Best Practices: Utilizing an Environmental Escrow Agreement

The Standard Operating Procedures 50 10 5(I) (the “SOP”) requires lenders to perform an environmental investigation on all commercial property securing a Small Business Administration (“SBA”) 7a loan. Before a 7a loan can be disbursed, the lender – and for general processing (“GP”) loans, the SBA – must believe that either (i) there is no risk of environmental contamination on the property or (ii) that the risk of contamination on the property has been sufficiently minimized. To determine whether (i) or (ii) applies, the lender should first follow the steps of an environmental investigation laid out in the SOP.

The SBA generally requires all environmental recommendations be resolved prior to funding the loan. If not, a GP lender may not disburse loan proceeds without the prior written approval of the SBA and a PLP Lender must include document its file with an explanation of how the risks have been mitigated pursuant to the nine mitigating factors provided for in the SOP.*

One of the most common mitigating factors used by Lenders is the environmental escrow account. Under the SOP, an escrow account mitigates the risks to the Lender and SBA so long as the escrowed amount (i) equals a minimum of 150 percent of the total estimated cost of required remediation and (ii) is controlled by the lender. To memorialize the terms of the escrow account, the parties will need to enter into an Environmental Escrow Agreement.

The SBA does not provide a form environmental escrow agreement, and the SOP provides very limited guidance regarding what must be included in an environmental escrow agreement. The SOP does state that the agreement should ensure that escrow funds will only be used for remediation costs. The lender must control of the escrow account can solely release funds upon the satisfactory completion of remediation, including the receipt of a “Closure Letter” or “No Further Action Letter,” if applicable. No SBA loan proceeds may be used for the environmental escrow account.

In negotiating the environmental escrow agreement, it is important for lender’s to consider and incorporate terms consistent with federal and state environmental laws. Failure to do so could result in the lender becoming liable for significant clean-up costs.

Ultimately, lenders are not in the business of owning or cleaning up contaminated property. As such, it is important for lenders who wish to or need to enter into an environmental escrow agreement to ensure that the document includes tailored, deal-specific and state-specific language to protect the lender – and the SBA – from the risks associated with contaminated property.

For more information on Environmental Escrow Agreements, contact Katherine at ktohanczyn@starfieldsmith.com or at (267) 470-1187.

* The nine mitigating factors provided in the SOP are as follows: (i) indemnification from available parties, (ii) completed remediation affirmed by a government entity, (iii) a No Further Action Letter from a government entity, (iv) minimal contamination, (v) clean up funds approved by a government entity, (vi) an escrow agreement by all parties involved, (vii) evidence that contamination is result of seepage from another property, (viii) additional or substitute collateral pledged and (ix) other relevant factors.