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In a case with ramifications for environmental remediation and real estate law, a Dallas jury found that a tenant that polluted leased property must continue paying rent until the state approves the tenant’s cleanup. After an eight-day trial in the 101st District Court, the jury hearing Corporate Property Associates v. VHC Inc., et al. returned its verdict March 9. The jury awarded landlord CPA $1.6 million in damages and $1.2 million in attorneys’ fees. The jury found that a provision in the lease on the property in Garland required VHC, formerly known as Varo Inc., and its parent company, IMO Industries, to pay rent and related charges until the Texas Commission on Environmental Quality (TCEQ) certified that that the tenant’s cleanup of the site met state standards. “This jury determined that the party that caused the pollution isn’t through, until the state certifies it’s through,” says Christopher Rentzel, CPA’s lead counsel and a partner in Bracewell & Giuliani in Dallas. But part of the disagreement is whether rent is due for the time between the lease’s expiration and the time when the regulatory agency certifies completion of the tenant’s remedial action. J. Michael Jordan, the defendants’ lead counsel and a partner in Gardere Wynne Sewell in Houston, says Varo cleaned up the site, but it took 22 months for the state to issue a final certificate of completion. So the question becomes: Does the lease allocate the risk of the property being unusable during that lag time to the landlord or the tenant? “The jury finding here captures the concept that physical remediation alone is not the only thing that matters, when you’re allocating responsibility between a landlord and tenant,” says Tim Wilkins, another of CPA’s attorneys. In the lag time between the physical cleanup and the state’s signoff, CPA claims in its petition that it was unable to finalize a sale of the property. Wilkins says the concern for any potential buyer of the property is that it not be held liable for existing contamination. Under Texas Health & Safety Code Chapter 361.610, a person or entity not associated with the property at the time the TCEQ issues the certificate of completion has a defense against liability. If the cleanup has not been done, the new owner is liable for cleaning up the property, says Wilkins, a Bracewell partner in Houston and head of the firm’s environmental section. CPA noted in its petition that Baylor Health Care System declined to close on its purchase of the property because of continuing environmental problems and resulting uncertainty at the site. Sale and Leaseback According to CPA’s fourth amended petition, Varo, a defense contractor, sold the Garland property to CPA and simultaneously leased the same property from CPA in 1979. CPA alleged in the petition that when CPA and Varo entered into a replacement lease for the property in 1992, IMO “unconditionally and irrevocably” guaranteed that Varo would comply with every term in the lease. IMO further agreed to pay CPA, if Varo failed to comply with its obligations under the lease, CPA alleged. As noted in the petition, a provision in the lease specified that, if an environmental violation occurred, the lease would remain in effect until VHC completed all remedial action “in accordance with applicable environmental laws.” CPA alleged in its petition that Varo, which manufactured range finders and other equipment on the Garland property, caused a number of environmental violations � including soil and groundwater contamination � at the site prior to Sept. 30, 2002, when the lease was scheduled to expire.
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As alleged by CPA, Varo’s environmental engineers, Erler & Kalinowski Inc. (EKI), conducted tests in 1994 that revealed the existence of volatile organic compounds in the groundwater below a wastewater neutralization pit on the property. Soil samples around an acid trench that drained into the pit revealed the existence of elevated levels of dangerous metals, including lead and cadmium, beneath an on-site building, CPA alleged. Jordan says the TCEQ subsequently determined that the property isn’t in a groundwater zone. Wilkins, who represents CPA, says the TCEQ’s determination that there wasn’t groundwater beneath the property is based on its finding that drilling a well on the property would not produce drinking water. Jordan says that if his clients decide to appeal, one issue is likely to be whether the jury should have heard evidence on groundwater contamination. CPA alleged in the petition that Varo also constructed and operated a hazardous materials storage site on the property. EKI’s testing of the storage site area revealed a long-forgotten subsurface cinderblock structure that had leaked various contaminants into the surrounding soil, CPA alleged. According to CPA’s petition, Varo chose to participate in the state’s voluntary cleanup program, and excavated soil and rock from the contaminated site but decided not to excavate soil from beneath the on-site building, because it feared that doing so would undermine the stability of that structure. As noted in the petition, in 2004, CPA twice demanded that Varo complete remedial action on the site, and Varo pledged that it would continue the cleanup. But Varo stopped making rent and other related payments as of Oct. 31, 2002, CPA alleged in the petition. Courtney Hill, an attorney in the litigation division at TCEQ, says the commission issued two certificates of completion in February 2004 and August 2004 for two different phases of the cleanup. In its petition, CPA asserted two causes of action for breach of contract, alleging that Varo failed to remediate contamination in a timely manner and failed to keep improvements on the property in good repair. According to the petition, CPA sought $388,538 in damages for the improvement. CPA also asserted that IMO breached the guaranty agreement executed in 1992. Varo and IMO filed a counterclaim against CPA, alleging that the lease on the Garland property didn’t require or create a duty for Varo and IMO to secure the certificates of completion. Varo and IMO further alleged in their second amended answer and counterclaim that CPA benefited when the TCEQ issued certificates of completion on the property. Arguing that CPA was unjustly enriched at their expense, Varo and IMO contended that they are entitled under quantum meruit to recover from CPA the value of the certificates and the costs for securing the certificates. The jury found that Varo failed to comply with the lease agreement and that IMO failed to comply with the guaranty agreement. But the jury didn’t award CPA damages for repairs to the property. Jordan characterizes Corporate Property Associates as a dispute over an alleged breach of the lease. 3rd Circuit Rentzel says the case is a logical extension of an earlier decision by the 3rd U.S. Circuit Court of Appeals. In June 2005, the 3rd Circuit determined in Jaasma, et al. v. Shell Oil Co., et al. that a jury could reasonably conclude that a tenant breached a lease agreement when it failed to pay rent during the period after the tenant cleaned up polluted property but before a state regulatory agency in New Jersey issued a “no further action” letter for the property. According to the 3rd Circuit’s opinion, the U.S. District Court for the District of New Jersey had granted a judgment as a matter of law against Alice Jaasma, the landlord. The district court held that Jaasma had not established that the defendants, Shell and Motiva Enterprises, breached their obligations under a lease agreement to operate a gasoline station on the property or that she had suffered cognizable damages as a result of the alleged breach. However, the 3rd Circuit found that Shell had breached the lease agreement by failing to comply with all applicable environmental laws and by failing to return the property to it original state. The 3rd Circuit held that a reasonable fact-finder could determine that compliance with all applicable laws, as required in the lease, includes the obligation to produce reports and evidence necessary for the New Jersey Department of Environmental Protection to issue the “no further action” letter. Rentzel says Corporate Property Associates is directly related to Jaasma. He says the 3rd Circuit held that a jury should decide whether the defendants in Jaasma breached the lease. “In our case, the jury did exactly that,” he says. The Dallas suit is different from the New Jersey case in one respect: whether the landowner can collect damages during the lag time. The 3rd Circuit found that the landlord in Jaasma could recover damages during the period of uncertainty after a physical cleanup has been completed but before the regulatory agency certified the property as compliant with all environmental regulations. In Corporate Property Associates, the jury awarded the landlord damages for rent and related charges for the period between the expiration of the lease and the TCEQ’s certification that site remediation was completed. The Corporate Property Associates and Jaasma cases show that the Texas and New Jersey legal systems can recognize property damage or loss that arises from the “limbo status” of contaminated rental property that has been cleaned up, although a state regulatory agency has not confirmed the cleanup’s adequacy, says John Eldridge, an environmental law partner in Haynes and Boone in Houston who reviewed the two cases but isn’t involved in either case. The second lesson of these cases, Eldridge says, is that the lease terms should address situations such as occurred in Corporate Property Associates in enough detail so that the parties’ allocation of risk is not left to a jury to figure out. Referring to the almost two-year time lag, Eldridge says, “It’s unfortunate that the state agency would have to take that long to issue a formal determination after having the facts on which to do so.” “This was not a lengthy process based on what had to be done,” Hill, the TCEQ attorney, counters. Hill says applicants in the voluntary program must submit information to project managers at the commission, who review the information and determine whether an applicant must do additional work. There was a lot of back and forth communication between Varo and the commission, she says. Notes Hill, “No one was dragging their feet on our side.”

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