By Dennis Sughrue and Adam Hirst, Pryor Cashman LLP
In a construction financing, the lender will often require the owner of the property that is being developed to have an individual or entity – also known as a “guarantor” – sign an environmental indemnity agreement.
In such agreements, the guarantor will (a) make certain representations and warranties with respect to the existing environmental conditions at the property, (b) covenant that all activities at the property will comply with applicable environmental law, and (c) indemnify the lender against liability arising from any environmental matters associated with the property, including remediation costs as well as any decrease in the value of the property caused by an environmental matter.
In this article, we explore some of the issues guarantors should consider when reviewing the definitions, representations, warranties and covenants and obligations in an indemnity agreement, and suggest a few ways a guarantor may narrow the scope of the indemnity to better protect its interests.
Revise Key Definitions
First, the guarantor should consider the ways it can revise key defined terms in the indemnity agreement.
For example, the guarantor should attempt to remove “common law” and workplace statutes from the definition of “Environmental Laws.”
If possible, the guarantor should revise the definition so only federal, state and local environmental statues are included therein. In addition, the definition of “Hazardous Substances” should be redefined to permit the owner to use hazardous substances in kinds and amounts ordinarily and customarily used in similar properties.
Though a lender may be reluctant to accept, the guarantor should attempt to limit the parties that are included in the definition of “Indemnified Parties.” Indemnified Parties are those that can make claims against the guarantor, and, for obvious reasons, the guarantor wants the number of these parties to be as few as possible. In particular, the guarantor should attempt to remove from the definition third-parties who are unaffiliated with the lender.
Furthermore, the definition of “Losses” should be constricted to actual damages (as opposed to consequential or punitive damages) incurred by the lender in connection with third-party claims made against the indemnified parties. Moreover, professional fees should be limited to “third-party, reasonable, out-of-pocket costs.”
Note that a lender may not agree to constrict losses to actual damages, as the decrease in the value of the property is arguably a consequential damage. Should the parties reach an impasse on this point, the guarantor should carve out those losses which are “unforseeable.”
Finally, the term “Liabilities” should include the complete list of all liabilities for which the Guarantor will be held liable. Incidentally, the list should not include pre- or post-default environmental costs incurred by the lender to assess the environmental condition of the property.
Negotiate Representations, Warranties and Covenants
The guarantor should also consider ways to revise the representations, warranties and covenants contained in the indemnity agreement.
The guarantor can limit its liability by inserting deal-specific exceptions, including anything shown in environmental reports furnished to the lender. As is commonly done in indemnity agreements, the guarantor should further attempt to qualify its representations as being made to its “actual knowledge.”
The guarantor should also take care to avoid making any representations about the property’s past compliance or non-compliance with applicable environmental laws.
Considering Modifying Obligations
Additionally, the guarantor should consider modifying its obligations under the indemnity agreement. In particular, liabilities should be limited to those “sought from or asserted against” the guarantor.
This language has been interpreted to preclude coverage of expenses incurred by the lender to assess the environmental condition of the property where the assessment had no connection with a lawsuit. (See VFC Partners 26, LLC v. Cadlerocks Centennial Drive, LLC)
The Guarantor should further seek to insert a “Sunset Provision” releasing it from liability following the expiration of one to five years following repayment or defeasance of the loan.
Some lenders, however, are unwilling to agree to such provisions unless the guarantor provides a “clean” Phase I environmental report upon the payment or defeasance of the loan.
The guarantor should also try to limit its compliance obligations “to the extent required” under environmental laws and to the extent such obligations do not conflict with other obligations of the owner and/or guarantor (e.g. obligations under condominium documents).
Granting a lender remedy and recourse to assets that are not connected with the property can lead to potentially damaging consequences to guarantor.
For this reason, it is important that guarantors attempt to narrow the scope of the indemnity agreement to the extent a lender will allow.