Standardized loan documents are highly useful and important tools in the commercial lending world. The boilerplate provisions in those standardized documents are critical to the effectiveness and efficiency of the standardized loan document package. Even so, boilerplate provisions, once adopted, can, so to speak, become part of the furniture and therefore assumed to be adequate without further review or analysis in the course of documenting a loan transaction. This can have potentially problematic consequences to the lender, as highlighted in VCF Partners 26, LLC v Cadlerocks Centennial Drive, LLC et al., 735 F.3d 25 (1st Cir. 2013).
The Cadlerocks case involved a CMBS loan on a mixed-use commercial property. Included in the loan document package was an Environmental Indemnity Agreement (Indemnity Agreement), signed by and imposing recourse liability under that agreement against both the borrower and Daniel Cadle (the loan recourse carve-out guarantor), standard for such a loan. After default, and as part of its normal due diligence, the special servicer arranged for a Phase I environmental site assessment. At the time, part of the building was used as a daycare center.
The Phase I disclosed the possible presence of perchloroethylene (PCE) based on certain prior usage of the property. Because of the Phase I results, the servicer cancelled the foreclosure sale, withdrew from deed in lieu of foreclosure discussions, and sought court- appointment of a receiver (to which the borrower did not object). Around this same time, the servicer ordered follow-up Phase II environmental testing, consisting mainly of a soil vapor investigation of the exterior of the building, which identified the presence of PCE in the soil outside of the building and as a result recommended indoor air quality testing at the building. The subsequent servicer-ordered indoor air quality test of the daycare center space, and a contemporaneous separate test of the daycare center space requested by the court-appointed receiver, confirmed that while a certain concentration of PCE existed within the air in the daycare center space, the concentrations were significantly below short term inhalation guidelines and did not represent an imminent health or safety risk. Shortly thereafter, the receiver requested another indoor air quality test at the daycare center space, which similarly concluded that no acute (short-term) risk was present. The receiver’s environmental professional also performed additional walk-throughs and air tests over the course of the next few months, none of which showed PCE concentrations at hazardous levels.
The receiver sought reimbursement from the borrower for the costs incurred in obtaining the environmental tests discussed above. When the borrower did not respond, the receiver requested payment from the special servicer. The servicer agreed to permit property income that otherwise would have been applied against the borrower’s mortgage loan to be used to reimburse the receiver’s environmental test costs. At a later trial in the servicer’s lawsuit against the borrower and Cadle, the trial court awarded money damages to the servicer under the Indemnity Agreement for the environmental testing expenses. The borrower and Cadle appealed this money judgment, arguing that the language of the Indemnity Agreement did not support liability for the environmental testing.
On appeal, the First Circuit Court of Appeals identified two boilerplate provisions of the Indemnity Agreement as relevant:
First, a provision providing, as related by the court, that the borrower and Cadle would indemnify the lender “’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.” Second, a subsequent provision specifying, as again related by the court, that “’such Liabilities shall include’ seven particular categories of liability, only one of which is arguably applicable here: ‘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 of the Property.’”
The Court of Appeals, after noting that no party argued that the Indemnity Agreement was ambiguous or attempted to introduce extrinsic evidence regarding interpretation of the Indemnity Agreement, dove into its analysis of the facts in relation to the two Indemnity Agreement provisions it found relevant. With regard to the first provision, the Court of Appeals concluded that, because the receiver made the decision to undertake these tests on its own, the environmental test costs incurred by the receiver were not liabilities sought from or asserted by a third party and therefore were outside of the scope of the Indemnity Agreement. Regarding the second provision, the Court of Appeals concluded that, regardless of whether the receiver’s environmental test costs fit within the first provision, the costs again were outside of the scope of the Indemnity Agreement because, in the court’s view, they were not costs “required to take necessary precautions to protect against the release of any Hazardous Materials,” but instead were merely costs incurred to determine whether the property was safe and help facilitate the sale of the property. It did not matter that the tests were reasonable in nature and scope and per the recommendation of the environmental consultant.
Could the court reasonably be criticized for its analysis and holding? That may be the takeaway of some, but prudent lenders and their counsel will instead recognize the real lesson, which is to pay attention to all of the words in your loan documents and not to assume that a boilerplate provision, once adopted, is eligible for autopilot.