The Purchase and Sale of Industrial Property: The Avoidance of Long-Term Liabilities

Introduction

With the onset and progression of increased governmental regulation of the closure and transfer of industrial properties that has occurred over the past 20 years, environmental issues in acquisition agreements, deeds, and, in some cases, settlement agreements, have become increasingly more complex and nuanced. In all cases, both the transferor and the transferee are looking to limit both short and long term exposure to liability and costs arising out of environmental issues. It is the intention of this article to briefly review the standard approaches to environmental issues in these agreements and to focus on evolving issues and approaches that should be considered by any experienced practitioner in this arena.

Standard Acquisition Agreement

Experienced corporate practitioners are familiar with the types of representations and warranties that are normally required in an agreement that transfers title to or control over property or facilities that are regulated by environmental law. The buyer would seek to include, and the seller would likewise seek to limit, the following types of representations and warranties:  

1. Compliance with all state, local, and federal environmental laws;
2. A history of, or representation with respect to the lack of, regulated discharges (whether impacting groundwater, soil, or the atmosphere);
3. A list of all permits used, and appropriate representations concerning the lack of violations thereunder;
4. A history of off-site shipments of hazardous materials and a representation concerning the absence of any liability for off-site disposal;
5. The absence of any environmental contamination at, under, or emanating from the property; and
6. All appropriate disclosures, including schedules, relating to the above.

In addition, buyer and seller would have to negotiate certain covenants with respect to future environmental actions:

1. In those states where prior approval (or at least the initiation of the approval process) is required prior to the sale of the property, a covenant by seller (or an appropriate assumption of the obligation by buyer) to take all necessary actions to obtain such approval; and
2. Appropriate covenants with respect to the assignment and transfer of permits necessary to continue operations at the property.

Additional Buyer Issues

In many transactions, the above "standard" representations and warranties may be substantially all that is necessary to appropriately protect your client's interest in a particular transaction. Depending on the nature and breadth of the operations conducted at the property and the depth of regulatory issues that may be involved, however, both sides need to do further work to protect their respective interests.

From a buyer perspective, additional issues may include:

Performing Further Due Diligence

If there is or was any activity on the property capable of causing an adverse environmental impact, or even if the property is located in an industrial area, the buyer must obtain its own due diligence to identify any adverse impacts. A Phase I Environmental Report is a given.

In many cases, Phase II Reports will be necessary to identify potential areas of concern and associated clean-up costs and operational impacts, if any. Normally, a buyer would want the satisfactory resolution of its due diligence tobe a condition precedent to any obligation to proceed with closing the transaction. Satisfaction of that condition should be at buyer's sole discretion.

Permit Review

In many cases, a review of the final schedules to an Acquisition Agreement is one of the issues that is left until the last minute. On environmental matters, this can be a significant mistake. Obtaining a list of permits from the seller and a review of same, and their assignability, can be critical to the continued operations of the facility once the closing occurs. Obviously, these issues can differ between states and even localities, and the particular industry in which the seller operates also will impact these issues.

Indemnification for Pre-Closing Activities

Normally a buyer will seek indemnification from the seller for any environmental liabilities relating to site conditions (and all off-site impacts) existing as of the closing date. In the context of such a provision, the parties normally discuss the duration of the indemnity period and an appropriate basket and cap for any liability. All too often, however, the parties fail to focus on whether there is a practical way of differentiating between pre and post-closing discharges or releases (i.e., establishing a baseline of pre-closing conditions) so as to appropriately allocate responsibility for future clean-up costs. This issue is further complicated if the buyer intends to continue existing operations. Thus, while careful pre-sale delineation of site contamination is critical, it is rarely dispositive where existing operations are to be continued. Because of these difficulties, many sellers will seek to resolve this issue by negotiating a credit with the buyer and agreeing to sell the property "as is" (an issue that will be discussed in more detail below.)

Capping of Future Costs

If the buyer agrees to assume certain ongoing environmental liabilities affecting the property, the buyer (and in certain situations, the seller) should consider options to cap its future liability. Environmental insurance has been available for a number of years for just this purpose. The buyer can purchase environmental insurance which, for a premium, will assume liability for any clean up costs over the negotiated amount.

This can be utilized not only by the buyer in connection with the assumption of activities, but can also be utilized by the seller in connection with its own commitment to clean up the property. The use of environmental insurance can, in the proper circumstance, close the gap and expectations between the buyer and seller by limiting the risks of future costs overruns.

Ongoing Seller Clean-Up Activities

If the seller assumes the obligation to perform the necessary regulatory clean-up, the seller necessarily will continue to be involved at the site. The negotiation of an appropriate access agreement, the commitment by the seller to limit interruptions in the ongoing activities of the buyer, agreement on the nature of the clean-up, and the buyer's interest in reviewing, and perhaps, approving work plans and other submission to the appropriate environmental authority, all need to be addressed in the event the seller retains this obligation.

Is ISRA-Clean Clean Enough?

The Industrial Site Remediation Act ("ISRA") is the underlying statute in New Jersey which governs the obligations of the seller to clean-up a property in connection with the transfer of its title or operations to an unrelated party. ISRA requires the seller to identify, define the extent of and clean-up soil and groundwater contamination on or migrating from the site.

The clean-up standards applicable to such activity are contained in ISRA's implementing regulations (the technical requirements for site remediation are found at N.J.A.C. 7:26E). The technical requirements provide some (albeit limited) flexibility with respect to those standards (i.e., unrestricted use — "residential" standards and restricted use — "non-residential" standards) and address whether contamination must be removed, treated, or where appropriate, left in place. Specifically, more liberal clean-up standards ("non-residential") are permitted where institutional and/or engineering controls are implemented. In addition, under appropriate circumstances, contamination may be left in place in conjunction with the filing of a deed notice and use of appropriate engineering controls (e.g., a cap, fence, etc.). Thus, a generalized reference to ISRA compliance in the transactional documents does not specifically address the issue of how "clean is clean" and without further specificity, is likely to lead to significant post-sale disputes regarding the nature and extent of the clean-up.

In addition, the contract should address other ISRA related issues such as responsibility for additional clean-up requirements resulting from remedy failure or a subsequent lowering of clean-up standards, as well as responsibility for operation and maintenance, if any, associated with the selected remedy. The latter would include the filing of biennial certifications required for certain institutional controls such as deed notices and groundwater classification exemption areas.

Additional Seller Issues

In many cases, particularly in the disposition of former manufacturing facilities, the primary interest of the seller will be to limit, both temporally and financially, its liability with respect to the ongoing environmental compliance costs associated with the property.

Achieving this limit, in many cases, is significantly more important to the seller than the actual purchase price. Accordingly, the seller also will have a number of additional concerns that need to be addressed.

Release and Indemnification

First and foremost, a seller normally will seek to be fully released from, and indemnified against, any continuing liability with respect to the environmental condition of the subject property.

This raises a number of significant issues:

1. For purposes of New Jersey law, the legal formalities for an "as is" purchase are not insignificant. New Jersey case law over the years has stated that in order for an "as is" purchase to be effective to serve as a release by the buyer against the seller, the Contract of Sale (or other transactional documents) must contain express language allocating those risks to the buyer. An "as is" clause, without specific reference to environmental matters, is not sufficient to effect a release.
2. The differences between release and indemnification are significant. A release is a personal covenant between the buyer and the seller. If the buyer purchases the property "as is", it may release any claims it may have for ongoing expenses with respect to environmental clean up costs. From a seller's perspective, the release also should cover any potential claims by the buyer for devaluation of the property (because, for example, it can only be used for nonresidential purposes). Such a release notwithstanding, the seller still retains certain obligations under both common and statutory law, including obligations to third parties and governmental entities. The seller might therefore seek indemnification from the buyer for those liabilities, once the seller has performed its necessary clean-up obligations (or has given the buyer an adjustment in the purchase price). The buyer, if willing to indemnify the seller for clean-up costs, may refuse to provide similar protection for third party claims for purporting devaluation and/or personal injury. The likelihood of such claims are difficult to assess let alone quantify. As such, the parties may decide to reserve all rights and remedies they may have against one another in the event claims are filed by a third party.

In addition to these concerns there are other negotiating nuances that should be considered by the experienced practitioner in this arena. For example, in the event a buyer is willing to release a seller from certain obligations as long as seller performs its clean-up obligations under the acquisition agreement, seller's attorneys must carefully review the agreement language to make sure that a minor breach of a seller representation and warranty does not, in fact, invalidate the entire release of seller by the buyer.

Seller's Clean-Up Obligations

If the seller has agreed to assume responsibility for clean-up costs, the nature thereof and the applicable clean-up standards, as discussed above, should be incorporated in the contract. If such specificity is not possible, then, at a minimum, the seller should insure that the contract permits him to undertake clean-up consistent with the commercial/industrial nature of the operations conducted on the property. Stated otherwise, the seller would want to confirm the availability of institutional and/or engineering controls, together with the use of "non-residential" soil clean-up standards. Pursuant to N.J.S.A. 58:10B-13b, "nonresidential standards" are not available unless the owner of the property agrees to the filing of a deed notice. As such, the contract must obligate the buyer to accept a deed notice in connection with the seller's assumption of clean-up responsibility.

The seller also should seek to avoid responsibility for post-closing maintenance requirements, if any. For example, if the seller is required to construct and maintain an engineered cap associated with the use of institutional or engineering controls to encapsulate and isolate contaminated soils, it should seek to put liability on the buyer to maintain that cap and make all appropriate filings with respect thereto.

Seller might also seek to obtain a covenant from the buyer with respect to its own post-closing activities, because, from the seller's perspective, residential construction, schools, certain types of office buildings, or other activities may potentially increase the exposure of individuals to contamination at the site and therefore increase the likelihood of third party claims against the seller. Such restrictions should be recorded in the Deed.

In addition, of course, as suggested above, the seller would have an interest in shifting the risk for unknown conditions, changes in environmental standards, and liability for historic operations, to the buyer as a result of the transfer of the property.

A Seller's Perspective and the Restatement of Servitudes

Consider the following hypothetical. A seller and a buyer, either in connection with the settlement of clean-up litigation between each other, or in connection with an ongoing acquisition, have reached agreement on representations and warranties and the scope of releases and indemnification. Assume, again, that the buyer is willing to covenant that it will provide the seller some level of protection with respect to the ongoing enforceability of the release from the buyer. The seller desires to ensure that it can obtain as much protection as possible. Certainly, a contractual release (and covenant as to future use) should be enforceable directly against the buyer. Is it enforceable against the buyer's successors? Is there any way that the seller can expand the benefit of this release against third parties by putting such parties on notice that liability has been shifted from the seller to the buyer?

The question requires us to revisit the concept of "covenants running with the land" from our law school days. The answer, ultimately, depends upon where the property is located. In New Jersey, in determining the enforceability of restrictive use covenants, the pivotal inquiry concerns the reasonableness of the covenant. See Davidson Bros. Inc. v. D. Katz & Sons, 121 N.J. 196 (1990) (addressing the issue in the context of non-competition covenants). While not altogether discarding the "touch and concern" test applicable under traditional servitudes doctrine, in Davidson the New Jersey Supreme Court relegated the test to a minor role in determining the reasonableness, and thus enforceability, of restrictive use covenants. The Court announced: "[t]he time has come to cut the Gordian knot that binds this State's jurisprudence regarding covenants running with the land. ... Reasonableness, not esoteric concepts of property law, should be the guiding inquiry into the validity of covenants at law." Id. at 210.

The Court enumerated eight factors to be considered in assessing the reasonableness, and hence enforceability, of the covenant: (1) whether the parties had a lawful intent at the time of execution; (2) whether the covenant impacted the consideration exchanged; (3) whether it clearly and expressly articulates the restriction; (4) whether the subsequent purchaser had record notice; (5) whether the temporal and geographic scope of the covenant is reasonable; (6) whether it imposes an unreasonable restraint on trade; (7) whether it is contrary to the public interest; and (8) whether, even if reasonable when first recorded, in light of changed circumstances, it has become unreasonable. Id. at 211-212.

It is not entirely clear whether the courts would apply the same analysis in the context of covenants not to sue, but the Davidson case certainly represents a significant departure from traditional doctrine with its strict adherence to the touch and concern/benefit and burden test.

Some jurisdictions appear to have gone further by recognizing the approach advocated in the Restatement (Third) of Property:

Servitudes

The Restatement places the central inquiry on whether the covenant, if allowed to run with the land thereby binding future owners, would be illegal, unconstitutional or in violation of public policy. Under the Restatement approach, the party seeking to avoid enforcement bears the burden of showing its illegality. See Susan F. French, "Can Covenants Not to Sue, Covenants Against Competition and Spite Covenants Run with the Land? Comparing Results under the Touch or Concern Doctrine and the Restatement Third, Property (Servitudes)," 38 Real Property, Probate and Trust Journal, Summer 2003, at 268-269. The focus is on implementing the legitimate intent of the contracting parties.

Ultimately, to the extent covenants not to sue are an issue in the context of the real estate transaction, or in settling litigation, counsel would be wise to make inquiry with regard to the law of the jurisdiction where the property is located. Whether that jurisdiction follows traditional doctrine, the approach favored by the drafters of the Restatement or something in between, ultimately will impact the manner in which to proceed.

Conclusion

The issues involved in connection with the purchase and sale of industrial or otherwise contaminated real property are numerous and varied. It is the hope of the authors that practitioners will be able to use this article as a guideline to identify issues and approaches that may be appropriate to protect the interests of their client in these transactions.

Attorney Jennifer L. Kapell was a co-author of this article.