In this second in our series of briefings on topics relevant to those involved in brownfield land, we focus on environmental indemnities.
These are perhaps most commonly encountered in an M&A context, but environmental indemnities are also frequently found in leases, storage agreements, service contracts and all manner of other contractual contexts where the nature of the relevant land, or past, present or future activities in question, carry environmental (particularly clean-up) risk.
Indemnities are obviously a standard mechanism for allocating risk in many areas of legal practice. However, there are various specific legal and practical issues that always need to be – but too often are not – borne in mind when drafting and negotiating any form of indemnity covering environmental risks. In this article we highlight just a few examples of issues to watch for.
Getting the basics right
There really is no such thing as a “standard environmental indemnity” (although it is a common enough request!).
Every site and every deal is different and, in our experience, significant time and cost is likely to be wasted if the parties do not take the trouble to work out the key “heads of terms” of an environmental indemnity before detailed drafting commences.
The commercial team might tell you that the other side has agreed to give an indemnity for historic environmental risks, “so please draft something up”; but what have the other side really agreed to cover?
- All historic contamination at or under the site(s)?
- “Known” and/or “unknown” contamination (of any type)?
- Perhaps just contamination caused during the seller’s period of occupation, or just particular “hot spots”?
- What about contamination that has already migrated off-site onto third-party land prior to completion or vice versa: is that risk covered?
- Does it apply to all sites in the deal or just some of them? In a share deal, what about former sites (see further below)?
- What risks are covered: mandated clean-up, clean-up that a reasonable and prudent operator would perform even if not mandated, voluntary clean-up, clean-up necessitated by the buyer’s future redevelopment of the site (see below), etc.?
- Should contamination and associated obligations be determined under the law as it stands now, or as it stands when a compliance obligation is triggered? Does this include laws relating to human health and safety or town and country planning?
- What about capital expenditure costs to bring plant and equipment into compliance with environmental law?
- How long will the indemnity last?
- What will the financial limits of cover be, the level of excess (and when reached, are claims paid from the ground up?) and other financial limits, and how do these interact with other warranty and indemnity cover in the SPA (if applicable)?
Environmental law is one of the most rapidly developing areas of legal practice today, and therefore one where the danger of over-reliance on previous “precedent” wording is particularly acute. Keeping up to date is therefore crucial.
For example, an indemnity precedent dating from before 2009 (and certainly before 2007) is very likely to take no account of the potentially significant changes to domestic legislation brought about by the EU Environmental Liability Directive: e.g., in terms of how the “Environment” is defined, the types of physical remedial works that can now be required, and the situations in which those works may have to be performed proactively without waiting for regulatory order.
Taking a holistic approach is also vital. All too often we see wording that focusses exclusively on regulatory requirements, but ignores the possibility that pollution liabilities can also arise at common law (e.g., claims in tort by neighbouring landowners) and in contract (relevant in share deals where the buyer acquires the corporate entity that owns the land in question, and not just the land itself).
If the buyer’s intention is, or might be, to sell on the land again in the short term (i.e., before the term of the indemnity expires), or use it as security for financing, does the indemnity contain adequate assignment rights or, alternatively, rights to provide back-to-back indemnities and, if so, do such rights “work” from a drafting perspective alongside any change-in-control provisions, the definitions of the indemnified party, and so on.
These are just some of the basic questions that need to be addressed at the outset.
Given that much of environmental law works on the “polluter pays” principle, former sites are a vitally important issue in transactions involving the buying or selling of a company’s shares (as opposed to purely its assets).
There is a natural tendency to focus in due diligence on the existing real estate and other assets of a target company. However, the case may well be that greater actual or potential environmental liabilities lurk within the target’s portfolio of formerly owned, leased or used land (about which, of course, much less is likely to be known).
This is particularly so given that modern levels of environmental stewardship are a comparatively recent (particularly post-1990) phenomenon. Land that a target company owned or used many decades ago may well have been subject to extensive contamination simply as a result of the then-prevailing industry standards (or lack thereof).
If the company you are acquiring has a long history, it is conceivable that in the process of acquiring what now appears to be a well-run and environmentally benign business, you are stepping into a raft of historic environmental problems.
Former sites also carry more risk in the sense that there will typically be less information available (or at least less up-to-date information) about current ground conditions and, in addition, the acquiring company will not gain control of the site at closing, and therefore generally will not be able to mitigate future risk (by cleaning it up, putting in place boundary protection measures, instituting a monitoring regime or the like).
Specific provisions – including but not limited to longer time periods and higher financial limits – may need to be included in any environmental indemnity to cover liabilities associated with former sites.
Obviously the ideal indemnity from the point of view of the indemnified party will be very simple, responding to any and all losses sustained under environmental law and/or in connection with environmental matters.
However, well-advised indemnifying parties will not agree to this and will instead seek to agree a regime whereby, rather than simply writing the proverbial “blank cheque”, the indemnity will only kick in if defined “trigger” events occur (for example, if liability is established by a court, or if a regulator imposes a clean-up obligation).
If unexpected surprises in the cover given or received are to be avoided, agreeing triggers requires a clear understanding of not just prevailing environmental laws, but also how they are enforced in practice and how that might change in the reasonably foreseeable future.
For example, we see far too much drafting circulating in the market that only looks at risk through a “Part IIA” (contaminated land regime) lens. This ignores (or has not caught up with) the changes to English environmental law brought about by implementation of the EU Environmental Liability Directive 2004, which in certain cases has introduced duties (so-called “self-executing provisions”) to carry out extensive remediation without any clean-up notice being served or other regulatory action taken.
This is a particular issue in the context of property that has been used for the same purpose (for example, a petrol filling station) for many years despite periodic changes of the occupier and/or where the new owner will continue the same use.
If gradual pollution occurs year on year by the same type of pollutants (for example, hydrocarbons), how do you prove who caused what? Depending on who bears the burden of proof and what evidence exists, this practical issue can be a major problem in environmental indemnity claims, so it is an issue that is best addressed upfront to the extent possible.
One approach is to expressly allocate the burden of proof and the risk of uncertainty in the legal drafting, but this is not straightforward and is likely to be controversial (the sort of issue parties tend to prefer to “kick down the road”). Another option is to conduct a baseline survey (whether on an agreed basis or independently of the other side), but there are important legal and practical downsides and complex tactical considerations in doing so. A future article in this series will look at baseline surveys in more detail.
Post-completion conduct limitations
From the perspective of the party receiving the indemnity, there would ideally be no conduct limitations at all. A one-paragraph indemnity may well be ideal for the indemnitee. In practice, the vast bulk of the drafting in a specialist environmental indemnity is there to protect the paying party and spell out what is not covered. A key part of this is post-completion conduct limitations.
There is no “one size fits all” solution. Negotiating the right conduct limitations (whether you are acting for the party giving or receiving the indemnity) requires a successful marriage of specialist knowledge of environmental law and practice, with a clear understanding of both existing and potential site conditions, and the activities to be undertaken there.
For example, it is common to include a carve-out for losses triggered or exacerbated by the buyer’s voluntary post-completion drilling/digging. However, certain environmental laws will require intrusive surveys of ground conditions to be carried out (and require discovered contamination to be cleaned up) as a condition of obtaining or surrendering key environmental permits, without which the client’s business cannot be operated. The same is true for works required (e.g., under planning laws) as part of future site redevelopment/extension.
Unless future site plans are thought about, and specialist advice taken on associated future regulatory requirements, standard/innocuous limitations in indemnity cover could produce unexpected results.
Other potential traps (for either side) include whether disclosure of information to regulators post-completion is permitted (the risk of “tipping off” versus the need to comply with mandatory “whistle-blowing” duties, or to protect corporate reputation), and how the indemnity responds to clean-up or other loss triggered by closure or decommissioning of sites, or parts of sites, variations of permits, sales or changes of occupier. Additionally, to what standard of remedial works shall the indemnity apply (is there a risk of goldplating the works?).
These are all examples of the need for the lawyer and client to focus as much on the future of a contaminated site as its past when negotiating contractual allocations of risk. Generally speaking, of course, the client will have a clear idea of its future plans, but it may be less aware of how forthcoming developments in the constantly evolving area of environmental law might impact those plans. A proper two-way dialogue, preferably done at the outset of negotiations, can avoid unnecessary pitfalls.