Indemnification clauses, a common element in almost every commercial contract, shift potential costs and liabilities from one contracting party to another. For example, assume that John, who is a musician, enters a contract with 20th Century Fox Studios to write the theme song for a new movie. As part of the contract, John agrees to indemnify 20th Century Fox Studios for all copyright violations arising out of the new movie’s theme song. If 20th Century Fox Studios eventually gets sued because the theme song to its new movie violates a copyright, John will be the party liable for the violation, not 20th Century Fox Studios.
One significant cost that is often shifted in business and real estate transactions is environmental liability. The transfer of environmental liability through indemnification clauses frequently occurs in transactions involving commercial or industrial real estate, such as factories, warehouses, vacant lots, hotels, dry cleaning operation, apartment buildings, gasoline stations, power plants, processing plants, and even farmland. Typically, the seller of the real property agrees to indemnify the buyer against environmental claims arising out of a condition that pre-dated the purchase of the real property.
For example, after John wins the copyright suit, he decides to use his theme song proceeds to buy a building that previously housed a dry-cleaning operation. John plans to convert the building into a music studio. Making a smart decision, John insists on an environmental indemnification clause from the seller because he knows that dry cleaners used toxic chemicals in the dry-cleaning process that often spill or leach into groundwater. Two years after purchasing the building, the U.S. Environmental Protection Agency (EPA) brings a cleanup action against John because the building’s property is contaminated tetrachloroethylene also known as perchloroethylene (PCE) – a common chemical used in dry cleaning operations. A release of a small amount of PCE – a spill on the floor, spillage during operations of machinery or when chemicals are delivered – can result in groundwater and soil vapor impacts. Groundwater contamination or soil vapors may impact neighboring properties. Even a small spill can result in a major environmental problem with crippling financial implications. Since John signed an indemnification clause with the previous owner that had a favorable term, the previous owner will be liable for the cleanup costs, not John. In this scenario, however, it is assumed the seller is viable and has financial resources to conduct the required investigation and cleanup.
Indemnification clauses can save a business millions of dollars in cleanup costs if the EPA or an equivalent state authority brings a recovery action and can be effective even if the environmental laws change. A recent example of the importance of indemnification agreements is found in Peoples Gas Light & Coke Co. v. Beazer E., Inc., 802 F.3d 876 (7th Cir. 2015).
In 1920, Peoples Gas Light & Coke Co. entered into an indemnification agreement with Koppers Company, which was subsequently acquired by Beazer East Inc. The EPA brought a cleanup action against Peoples under the federal Comprehensive Environmental Response and Liability Act (CERCLA). Over the course of a few years, Peoples incurred a staggering $70,000,000 in cleanup costs for the property that was subject to the 1920 indemnification agreement. Peoples sued Beazer to offset the cleanup costs. The Seventh Circuit held that the 1920 pre-CERCLA indemnification agreement signed by Koppers was broad enough to absolve Beazer of liability for contribution costs under CERLA. The Peoples case underscores the importance of indemnification clauses and the wide-ranging protections they can offer if drafted properly.
At Hessian & McKasy, our environmental lawyers assist clients on transactional matters involving the sale of businesses or real estate. When advising clients on transactions, we address environmental liability concerns. Members of the Hessian & McKasy Environmental Law Practice Group including Practice Chair Joseph Maternowski consider environmental issues in advising clients on transactions.
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For additional information please contact:
Joseph G. Maternowski
Hessian & McKasy, PA