The allocation of environmental liabilities in a commercial transaction can be central to the terms of the business deal. Given today's climate of increasing awareness of environmental risks, environmental counsel involved in commercial transactions are likely to spend a significant amount of time drafting contractual provisions designed to effectuate the liability allocations agreed to by their clients. It is fair to say that a well-drafted agreement involving the sale, lease or financing of commercial property or operations is not complete unless it undertakes to allocate environmental liabilities. As part of an asset purchase agreement, for example, a purchaser typically will attempt to negotiate extensive representations and warranties that the property in question is not contaminated with hazardous substances. The parties also may attempt to negotiate remediation agreements where one party commits to undertake certain cleanup responsibilities in connection with the property after the closing date. Perhaps most important, one of the parties will attempt to negotiate an indemnity provision that assures that the other party will cover all costs relating to environmental conditions arising from operations or use of the property prior to the closing.

Because of the lack of predictability in the judicial interpretation of contractual environmental provisions, the importance of careful drafting cannot be overestimated. This memorandum provides an overview of the concerns associated with the contractual allocation of environmental liabilities, specifically with respect to the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) and comparable state statutes. We then discuss the mechanisms most often used to allocate liabilities: representations and warranties, assumption of liability clauses and indemnities, releases and remediation agreements. We review recent case law addressing the allocation of environmental liabilities in business transactions and suggest general practice considerations in drafting contract provisions in light of the recent case law developments, including an important decision limiting the scope of the attorney-client privilege in the context of negotiating the environmental provisions of a purchase agreement.

Background: Contractual Transfer of Liability Under CERCLA

Although a number of environmental statutes and regulations impact business transactions, CERCLA is the primary cause for concern in the commercial context and the leading catalyst for the need to manage and allocate environmental risks effectively. First, by its terms CERCLA imposes liability upon a broader class of actors than most other environmental statutes. For example, mere ownership of property on which hazardous substances have been disposed of results in liability, even if the owner is a new owner and had no connection with the disposal. Second, and perhaps as a result of the first, most of the litigated cases regarding the contractual allocation of environmental liability arise under CERCLA.

CERCLA imposes liability for costs of environmental cleanup and other response actions required as a result of releases of hazardous substances. CERCLA § 107(e) specifically addresses the transfer of, and indemnification for, such liability

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. 42 U.S.C. § 9607(e).

The vast majority of courts have held that the second sentence of this provision allows potentially responsible parties ( PRPs ) to shift responsibility for CERCLA response costs from one party to another by way of contract, but that the first sentence of the provision prohibits the use of such a contractual allocation to shift the indemnified party s underlying CERCLA liability to the government.¹ Thus, PRPs under the statute remain liable for response costs to the government in a government-initiated cleanup regardless of their contractual arrangements, but as between themselves, PRPs retain the freedom to allocate CERCLA liability by agreement. Although some district courts have held that private parties may not contract to distribute risk of environmental liability under any conditions,² these decisions have been reversed and all circuit courts that have addressed the issue have ruled that CERCLA does not prohibit contractual allocations of liability. Thus, it seems safe to conclude that contractual indemnities against CERCLA liability generally will be effective.³ Of course, if an indemnitor is unable to pay, the indemnitee remains exposed.

While federal law governs the question of whether parties are able to allocate responsibilities for CERCLA response costs, state law determines how specific contractual language will be interpreted.⁴ Thus, a careful draftsperson must consider applicable state authority on issues such as the prohibition of indemnities in connection with the imposition of liability for illegal acts.⁵ A minority of courts have applied federal law,⁶ but some courts have noted that they would rule the same way whether federal or state law applied.⁷

Techniques of Risk Allocation: Specific Contractual Provisions and Recent Caselaw

The following is an overview of contractual provisions commonly used for allocating risk and a discussion of recent judicial developments relating to specific contractual language. Many of the contractual provisions can be used singularly or in combination to achieve the desired risk allocation, and each has strengths and weaknesses for the buyer and seller. As discussed below, recent case law addressing the effect of the specific wording used in the provisions points to the need for careful drafting and the skillful use of the provisions to provide clarity and the desired protection in an agreement.

Representations and Warranties/As Is Provisions

In negotiating a contract of sale or other agreement, the buyer generally will require the seller to give representations and warranties concerning environmental matters affecting the business or property. A representation is an express statement of fact made by a party to a contract to induce the other party to enter into the contract. Typical environmental representations cover matters such as past use of the seller's facilities, hazardous materials present onsite and actions or claims by the government or private parties relating to environmental compliance or cleanup. A warranty is a promise that the representation is true. The seller, of course, will resist making such representations and warranties, preferring that the buyer rely on the results of environmental due diligence investigation. As a discovery device, the buyer's due diligence is facilitated by the information that is supplied as a representation; the buyer may choose to limit the amount spent on diligence investigations based on such representations. The buyer will want to have the representations survive the closing, so that if any inaccuracies in the representations are discovered after the closing date, the buyer will have recourse against the seller for damages for breach of contract and rights of contribution under applicable environmental laws. The seller will negotiate to limit the effect of the representations and warranties. For example, the seller might limit the survival period, restrict the use of the representations to the buyer only as opposed to the buyer's successor, or require that any amount of claim for breach of warranty exceed a certain threshold amount before the buyer is entitled to compensation.

Representations are generally less effective as environmental risk-shifting devices than specific allocations and indemnities.⁸

On the theory that Congress intended the CERCLA liability scheme to cast a wide net, courts generally have found that an "as is" clause by itself does not release the seller from CERCLA liability.⁹ Such clauses frequently have been used by sellers in the sale of potentially contaminated properties, and often recite that the buyer has had the opportunity to investigate the environmental conditions at the property to discover any problems prior to closing. Courts have held that such an "as is" clause precludes only claims for breach of warranty but does not shift CERCLA liability from the seller to the buyer. For example, in New West Urban Renewal Co. v. Westinghouse Electric Corp.,¹⁰ a section of a sales contract entitled "Property Sold As Is" provided that the property was to be sold in its present condition and that the seller would have no obligation to alter, restore, repair or develop the property. The court held that this "as is" provision did not automatically transfer liability for site contamination to the buyer, noting that the agreement was silent regarding allocation of environmental liability. The court rejected the argument that the buyer was a sophisticated developer that knowingly assumed liability for environmental conditions at the property.

Thus, absent other carefully drafted language specifically allocating environmental liability, a seller may well retain liability for environmental conditions at the site even in situations where most transactional lawyers would believe that the parties' intent to shift it was clear. To illustrate, in Niecko v. Emro Marketing Co., the purchase agreement contained an as is clause but also recited that the buyer assumes all responsibility for any damages caused by the conditions on the property upon transfer of title.¹¹ In this case, the court found that the buyer was liable for environmental conditions on the property not because of the "as is" clause, but because of the specific assumption of liability language of the contract.

Careful attention must be given to drafting representations and warranties. For example, a representation that a seller is in compliance with environmental laws does not by itself protect a purchaser from contamination on a property being purchased. Under the law of most states, the existence of contamination on a property usually does not in and of itself constitute a violation of law. In most cases a buyer will not obtain the protection it seeks unless there is also a representation to the effect that the seller is not under any obligation to investigate or remediate contamination at the property.¹²

Indemnities

A buyer will usually seek seller indemnification against any liabilities resulting from the presence of any pre-existing contamination at the time of the sale. Generally, indemnifications provide that one party to a contract promises to compensate or reimburse the other party for environmental losses or damages arising after the closing. The seller will seek to limit an indemnity with time limits, narrow coverage, specific exemptions and dollar caps. An indemnity, of course, is only as good as the financial condition of the indemnitor. Particularly in situations where the party providing the indemnity is part of a complex corporate structure, it is crucial that the indemnitee focus on the identity and financial viability of the indemnitor.

Indemnities are often free-standing (as opposed to being tied to representations and warranties) and thus create an independent basis of contractual protection. Whether or not tied to representations and warranties, an indemnity creates a cause of action under the contract that provides a basis for recovery in addition to any provided by statute or common law. Unless the contract contains an exclusive remedy provision, an indemnitee may still bring a cause of action under statutory or common law in addition to contractual indemnity claims.¹³ One court, however, has held that when an indemnity expires, the indemnitee assumes the environmental liabilities addressed in the indemnity provision.¹⁴

A threshold issue has been the effect of pre-CERCLA contracts on CERCLA claims. Generally, courts have held that a broad contractual indemnity or hold harmless agreement will be read to encompass CERCLA liability even if CERCLA postdated the contract.¹⁵ For the majority of courts, the challenging issue has not been whether contractual allocations of CERCLA liability are permitted, but whether the specific language negotiated by the parties encompasses CERCLA cleanup costs. Courts have refused to recognize implied or equitable indemnities on the theory that Congress intended CERCLA liability to reach a wide class of PRPs.¹⁶ A minority of courts have required specific reference to CERCLA or environmental liabilities for an indemnity provision to cover cleanup costs.¹⁷ Most courts have read broad language, e.g., any and all claims, without any more specific reference, to include CERCLA-type costs.¹⁸ Some courts, however, look to the intent of the parties to determine whether cleanup costs are included in specific indemnity provisions.¹⁹ In any event, prudent drafting in the typical case requires that indemnity language be explicit with nothing left to implication. Thus, if the indemnity is to apply to certain types of claims or facilities and not others, ordinarily that should be spelled out.

Even broad indemnities must be carefully drafted to ensure that all possible areas of liability are covered. In Schiavone v. Pearce,²⁰ an important 1996 decision, the Second Circuit found that specific language in an indemnification agreement did not transfer the seller s direct liability under CERCLA for contamination found at a plant operated in Connecticut by its wholly owned subsidiary. In 1964, Union Camp Corp. sold its subsidiary, AmCre Corp., to Kerr-McGee, and Union Camp agreed to indemnify AmCre and Kerr-McGee for certain claims and suits filed against them prior to August 1, 1965. The indemnification agreement provided, in pertinent part:

Union [Camp] hereby indemnifies and agrees to hold [AmCre Corp.] harmless from and against any and all of the following:

Any obligation or liability of [AmCre Corp.] under or pursuant to any legal action or other proceeding, now or hereafter instituted, based on a cause of action arising out of or attributable to the operations or activities of [AmCre Corp.] prior to the time of Closing hereunder; and Union does further indemnify and agree to hold Kerr-McGee harmless from any and all loss or expense, of whatsoever nature, which Kerr-McGee may sustain or incur by reason of any such liability or obligation.

Nearly thirty years later, Kerr-McGee was sued for cleanup costs at the Connecticut plant. Kerr-McGee, in turn, sued Union Camp, who argued that under the 1964 indemnification agreement, all of Union Camp's liabilities relating to the plant were transferred to Kerr-McGee after the August 1, 1965 cutoff date. The Second Circuit found that the indemnity agreement encompassed only AmCre's liability, and not that of Union Camp based on Union Camp's own culpable conduct, as distinguished from its status as owner of AmCre Corp.

The need for precise drafting is illustrated in Bancamerica Commercial Corp. v. Trinity Indus., Inc.,²¹ a 1995 case in which a bank took possession of a steel plant which acted as security for a defaulted loan. The bank agreed to indemnify the current operator (lessee) of the property for any claim in which it is alleged that [the current operator] is liable as a transferee or successor to [a prior operator] . The court held that the current operator s CERCLA liability was based on its status as an operator of the steel plant, not on its status as a transferee or successor, and thus was not covered by the indemnity. The court noted that the fact that the current owner might be jointly and severally liable with the bank did not make the current owner a transferee or successor.

Careful attention must be given to the language specifying what liabilities will be retained by the seller. In Taracorp Inc. v. NL Industries, Inc.,²² another 1996 decision, the Seventh Circuit found that a seller retained liability for off-site cleanup costs based on the particular choice of words in an indemnification agreement. The court decided that use of the phrase environmental hazards associated with a site created a broader liability than language allocating liability for contamination located at, on or near a site. NL Industries had used one phrase in an agreement to sell an Illinois facility and the other phrase in the sale of a Minnesota facility. The district court concluded that while the phrase associated with was not as precise as the phrase at, on, or near, the entire context of the agreement supported reading the phrases as having the same scope and meaning. The Seventh Circuit rejected the district court s reasoning and found that when parties to the same contract use different language to address the same issue, it is reasonable to infer that they intended the language to encompass different things. Thus, by using the broad phrase environmental hazards associated with a site, NL Industries retained off-site CERCLA liability for hazardous wastes generated at the site.

Care also must be taken to ensure that provisions in an agreement are not contradictory. For example, in CBS Inc. v. Hasbro, Inc.,²³ the general indemnity and the environmental indemnity clauses in a purchase agreement were in conflict. In the general indemnity, the seller agreed to indemnify the buyer for all liability relating to the purchased property not expressly assumed by the buyer. In the environmental indemnity, the seller agreed to indemnify the buyer for liability based on conditions identified in an environmental assessment report. After a full trial focused on the circumstances surrounding the selection of the language in the purchase agreement, the court rejected the seller s argument that it had retained liability only for the conditions identified in the report, as provided in the environmental indemnity. Instead of finding that the environmental indemnity served as a limitation on the general indemnity, the court held that the indemnity provisions overlapped. The court concluded that the purchase agreement, read as a whole, allocated all environmental liability to the seller under the general indemnity. The court observed that if the parties intended to make the environmental indemnity the exclusive provision dealing with environmental matters, they would have used language that clearly expressed that the seller retained no other environmental liability, or that the buyer assumed that liability, or that the environmental indemnity was the exclusive provision dealing with environmental matters.

Assumption/Allocation of Liability Claims

In GNB Battery Technologies, Inc. v. Gould, Inc.,²⁴ a 1995 case, the Seventh Circuit held that an agreement executed in connection with an acquisition conveyed environmental liabilities even with respect to facilities not included in the sale. In a restructuring effort in the 1980s, Gould formed a wholly owned subsidiary comprised of all its battery operations. Gould sold the subsidiary, GNB Batteries, to an investment banker and two Gould corporate officers. In a Restated Assumption Agreement, GNB Batteries agreed to assume any and all obligations and liabilities of any nature . . . of Gould relating to the business and operations of the [Battery] Divisions incurred by Gould or the Divisions prior to the closing date of the sale. Subsequently, significant environmental liabilities arose in connection with certain sites that were sold by Gould before the sale of GNB Batteries and in connection with certain pre-sale disposal activities at off-site landfills by the former Gould-owned facilities. GNB sought declaratory judgment, arguing that it was not a PRP under CERCLA for the sites it did not acquire or for disposal activities prior to the sale. The Seventh Circuit upheld the district court s finding that the assumption agreement transferred all of Gould s battery divisions s environmental liabilities. The court focused on the fact that the agreement contained certain exceptions, including one covering certain environmental claims arising from matters that related to incidents that occurred at battery division sites that were not owned by GNB at the time of the sale. The Court reasoned that if the document were read as exempting all former liabilities relating to the battery division, as GNB contended, it would not have been necessary to exempt specifically former sites. The Court also rejected GNB's argument that the clause where it agreed to assume liabilities incurred by the battery division prior to the sale did not encompass subsequent environmental claims: [b]ecause the acts giving rise to CERCLA and RCRA liability already had occurred at the time of sale, the language and structure of the Agreement require that the Agreement encompass all environmental liabilities transferred at purchase. The Seventh Circuit also found persuasive a letter from GNB's outside counsel stating that GNB intends to take the positive and negative aspects of [Gould's] battery business.

Another important point for the draftsperson is illustrated by Beazer East, Inc. v. Mead Corp.:²⁵ An assumption of responsibility for compliance with environmental laws may not be interpreted by a court to encompass liability under CERCLA for cleanup costs. In Beazer, the court held that the pre-CERCLA assumption of responsibility for compliance with specified permits, licenses, or orders did not include an assumption of CERCLA response costs incurred in removing toxic wastes from the facility after the date of sale.

Release/Waiver Provisions

A release clause functions to waive a right. In the environmental context, the releasing party generally agrees not to seek from the released party damages arising out of environmental conditions at the property. Often, in exchange for an agreement to remediate certain environmental conditions, a party will seek to obtain a full release from any future environmental claims that could be asserted under any statute or common law theory. Generally, release provisions are construed against the released party. The major issue with respect to release clauses is their scope and whether the release was meant to cover particular environmental conditions. For example, some courts require some clear transfer or release of future CERCLA-like liabilities.²⁶ In Mardan Corp. v. C.G.C. Music Ltd.,²⁷ however, the Ninth Circuit concluded that an agreement to release the seller from claims in any way relating to the Purchase Agreement was broad enough to bar a CERCLA claim, even though such a statutory claim is not based on the agreement. It is generally the releasor who bears the burden of establishing what the parties intended with respect to the scope of a release.²⁸

Remediation Agreements

If environmental conditions are known to be present at a site or are discovered on the property in the course of due diligence relating to a commercial transaction, the parties may decide to enter into a remediation agreement obligating one of the parties to perform certain environmental remediation of the property post-Closing.²⁹ The seller may choose to maintain control and perform the remediation as opposed to reimbursing the buyer. The seller may prefer to conduct the remediation to avoid having to pay for a buyer's excessive or ineffective remediation efforts. Of course, while a buyer may want to avoid the negative cash flow and energy involved in conducting the work, he may be concerned about the adequacy of the remediation if the seller performs the work. A buyer may attempt to prescribe a specific cleanup level, but given the technicalities and regulatory issues involved in determining such a level, this may be an ineffective solution for both the buyer and the seller.³⁰ As a general matter, a limitation on cleanup to that required to satisfy government agencies with jurisdiction may be sufficient to provide the requisite protection to both parties. It is also advisable that the purchase agreement impose a duty on both parties to cooperate with each other with respect to the cleanup and that it address access, permitting and issues regarding the seller s ability to interfere with ongoing operations post Closing.

In Sumimoto Machinery Corp. of America, Inc. v. Allied-Signal, Inc.,³¹ a 1996 decision, the Third Circuit remanded a dispute between a current property owner and a successor to the former owner over the appropriate remediation level for a New Jerse site because the parties settlement agreement was ambiguous as to what cleanup standards were applicable. Sumimoto, the current owner, argued that the site should be cleaned up to stringent residential standards while Allied, the successor who was performing the cleanup, argued that the property should be cleaned up to a less stringent standard and remain subject to a deed restriction. Under New Jersey s Industrial Site Recovery Act, either cleanup option is available.

The settlement agreement provided:

Cooperation in Sale or Lease of Site. Allied-Signal shall cooperate fully with Sumimoto in the event of a sale or lease of all or a portion of the Site. . . . Sumimoto shall provide any such purchaser or lessee with a copy if this Agreement and any Declaration of Environmental Restrictions and Grant of Easement ( Deed Restrictions ) which the NJDEP may impose or require for the Site. Sumimoto or any such purchaser or lessee shall fully comply with the terms of such Deed Restrictions which limit utilization of the Site. Allied-Signal shall comply with the terms of such Deed Restrictions that are applicable to its conduct of the Work and shall pay for any portion of the Work required by the NJDEP as part of any Deed Restrictions. (emphasis added)

Allied admitted that the agreement forced it to remediate to the extent required by the NJDEP; however, it argued that the agreement was ambiguous regarding what remediation was required because New Jersey gives the landowner the option between cleaning up to the standard proposed by the landowner and accepting a deed restriction, or cleaning up to a higher standard. The court agreed with Allied and concluded that Paragraph 6 was susceptible to two interpretations: it could be read as providing that Sumimoto simply had a duty to provide copies of any Deed Restrictions or as imposing a duty to execute future Deed Restrictions. The Third Circuit remanded the matter to the district court to hear extrinsic evidence and to ascertain the intent of the parties.

As with other contractual provisions, any remediation agreement should be carefully worded and address which types of costs and expenses are covered. An example of problems to avoid is seen in Union Oil Co. of California v. Professional Realty Investments, Inc.,³² where the Sixth Circuit found that a reimbursement agreement concerning necessary remediation costs at a former gas station site did not cover costs for interest, lost value and oversight expenses. The court stated that such costs were more similar to incidental and consequential damages sought in a lawsuit and are not representative of expenses to be recovered based on the reasonable interpretation of the letter agreement.

Additional Considerations: Attorney-Client Privilege

In Georgia-Pacific Corp. v. GAF Roofing Mfg. Corp., another 1996 decision, the Southern District of New York held that the attorney-client privilege does not extend to discussions between an in-house attorney and corporate management regarding the environmental provisions of an asset purchase agreement if the attorney is acting in a business capacity as a negotiator for the company.³³ In 1993, defendant GAF asked its in-house environmental counsel to review a proposed agreement provided by plaintiff Georgia-Pacific. GAF's in-house counsel met with Georgia-Pacific's lawyers to discuss the environmental provisions and to negotiate the environmental issues. Subsequently, GAF terminated the agreement before closing based on contamination at one of the sites to be purchased. Georgia-Pacific commenced a breach of contract action and sought to depose GAF's in-house counsel on the recommendations he provided to GAF management regarding the environmental provisions of the agreement. At the in-house attorney s deposition, GAF blocked inquiry into this area, asserting the attorney-client privilege. The court ruled that the plaintiff was entitled to depose the defendant's in-house attorney to learn what he said to company management during the contract negotiations. The court reasoned that the privilege did not apply because the attorney was acting as a business advisor. The court found that the attorney was acting in a business capacity as a negotiator on behalf of GAF management and was not engaging in a lawyer s traditional function. The decision points to the need to anticipate exceptionally close scrutiny of the negotiating process when the scope of environmental provisions in the transactional context are in issue.

Conclusion

Not long ago, the presence or suspicion of contamination on a property was likely to ruin any prospects for its sale. Now, such sales are going forward in light of the general acceptance and enforceability of environmental risk allocation provisions and with the increased awareness and sophistication of the business community in dealing with environmental liability issues. As we have illustrated in this discussion by reference to real life situations that went, in many instances, to a trial on the merits in federal court, a draftsperson of those provisions cannot be too careful in crafting language that achieves its intended result.

This memorandum is intended only as a general discussion of these issues. It should not be regarded as legal advice. We would be pleased to provide additional details or advice about specific situations if desired. Please feel free to contact Margaret Murphy or Emily Conant of this Firm at (212) 848-4000.