Environmental Indemnity in Real Estate Transactions: Allocating Risks of Potential Cleanup Costs

Presenting a live 90-minute webinar with interactive Q&A
Environmental Indemnity in Real Estate
Transactions: Allocating Risks of
Potential Cleanup Costs
Negotiating Key Provisions, Drafting and Reviewing the Agreement to Ensure Complete Coverage
WEDNESDAY, APRIL 23, 2014
1pm Eastern
|
12pm Central | 11am Mountain
|
10am Pacific
Today’s faculty features:
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
[email protected]
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
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)
10
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
Natural
Resource
Damages
Voluntary
Cleanup
Added
Costs Site
Redevelopment
Business
Interruption
Gov’t
Ordered
Cleanup
Toxic Tort
Property
Damage
Diminished
Property
Value
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
[email protected]
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
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?
1.
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 postclosing 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
[email protected]
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
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