It is difficult to raise capital in the current economic times even for a greenfield development. Raising capital for a brownfield redevelopment has historically been a more difficult proposition. Lenders are scarce and only high rate of return, speculative capital is available for equity.

As a result, brownfield redevelopers must be even more creative to obtain funds to finance a project. One solution to consider is the use of a joint venture between the redeveloper and the owner of the contaminated site. In a joint venture transaction, the owner of a contaminated site would contribute his land into a limited liability company or other suitable legal entity to form a joint venture with the brownfield redeveloper. The brownfield redeveloper would contribute the new capital which is necessary to remediate the site, as well as any funds required for demolition, entitlement, insurance and operations through the period for remediation.

The advantage of the foregoing structure is that it reduces the amount of capital which must be raised for the redevelopment by the value of the land. The lower the amount of capital required to be raised, the easier it is to obtain new capital to redevelop a site.

In the foregoing example, a sale transaction would require the redeveloper to raise $20 million of funds to properly capitalize the redevelopment. A joint venture transaction would, however, require only a $10-million capital raise.

Although all financial terms are subject to negotiation, typically the brownfield redeveloper will demand that new capital be returned, together with a return on such new capital, prior to payment of a return on the existing capital, being the contaminated site. Such a structure provides for a greater certainty of a return of capital to the brownfield redeveloper and thus a greater chance that the transaction will be accomplished. However, a greater certainty of return of capital should result in a lower return to the new money.

Such structure can be illustrated by the following priority allocation of distributable funds from the operation and sale of the remediated property, utilizing the assumptions contained in the prior example.

1. $1.5 million paid to the redeveloper as a return on new capital, assuming a rate of 10% per annum on $10 M for 3 years with an average outstanding balance of $5 M;
2. $10 M paid to the redeveloper as return of new capital;
3. $10 M return of cost of land to property owner; and
4. 50% to the redeveloper and 50% to landowner.

The brownfield redeveloper can then envision a return of capital with a relatively modest return if the property is sold clean in a downside scenario for $11.5 million in 3 years. In the context of a sale transaction, the redeveloper would have to project a future sale price of at least $24.5 million to achieve the same modest return as shown in the following illustration.

Insulate vs. overruns
Besides lowering the amount of capital to be raised and lowering the return thresholds, a joint venture structure can provide the redeveloper with assurances against cost overruns in the remediation.

To effect such assurance, the redeveloper could negotiate that the landowner contribute capital in the amount of any remediation costs overruns. Alternatively, if the redeveloper must fund such cost overruns, the redeveloper may negotiate for a reduction in the amount to be paid for the land upon sale by the amount of the remediation cost overruns. It is certainly reasonable to conclude that if remediation cost overruns occur, without fault of the redeveloper, the land was overpriced at the time of the formation of the joint venture.

From the landowner’s perspective, the brownfield property receives a current capital infusion, which is essential to creating any value, as well as a participation in the proceeds from the sale of a clean site at a later date, which is likely to provide a more favorable market than exists today.

The joint venture can be formed and the land and cash can be contributed to the joint venture without the occurrence of a taxable event. The contribution of land and cash into a joint venture in exchange for an equity interest in the new entity does not generally result in taxable transaction under Internal Revenue Code §721. Further, the landowner should be able to eliminate any recognition of the remediation costs on its books where the joint venture assumes the remediation obligation and is adequately capitalized.

FASB Statement No. 143 requires recognition on financial statements of liabilities for conditional asset retirement obligations (remediation costs in this context) where the fair value of the liability can be estimated. However, where the liability is assumed by a well-capitalized entity, the liability to be recognized should be zero, even though the landowner is entitled to residual profits upon sale of the assets.

Consequently, the joint venture can address some of the biggest fears of the parties and thus raise the probability that the transaction and redevelopment will proceed.

Steven M. Sommers, Esq. is a partner with Brownstein Hyatt Farber Schreck LLP, Denver, Colo.