Definition of an Environmental Indemnity Agreement
Environmental indemnity agreements are contracts that indemnify the indemnitee against future loss or liability. It is a promise by the indemnitor to compensate the indemnitee for loss or damage resulting from the conduct of the indemnitor or something for which the indemnitor is responsible. Indemnity provisions may be used to allocate risk in corporate transactions requiring the assumption of certain environmental obligations.
For example, in asset acquisitions it is common for environmental indemnities to be included, pursuant to which the seller indemnifies the buyer for certain environmental liabilities. The foregoing are private indemnitums between the contracting parties and are not part of a statutory scheme.
However, statutory or regulatory indemnity agreements exist in Federal legislation as well as in many, if not most States. They usually provide, in part , that the federal or State Government will reimburse certain costs incurred in connection with the cleanup of contamination in the course of complying with applicable statute or regulations. An example of such legislation providing for State compliance and reimbursement is Massachusetts General Laws Chapter 21E. Another Massachusetts statute, M.G.L. c. 21I, provides for a grant of state indemnity in the context of remediation of contaminated properties where the State requires a responsible party to perform remedial actions.
The treatment of the indemnity relationship in the statutory scheme facilities compliance and aids in the interpretation of federal or State indemnity agreements providing for State reimbursement of costs, or for indemnification of responsible parties in complying with these obligations, for the liability of the Agencies for environmental cleanup costs.
Main Elements of Environmental Indemnity Agreements
Environmental indemnity agreements are often complex and may vary depending on the deal. However, most environmental indemnity agreements will include the following basic components:
Indemnity Clause
The indemnity clause is a key part of an environmental indemnity agreement and identifies the obligation to indemnify and the respective triggers, conditions, conditions precedent, and limitations thereon. In the context of an indemnity for environmental liabilities, the indemnity clause will generally define "Indemnified Liabilities" as any release of Hazardous Materials that is identified in a government audit or investigation, by a private third party (e.g., an RPM), or that requires the filing of a government report (e.g. Form I in New Jersey). The scope of the indemnity is then typically limited by the following conditions:
Parties to the Agreement
An environmental indemnity agreement may be a stand-alone agreement, but is more frequently part of the purchase and sale agreement (in which case it is also typically cross-defaulted to the seller’s obligations under the purchase and sale agreement). The parties to an environmental indemnity agreement will include the indemnitor and the indemnitee. If there is more than one indemnitor and/or indemnitee, the agreement will usually list each party. If the parties are not listed, an excess insurer could have standing to enforce the agreement as a third-party beneficiary.
Environmental Indemnity Agreements v. Environmental Escrows
Because it may be difficult (if not impossible) for an indemnitor to obtain environmental insurance to cover the risks being indemnified, many real estate transactions include an environmental escrow. An environmental escrow is a mechanism in which a predetermined amount of money is reserved to pay lenders’ and purchasers’ costs associated with environmental liabilities. If a lender obtained an environmental escrow in its loan documents, or a purchaser negotiated an environmental escrow as a condition to its purchase of the property, the lender and purchaser may not later assert an indemnification claim against the indemnitor. The purpose of an environmental escrow is to provide the lender or purchaser with a source of funds to pay environmental liabilities.
Significance in Trading Real Estate or Businesses
Environmental Indemnity Agreements (EIAs), combined with other contract terms and indemnification provisions, are a central feature of the risk allocation framework for many real estate transactions, insurance contracts and indemnification agreements. In particular, EIAs represent a critical tool for real estate owners, operators and occupiers to manage risks associated with existing environmental contamination, as well as emerging areas of concern.
But why are EIAs and other contractual tools so important to business transactions? Increasingly, public and private entities are confronted by threatening liabilities in the realm of environmental laws and regulations. Environmental liabilities, while often complex (focused on claims for cleanup, inquisitions and costs for fines and penalties), nevertheless generally fall into three categories. These categories are (i) existing environmental contamination – in facilities, adjacent areas or commingled activities; (ii) contamination resulting from historic activities in light of long-term liability for the "time placed" of pollutants; and (iii) contribution toward future environmental conditions and cleanups. In addition to these long-term types, companies must also grapple with short- and medium- term risks, such as lawsuits based upon the future effects of microscopic particles from industrial processes, emergence of new migration pathways for known contaminants, and the long-term costs (in heightened risk) for sites administered under private brownfield programs. On the public side, increasing government focus on brownfields, superfund cleanup and redevelopment, and other enforcement actions translating to multi-million dollar claims for environmental cleanup under CERCLA, EPA 166’s and many state analogues, and indirect role liability for bona-fide purchasers and contiguous landowners make attention to environmental issues essential to risk management for real estate properties. Parties must be cognizant of risks associated with the transfer of assets and activities, the potential for latent conditions which may complicate legacy compliance issues, and controlling for both environmental and regulatory compliance in contracts. Given the risks associated with environmental liabilities, it is no surprise that EIAs, contract representations and warranties, insurance, release and hold harmless provisions have become a normal feature for many complex real estate and business transactions. For example, where real estate owners seek to establish indemnity protection for current and historical contamination, they may use indemnity provisions to create a transference of current and accrued environmental costs and risks. The time-value of future uncertainty is a crucial factor in determining commercial terms in an acquisition, sale or other transaction.
Relevant Legal Issues and Problems
In the world of real estate and corporate acquisitions, it is not unknown for negotiations to be conducted in good faith without the participants devoting any serious focus to indemnity agreements. In such circumstances, problems can arise for all involved when a subsequent triggering event occurs – i.e., when liability in fact develops over and above any limitations – and the aggrieved party looks to enforce the indemnity agreement against the other party on a strict liability basis. A good example of this is where the indemnitor housing the environmental indemnity is no longer in existence, in which case the parties seek to impose liability upon the administrator of the indemnity.
The subject matter of these agreements often involves substantial remediations where the regulatory agency is involved and a multi-year process will result before all of the environmental release issues are cleared. A critical component of this process is usually the financial strength of the indemnitor to support the remediation. If the original entity underlying the indemnitor is dissolved or weakened, the party is at risk for the limits of its remaining insurance coverage. Use of letters of credit and/or self funding may be critical.
There are also many potential practical challenges to the enforceability of an indemnity agreement. From a practical standpoint, the question of enforceability may depend upon the particular facts surrounding each situation, especially any procuring relationships between the parties. A court may deem an indemnity agreement to be valid if it is supported by consideration and is entered into in good faith. Even so, a written indemnification agreement may not be enforceable if it is in violation of public policy. Courts that are asked to adjudicate enforcement actions under an indemnity agreement may consider several factors, including: the industry custom relating to the use of an indemnity agreement, whether the indemnification agreement was the subject of an arm’s length bargaining process, whether the indemnity agreement is triggered by relatively common events, and whether the indemnifying party has been put on notice of the claimed breach and the amount of damages. Privity of contract will be an important factor.
Environmental indemnification agreements are frequently used in the context of an asset purchase transaction. A new entity emerging from or involved in the asset purchase transaction may not have entered into the transaction as an arm’s length party and there may be evidence of fraud surrounding the agreement. There may also be similar documents that are inconsistent with the subject indemnity agreement. In practical terms, indemnity agreements will only be enforceable if they are supported by an investigation of the other party. Upon discovery of the breach, the parties have the responsibility of complying with the terms of agreement and that party will bear costs and liability unless otherwise agreed. There may also be personal liability for employees of the indemnitor and the members of an entity if an indemnity obligation is not met. An indemnity agreement will be enforceable only to the extent that the ordinary courts of the state have personal jurisdiction over the parties, and as to the principal amount of the damages sought.
Properly Drafting Environmental Indemnity Agreements
Numerous considerations are made when drafting a well-written agreement to ensure its validity and enforceability, particularly in situations involving response costs for environmental contamination. These considerations are relevant when drafting environmental indemnity agreements. In addition to the requirements of a contract, and the general enforceability of indemnity agreements, an environmental indemnity agreement must be unequivocal in establishing the duty to indemnify or provide reimbursement for all response costs.
Best practices when drafting environmental indemnity agreements include:
While most of the issues that arise in interpreting environmental indemnity agreements can be found in other agreements, environmental indemnity agreements present some additional concerns. For instance, indemnities that extend beyond the closing date of a transaction or the termination date of the governing lease may be considered penalties. An indemnity agreement designed to extend beyond a closing date should clearly explain that it is designed to protect future property owners. The indemnity agreement in such a scenario is a benefit to future property owners, and courts are more likely to uphold these agreements.
Indemnity agreements are generally interpreted based on their plain meaning. When litigating cases involving an indemnity, courts look to whether the terms of the indemnity are clear and unambiguous. If the terms of an indemnity are plain, courts will look no further than the indemnity itself to determine the rights and duties of the parties. Thus, it is critical that parties consider the specific language in an indemnity agreement when drafting it.
Many states have laws that address what information should be provided to indemnitors. Parties should always consult with legal counsel to determine what information is required.
Indemnity agreements must be clear and unequivocal. Indemnity agreements should:
Indemnity agreements may also include conditions precedent , notice provisions, a duty to defend clause, and clearly pronounce any caps on indemnification. Indemnity agreements should also immediately notify parties of the need to obtain necessary insurance policies to cover indemnity claims. Furthermore, the party seeking indemnification should preserve its rights to indemnification and coverage whenever possible. Indemnifying parties should also promptly pay for all covered claims and should consider including a harmful conduct clause, which requires the parties to notify others if they cause or contribute to a release.
Indemnity agreements should clearly spell out the difference between indemnity agreements and indemnification agreements. Indemnification is a general obligation to reimburse another party for a claim or share in the burden of providing a defense for a claim. Indemnification can potentially extend to third-party claims if the language of the agreement is similar to other common types of indemnity agreements. Entities may be indemnified for fines, penalties, and legal expenses arising from violation of environmental law.
Retention of counsel and settlement of claims made against the indemnitee are often the subject of lawsuits. Because many indemnity agreements seek to shift responsibility of defending claims to the indemnitor, clients should reach an understanding with indemnified parties, particularly lenders, regarding these obligations. Environmental indemnity agreements should list the requirements needed to comply with, among other actions, insurance procurement and notice requirements. Indemnified parties should set forth the best possible understanding as to any agreement on the use of consultants.
Practical Examples
Environmental Indemnity Agreements (EIAs) have been instrumental in many notable environmental cases. The former Denver Union Stockyards in River North Denver is an example of a successful redevelopment project where an EIA helped mitigate environmental risks. The former site of an 80 acre meat packaging facility, the project was redeveloped into industrial lofts, condominiums, and retail space. To fund the redevelopment, the City of Denver issued debt through an Urban Renewal Authority which made it the owner of the property until the bonds were paid off. In connection with this issuance, Denver negotiated a resolution with the Colorado Department of Public Health and Environment for environmental cleanup of the site. As part of the deal, the Denver Urban Renewal Authority entered into an Environmental Indemnity Agreement with the State. The selected developer and owner of the certain property at the site (Unity Hunt Denver Industrial, LLC) took an assignment of the EIA through a subordination agreement. Readers interested in this redevelopment project will note that the site now supports a regional headquarters for Coors, residential and commercial development known as LoHi, and outdoor events in an area known as Commons Park.
Another example of the use of environmental indemnities are found in the case of Molina & Sons, Inc. v. Massachusetts Turnpike Authority, where the Massachusetts Turnpike Authority ("the Authority") sought recovery of costs for pre-1987 environmental contamination from Molina & Sons, Inc. ("Molina"). Molina brought fill to the Authority in 1959 to fill the area now known as Boston’s Big Dig and to support Boston’s Central Artery Project. The towns of Westwood and West Roxbury were the source of the fill. Subsequent studies and tests revealed that the fill apparently contained various hazardous substances. In 1972, Molina joined more than 15 municipalities, including Westwood and West Roxbury, who entered into a Contractual Indemnity Agreement with the Authority. Under the terms of the Contractual Indemnity Agreement, any person who brought or deposited soil or fill onto the project site was indemnified against any claims for injury to persons or damage to property. On March 28, 1990, the Authority issued a Claim Notice to Molina to recover cleanup costs for pre-1987 environmental work at a cost of $21.8 million and approximately $7 million for property damage. Molina sued the Authority claiming contribution and indemnification based on the 1972 Contractual Indemnity Agreement. The Superior Court found in favor of Molina, ruling that the indemnification agreement was binding on the Authority and not subject to the Massachusetts Municipal Modernization Act (M.G.L. c. 44 ยง 7(1)), which prohibits municipal financing without authority approval. The Appellate Court agreed in Molina & Sons, Inc. v. Massachusetts Turnpike Authority, which sets a precedent for contract law when municipalities enter into binding indemnity agreements, notwithstanding provisions of the Massachusetts Municipal Modernization Act.
These case studies illustrate how EIAs can be effectively utilized to mitigate both liability and cleanup costs.
Emerging Issues
Future trends and developments in environmental indemnity agreements may include increased complexity due to the implementation of new environmental regulations and market developments that will drive requirements for expanded use and development of new indemnity agreements. We expect increased use of indemnity agreements to deal with continuing or unforeseen complex environmental risks that require indemnity from current and/or past owners, lessees and/or operators of the site. This trend may include an attempt to cover all parties historically responsible for the site . For example, this may occur where responsible parties in the past indemnified the past owner, but the original remaining property owners did not, due to the fact that the property was conveyed with a warranty of title.
Another expected trend would be the inclusion of alternative to indemnity provisions through which an indemnitor agrees to cover losses in the event of claims asserted against the site owner and/or operator. These types of agreements may also include assumptions of liability or control of a facility when circumstances arise.