Insights

Built environment insights, issue 3 | Germany 27 Feb 2018 Contaminated industrial sites

How to structure a perpetual motion machine that limits the eternal environmental liability for heavy industry sites – or how to turn a liability into an asset

The PDF server is offline. Please try after sometime.

Eternal Environmental Liability

A statistic from the German Ministry of the Environment states that approximately 283,230 properties in Germany are either contaminated or at least suspected to be potentially contaminated.1 This is partly as a result of two World Wars but also a result of Germany's strong heavy industry sector, which mirrors the success of Germany's economy. Many of these sites are large former industrial sites that have seen decades of industrial fabrication but for some reason production on the site has ceased. There are many sites still owned by companies, or their legal successors, which have caused contamination in the past. Having such a property on a company's books means effectively a liability that drags on for years and years necessitating costly safety and decontamination measures. In addition, as there are limited incentives to decontaminate where the contamination is permanent or requires long-term treatment, decision makers may opt only for safety measures if the environmental authority does not require more.

The most important environmental legislation in relation to handling contaminated sites is the German Federal Soil Protection Act (FSPA), which came to effect in 1999. The FSPA intends to protect and if necessary restore the functions of the soil on a permanent sustainable basis and to establish the  liability of polluters and owners of contaminated sites. As a general rule, the FSPA constitutes the obligation to act in a manner that prevents harmful soil changes and it constitutes what is called "eternal liability": the owner of a contaminated property is not only under the obligation to remediate the site but also to carry out protection and restriction measures in order to prevent any hazards, considerable disadvantage or nuisance by individuals or the general public. This liability is established simply by ownership of a site and does not require that the owner has actually caused the pollution. Moreover, the authorities may hold the owner of a contaminated site (the Owner) liable for any costs in connection with measures carried out by the authorities as well as for compensation for damages. The same generally applies to the individual or organisation that has caused the contamination (the Polluter) and the Owner may reclaim costs and compensation provided the Polluter has sufficient financial strength and still exists. 

However, if the Owner is also the Polluter – which is the case for many former industrial sites in Germany, they cannot benefit from this provision. To make matters worse, under FSPA, even a former owner of a contaminated property can be held liable if the contamination was already on the site at the time the former owner was the registered owner of the property. It is at the discretion of authorities who they may hold liable – the Owner, the former owner or the Polluter. The authorities only have to take into account who is able to most effectively achieve the purpose of the intended order (in other words: who can carry out the decontamination measures and who can bear the costs). A sale of a contaminated property may therefore not have an impact in terms of eternal liability either for the Owner/Polluter (who usually has to account for a deferred liability) or for the buyer of a contaminated property (who may also be held liable). The eternal liability under public law is statutory law that cannot be excluded, even if the parties to a sale and purchase agreement agree on a different regime (which would only apply inter partes).

From an economic point of view, being the Owner of such a property therefore causes a continuing financial loss. And the "eternal liability"  is a barrier that sometimes effectively hinders economically reasonable solutions. 

But there is hope: there are strategies to effectively create a perpetual motion machine that functions on a stand-alone basis, with limited input from the Owner's side, once it is set up and running. While such a machine cannot limit the statutory "eternal liability" in legal terms, it can factually bring it to an end once it is in motion. This machine may at best generate a profit and can at least remove a liability from the balance sheet.

How to structure a perpetual motion machine

The starting point is to determine the objectives of the Owner. They may want to sell the contaminated property to a new owner (in the best case scenario with profits) and (to the extent possible) pass over the responsibility for continuous measures (e.g. monitoring obligations) which will cause the eternal liability to end. The Owner would want to minimise the insolvency risks of the buyer of the site (the Investor) because an insolvency might trigger a "boomerang effect", returning the liability to the Owner.

The easiest way to limit future liability is to introduce a clause in a property sale and purchase agreement that excludes any claims resulting from environmental issues and obligates the buyer to take care of these and bear any associated costs. This should go hand in hand with a succession clause secured by an easement that should be registered in the land register. This is the way some of the major German (public) infrastructure companies manage their risks, including Deutsche Bahn AG, various airports and harbours. The downside is that this concept  has a negative impact on the price and there is no protection in case of an insolvency of the Investor (because then the authority will hold the former Owner liable, again). As a result, this works best if the pollution is not of a material nature and might be completely remedied. But what if the contamination requires steady controls and/or may not be able to be entirely removed (e.g. ground water pollution)? 

The first thing to note is that there is no "one-size-fits-all" approach. Each contaminated site is different and requires a particular treatment, some authorities might be stricter than others and each Owner has different needs. Having said that, there are some components that each machine requires to function:

  • the contaminated site should be of a certain size to justify the efforts;
  • the site should be suitable for its different use once it has been cleaned (e.g. business park, commercial use, infrastructure projects, etc.);
  • decontamination and development of the site might require a reliable developer/construction company that is able to carry out a project of a certain size;
  • the structure is usually complex and therefore requires sophisticated partners on all sides; and
  • co-operation of the environmental authority. 

A recent project we handled showed that one structure in particular  effectively achieves the objectives of most clients. This structure is based on the creation of a heritable building right (Erbbaurecht, "HBR"). To understand this concept better, we have to delve into the German Law of Heritable Building Rights: an HBR is a right in rem similar to a freehold title (grundstücksgleiches Recht) and similar to a long-term lease (e.g. 100 years or more). The owner of an HBR benefits from a limited environmental liability: after the HBR is transferred to a third party, the previous owner of the HBR is no longer liable for his former asset; in other words: there is no eternal liability. This is clearly an incentive for marketing the parcels to Investors.

The first step would then be to transfer title of the contaminated site to a special purpose vehicle with limited liability (SPV) whose sole shareholders are initially the Owner and a developer who shall ultimately be responsible for decontamination and development of the site. The backbone of this structure is then to split the site into smaller parcels be developed for the Investors after decontamination. However, these smaller parcels shall not be transferred to the end users by way of transfer of title, but by creating a heritable building right (Erbbaurecht, "HBR") for each parcel. 

Each HBR is ready to be sold to the Investors after decontamination. Together with acquisition of an HBR, each end user shall be obliged to acquire shares in an SPV (thereby reducing the shares of the developer and Owner). A control stock, however, will remain with the Owner. This helps the Owner ensure that the structure will not be dissolved at a later stage.

After development of the site and once the HBRs of the parcels are sold to the Investors, the purpose of the SPV shall be to undertake and observe all continuous environmental measures. The SPV will be financed by a rent which each end user pays for the HBR. All Investors therefore contribute to the costs of ongoing environmental obligations; any profits of the SPV will be distributed to its shareholders, i.e. the Investors. To protect the Owner in the case of insolvency of an Investor, the shares of each Investor should be subject to forfeiture in case of insolvency and the HBR should fall back to SPV (who can then sell the HBR to another Investor) – this can be managed by introducing respective clauses in the relevant agreements.

If we compare the Owner's objectives with the construction manual for the machine outlined above, we can tick off most boxes: the contaminated site is decontaminated by the developer. The parcels of the site are sold to the Investors in the form of HBRs and the purchase price may make up for the costs for decontamination and at best create a profit. The SPV will take care of any continuous environmental measures whose costs are borne by the Investors and not the Owner. And, in case of an insolvency of an Investor, the shares in the SPV and the respective HBR can be reclaimed and then sold again.

Wrap-Up

Eternal liability for environmental matters is not the end of the story. Former industrial sites can be turned from a liability into an asset and the eternal liability can be limited. The key factor is to structure projects in a way that meets the demands of the real estate market for the benefit of all parties involved. However, there is more than one road to Rome and we all know this city was not build in a day. Diligent preparation of the contracts that will run the perpetual motion machine for a long period of time is crucial, as well as carefully hand-picking your developer and partners.

 

 
1. Nationwide overview about contaminated site by the ministry of environment, 9 August 2017, can be found here.


Meet Ashurst at MIPIM 2018

Members of Ashurst's market-leading European real estate team will be joining 24,000 real estate professionals attending the MIPIM conference from 13-16 March 2018.

READ MORE >

Next article

bei_issue3_madrid_thumbnail_banner_bw_1560x780
built environment insight, issue 3 | Spain

Spanish market residential loans

Read Now

Keep up to date

Sign up to receive the latest legal developments, insights and news from Ashurst.  By signing up, you agree to receive commercial messages from us.  You may unsubscribe at any time.

Sign up

The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying it to specific issues or transactions.

Get Started
WORLD MAP
  • REGION
  • OFFICE

        Forgot Password - Ashurst Account

        If you have forgotten your password, you can request a new one here.

        Login

        Forgot password? Please contact your relationship manager to find out more about our client portal.
        Ashurst Loader