anticipating post-closing environmental issues in real...

Anticipating Post-Closing Environmental

Issues in Real Estate Deals

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WEDNESDAY, DECEMBER 11, 2019

Presenting a live 90-minute webinar with interactive Q&A

Toby Chun, Partner, Kirkland & Ellis, Washington, D.C.

Cindy J. Karlson, Founder, Law Offices of Cindy J. Karlson, Groton, Conn.

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A Road Map for Post-Closing Environmental Liabilities

PROGRAM AGENDAI. Anticipating and identifying potential

environmental issues which may occur post-closing

II. Negotiation strategy and contractual tools to address post-closing issues

III. Hypotheticals

6

Rules of the Game1. Joint and several liability

2. You cannot contract away liability vis-à-vis the government

3. Environmental conditions are frequently latent and unknown at the time of closing

4. Most environmental issues run with the land

7

Rules of the Game

Real estate contracts often do not bind third parties

Some environmental agreements are not recorded on the land records

(access agreement, technical risk management plans)

8

Rules of the Game

Potential key differences from M&A

Redevelopment/sale-leaseback scenarios can drive more pre-closing Phase II work

As a result, environmental consultants in the RE space can be more predisposed to RECs and Phase II recommendations

9

The Art of the Commercial Real Estate Deal

- There is no boilerplate or default deal format

- Identifying environmental risks/liabilities

- Allocate the risks

- Pre-closing

- Post-closing

10

The Spectrum of Liability

11

Types of Post-Closing Liabilities

Cleanup Liabilities Monetary Claims

Government1st

Party

VoluntaryContract

Conditions

3rd

PartyGovernment

12

Potential Cleanup Obligations

Investigation

Remediation

Post-remediation monitoring

Land use restrictions

Ongoing operation & maintenance

Financial assurance

13

Logistical Cost Considerations

Soil sampling Location

Timing

Groundwater sampling Location of wells

Repair and replacement of wells

Removing or abandoning wells

Indoor air sampling Where and when

14

Remediation Cost Considerations- Specific level of cleanup

- Who is responsible for government submittals

- Who chooses remediation option

- Who pays for what costs and unknowns

- Will land use restrictions be allowed as remediation

- How will remediation impact post-closing existing or future use of the property

- Are financial assurances required?

15

Post-Remediation Monitoring Define length of monitoring program

Site access issues

Sharing data and information

Cooperation

Post-closing use of property potential impacts on remediation outcomes

Communications with government

Impacts on financial agreements

16

Land Use Restrictions Agree on which restrictions may

be allowed by the parties

Who will pay for costs?

A2 surveys

Legal title work

Subordination agreements

What if remediation or land use

restrictions not completed and

property is sold again?

17

Odds and Ends

Operation and Maintenance

Remediation systems

Who pays for electric

Equipment and structures

Engineering controls

Cap repair and maintenance

Trees and green cover

18

M&A Deal Notes Materiality (business vs. property)

Private equity (short-term) vs. Strategic (long-term)

Rise of R&W insurance deals = Back-half environmental provisions becoming lost art

19

Complicating Factors

Tenants/Leases

Lender conditions

Third party claims

Government

20

Issues to Parse Out Site access

Obligation triggers

Cleanup end points

Notice requirements

Information dissemination

Agency communication parameters

Cooperation requirements

21

Anticipating Post-Closing Environmental Issues in Real Estate Deals:

Negotiation Strategies and Contractual Tools

22

Agenda

Allocation and Management of Risks

Contractual Considerations And Tools

Techniques to Address Post-Closing Environmental Risks

23

Preliminary Considerations for Negotiation Do necessary due diligence

Identify as many issues as you can to avoid surprises

Understand the key players and their objectives

Allocate risks appropriately Allocate based on knowledge of

existing conditions at closing

Outline Key Concerns Carve out specific environmental

conditions

24

Preliminary Considerations for Negotiation What are the parties

relative rights pre- and post- closing?

Who can recover monies (successors and assigns)?

Define any terms?

Length of indemnity period?

Which costs covered?

Which costs are NOT covered?

25

Preliminary Considerations for Negotiation Understanding the terms

Term sheets

Definitions – Avoid ambiguous terms

Representations and Warranties

Limiting the scope of coverage

Indemnities

Conditions to closing/ conditions precedent

Other unique considerations

26

Preliminary Considerations for NegotiationDrafting: Use general or specific language to address post-closing concerns?

Pros

Avoid potential costly litigation

Manage parties’ expectations

Cons

Could incur additional transactional costs in negotiation

Could unknowingly exclude costs if provisions too specific

27

Contractual Considerations

Definitions are critical!!!

“Environmental Laws”- Understand what is and is not included (agency guidance, directives, orders. future laws?)

“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, PFAS- Also consider including solid waste, explosives, radioactive materials

28

Contractual Considerations

Definitions - Drafting Example

“HAZARDOUS MATERIALS” SHALL MEAN (1) ANY “HAZARDOUS WASTE” AS DEFINED BY THE RESOURCE CONSERVATION AND RECOVERY ACT OF 1976 942 U.S.C. SECTION 6901 ET SEQ.), AS AMENDED FROM TIME TO TIME, AND REGULATIONS PROMULGATED THEREUNDER; (2) ANY “HAZARDOUS SUBSTANCE” AS DEFINED THE COMPREHENSIVE ENVIRONMENTAL RESPONSE, COMPENSATION AND LIABILITY OF 1980 942 U.S.C. SECTION 9601 ET SEQ.), AS AMENDED FORM TIME TO TIME, AND ANY REGULATIONS PROMULGATED THEREUNDER AND ALL APPLICABLE STATE AND LOCAL LAWS, RULES, AND REGULATIONS RELATED TO HAZARDOUS SUBSTANCES NOW EXISTING OR HEREINAFTER ENACTED; (3) ANY TOXIC SUBSTANCE; (4) ANY EXPLOSIVE OR EXTREMELY DANGEROUS MATERIAL; (5) ASBESTOS; (6) POLYCHLORINATED BIPHENYL; (7) RADON GAS; (8) LEAD BASED PAINT; (9) PETROLEUM PRODUCTS OR BY-PRODUCTS; (10) PER- OR POLYFLUOROALKYL SUBSTANCES; (11) ANY SUBSTANCE THE PRESENCE OF WHICH IS PROHIBITED BY ANY GOVERNMENTAL REQUIREMENTS; AND (12) ANY OTHER SUBSTANCE, MATERIAL OR WASTE FOR LIABILITY OR STANDARDS OF CONDUCT MAY BE IMPOSED UNDER ANY ENVIRONMENTAL LAW.

29

Contractual ConsiderationsKey Points

Materiality: “little m” material vs. MAE/MAC ?

“Knowledge” qualifiers?

Scope of reps? Options include –

Contamination Compliance Toxic torts AROs/financial assurances Transaction-triggered laws Off-site waste disposal liabilities

30

Contractual Considerations “Third Party vs Direct Claims” –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?

“Release” – how broad you define a “release” can impact the scope of the indemnity “spilling, leaking, pumping, pouring, emitting, injecting,

escaping or dumping”

What about “migration”? Potential or threatened releases included?

31

Techniques to Limit Liability Disclosure Schedule

Knowledge Qualifier

Materiality Qualifier

Specific Time Limitations

Limitations on scope and locations

Limitation on survivability

32

Seller’s General Position

Wants specific and narrow definitions

Will attempt to limit any representation and warranty by adding materiality and knowledge qualifiers

Attempt to add a disclaimer of warranty that the property is being sold “AS IS”

Will want anti-dogkicking/anti-goldplating limitations

Time and commercial limitations

33

Buyer’s General Position Typically wants broad definitions and reps/warranties

No limitations or qualifiers is preferred – good faith exceptions at least

Will want any representation or warranty to be supported by an indemnity from the Seller

“Dollar one,” uncapped, longer survival periods

34

Addressing Post-Closing Environmental Risks

Disclosure Schedules Detailed summaries or broad incorporation by reference?

Knowledge Qualifier Whose knowledge?

What is “knowledge” – actual or imputed?

Specify a particular individual or impute knowledge to the company as a whole?

Specific time, scope or location Is the scope limited by time period (i.e., “my watch, your watch”)

Do you carve out certain types of liability or contamination?

Do you carve out certain locations?

Limitation on Survivability (e.g., 2 or 3 years after closing)35


Materiality Triggers

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 (scrapes, deductibles)?

36


“As Is” Clauses Purpose: Used as a tool for Seller/Owner to shift liability to

Buyer/Tenant

Must be conspicuous in the agreements

Limitations

Does not preclude Buyer’s statutory contribution claims under CERCLA

Some courts may apportion CERCLA liability or allow claims of breach of implied representations/warranties

37


“As Is” Clause/Release – Drafting Example

NOT WITHSTANDING ANYTHING TO THE CONTRARY, IT IS UNDERSTOOD AND AGREED THAT WITH RESPECT TO THE PHYSICAL AND ENVIRONMENTAL CONDITION OF THE PROPERTY, THE PROPERTY IS BEING SOLD “AS IS,” “WHERE IS,” AND SUBJECT TO ANY ENVIRONMENTAL CONDITION THAT MAY EXIST, WITHOUT ANY REPRESENTATION OR WARRANTY BY SELLER, EXPRESS OF IMPLIED….

PURCHASER HEREBY EXPRESSLY ACKNOWLEDGES AND AGREES THAT (i) PURCHASER HAS THOROUGHLY INSPECTED AND EXAMINED THE PROPERTY TO THE EXTENT DEEMED NECESSARY BY PURCHASER IN ORDER FOR PURCHASER TO EVALUATE THE PURCHASE, AND (ii) PURCHASER IS RELYING SOLELY UPON INSPECTIONS, EXAMINATION, AND EVALUATION OF THE PROPERTY BY PURCHASER IN PURCHASING THE PROPERTY ON AS “AS IS, “ “WHERE IS,” AND “WITH ALL FAULTS” BASIS….

PURCHASER HEREBY ASSUMES THE RISK THAT ENVIRONMENTAL CONDITIONS MAY EXIST ON THE PROPERTY AND HEREBY RELEASES SELLER OF AND FROM, AND AGREES TO HOLD HARMLESS AND INDEMNIFY SELLER FROM AND AGAINST ANY AND ALL CLAIMS, ACTIONS, DEMANDS, RIGHTS, DAMAGES, COSTS OR EXPENSES WHICH MIGHT ARISE OUT OF OR IN CONNECTION WITH THE PHYSICAL OR ENVIRONMENTAL CONDITION OF THE PROPERTY…

38


Release Provisions Purpose: Used by Seller/Owner to shift liability to Buyer/Tenant in “as

is” deals. Also, serves as a waiver and potentially prevents comeback claims

Must be conspicuous in the agreements

Limitations

Cannot alter or change underlying CERCLA or cost recovery liability to the government (e.g., EPA or state)

Can only be used to change who ultimately pays the response costs Mardan v. C.G.C Music, 804 F.2nd 1454 (9th Cir. 1986)

39


On-Site or Offsite Disposal of Environmental Contaminants

Both parties are liable under CERCLA for on-site disposal.

Parties can contractually allocate responsibility, but joint and several liability remains as to the government.

Buyer generally prefers broad representations that there has been no on-site disposal of, or contamination by hazardous materials or other pollutants

Seller typically prefers narrow representations that extend only to those substances or materials which constitute a violation of environmental law

40


On Site or Off-site Contamination Concerns Who is responsible – Buyer or Seller?

For what?

➢ Pre-closing contamination caused by Seller only?

Presumptions and baselines

➢ Only government ordered cleanup?

Or anything required by laws or in excess of applicable standards?

➢ Cleanup of soil and groundwater only?

Asbestos, lead paint, mold, drum removal, demolition

41


Environmental Remediation Obligations• Who controls communications with government for past

contamination?

• What kind of cleanup?

• Industrial/commercial versus residential?

• Risk-based cleanup standards?

Use of institutional controls permitted? (e.g. site management plan, deed restrictions)?

Engineering controls (e.g., cap)?

42


Indemnities Purpose: Serves as a promise to safeguard against existing or future

liabilities

It is only as good as the party providing the indemnity (indemnitor)

Has no effect on an environmental agency’s rights to sue or seek recovery

Express Negligence Rule:

Indemnity for a party’s own negligence must be expressly spelled out in the agreement. See e.g., Fina v. Arco, 200 F.3d 266 (5th Cir. 2000)

Drafting Considerations:

One size does not fit all – Tailor specifically for the deal

Indicate the effective period and the trigger for the applicability

43


Indemnities

Default arrangement:

▪ Seller indemnifies buyer for all pre-closing liabilities

▪ Buyer does not indemnify seller for all post-closing liabilities

Because buyers can 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 consideration

44


Indemnity Cost sharing

Escrow

Procedures

45


Cost Allocation and Limitations

Basket

Buyer maintains a running total of the post-closing environmental liabilities it has incurred; when the total exceeds the agreed threshold dollar amount, buyer may 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)

46


Escrow These provisions are useful when there are ongoing remediation expenses that

are expected post-closing.

Purchasers of property that is contaminated, suspected to be contaminated, or have regulatory compliance issues may require sellers to establish escrow accounts that could pay the cost of cleanup, address third party claims, and/or address regulatory compliance deficiencies.

These accounts are often limited to specified dollar amounts and a limited period of time following the completion of the transaction.

47


Indemnity – Devil is in the details: WHAT ?

The question of how clean is clean and what condition triggers the obligations of the Sellers or Buyers should not be left to post-closing discussion or negotiation.

Is the goal of remediation getting to zero detection (restoration) or is it to receive a regulatory determination such as a No Further Action determination (risk based closure), or something else Even under Risk Based Closure, what institutional controls are acceptable for the property and what closure document is required to meet the party’s obligations.

Regarding environmental compliance, consider listing each known deficiency along with a scope of work, costs, schedule and the party responsible for the defined

actions, and consider a shorter time limit for unknown deficiencies.

48


Indemnity – Devil is in the details: WHO?

Define who is responsible for what tasks and be specific. Who will take the lead on the project and be responsible for achieving the final outcome? Who will oversee the work on the project? Who will be responsible for coordination with agencies? Who will confirm conclusions and strategy for achieving the final outcome? Who are the parties who decide fund disbursement and what are the hurdles to access the escrow account? If the escrow includes addressing compliance deficiencies, who defines the scope, schedule, and cost? Who will be responsible for any regulatory penalties that might result from the situation to be remedied? What participation rights will the other party have?

WHEN?

Laying out and agreeing to a critical path to complete all items specified in the escrow agreement is crucial. Consider financial incentives for success and forfeitures

for delays.

49


Environmental Insurance There are a variety of products available to protect against certain

environmental liabilities. Should be scrutinized before the deal closes

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

R&W insurance policy

▪ Requires certain level of diligence

▪ Might have exclusions or sit in excess of existing policies

▪ High deductible

50


Other Considerations Dispute Resolution?

How will disputes be resolved post-closing – court or ADR?

Specialized knowledge in real estate as well as environmental law or remediation technologies

Pre-signing Phase II work (e.g., redevelopment, sale-leaseback)

Keep confidential (even from Seller?)

Reporting obligations

51

Final Take-Aways Early due diligence

before the deal closes is important to understanding post-closing obligations

Understand and memorialize the exact risk allocation

Consider eternity – there will be changes

52

Anticipating Post-Closing Environmental

Issues in Real Estate Deals:

Post-Closing Disputes

53

Background

• Post-closing environmental issues cannot always be

predicted.

• Sometimes the issue is clearly addressed by the

underlying property conveyance agreement. In other

cases, issue is a surprise or does not fit neatly into

contract terms.

• Resolution of dispute will be driven by a combination

of contract, statutory, and common law.

54

Legal Principles Parties may contractually allocate liabilities, but may not

shed liability to government by contract. Beazer East,

Inc. v. Mead Corp., 34 F.3d 206 (3d Cir. 1994).

(“agreements to indemnify or hold harmless are

enforceable between the parties but not against the

government”).

“A plaintiff suing to recover on an indemnity contract must

prove, inter alia, that it has suffered a loss within the

meaning of the parties’ indemnification agreement, as

well as the amount of the loss sustained.” Carson Harbor

Village, Ltd. v. Unocal Corp., 287 F. Supp. 2d 1118 (C.D.

Cal. 2003).

55

Legal Principles (cont’d)

Indemnities are contracts subject to the laws of contract.

But, court hesitate to construe indemnities broadly unless they are express and unambiguous.

56


See, e.g., Tara Corp. v. NL Indus., Inc., 73 F.3d 738

(7th Cir. 1996): “Illinois interprets indemnity

agreements according to its general principles of

contract law. Yet Illinois law also provides that

indemnity agreements must be set forth in clear and

explicit language, so that the indemnitor’s obligations

are manifest. Moreover, since indemnity

agreements are not favored in Illinois, they must be

strictly construed against the indemnitee.” See also

Kiewit Eastern Co., Inc. v. L&R Construction Co., 44

F.3d 1194 (3d Cir. 1995).

57

• See, e.g., Viad Corp. v. United States Steel

Corp., 343 Ga. App. 609 (2017): “‘[T]he words

of a contract of indemnification must be

construed strictly against the indemnitee, and

every presumption is against an intention to

indemnify.’ Accordingly, and as the Supreme

Court of Georgia has held, we will not interpret

‘contractual indemnities [to] extend to losses

caused by an indemnitee's own negligence

unless the contract expressly states that the

negligence of the indemnitee is covered.’”


58


Where indemnification shifts liability for indemnitee’s negligence to indemnitor, indemnity must be clear on this point. See, e.g., Fina Inc. v. ARCO, 200 F.3d 266 (5th Cir. 2000).

State law limitations on indemnities include punitive damages, fines, and certain construction contracts.

59

Hypothetical 1 Fact Pattern

Seller has indemnified buyer for pre-existing contamination.

Two years after closing, buyer decides to redevelop property. In connection with redevelopment, buyer will excavate large volumes of contaminated soil at depth. Environmental law does not require removal of soil unless it is disturbed.

Buyer submits indemnity claim for incremental costs of handling and disposing of contaminated soil as well as dewatering.

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Hypothetical 1 (cont’d) Does the contract cover first-party costs?

How does the voluntary nature of the redevelopment impact the indemnity obligation? Will turn on specific language of indemnity.

G.J. Leasing Co., Inc. v. Union Elec. Co., 54 F.3d 379 (7th Cir. 1995) (stating that CERCLA’s limitation of recovery to those response costs that are “necessary” acts as a “check on the temptation to improve one’s property and charge the expense of improvement to someone else”)

24 Leggett Street LTD v. Beacon Indus., Inc., 239 Conn. 284 (1996) (indemnity applied to metal shavings below regulatory action levels).

61

Hypothetical 1 (cont’d)

Must the buyer incur the costs before indemnity is ripe?

See, e.g., Carson Harbor Village, Ltd. v. Unocal Corp., 287F. Supp. 2d 1118 (C.D. Cal. 2003): “Where an indemnity contract protects against loss, as opposed to liability, the indemnitee may not recover without payment of the amount of the loss. Where the contract protects against liability, however, the indemnitor’s obligation arises when the liability of the indemnitee is established.”

62

Hypothetical 2 Fact pattern

Property contains soil contamination from Seller’s operations.

Purchase contract contains a “my watch, your watch” allocation of environmental liability.

Post-closing, Buyer re-grades property, redistributing contamination.

Post-closing, EPA issues PRP letter to both Seller and Buyer.

Buyer asserts bona fide purchaser defense and makes indemnity demand against Seller.

Seller asserts indemnity demand against Buyer.

63

Hypothetical 2 (cont’d) Does Buyer’s re-grading of contaminated soil

constitute a release by Buyer and thus defeat bona fide purchaser protection?

Ashley II of Charleston, LLC v. PCS Nitrogen, Inc., 791 F. Supp. 2d 431 (D.S.C., 2011): “Disposals are not limited to one-time occurrences, but instead include times when hazardous materials are moved or dispersed. A ‘disposal’ “may occur when a party disperses contaminated soil....”

Indemnity is not a defense against EPA action.

Factual issue of what contamination occurred under each party’s watch.

64

Hypothetical 3 Fact Pattern

Seller indemnified Buyer for pre-existing hazardous substances.

Post-closing, Buyer makes indemnity claim to Seller seeking cost of removing asbestos and lead paint in connection with remodeling of old buildings.

65


Issues

What is the scope of the indemnity? Limited to soil and groundwater? Releases to the environment?

Sycamore Indus. Park Assocs. v. Ericsson, Inc., 546 F.3d 847 (7th Cir. 2008): “We reaffirm that when there is no emission into the outside environment, but rather any hazard resulting from emission of asbestos fibers would be confined inside a building, there is no release or threatened release, and thus there can be no liability under CERCLA.”

66


Seller indemnifies Buyer for known pre-existing contamination.

Post-closing, Seller completes government required remediation. Regulators will allow deep subsurface contamination to remain in place but require a deed restriction prohibiting residential use and prohibiting subsurface excavation without a soil management plan.

Buyer resists deed restrictions, taking the position that they will diminish value of property and shift remediation obligations back to Buyer.

67


Issues

Does contract affirmatively obligate Buyer to record a deed restriction? If so, what are the terms?

Does contract require Buyer to cooperate with Seller in performance of remediation?

Does contract give Seller the right to select remedy?

Is cooperation by Buyer an implied condition of indemnity?

68


Buyer agrees to release and indemnify Seller from liability for all contamination pre-dating the sale.

Buyer and Seller agree that the indemnity and release will run with the land and record notice of the indemnity and release in land record.

Buyer then sells property.

New owner discovers contamination on property and makes claim against Seller. Seller cross-claims, asserting that indemnity and release bind new owner.

69


Issues

Are indemnity and release enforceable against subsequent purchaser even though subsequent purchaser is not party to the indemnity and release agreement?

Calabrese v. McHugh, 170 F. Supp. 2d 243 (D. Conn. 2001): “The major difficulty that we have with defendants' argument that the Scovill Foundation/McHugh release is a covenant running with the land is that it does not ‘touch or concern the land’ nor is it ‘appurtenant’ to the land, as those terms have been used by the Connecticut courts.”

70

Financing Terms and

Conditions When loan is secured by “impaired real property” lenders will often include

specific terms and conditions in the financing documents for extra

protection for them

Breach = default

Evaluate and understand the implications of the post-closing conditions

Lenders may have more strict requirements and internal policies for

environmental compliance than governmental agencies

Cleanup endpoint for a bank may be different than the regulatory

standard

Could the bank’s conditions mean extra costs for you?

FDIC guidance & SBA

71

Financing T&Cs (Cont.)• Withholding an escrow sum from the loan proceeds

• Limitations on property use

• Representations and warranties regarding environmental compliance

• Additional costs to purchase secured creditor insurance policies

• Consultant reliance letters

• Personal guarantee

• Indemnity

72

Financing T&Cs Tips1. Consult with lender early to get an idea of their requirements

2. If lender requires a holdback/escrow to cover the costs for post-closing environmental work, two things to negotiate:

The cost estimate for the work (the bank will use this number as basis for escrow amount)

The amount of the buffer the bank adds to the cost estimate

3. Have clear release points for escrow monies

Banks will drag their feet on allowing milestone payments and prefer lump sum payout at the completion of all the work

73

Further Questions:

Toby Chun

Kirkland & Ellis LLP

T 202.389.5193

[email protected]

Cindy Karlson

Karlson Law Firm, LLC

T 860.614.0184

[email protected]

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