“The devil is in the details” is a familiar motto when it comes to legal drafting. Too many times attorneys make seemingly innocuous edits, such as “including but not limited to…” in contracts, or are not mindful of their time entries in terms of a client’s potential future claims for cost reimbursement. Two recent court decisions reinforce the importance of language choice relative to a party’s success on recouping costs relating to environmental liabilities. If the language is not precisely drafted, the claimant may be stuck with the costs it intended to recover from other parties.
On Nov. 12, 2013, the U.S. Court of Appeals for the First Circuit, in VCF Partners 26 LLC v. Cadlerocks Centennial Drive LLC, 735 F.3d 25 (1st Cir. 2013), denied a mortgage lender’s claim seeking to recover more than $100,000 in environmental investigation costs pursuant to an indemnity agreement. The case arose from a foreclosure of a mixed-use commercial and industrial property after the borrower defaulted on a $1.925 million loan.
Prior to the loan closing in 1999, the lender did a Phase I site assessment, which identified the possible presence of tetrachloroethylene (PCE). The lender obtained an environmental insurance policy and the borrower executed an environmental indemnity agreement and a personal guarantee as part of the loan documentation package. The loan was later assigned to another lender and ORIX Capital Markets LLC became the loan servicer.
The borrower defaulted in 2010 and a receiver was appointed. ORIX ordered a new Phase I investigation as part of the decision whether to accept a deed-in-lieu of foreclosure from the borrower. A subsequent Phase II investigation was done to evaluate indoor air conditions, soil vapor and the underground tanks on the property. The receiver later hired its own consultant and environmental attorney to evaluate potential risks associated with on-site conditions. The consultants concluded that none of the tests showed concentrations of PCE at hazardous levels.
The receiver unsuccessfully sought payment from the borrower for the costs it incurred. Subsequently, following demand for payment, ORIX agreed that the receiver could be paid from the funds of the sale of the property. In 2012, the receiver requested ORIX to do additional testing in connection with a potential sale of the property. ORIX sued the borrower to recover its costs. The Massachusetts District Court awarded ORIX more than $100,000 to pay for the environmental work, which included two Phase II investigations and several rounds of indoor air sampling. The borrower appealed the decision. The First Circuit reversed, in part, the lower court decision based on the precise language of the indemnity agreement.
The First Circuit analyzed the indemnity language, which provided that the borrower would indemnify the lender (and assignees and successors) “from and against all … costs, … demands, … expenses” and other liabilities “of any kind or nature whatsoever … sought from or asserted against indemnitees in connection with, in whole or in part, directly or indirectly, … the presence, suspected presence, release, suspected release, or threat of release of any hazardous material on or around the Property.” (Emphasis added.)
The indemnity provision went further and enumerated seven categories of liabilities within the scope of the indemnity. It set forth that “such liabilities shall include … the cost required to take necessary precautions to protect against the release of any hazardous materials in, on, or under the property, the air, any ground water, waterway or body of water, any public domain or any surrounding areas to the property.” (Emphasis added.)
The First Circuit’s analysis of whether the borrower must indemnify the lender turned on the interpretation of two issues: (1) whether the phrase “sought from or asserted against” limited the scope of the indemnity to third-party claims; and (2) whether the costs were incurred “to protect against the release of any hazardous materials.”
First, the First Circuit found that an indemnitor could only recover liabilities “sought from or asserted against” those parties indemnified by the indemnity agreement. The costs that ORIX wanted indemnified were not “sought from or asserted against” ORIX. The court stated that ORIX incurred the costs on its own behalf and for its own purposes. Further, the court rejected ORIX’s argument that the receiver made demand for payment on ORIX because ORIX had tests done before the receiver requested work.
Second, the First Circuit interpreted the listing of liability categories to be a limitation on the scope of the preceding indemnity language. The court cited the principle that “a subsequent specification impliedly limits the meaning of a preceding generalization.” It reasoned that if the second sentence did not act as a limit, then the indemnitor would be exposed to liability for costs of testing that was completely unreasonable or unnecessary.
The court noted the absence of “the typical language parties often use to introduce a list of non-exclusive examples, such as ‘shall include but not be limited to,’ or ‘without limiting the foregoing, … shall include.’” This is significant because the court interpreted its absence in the subject agreement as weighing against reading the second sentence as a list of nonexclusive examples.
Therefore, the court concluded that the borrower would be liable for the receiver’s expenses related to environmental testing “required to take necessary precautions to protect against the release of any hazardous materials” in or around the property. However, since no test results indicated a hazardous level of PCE and ORIX or the receiver did not take steps to prevent a potential release of PCE into the indoor air, the court concluded that the tests done by and for the receiver were not within the scope of the indemnity. The court rejected the argument that the agreement covered environmental assessment costs related to the mortgagee’s due diligence and evaluation whether the property was safe for the on-site day-care business.
While due attention is paid to contract drafting, attorney time entries sometimes are not afforded the same review. A recent decision by the U.S. District Court of Connecticut reminds parties that the description of legal activities performed are important for a client’s cost-recovery efforts. The district court denied defendant’s motion to dismiss the plaintiff’s request for attorney fees under the Comprehensive Environmental Response, Compensation, and Liability Act (SRSNE Site Group v. Advance Coatings Co., C.A. No. 3:12-CV-443 (VLB)). In SRSNE Site Group, the plaintiffs brought suit against other responsible parties seeking contribution for environmental investigation and remediation costs and attorney fees under CERCLA.
The district court denied the motion to dismiss based on precedent that certain attorney fees may be recovered under CERCLA Section 107. It noted that private party plaintiffs are not entitled to receive attorney fees associated with the cost of bringing the private recovery action. However, it recognized that “some lawyers’ work that is closely tied to the actual cleanup may constitute a necessary cost of response in and of itself under the terms of § 107(a)(4)(B)” (citing Key Tronic Corp. v. United States, 511 U.S. 809, at 819-20 (1994)).
The district court offered examples of legal work that may be recovered, such as costs for tracking down other solvent responsible parties. The court also noted that legal work which primarily protects a plaintiff’s interest in its capacity as a defendant (such as consent decree negotiations or undertaking studies prepared or supervised by counsel during such negotiations, even if such studies ultimately provide information to assist with the cleanup) would likely not be deemed closely tied to the actual cleanup of the site and, therefore, not recoverable. The court did not reach the issue of whether plaintiff’s attorney fees were recoverable in this case and ruled defendant’s motion was premature.
Cadlerocks demonstrates the importance of precise drafting with an eye toward what liabilities could arise in the future. While the First Circuit appreciated that environmental testing was prudent and reasonable from a business-risk perspective, it could not conclude that the costs fit within the scope of the indemnity as structured.
Therefore, drafters should be mindful that lenders may incur environmental costs to market the property in order to recoup monies on the defaulted loan and draft accordingly. To this point, a decision should be made as to whether and, if so, how to set out categories of included liabilities to reflect whether the parties intend the list of be exhaustive or nonexclusive.
SRSNE Site Group is a reminder that time entry drafting, while a tedious task, is a necessary skill. If a client’s ultimate goal is cost recovery, attorneys should be circumspect with respect to time entry descriptions and how a court could potentially view such. These recent decisions underscore the importance of choosing your words wisely as a client’s success will turn on a court’s exacting scrutiny of your choices. •