environmental indemnity in real estate transactions...
TRANSCRIPT
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
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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
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
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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
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General Principles: Contracts And Environmental
Law
Principle 1: Beware of general principles!
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General Principles
Principle 2: You
cannot contract away
your liability vis-à-vis
the government
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General Principles
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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
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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
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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…”
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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
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The Architecture of an Environmental Indemnity
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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”
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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
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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?
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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?
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Third Party Claims
Toxic tort claims
Examples: site workers, future
occupants
Property damage claims
Example: offsite neighbors
Natural resource damages
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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
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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?
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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
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You can’t be a wizard……
But be careful when drafting environmental
indemnities
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AGENDA Indemnities: Not One Size Fits All
Specific Language And Other Options
Complex Structures
Synthesizing Indemnity Provisions With The Agreement And Other Deal Documents
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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
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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.
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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?
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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
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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
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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
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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
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Synthesizing Indemnity Provisions Within the Agreement Itself:
Representations and Warranties
Disclosure Schedules
Covenants
Third-Party Beneficiaries
Assignment
Survival
Choice of Law
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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
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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:….
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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
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
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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
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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
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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
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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)
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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
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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
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Lessons Learned Consider all media
Look past the current transaction
Plan for stricter standards
Consider eternity
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