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February 10, 2016 Article

Tips for Negotiating Environmental Risk Allocation Provisions in Leases for Non-Environmentally Sensitive Properties

The California Court of Appeal weighs in the issue in regard to retail leases

by Maryam F. Mujahid

Office buildings and retail stores do not conjure up images of impending environmental catastrophe. In fact, from an environmental perspective, these non-chemically intensive sites are usually about as low-risk as commercial sites come. However, it is important for a lessee to take certain precautions for even the most seemingly environmentally benign properties because these sites can have latent environmental liabilities that arise from contamination tied to a prior use or migrating from a neighboring site and that could lead to liability and litigation for the lessee down the line. For example, if liability for preexisting contamination is not explicitly addressed in the lease, the lessee may end up facing claims from owners of affected neighboring properties, other third parties, or even the lessor relating to that contamination. This article offers some tips to guard against these oft-underestimated environmental risks.

Start Early

First, it is important to start environmental-specific negotiations concerning seemingly non-environmentally sensitive properties early in the lease drafting process so that the lessor is aware that this is an issue of focus for the lessee. Failing to convey to the lessor that you expect environmental risk to be addressed in the lease during the preliminary drafting phase may leave the lessor feeling ambushed and concerned that you have unearthed a costly environmental issue in the due diligence process that you’re attempting to saddle the lessor with.

Further, because a lessor may be hesitant to accept lessee-protective environmental provisions for a non-chemically intensive property, starting this discussion early can give the lessor time to warm to the idea, leaving an opportunity to conduct meaningful negotiation. Expect to get push back along the lines of “But it’s an office building! Why do we need to worry about contamination concerns?” And recognize that this logic works both ways—if there is no real risk to worry about, the property owner (who would generally have more insight into the history of the property) should be willing to accept the brunt of that ostensibly negligible risk. The ensuing negotiation will be informed by the parties’ understanding and weighing of the risk of latent contamination.

Do Your Due Diligence

Because non-chemically intensive properties may not appear to be environmentally risky, lessees may fail to do sufficient due diligence before entering into a lease agreement. This can be a costly mistake and should be avoided to the extent that there is time to conduct due diligence. The good thing about these types of properties, however, is that due diligence does not have to be a particularly expensive or lengthy process. Evaluating the environmental risks associated with these types of properties may generally be achieved by taking the following steps:

  • Review the disclosure schedules, if they are available, for prior lease or purchase agreements to see whether any legacy environmental issues have been previously disclosed.
  • Analyze any available environmental site assessments for recognized environmental conditions on the subject and surrounding properties.
  • Check property records to see whether there are any contamination-related deed restrictions on the property.
  • Conduct environmental database searches on the subject and surrounding properties for current or past contamination.
  • Review the relevant federal or state environmental agency records concerning the subject and surrounding properties.

If, in your due diligence, you uncover contamination, that contamination need not be a deal breaker and may make negotiating environmental terms even easier because there is more than a remote or undefined risk to worry about. However, be sure to get a handle on whether there is a known responsible party that appears to be financially viable and thus in a position to remediate the identified contamination. And be sure to conduct sampling work (pursuant to a valid access agreement) and review recent sampling reports to get a better handle on the extent of the contamination. In particular, try to rule out vapor intrusion concerns before the lessee takes occupancy of the site because any vapor-related contamination could lead to workers’ compensation or personal injury claims against the lessee that may go beyond the scope of the lease protections that are typically contemplated. For example, because the lessee’s employees would not usually be deemed covered third parties for purposes of the lessor’s indemnity to the lessee, any vapor-related injuries of the lessee’s employees would not likely be covered by the lease.

Protect Yourself Through Strong Risk-Allocation Language

As important and beneficial as due diligence is, the limited time frame for lease negotiations may not allow for a comprehensive environmental risk assessment. Even during negotiations that allow for more thorough due diligence, there can be latent contamination that your due diligence does not uncover. For this reason, it is very important to include explicit environmental risk allocation language in the lease.

Ideally, you should negotiate an environmental indemnity from the lessor that protects the lessee against claims related to releases caused or contributed to by any party other than the lessor, regardless of when they are discovered. However, at a minimum, work to negotiate an indemnity for any contamination that occurred prior to the term of the lease and for any contamination caused by the lessor or a third party. To make this indemnity as potent as possible, it is helpful if the lessor represents that there is no contamination on the property at the time of the lease term (but watch for knowledge qualifiers that have the effect of nullifying the representation). The lessee’s indemnity to the lessor should be limited to costs related to hazardous materials brought on the property by the lessee or its employees, agents, or invitees.

Further, carefully draft and modify relevant definitions, including “Environmental Law,” “Hazardous Materials,” and “Liabilities,” to ensure that the definitions are sufficiently broad so that the lessor’s representations and indemnities are most beneficial for the lessee.

Consider Hazardous Material Use

In addition to drafting solid environmental risk allocation provisions, it is important to consider the lessee’s anticipated hazardous material use during the lease negotiation process. In particular, while a non-chemically intensive business may not use, manufacture, transport, store, dispose, or treat hazardous materials, substances, or waste in connection with its business operations, it remains very likely that some de minimis amount of hazardous material will be located at the site during the lease term. For example, cleaning supplies and small amounts of printer ink which are common in most businesses, could be deemed hazardous materials.

Because hazardous materials, in the broadest sense of the term, are ubiquitous in business environments, the lessee should negotiate for a lease provision that allows for certain hazardous material storage, transport, and use as appropriate for the type of business the lessee plans to conduct at the site; further, if the business is anticipated to expand to include more chemically-intensive operations, that should be accounted for in the lease as well. Many form office leases include a blanket hazardous material prohibition that is easy to overlook in the lease for a business whose operations don’t involve any significant use of hazardous materials or dangerous chemicals. This language should be modified as needed to ensure that the lessee’s limited hazardous material use is in compliance with the lease. This is particularly important for leases that tie the lessor’s environmental indemnity to the lessee’s compliance with the provisions of the lease.

Bottom Line: Remain Cautious, But Be Reasonable

At the end of the day, transactions involving retail and office space, and similarly non-chemically intensive properties, do not keep environmental attorneys up at night. However, every once in a while a legacy environmental issue is uncovered during a lease term that could have easily been protected against during the due diligence and lease negotiation process. When negotiating on behalf of a lessee, be mindful of that real (if seemingly remote) risk, while keeping your environmental provisions reasonable enough so that other more sensitive aspects of the negotiations are not jeopardized.

Keywords: real estate litigation, environmental, due diligence, lease agreements, risk allocation, indemnities

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