Don’t Let Bad Indemnity Provisions Become Your Environmental Disaster

Successor liability is a phrase that corporate officers hope to never have to utter to their board of directors or shareholders. Unfortunately, it’s a common phrase in environmental litigation and a need-to-know concept in transactional law. Successor liability can arise directly from the activities of an entity that has been acquired or merged into your company, or an outside transaction conducted by the entity (even if the transaction occurred years prior to your merger or acquisition). This concept creates the ever-fun phenomenon wherein an entirely unrelated company can be held liable for the acts of an acquired entity or even as the result of a simple property purchase. For illustrative purposes, picture purchasing a ketchup company but realizing that the ketchup company carries liability from an alkaline battery manufacturing plant. Although the ketchup company seems like a safe purchase, if there was ever a contamination near the battery manufacturing plant, the ketchup company will be one of the first calls made by environmental regulators. Quality environmental indemnity provisions are the best way to deal with the unknown in successor liability.

How Courts Have Handled Prior Provisions

Understanding the potential financial impacts of successor liability, CERCLA [1] specifically allows for indemnity provisions to shift liability of environmental cleanup costs, by stating that “[n]othing in this subsection shall bar any agreement to insure, hold harmless, or indemnify a party to such agreement for any liability under this section.” [2] Further, courts in interpreting this language have followed the legislature’s intent and enforced well-written indemnity provisions under the right circumstances. [3] However, before an indemnification provision is approved by the court, it must determine that indemnity is “clearly implied from the language and purposes of the entire agreement and the surrounding facts and circumstances.” [4] As such, courts are careful to “avoid reading into [an indemnification provision] a duty which the parties did not intend to be assumed.” [5]

For example, in Tartan Oil Corp., the New York state court evaluated the following indemnity provision:

[Company A] assumes all risks incident to the use of the property, including the risk that some liquids or mixtures, such as oxygenated fuels (including “Gasohol”), may react with storage tank interiors, linings, or both, causing corrosion and leakage. [Company A’s] indemnification of [Company B] shall include indemnification against this risk. Relining of tanks shall be at [Company A’s] sole cost and expense.” [6]

The Court held that this indemnity provision was not enforceable because the leak at issue existed at the time of purchase and this provision only applied to future leaks. Bero Fam. P’ship v. Elardo [7] is one of the more interesting environmental indemnity cases. The indemnification provision at issue in Bero was:

“[I]f [Defendant] learns or is notified that any removal or other remediation of any hazardous substance is necessary, [Defendant] shall promptly take all necessary remedial actions, and will indemnify and hold Mortgagee[s] harmless for all damages, costs and expenses of any kind … related to any such removal or remediation, regardless of the source or cause of the contamination or other environmental law violation.”

Due to the indemnity provision’s “regardless of the source” language the Court held that the provision was enforceable even though the party seeking indemnification had caused the environmental contamination. The Court rejected the argument that the term “hazardous substance” carried the same definition as in CERCLA, which does not include the petroleum at issue in the case, because the record did not evidence any intention by the parties to include CERCLA terminology. The Second Circuit has also held that broad language such as “all liabilities” creates an enforceable indemnification agreement for federal CERCLA liability. [8] The court held the indemnification enforceable even though CERCLA was not even law at the time the agreement was entered into.

Despite these rulings, however, the broad “any liability” language will not always be sufficient to create an enforceable indemnification provision. [9] If broad indemnity language is coupled with language limiting statutory liability, then the clause may not cover CERCLA indemnification. An issue along these lines arose in the Eastern District of North Carolina, where the court ruled that despite “as-is” terminology and indemnity clauses, the purchasing company did not adequately shift its liability away. [10] In reaching this conclusion, the court reasoned that the indemnity provision only specifically mentioned state and local laws. The cleanup payments that had been made by the company seeking indemnification were voluntary payments and only federal law under CERCLA allows for cost recovery without a governmental order requiring a party to pay cleanup costs. Thus, the suit seeking recovery of payment was under CERCLA, and as the indemnity provision only applied to state or local law it could not shift liability from the purchasing company.

Whether a company is a successor in liability is a fact-intensive question the court will have to analyze based on the chain of transactions and underlying contracts to each transaction. [11] What the precedent makes clear, though, is that it is imperative to not only diligently draft and review the indemnity provisions in the immediate transaction, but that thorough due diligence of potential successor liability should not only be conducted on target entities, but also historical occupiers.

Remember to Check These Provision Boxes

Due to the different aspects of their prospective liabilities, environmental issues and commercial transactions will require different indemnity language in their respective provisions. In addition to proper drafting of transactional documents, there are several principles that can help protect a company that could potentially become a successor in liability. First, if an environmental issue ever arises after the transaction has closed, prior to voluntarily making environmental remediation payments, the company should review its indemnity provisions and confirm that the company will be indemnified under CERCLA. If the indemnity provision only applies to state law, voluntary payments may not be indemnifiable. Second, language that covers both existing and future contamination is critical. Although most transactions will perform environmental due diligence, the unfortunate reality is that due diligence can miss a contamination, and language covering existing contamination will save the day. Third, it’s critical to include as broadly worded language as possible in the environmental indemnity provision which includes broad language requiring indemnity no matter who causes the contamination, defining a contamination that will trigger an indemnity, and defining the type of law that is indemnifiable.

Conclusion

The other party to the transaction may push back on the perfect indemnity provision. However, environmental litigation is one of the most expensive fields of litigation when considering the technical expertise required. Further, environmental remediation is expensive and can last decades. Strategically, it may be wise to concede language elsewhere in negotiating a transaction and leave the environmental indemnity provision as strong as possible so your business is not stuck holding the bag when the regulators call.

——————————–

This DarrowEverett Insight should not be construed as legal advice or a legal opinion on any specific facts or circumstances. This Insight is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The contents are intended for general informational purposes only, and you are urged to consult your attorney concerning any particular situation and any specific legal question you may have. We are working diligently to remain well informed and up to date on information and advisements as they become available. As such, please reach out to us if you need help addressing any of the issues discussed in this Insight, or any other issues or concerns you may have relating to your business. We are ready to help guide you through these challenging times.

Unless expressly provided, this Insight does not constitute written tax advice as described in 31 C.F.R. §10, et seq. and is not intended or written by us to be used and/or relied on as written tax advice for any purpose including, without limitation, the marketing of any transaction addressed herein. Any U.S. federal tax advice rendered by DarrowEverett LLP shall be conspicuously labeled as such, shall include a discussion of all relevant facts and circumstances, as well as of any representations, statements, findings, or agreements (including projections, financial forecasts, or appraisals) upon which we rely, applicable to transactions discussed therein in compliance with 31 C.F.R. §10.37, shall relate the applicable law and authorities to the facts, and shall set forth any applicable limits on the use of such advice.

[1] Comprehensive Environmental Response, Compensation, and Liability Act

[2] 42 U.S.C. § 9607(e)(1).

[3] Fina, Inc. v. ARCO, 200 F.3d 266, 270 (5th Cir. 2000).

[4] Drzewinski v. Atl. Scaffold & Ladder Co., 70 N.Y.2d 774, 777, 515 N.E.2d 902, 904 (1987).

[5] State v. Tartan Oil Corp., 219 A.D.2d 111, 115, 638 N.Y.S.2d 989, 991 (1996).

[6] Id.

[7] 122 A.D.3d 1279, 1280, 996 N.Y.S.2d 430, 431 (2014).

[8] Olin Corp. v. Consol. Aluminum Corp., 5 F.3d 10, 15 (2d Cir. 1993).

[9] Elf Atochem N. Am. v. United States, 866 F. Supp. 868, 871 (E.D. Pa. 1994).

[10] Channel Master Satellite Sys., Inc. v. JFD Elecs. Corp., 702 F. Supp. 1229, 1232 (E.D.N.C. 1988).

[11] See generally United States v. Conagra Grocery Prod. Co., LLC, 4 F. Supp. 3d 243, 259 (D. Me. 2014).