Environmental Testing Costs Not Part Of Indemnity Agreement

This environmental action involves the interpretation of the scope of an indemnity agreement involving the costs of environmental testing on property contaminated with percholorethylene (PCE) in a real property transaction.

Cadlerocks entered into a loan in the principal amount of $1,925,000.  The note was secured by a mortgage, along with a separate Environmental Indemnity Agreement.  Cadlerocks failed to make the payment on the balloon balance due on the note and defaulted on the note causing the Trust to commence foreclosure proceedings.

The original lender conducted a Phase I Environmental Site Assessment prior to the closing of the loan, which revealed the possible presence of perchloroethylene (PCE), on the property. Instead of following the Phase I test with a more comprehensive Phase II test, Cadlerocks decided to obtain an environmental insurance policy naming the Original Lender as the insured.

Subsequent environmental testing consisting of new Phase I and Phase II investigations and air monitoring testing for PCE was conducted by the loan servicer. An underground storage tank passed the integrity test, but the soil vapor investigation identified the presence of PCE in the soil outside of the building. A second air quality test, revealed PCE followed by more extensive testing for PCE. Further testing occurred in 2012 and included groundwater testing, soil borings, and indoor air testing.

The receiver sought reimbursement from Cadlerocks for the expenses he incurred related  to the environmental tests. Cadlerocks did not respond, and the receiver therefore requested payment from the loan servicer.  The loan servicer agreed that the receiver could draw down on income and sales proceeds generated from the property that otherwise would have been applied to pay down Cadlerocks’s debt.

Thereafter, the loan servicer filed suit against Cadlerocks alleging breaches of the various agreements related to the loan including $102,536 for expenses related to the environmental testing on the property under the indemnity agreement.

Cadlerocks argued that all of the costs for environmental testing fell outside of the scope of the plain terms of the indemnity agreement, while the loan servicer urged the court to affirm the district court’s broad reading of the agreement.

In assessing the issue of whether the district court correctly determined the scope of the indemnity agreement, the First Circuit applied the well-established contract interpretation in holding that the district court’s interpretation of the Indemnity Agreement was erroneous in two respects. First, it overlooked the term of the agreement limiting coverage to those liabilities “sought from or asserted against” the indemnitees. Second, it ignored the sentence that limited coverage to certain specified categories of liability.

Specifically, the court noted that by its plain terms, the Agreement only covered liabilities “sought from or asserted against” the Indemnitees, thus requiring the existence of a third party imposing some type of liability on the Indemnitees.  It therefore concluded that the loan servicer could not seek costs from or assert claims against itself. Therefore, any costs that the servicer incurred on its own behalf, for its own purposes, did not fall within the scope of the indemnity agreement.

Further, the court noted that the servicer is only liable for the receiver’s expenses related to environmental testing if those expenses were “required to take necessary precautions to protect against the release of any Hazardous Materials.”  The court concluded that test results given to the receiver did not indicate the possibility of a release of hazardous materials into the atmosphere.  Instead, the evidence indicated that the purpose of the receiver’s additional testing was to confirm that the known presence of PCE in the air was at a safe level, in order to ensure the building was safe for the daycare center and to facilitate the foreclosure sale.

Therefore, as the costs  were not “required to take necessary precautions to protect against the release of any Hazardous Materials,” but rather were conducted for the purpose of confirming the safety of tenants or attracting buyers in a foreclosure sale, they clearly fell outside of the scope of the indemnity agreement. Accordingly, the court reversed the district court’s order awarding the servicer the costs associated with environmental testing.

For a copy of the decision, click here.