environmental indemnity in real estate transactions...

Environmental Indemnity in Real Estate

Transactions: Allocating Risks of

Potential Cleanup Costs Negotiating Key Provisions, Drafting and Reviewing the Agreement to Ensure Complete Coverage

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WEDNESDAY, APRIL 23, 2014

Presenting a live 90-minute webinar with interactive Q&A

R. Morgan Gilhuly, Partner, Barg Coffin Lewis & Trapp, San Francisco

Cindy Karlson, Founder, Law Offices of Cindy J. Karlson, East Hampton, Conn.

Karen J. Nardi, Partner, Arnold & Porter, San Francisco

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ALLOCATING LIABILITY: ENVIRONMENTAL

INDEMNITIES

Karen J. Nardi

ARNOLD & PORTER

Three Embarcadero Center, 10th Floor.

San Francisco, CA 94111

Phone: 414-471-3100

karen.nardi@aporter.com

April 23, 2014

©Arnold & Porter

Agenda

Transactions with Environmental Indemnities

General Principles for Contracts and Indemnities

Key Considerations for Allocation of Liability

The Architecture of an Environmental Indemnity

Practical Tips

6

Transactions Involving Environmental

Indemnities

Sale and lease of real property

Sale of business (asset or stock)

Settlement agreements

Loans and other financing documents

Land use restrictions

Access agreements

Service contracts with environmental contractors

7

General Principles: Contracts And Environmental

Law

Principle 1: Beware of general principles!

8

General Principles

Principle 2: You

cannot contract away

your liability vis-à-vis

the government

9

General Principles

10

As the Third Circuit said with regard to indemnities and CERCLA liability: “Agreements to indemnify or hold harmless are enforceable between the parties but not against the government.” Beazer East, Inc. v. Mead Corp., 34 F.3d 206 (3d Cir. 1994)

General Principles

Principle 3: For the most part, contracts only bind the parties to the contract and do not bind third parties

– Exceptions (sometimes):

• Successors and assigns

• Affiliates

• Running with the land

11

General Principles

Principle 4: Contract promises are only as good

as the assets that back them up An environmental indemnity is only as good as the balance

sheet of the party giving the indemnity

Consider parent company guarantee, letter of credit, reserves,

escrows, other financial mechanisms

12

Key Contract Terms to Allocate Environmental

Liabilities Environmental Indemnity

• “We agree to indemnify, defend and hold harmless….”

Covenants and Affirmative Commitments

• “We agree to perform government ordered cleanup and reimburse your added site redevelopment costs…”

Releases

• Covenants not to sue

Representations and warranties

• “We are in compliance with all environmental laws as of the closing…”

13

Practice Tips

A good contract has: – A separate

environmental section

– All of the above terms (indemnity, covenants, release of liability, reps and warranties)

– Consider a deed restriction (no sensitive uses)

– Consider an access agreement

– Consider a technical risk management plan

14

The Architecture of an Environmental Indemnity

15

Key Questions to Ask and Answer

Who is giving protection?

Who is receiving protection?

“Indemnify, defend, and hold harmless”?

What is covered?

What is not covered?

Proportional fault, or not?

“Arising from or related to” vs. “to the extent caused by”

16

What Kinds of Liabilities Might Occur?

Types of Liability

Cleanup Liabilities

Economic

Losses

Third Party

Claims

Voluntary Cleanup

Natural Resource Damages

Gov’t Ordered Cleanup

Business Interruption

Added Costs Site

Redevelop-ment

Diminished Property

Value Toxic Tort

Property Damage

Drafting an Indemnity

When you draft:

– Consider all these

types of liabilities

• Allocate them

• Use definitions for

clarity and

economy of style

19

Site Cleanup Liabilities

Who is responsible – Buyer or Seller?

For what?

Pre-closing legacy contamination only?

• Presumptions and baselines

Only government ordered cleanup?

• Or anything required by laws?

Voluntary cleanup?

Cleanup of soil and groundwater only?

• Asbestos, lead paint, mold, demolition?

20

Site Cleanup Liabilities

What kind of cleanup?

• Industrial/commercial versus residential?

• Risked-based permitted?

– Use of institutional controls permitted?

– How implemented and complied with?

– Deed restrictions?

Who controls communications with government?

21

Third Party Claims

Toxic tort claims

Examples: site workers, future

occupants

Property damage claims

Example: offsite neighbors

Natural resource damages

22

Site Redevelopment Costs

– Future owners may incur added costs beyond gov’t ordered cleanup

• Excavation in connection with development

• Disposal of contaminated media

– Example of parking garage

• Cost of studies and hazmat contractors

23

Vapor Intrusion Liabilities

Vapor intrusion into site buildings?

• Investigation and testing

• HVAC control

• Engineered mitigation systems

– Installation and long term O&M

Who pays? Who controls?

24

First Party Costs and Damages

First party costs and damages

– Site redevelopment costs

– Voluntary cleanup

– Diminution in value of property acquired

– Other direct costs to buyer

IMPORTANT: Many courts interpret standard indemnities to cover only third party claims, not first party damages, costs and losses

Draft accordingly

25

You can’t be a wizard……

But be careful when drafting environmental

indemnities

26

Cindy J. Karlson

Law Offices of Cindy J. Karlson

Phone: 860.614.0184

Cindy@karlsonlawfirm.com

27

AGENDA Indemnities: Not One Size Fits All

Specific Language And Other Options

Complex Structures

Synthesizing Indemnity Provisions With The Agreement And Other Deal Documents

28

NOT ONE SIZE FITS ALL Do optics matter?

Sweet and simple Allocate based on knowledge of

existing conditions at closing

Complex indemnity provisions Carve out specific environmental

conditions

29

NOT ONE SIZE FITS ALL Example:

Tenant will indemnify and hold Landlord harmless from and against any and all liabilities, losses, damages, suits, penalties, claims and demands of every kind, including reasonable attorneys’ fees, arising out of or relating to any environmental conditions on the property or the

operations conducted thereon.

30

NOT ONE SIZE FITS ALL Tenant will indemnify and

hold Landlord harmless from and against any and all

liabilities, losses, damages, suits, penalties, claims and

demands of every kind, including reasonable

attorneys’ fees, arising out of or relating to any

environmental conditions on the property or the

operations conducted thereon.

Issue Spotting

1. Who can recover monies (successors and assigns)?

2. Define any terms?

3. Length of indemnity period?

4. Which costs covered?

5. Which costs are NOT covered?

31

SPECIFIC LANGUAGE CHOICES Deciding whether to set forth the indemnity scope in a general or specific fashion

Pros

Avoid potential costly litigation

Manage parties’ expectations

Cons

Could incur additional transactional costs in negotiation

Could unknowingly exclude costs if provisions are too specific

32

SPECIFIC LANGUAGE CHOICES Definitions are critical!!!

“Environmental Laws” - Understand what is and is not included (agency guidance, directives, orders?)

“Hazardous Substances”

- Be careful if you only limit it to substances under CERCLA - Petroleum and its by-products, PCBs, asbestos, lead paint, urea formaldehyde (building materials), mold, microbial matter - Also consider including solid waste, explosives, radioactive materials

33

SPECIFIC LANGUAGE CHOICES Environmental Claims – does it have to be third party

demand or can buyer or seller make direct claims to reimburse costs they incurred not at the request of third party/government requirement? (what about a bank?)

Release – how broad you define a “release” will impact the scope of the indemnity “spilling, leaking, pumping, pouring, emitting, injecting,

escaping or dumping”

(what about “migration”?)

34

SPECIFIC LANGUAGE CHOICES Key concepts:

How is “known environmental liability” defined?

What is included as an “Environmental Matters?

Definition could include –

generation, storage, handling, treatment and disposal of hazardous materials/substances (not just release of same)

Compliance with permits Financial assurance requirements Deed restrictions Covenants Site access costs

35

COMPLEX STRUCTURES

Using a Materiality Trigger

Single event or in the aggregate

What costs will be considered as part of materiality total

What if the parties do not agree on what conditions are material for purposes of triggering indemnity claims

36

COMPLEX STRUCTURES Caps and Baskets

Basket: Buyer maintains a running total of the post-closing environmental liabilities it has incurred; when the total exceeds the agreed threshold dollar amount, buy make an indemnity claim against Seller

Cap: Dollar amount limit on a party’s liability (or can act as trigger for shared liability after the cap amount is reached)

37

COMPLEX STRUCTURES When does the indemnity terminate?

Are termination provisions linked to achieving some

kind of end point?

Obtaining a No Further Action letter from the agency

(not all states provide this)

Obtaining sign off from environmental consultant

Completion of specific tasks

38

Synthesizing Indemnity Provisions Within the Agreement Itself:

Representations and Warranties

Disclosure Schedules

Covenants

Third-Party Beneficiaries

Assignment

Survival

Choice of Law

39

Synthesizing Indemnity Provisions Representations and Warranties

What if party reps to “the absence of hazardous substances on Property” and the party stores hazardous substances on-site – you will automatically be subject to indemnity because of breach of representation

What about background levels of some naturally occurring materials?

40

Synthesizing Indemnity Provisions Covenants

Is certain work a required obligation? If default and another party steps in to do the work, is it covered by indemnity or potentially escrow or other funds?

Assignment Is the agreement assignable? With or without prior written

consent?

Third party beneficiaries Who is a beneficiary to the agreement? Can they make

indemnity claims?

Choice of law

41

Synthesizing Indemnity Provisions Disclosure schedules

What and how is information included in the disclosure

schedules?

Covered by indemnity?

Issue – a disclosure schedule can be list of environmental reports (which often reference other prior reports and documents) Does mere reference constitute disclosure of a specific issue

Does the simple mention of a description of the business operations or a process constitute a disclosure?

42

Synthesizing Indemnity Provisions With other deal documents:

Master purchase and sale agreement

(if indemnity is contained in separate environmental side agreement)

Personal and Corporate Guarantees

Loan and financing agreements

Leases

Risk Liability Transfer Contracts

43

Example 1 Seller agrees, at its sole cost and expense, to indemnify, defend

and hold harmless Buyer, its directors, officers, stockholders, employees, assigns and successors, from any loss, cost, damage (whether direct or consequential), obligation, liability, judgment, action, penalties, claims, proceeding, injunction suit, fines, or expense (including consultants’, experts’, attorneys’ fees and court costs) incurred or sustained by Buyer arising directly or indirectly, from : (a) any failure of Seller to comply with any Environmental Laws; (b) Existing Contamination (whether known or unknown); (c) any breach of this agreement; or (d) contamination, if attributable to the actions or omissions of Seller, including without limitation any of the following:….

44

Example 2

Buyer shall indemnify, defend and hold Seller harmless from any loss, cost, damage or expense (including attorneys’ fees) actually incurred or sustained by Seller in connection with

the Release or disposal of Hazardous Substances on the property by Buyer, its agents, tenants, employees or

contractors.

45

Final Take-Aways

Boiler plate is only a good starting point

Understand and memorialize the exact risk allocation

Pick your battles

46

R. Morgan Gilhuly Managing Partner

Barg Coffin Lewis & Trapp, LLP

415-228-5400

rmg@bcltlaw.com

The Environmental Indemnity Tool Kit Default arrangement:

Seller indemnifies buyer for all pre-closing liabilities

Buyer indemnifies seller for all post-closing liabilities

Because buyers become liable for environmental costs upon purchase, the seller is usually asked to indemnify the buyer for liabilities that arise post-closing but are related to pre-closing events

Buyers may be willing in some cases to assume environmental liabilities in return for a reduced purchase price or other compensation

48

The Environmental Indemnity Tool Kit

Some commonly used tools:

Insurance

Deductibles and thresholds

Cost Caps

Cost sharing

Time limits

Corporate guarantee

Letters of credit

Reserves

Escrow

49

The Toolkit: Insurance Pollution Legal Liability policy

Covers liabilities that are unknown and unexpected

Not always available, depending on market conditions, size of potential claims

Costly

Time consuming

Cleanup Cost Cap policy

Covers specific plan to clean up known contamination

Not available when site poorly characterized

Expensive, risky

50

The Toolkit: Insurance Indemnity only for non-insured claims

Watch out for policies that provide only excess coverage

The indemnity may be considered primary coverage

51

The Environmental Indemnity Toolkit

Deductibles and thresholds:

Many environmental statutes impose liability for trivial releases

Transaction costs may make indemnity for small claims inefficient

Limit indemnity to claims exceeding a $ threshold

Or limit indemnity to amounts exceeding a “basket” amount

52

The Environmental Indemnity Toolkit Cost Caps and Cost Sharing

Cost caps may be coordinated with insurance

Cost sharing may be linked to parties’ roles with respect to site operations

Time Limits

Time limits may be linked to loan terms, if property is financed

May be extended if environmental issues discovered

Restrictions on use of property

Indemnity limited to commercial/ industrial use

Limits on types of businesses (e.g., daycare or school)

53

The Environmental Indemnity Toolkit

Other provisions:

Predecessor operations covered?

First-party claims covered?

Notice and opportunity to defend

Time limit for payment

Copies of reports, communications with regulators

Access/recorded easement

Arbitration or mediation clause

54

Environmental Indemnity Case Law Early litigation: Do pre-CERCLA indemnity

agreements cover CERCLA liability?

Section 9607(e)(1) of CERCLA provides:

“No indemnification, hold harmless, or similar agreement or conveyance shall be effective to transfer from the owner or operator of any vessel or facility or from any person who may be liable for a release or threat of release under this section, to any other person the liability imposed under this section. Nothing in this subsection shall bar any agreement to insure, hold harmless, or indemnify a party to such agreement for any liability under this section.”

55

Environmental Indemnity Case Law U.S. v. Hardage

985 F.2d 1427 (10th Cir. 1993)

Under Section 9607, parties may allocate liability through indemnity agreements

Kerr–McGee Chem. Corp. v. Lefton Iron & Metal Co. 14 F.3d 321, 327 (7th Cir. 1994)

Pre-CERCLA indemnity agreement covered CERCLA liabilities

Indemnity agreement and “as is” clause considered as factors in allocating liability in contribution action

Beazer East, Inc. v. Mead Corp. 34 F.3d 206 (3d Cir. 1994)

State law governs interpretation of agreements allocating liability among private responsible parties

Pre-CERCLA indemnity may be effective to transfer CERCLA liability

56

Environmental Indemnity Case Law Cadillac Fairview/California, Inc. v. Dow Chem. Co.

299 F.3d 1099 (9th Cir. 2002)

Indemnity agreement properly considered as allocation factor in case finding government 100% liable

57

Environmental Indemnity Case Law The specific language of the indemnity matters

Taracorp, Inc. v. NL Industries, Inc. 73 F.3d 738 (7th Cir. 1996)

Two indemnities:

One for environmental contamination “located at, on, or near” Facility #1

One for liabilities “related to environmental hazards associated with” Facility #2

NL argued that both indemnities were limited to contamination on or near the facility

But Seventh Circuit held that NL was liable as an arranger for wastes transported off-site from Facility #2

58

Environmental Indemnity Case Law VFC Partners 26, LLC v. Cadlerocks Centennial Drive, LLC

735 F.3d 25 (1st Cir. 2013)

Borrower defaulted on loan secured by daycare center with suspected PCE contamination

Lenders’ assignees foreclosed and sought appointment of receiver rather than taking possession of property

Lenders conducted Phase I assessments and indoor air testing and sought costs from receiver

59

Environmental Indemnity Case Law VFC Partners 26, LLC v. Cadlerocks Centennial Drive, LLC

735 F.3d 25 (1st Cir. 2013) (cont’d)

The Indemnity Agreement provided that borrowers would indemnify the lenders:

“from and against all. . . costs, . . . demands, . . . expenses” and other liabilities “of any kind or nature whatsoever . . . sought from or asserted against Indemnitees in connection with, in whole or in part, directly or indirectly, . . . the presence, suspected presence, release, suspected release, or threat of release of any Hazardous Material” on or around the Property

60

Environmental Indemnity Case Law VFC Partners 26, LLC v. Cadlerocks Centennial Drive, LLC

735 F.3d 25 (1st Cir. 2013) (cont’d)

Court held recoverable costs limited to costs sought by a third party

Court held indemnity was so broad that it must have been limited by the next sentence providing “Such liabilities shall include . . . .”

To hold otherwise would make borrower liable for costs that were neither reasonable nor necessary

61

Environmental Indemnity Case Law VFC Partners 26, LLC v. Cadlerocks Centennial Drive, LLC

735 F.3d 25 (1st Cir. 2013) (cont’d)

Lesson of VFC Partners is that courts will parse the specific language of the indemnity and will apply common sense limits

Lenders will want provisions to allow recovery of costs necessary to investigate contaminated property

But an indemnity that is so broad that it would subject the indemnitor to unlimited liability may backfire on the indemnitee

62

Lessons Learned Consider all media

Look past the current transaction

Plan for stricter standards

Consider eternity

63