yet there would be nothing exploitive about such limited coverage if the insurance premium were correspondingly small, and in fact it is commonplace for insurers of claims-made policies to limit retroactive coverage by specifying a cut-off date, such as the date of the first claims-made policy issued by the insurer to the insured, so that claims based on occurrences before that date are excluded from coverage. For protection against old occurrences the insured must look to his occurrence policies. Claims-made policies that lack retroactive coverage are attractive mainly to new entities … or young professionals just beginning their careers. They don’t need retroactive coverage.

Truck Ins. Exch. v. Ashland Oil, Inc., 951 F.2d 787, 790 (7th Cir. 1992).

Because neither Atlantic policy had a retroactive date, the policies covered bodily injury or property damage that only both occurred and resulted in a claim during that same one-year policy period. In other words, the 2009 policy only covered bodily injury and property damage that arose and resulted in a claim being asserted during the one-year policy period. The same was true for the 2010 policy as it only covered bodily injury and property damage that arose and resulted in a claim being asserted during the one-year period. The 2010 policy did not even use the 2009 policy inception date as its retroactive date. Had the Garcias argued that application of the claims-in-process exclusion rendered the coverage illusory, they may have been able to survive Atlantic’s motion for summary judgment.

4.  The takeaway

Before you buy commercial real estate, consider conducting environmental due diligence and consider your insurance needs. The time to find out whether your $100,000 property will require a $1,000,000 cleanup is before you close.