First Circuit Holds Environmental Indemnity Provision Limited To Costs Necessary To Prevent Release Of Hazardous Materials

| Nov 17, 2013 | Firm News

The First Circuit has held that an environmental indemnity agreement is limited to costs related to liabilities to third-parties and necessary to prevent the release of hazardous materials. The Court rejected an argument that the agreement covered environmental assessments costs related to a mortgagee’s due diligence and to determine if the property was safe for a day care operating on the property.

The mortgagor had signed an environmental indemnity agreement as part of a financing package secured by a mortgage on a commercial property. The agreement stated the mortgagor would indemnify the lender and its assigns “from and against all…costs…demands… expenses…[and other liabilities] of any kind or nature whatsoever…sought or asserted against Indemnitees in connection with, in whole or part, directly or indirectly…the presence, suspected presence, release, suspected release, or threat of release of any Hazardous Material” on or around the property. It further specified that “[s]uch Liabilities shall include…” seven particular categories including “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.”

A Phase I environmental assessment at the time of the financing agreement had indicated the possible presence of PCE, a known carcinogen, probably from a former tenant. The mortgagor did not do any further testing but supposedly obtained an environmental insurance policy naming the lender as the beneficiary although it could not locate the policy at the time of trial. The promissory note subsequently went into default and the original lender’s assignee began foreclosure proceedings on the property. As part of its due diligence, it had an environmental consultant do a new Phase I study that indicated the possible presence of PCE and then do a Phase II study that found the PCE did not represent an acute risk. Because there was a daycare facility in the property, the assignee did additional studies to determine whether the PCE was a chronic risk. These tests showed no concentrations of PCE at hazardous levels. A prospective buyer of the property wanted additional tests done which the lender’s environmental consultant performed.

The assignee sued the mortgagee to recover the costs of the environmental assessments, as well as other costs and attorney’s fees, pursuant to the environmental indemnity agreement. The district court held the assignee could not recover the cost of the Phase I survey because it would have conducted it anyway as part of its normal due diligence. It held the assignee could recover the remainder of the testing costs because those tests were reasonable and necessary to assure the property was safe for the day care facility. It awarded the assignee $102,536 for the expenses of the environmental assessments, as well as $50,000 in attorney’s fees and $5,609.75 in costs.

The First Circuit noted that neither party claimed the agreement was ambiguous or required extrinsic evidence to interpret it. Accordingly, the agreement was to be interpreted as a matter of law. It held the district court had erroneously interpreted the agreement in two respects. First, it overlooked the part of the agreement that limited coverage to liabilities “sought from or asserted against” the indemnitees. Second, it ignored the sentence that limited coverage to certain specified categories of liability.

With respect to the first error, the First Circuit said the agreement only covered claims by third-parties against the indemnitee. The language “sought from or asserted against” the indemnitee required the existence of a third-party making the claims against the indemnitee. The indemnitee cannot make claims against itself.

With respect to the second error, the Court said the issue was whether the sentence that listed particular kinds of liabilities was a limitation on the broader grant of indemnity in the prior sentence or whether it provides non-exclusive examples of certain types of liabilities covered. The Circuit Court said it is a “well established principal that ‘a subsequent specification impliedly limits the meaning of a preceding generalization.'” It noted that unless the second sentence was a limitation the indemnitor would be liable for testing that was completely unnecessary or unreasonable. It said common sense is as much a part of contract interpretation as is the dictionary or the arsenal of canons. The Court determined that it made more sense to read the second sentence as imposing reasonable limitations on the first.

The First Circuit also noted that the second sentence did not include the typical language used to introduce a list of non-exclusive examples, such as “shall include but not be limited to.” It held that none of the tests were required to take necessary precautions to protect against the release of any hazardous materials because none of them indicated the possibility of the release of materials in at any level that posed a health threat. Rather, the tests were done to confirm that the PCE present was at a safe level. Accordingly, the environmental indemnity agreement did not cover the tests.

The First Circuit reversed the district court’s determination that the agreement covered the costs of the tests. It remanded the district court’s award of attorney’s fees and other costs for reconsideration in light of its decision.

VFC Partners 26, LLC v. Cadlerocks Centennial Drive, LLC, No. 13-1128, 2013 WL 5976333 (1st Cir. Nov. 12, 2013)

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