Indemnification clauses, a common element in almost every commercial contract, shift potential costs and liabilities from one contracting party to another. For example, assume that John, who is a musician, enters into a contract with 20th Century Fox Studios to write the theme song for a new movie. As part of the contract, John agrees to indemnify 20th Century Fox Studios for all copyright violations arising out of the new movie theme song. If 20th Century Fox Studios eventually gets sued because the theme song to its new movie violates a copyright, John will be the party liable for the violation, not 20th Century Fox Studios.
One significant cost that is often shifted in business and real estate transactions is environmental liability. The shifting of environmental liability through indemnification clauses frequently occurs in transactions involving real property such as: factories, warehouses, vacant lots, hotels, apartment buildings, gasoline stations, power plants, processing plants, and even farmland. Typically the seller of the real property agrees to indemnify the buyer against environmental claims arising out of a condition that pre-dates the purchase of the real property.
For example, after John wins the copyright suit, he decides to use his theme song proceeds to buy a building that previously housed a dry cleaning operation. John plans to convert the building into a music studio. Making a smart decision, John insists on an environmental indemnification clause from the seller because he knows that drycleaners use toxic chemicals in the dry cleaning process that often spill or leach into groundwater. Two years after purchasing the building, the U. S. Environmental Protection Agency (“EPA”) brings a cleanup action against John because the building’s property is contaminated with perchloroethylene (“PERC”) – a common chemical used in dry cleaning operations. A release of a small amount of PERC – a spill on the floor, spillage during operations of machinery or when chemicals are delivered – can result in groundwater and soil vapor impacts. A small spill can result in a major environmental problem with crippling financial implications. Since John signed an indemnification clause with the previous owner that had a favorable term, the previous owner will be liable for the clean up costs, not John.
Indemnification clauses can save a business millions of dollars in clean up costs if the EPA or an equivalent state authority brings a recovery action and can be effective even if the environmental laws change. A recent example of the importance of indemnification agreements is found in Peoples Gas Light & Coke Co. v. Beazer E., Inc. In 1920 Peoples Gas Light & Coke Co. (“Peoples”) entered into an indemnification agreement with Koppers Inc. Beazer E., Inc. subsequently acquired Koppers. The EPA brought a cleanup action against Peoples under the Comprehensive Environmental Response and Liability Act (“CERCLA”). Over the course of a few years, Peoples incurred $70,000,000 in cleanup costs for the property that was subject to the 1920 indemnification agreement. Peoples sued Beazer E., Inc. in an attempt to offset the cleanup costs. The Seventh Circuit held that the 1920 pre-CERCLA indemnification agreement signed by Koppers was broad enough to absolve Beazer E. Inc., of liability for contribution costs under CERLA. Peoples Gas Light & Coke Co. underscores the importance of indemnification clauses and the wide-ranging protections they can offer if drafted properly.
Please see the disclaimer at the bottom of this page that relates to limitations on this blog and to legal advice. For advice on limiting environmental liability through contractual provisions such as indemnification clauses please contact:
Hessian & McKasy, P.A.