Issues in Lending ... Environmental Indemnities for Lenders

Article excerpt

After an investigation initiated by the Environmental Protection Agency (EPA) revealed in the early 1980s that hazardous substances had been disposed of improperly at a plant owned by Purolator Products, Purolator asked Allied-Signal, the former owner of the site, to assist with the cleanup. Allied refused, contending that it was entitled to be indemnified for environmental liability by Purolator as provided by two agreements entered into by their corporate predecessors. Purolator went to court.

The decision rendered in this case by a federal district court in western New York is one of the most recent instances in which a court has analyzed indemnification agreements as they affect environmental liability.(1) However, while the court ruled that the indemnification provisions may be asserted by Allied "as a defense in an action between the parties," the general enforceability of indemnification agreements in the face of environmental liability is by no means certain.

In the absence of any clearly controlling appellate court authority on this issue, there is flat out disagreement among federal district courts on whether indemnification agreements are enforceable at all under the environmental laws and, even if enforceable, whether the scope of any particular indemnification provision is broad enough to cover environmental liabilities.

Our article first briefly discusses the potential areas of environmental risk for lenders. Then, it analyzes the laws relating to environmental indemnities and suggests steps that lenders should take to ensure that they are able to recover from borrowers or other third parties any losses they may suffer stemming from environmental cleanups or as a result of environmental laws or regulations.

Environmental Liability

The Comprehensive Environmental Response, Compensation and Liability Act, (CERCLA), the Clean Water Act, other federal laws and regulations, and states' rules all are potential sources of environmental liability. For instance, a lender that forecloses on real estate and becomes an owner of contaminated property may be held responsible for the environmental damage to that property. Indeed, under the Fleet Factors rule, a lender may be held liable for costs associated with an environmental cleanup even before any foreclosure, if its involvement with the management of a site was sufficiently broad to support the inference that it could have affected hazardous waste disposal decisions if it had so chosen.(2)

Diverse Transactions

The potential problem goes beyond traditional real estate transactions. It includes situations as diverse as loans secured by ship mortgages, transactions in which a lender obtains a security interest in the stock of a corporation that has environmental problems, and financings that are utilized by borrowers to acquire companies or assets in environmentally sensitive industries.

If the transaction falters, the lender could end up owning or operating environmentally contaminated property. In fact, in one case, a court ruled that a lender could be held liable, under an aiding and abetting standard, if it merely knew that its borrower was violating environmental rules yet failed to require the borrower to cure those violations as a condition for the loan.(3)

Indemnity Agreements

Lenders may be able to limit their exposure for environmental damage, however, by obtaining indemnification agreements from borrowers, guarantors, or others. An indemnification agreement is simply a contract in which one party agrees to cover specified obligations of another party. Lenders should recognize, however, that while the indemnification agreement was enforced in the Purolator Products case, other courts have refused to uphold indemnification agreements in environmental matters in other cases.

CERCLA Rules

The problem arises from a provision of CERCLA that states that "no indemnification, hold harmless, or similar agreement or conveyance shall be effective to transfer from the owner or operator of any vessel or facility or from any person who may be liable for a release or threat of release under [CERCLA], to any other person the liability imposed under [CERCLA]. …