Negotiating and Drafting Key Contractual Provisions

 

INTRODUCTION

 

More and more buyers or sellers of commercial real estate are encountering contamination issues these days.  The presence of contamination should not be a deal-breaker, but to avoid liability the prospective purchaser or seller should be pro-active in evaluating the nature and scope of the contamination.

 

The first step is to consult with an environmental attorney, who will recommend the appropriate environmental consultant for the contamination issue.    The consultant will review existing technical documents about the contamination and, if appropriate, perform some sampling and analysis to get data   on the extent and severity of the contamination. I always advise a client to a transaction to perform his or her own environmental due diligence, even if the other side has already done environmental review. The other party may not be using a competent environmental consultant and the other party has an incentive to skew the data and recommended remedy in its favor. I want my client to have an objective evaluation and control the process.  

Concurrent with technical review, the attorney should discuss the client’s goals for the transaction and future use of the property.  For example, if the property will be re-developed into mixed use housing and retail with extensive excavation, then a more permanent and expensive cleanup may be required.  By contrast, if the property is already paved and the future use will be for warehousing, then a mess costly remedy may be acceptable. The lawyer and consultant should communicate well during this period to ensure that the consultant understands the client’s future use goals, since that will inform the consultant scope of work and recommendations.

 

After the consultant has completed his review, you should sit down with him and the attorney to discuss liability risks and the path forward.  This may be the first exit ramp because the contamination may be too significant and extensive to clean up or it may pose an unresolvable conflict with your future use of the property.

If the client fully understands the risks and wants to move forward, then the environmental attorney and consultant should craft a strategic plan with the client.   The client, whether buyer or seller, may decide to perform the cleanup and accept future liability risk.  Of course, this will implicate the structure of the transaction: is the buyer released of all future liability; does either party indemnify the other for liability; will one party fund an escrow to pay for cleanup; can the seller trigger insurance coverage to pay for the cleanup?  The parties can structure the transaction and allocate environmental liability however they desire.  But working with an experienced environmental lawyer and consultant helps you accurately value the property and avoid environmental liability.  It is an investment of time and money that is well spent. 

 

A. RELEASE OF ENVIRONMENTAL LIABILITY

 

Anyone does a purchase or sale transaction involving contaminated property or even settling future liability involving contamination needs to read this posting. Lawyers sometimes confuse an indemnity with a release of future liability. Doing so is a trap for the unwary.  An indemnity in favor of one party protects that party from all environmental claims during the period of the indemnity.  For example, during the indemnity period, the indemnitor must defend and indemnify the indemnitee from third party claims brought by subsequent owners of the property or adjacent landowners or a government agency.  Because the indemnitor steps into the shoes of the indemnitee have to defend and indemnify it, the indemnitor cannot assert a claim, which is covered to the indemnity, against the indemnitee during the indemnity period.

 

But an indemnity is not a release of liability so once the indemnity has expired; the indemnitor can sue the indemnitee for claims that were covered under the indemnity.  A classic example of this trap, discussed in a recent Washington Court of Appeals decision, involves the seller of contaminated property.   The seller agrees to clean up the property and indemnify the buyer for any claims arising from the contamination for three years, without obtaining a release of liability from the seller.   The Washington State Department of Ecology approves the cleanup, and thus the parties reasonably believe that the transaction is complete.

 

It may be complete, but the parties’ relationship is not over.  As the buyer begins development of the property 15 years later, it discovers new contamination.  The buyer sends a letter notifying the seller that it is liable for the cleanup under the Model Toxics Control Act, Chapter 70.105D RCW because the buyer had not released its claims of environmental liability against the seller.  The seller was shocked thinking that the parties had allocated their environmental liability by virtue of the Ecology-approved cleanup and the indemnity.  But the real estate transaction documents did not release any environmental liability between the parties.  The seller sued for a declaratory judgment that the cleanup and indemnity were an allocation of liability that effectively released all claims against the seller and thus barred any Model Toxics Control Act claim.  The trial court granted summary judgment in favor of the buyer and the court of appeals upheld the decision.

 

This decision is now binding legal precedent in Washington State that attorneys and parties to transactions need to be mindful of in allocating environmental liability.       

 

B. REMEDIATION ACTIVITIES AND RESPONSIBILITIES

 

There is no hard and fast rule as to whether the seller or buyer will perform the agreed upon remediation.  I counsel that if you are the buyer and blending the cleanup with your development of the property, then it is best for you to do the cleanup.  This allows you to work on your own timetable, choose your own environmental consultant and engineer and generally control the process.

 

The Seller, however, may want to perform if it is providing an indemnity or if   its insurer is reimbursing it for the cleanup costs. Obviously, each party wants certainty and assurances that the cleanup is done competently and contractual obligations are met.  One party may be more experience or sophisticated in doing cleanup so that party may be the right choice.  A party’s relationship with a regulatory agency, such as the Environmental Protection Agency or the Washington Department of Ecology, who is overseeing the cleanup, may be a deciding factor as well.

 

Regardless whether the seller or buyer performs the remedial work, be sure that the purchase and sale agreement or an environmental addendum clearly spells out responsibilities and who will pay for cleanup – including cost overruns.  Paying for cleanup can be done in a number of ways: escrow, holdback at closing, insurance, or even contribution from a one or more liable former owners and operators.  If a local government is performing the cleanup, then take advantage of the Ecology remedial grant program and the new amendments (effective 9/30/14) that allow the local government to include contribution from liable parties in the total amount that Ecology will match.

 

C. INDEMNIFICATION FOR ENVIRONMENTAL LIABILITIES

 

Allocate the responsibility to clean up the known contamination and indemnify for the unknown conditions.   Seek the broadest indemnity possible.  For example, be sure to cover claims relating to ground water migrating off the property and tort claims.  Define key terms and use the phrases “arising from the contamination” or “relating to the contamination.”

 

 I recommend putting all environmental provisions in a separate section of the PSA or an environmental addendum or agreement.  As in all contract drafting, draft an indemnity in a clear and concise manner.  As shown below in my sample indemnity, define the term “Claim,” which provides the scope of the indemnity, in a broad, comprehensive way that captures all possible costs that you want indemnified. Of course, you can limit the scope   if the other side balks.  For example, the indemnity can just cover performing a cleanup and getting an Ecology No Further Action Letter.    If you draft the release and indemnity in this way, then they can be short and simple and more likely to be interpreted in your favor by a court of law and upheld on appeal. 

 

Here is a release and indemnity that reflects this approach:

 

          “[   ]” shall mean [   ], and its predecessors, successors, assigns, subsidiaries, affiliates, tenants, and any person having an interest through or under them including directors, officers, employees, agents and representatives of any of the foregoing.

 

          “Claims” shall mean any and all statutory, contract or common law liability, claims, costs, losses, expenses, penalties, damages, theories of liability, actions, causes of action, and rights to recover contribution and/or damages of any type of nature whatsoever, whether known or unknown, relating in any way to remedial action costs or pollution, including attorneys’ fees, internal costs, and interest, incurred in response to a release or threatened release of hazardous substances at or from the

[   ].

           

          Releases by Parties.  The Parties hereby release each other from any and    all Claims.  The Parties stipulate and agree that they each expressly waive any and all provisions, rights, and benefits conferred by any law of the United States, any law of any state, or principle of common law which  governs or limits a person’s release of unknown Claims.

           

          Indemnity by [   ].  The [   ] shall defend, by and through counsel selected by the [   ], and indemnify and hold the Funding Parties harmless from and against any and all Claims.     

     

Remember that an indemnity is not worth much, if the indemnitor does not have the financial ability to indemnify your client.  If the indemnitor is not a publicly-traded corporation with deep pockets, for example, then consider using an escrow account parent company guarantee, letter of credit or insurance policy as a way to guarantee the indemnity obligation.

 

Remember that you cannot contract away your liability vis a vis the government.

 

D. & E. THE USE OF REPRESENTATIONS AND WARRANTIES

 

In Washington State, RCW 64.06 provides a statutory basis for reps and warranties.  This statute requires that in both the commercial and residential transactions, that the seller provides information about the environmental condition of the property in the Form 17, which includes providing all environmental reports to the buyer that the seller has knowledge of.  The seller does not have an affirmative obligation to do his or her own investigation, but need only provide documents in his possession or alert the buyer to documents in another party’s possession if the seller knows of them.  Note that if the seller has checked the box in the Form 17 indicating there is an environmental issue at the property, then the buyer cannot waive its right to receive the Form 17 and related documents.

 

If the seller intentionally puts incorrect information in the Form 17 or omits key info, there is no independent cause of action against him.  However, such a Form 17 could be evidence of fraud in a breach of contract action against the seller.

 

Since reps and warranties may be the basis for a breach of contract claim, it is in the seller’s interest to limit them.  Typically, in contaminated property transactions the seller wants to limit reps and warranties to known contamination as reflected in the Form 17 disclosure. In essence, the scope of cleanup determines the scope of the reps and warranties because the seller is warranting that a specific level of cleanup will be done.  An indemnity guarantees that the warranty is fulfilled by the seller.

 

A lessee of contaminate property needs to get a rep and warranty concerning the baseline environmental condition of the leasehold so that it can show it is not responsible for changed environmental conditions that occur during the term of the lease. Of course, the lessor benefits from the baseline as well, since the lessee will be responsible for changed environmental conditions that have occurred during the term of the lease, unless the lessee can show the conditions were caused by the lessor or a third party. 

 

The seller’s Reps and warranties are more important for the sale or lease of an on-going business that the buyer will continue to operate.  The buyer needs assurance and the seller needs to warrant that the business fully complies with applicable environmental laws and permits and that the seller has obtained all required permits and licenses to operate the business.  As with a cleanup warranty, an indemnity can cover permits and compliance and guarantee that the seller fulfills this contractual obligation.

 

 

F. COMPLIANCE OBLIGATIONS

 

As noted above, compliance obligations are typically part of the sale of an on-going business, rather than the sale of property that will be re-developed for another use.  It is the buyer’s burden to demand a warranty from the seller. Since compliance may be vital for a successful business, the buyer should ensure that an indemnity covers this obligation.  This compliance obligation applies equally to leasers of an on-going business or a portion of a larger industrial parcel, where the business depends on infrastructure that may require a permit, such as a stormwater system.   Of course, a buyer may be dependent on this larger infrastructure as well.

 

G. TRANSFERRING PERMITS

 

The seller’s transfer of permits to a buyer or lessee in two situations: (1) the seller is under an administrative order or consent decree  with an agency to perform an investigation or cleanup; and (2) a buyer or lessee is purchasing or leasing an on-going business and requires the permit  to operate in compliance with applicable law.  Given the costs and liability risks of stepping into the shoes of the seller and assuming the seller’s permit obligations, it is critical that the buyer or lessee do  comprehensive due diligence on the costs and liability risks of performing a cleanup under an order or consent decree.  This due diligence requires a legal analysis by an environmental lawyer to adequately evaluate the risks.

 

The Washington State Department of Ecology, like many state environmental agencies, requires that a form be completed before transferring Clean Water Act permits and permits for water rights.  Check the applicable forms early in the due diligence process, because there may be notice and timing rules that could impact the closing date.  Further, the potential buyer or lessee may have to certify that it can meet the permit conditions and that certification may require some time and money to complete.

 

H. DISPUTE RESOLUTION PROVISIONS

 

As with any contract provision, draft it clear and concise.  Dispute resolution should be in two phases: The parties are required to first try negotiating the dispute and then use a third party mediator. Parties pay for their own legal counsel through these two phases.   If negotiation and mediation fail, then the parties may pursue litigation in the superior court where the real estate is located. The prevailing party in any judgment must pay the losing party’s attorneys’ fees and costs. 

 

Below is an example of a provision that reflects these concepts:

 

                        Dispute Resolution.  Any dispute that may arise under this Agreement (including without limitation non-compliance with the Agreed Order) shall be resolved according to the procedure detailed in this Section.  If any Party alleges a violation of or dispute over any provision of this Agreement it shall provide written notice of the alleged violation or dispute to the other Parties.  The Parties and/or their attorneys shall meet in person within 14 days (or as soon as reasonably possible) to attempt to resolve the dispute.  If the Parties cannot resolve the dispute within 30 days of such meeting, the Parties shall seek to agree on a mediator to mediate the dispute.  The mediation shall be nonbinding on the Parties.  In the event the mediation is unsuccessful and the Parties are not able to resolve the dispute, each Party reserves all rights and defenses available to them under applicable laws.