TACKLING ENVIRONMENTAL ISSUES IN NORTH CAROLINA. Presented by The Cambridge Institute

TACKLING ENVIRONMENTAL ISSUES IN NORTH CAROLINA Presented by The Cambridge Institute

This publication is designed to provide accurate and authoritative information in regard to t subject matter covered. It is sold with the understanding that the publisher is not engaged i providing legal, accounting, or other professional services. If legal advise or other expertis is required, the services of a competent professional person should be sought. --From a Declaration of Principles adopted by the American Bar Association 0 COPYRIGHT 1993 The Cambridge Institute 1960 Gallows Road Vienna VA 22182 (703) 893-8500 FAX (703) 893-1354

CHAPTER SIX ENVIRONMENTAL IMPACTS ON REAL ESTATE AND BUSINESS TRANSACTIONS I. PERSPECTIVE OF PARTIES TO TRANSACTIONS A. RETROACTIVE, JOINT AND SEVERAL LIABILITY. 1. Just a little more than a decade ago, environmental issues had a limited effect on business transactions. At that time, the issues involved usually only what could be seen, such as the condition of the land, buildings and other assets. Legal issues were usually limited to local sewer ordinances and zoning regulations. The parties showed little concern for things that could not be seen, such as groundwater and underground storage tanks. 2. In 1980, Congress passed CERCLA, the federal law to clean up abandoned hazardous waste dump sites. The scheme of liability adopted under CERCLA and subsequently adopted by many states, including North Carolina, in their own versions of CERCLA, have brought a dramatic change in the impact of environmental issues on business transactions. 3. CERCLA and its state counterparts impose strict liability. Lack of fault is not a defense. 4. Liability under CERCLA and its state counterparts is also joint and several. This concept of liability means that one party can be held responsible for the entire clean up of a site even if there are a number of other parties who are also liable for the contamination. The fact that a party may have only contributed a small volume of waste to a site or that its waste is less toxic than the waste contributed by others does not limit that party's liability as to the government. The allocation of liability among the various parties is left to resolution between them at a later date. 5. CERCLA liability is also retroactive. Even if the disposal of a material 30 years ago was 6-1

legal and the accepted practice, that is no defense today. B. POTENTIALLY RESPONSIBLE PARTIES UNDER CERCLA AND STATE ACTS, 1, As discussed in greater detail in Chapter 3, CERCLA imposes liability on the following parties: a. Current owners and operators of a facility; b. Owners and operators of a facility at the time the release of hazardous substances occurred; c. Generators of hazardous substances disposed of at the facility; and d. Transporters of hazardous substances to the facility. 2. The North Carolina Inactive Hazardous Waste Sites Act, N.C.G.S. S 130A-310.7, imposes liability on any person who: a. Discharges or deposits a hazardous substance; b. Contracts or arranges for any discharge or deposit of a hazardous substance; c. Accepts for discharge or deposit any hazardous substance; or d. Transports or arranges for the transport of a hazardous substance for the purpose of discharge or deposit. 3. The Inactive Sites Act does not directly state that current owners of contaminated property are liable, as does CERCLA, However, the North Carolina statute does state that an innocent landowner is not considered a responsible party. By negative inference, this may mean that any landowner who is not 81innocent@1 is a responsible, liable party. The courts have not yet resolved this issue. 6-2

I. C. SHARED LIABILITY BETWEEN PARTIES. 1. The Potentially Responsible Party ( IrPRP1I 1 concept has been interpreted by the courts and state and federal agencies very broadly. Nearly any party can be considered a PRP based either on ownership of property, operations conducted on the property, or contractual or business relationships with other parties who may have some involvement with environmental problems at a piece of property. 2. As a result of this broad scope, there is usually more than one PRP at a hazardous waste site. Furthermore, a number of PRPs may have contractual or other relationships with one another. a. If a tenant causes environmental contamination on the property, the tenant can be held responsible for that contamination as the operator. Likewise, the lessor can be held responsible as the owner of the property. b. When one company merges with another company, the surviving corporation succeeds to all the liabilities of the former corporation which is extinguished by the merger. These liabilities include environmental liabilities. c. When one party purchases real estate from another party, and the real estate is contaminated, the buyer can be held liable for the contamination as the current owner of the property. If the contamination occurred during the seller's ownership, the seller can also be held liable. d. Parent corporations can be held responsible for environmental problems caused by their subsidiaries in situations where they have too much involvement in the operations of the subsidiary. 3. Due to the liability of multiple parties and the contractual relationships between those parties, transaction documents need to address environmental issues. 6-3

11. THE ROLE OF DUE DILIGENCE A, THE DEMISE OF CAVEAT EMPTOR. 1. The common law doctrine of caveat emdtor ("let the buyer beware") means, broadly, that the buyer assumes liability for the condition of the property. Conversely, the seller has no obligation to the buyer to investigate or disclose the conditions of the property. Likewise, the seller does not impliedly or expressly warrant the condition of the property. 2. For the most part, the doctrine of caveat emptor has been eroded as a defense for the seller when it comes to environmental liabilities. 3. In North Carolina, fraud by the seller in misrepresenting the condition of the property to the buyer is a recognized exception to the application of the caveat emdtor doctrine. Whether fraud has occurred is generally determined by whether the seller has provided the buyer with an adequate opportunity to inspect the premises to determine the condition of the property. a. While access to the property generally provides the buyer with the required "adequate opportunity to inspectt1, the concept of an "adequate opportunityv1 is also affected by the relative positions of the seller and the buyer and the discoverability of any contamination. b. Factors which could affect the buyer's adequate opportunity to inspect may include location and quantity of hazardous substances in the buildings or the ground, sophistication of the buyer, likelihood that the buyer's routine inspection would reveal contamination and, whether the seller has any actual knowledge of any hazardous substances being used or disposed of on the property. 4. In Newsom v. Reichhold Chemicals, Inc., No. H86-0777(g) (D. Miss), the court found that caveat emdtor did not protect the seller who buried chemical waste at the site and then sold the property without disclosing the environmental condition to the buyer. The court reached this conclusion because the contaminants could only be discovered by chemical analysis and were not 6-4

readily ascertainable by the buyer's gence environmental audit. due dili- 5. Both Congress and the courts have taken steps to erode or eliminate the doctrine of caveat emdtor as a defense under Superfund. a. The Superfund Amendment and Reauthorization Act of 1986 (SARA) imposes potentially significant penalties if the seller fails to disclose any actual knowledge he has at the time of the sale with regard to hazardous substances which were released or are present on the property. The penalty is that the seller remains liable under Superfund and is not entitled to any third-party defense. See 42 U.S.C. 5 9601(35) (a). b. A number of courts have rejected caveat emdtor as an appropriate defense in Superfund cases. As stated by the court in Sunnen Products Co. vs. Chemtech Industries. Inc., 658 F. Supp. 276, 278, n.3 (E.D. Mo. 1987) "NO court has accepted the defense of caveat emptor, which would improperly shift liability for environmental contamination from the responsible party to an unwitting purchaser." c. Caveat emr>tor may still be an "equitable consideration" in the allocation of response costs among responsible parties. d. Buyers seeking to recover their costs for remedying contaminated property from seller's under tort theories, such as abnormally dangerous activity, public or private nuisance, and negligence, have generally not been successful in eroding the doctrine of caveat emtor. However, a New Jersey court has set aside the doctrine to find that purchasers can recover from the previous owner costs and expenses resulting from the discovery and clean up of hazardous substances at the property where the prior landowner's radium processing operation was ruled to be an abnormally dangerous activity. See T t E Industries, Inc. v. Safety Liaht CorD., 227 N.J. N. J. Super. 228, 546A 2d 570 (N.J. Super. A.D., 1988). 6-5

B e IMPACT ON TEE INNOCENT LANDOWNER DEFENSE. 1. In order to negotiate and allocate environmental liabilities, the environmental liabilities must be known. This requires an investigation of the company and/or property being acquired to determine the potential environmental liabilities that may exist. 2. Although the purpose of identifying potential environmental liabilities may be obvious, the ability to achieve that purpose may not be that great. This is because the buyer and the seller have different interests in an environmental assessment based upon their distinct relationship to the site. 3. The buyer's primary interests are to avoid known or discoverable environmental risk and to protect itself against unknown environmental risk. a. To the extent contamination is discovered at the site or non-compliance with environmental laws and regulations is determined, the buyer seeks to have the seller assume such liabilities under the terms of the purchase agreement. b. As for unknown risk, the buyer can seek to qualify for the innocent landowner defense by conducting an appropriate due diligence environmental assessment, and request indemnification from the seller. For the particular steps to be taken to satisfy the innocent landowner defense, see Chapter 3. 4. The seller's interests in the assessment are to identify its current environmental liability and to limit its future liability for not yet discovered environmental conditions. a. The seller needs to determine the site's compliance with environmental laws and regulations in order to provide appropriate environmental warranties and representations in the purchase agreement. b. The seller may look to the assessment report as a base line regarding the site's environmental status as of the purchase date. Any contamination discovered after that date may be attributable to the buyer. 6-6

c. The seller often has a specific concern that any contamination or other items of noncompliance discovered at the site may trigger reporting and clean up requirements. Likewise, if the contamination has future consequences on the seller's liability, the seller needs to decide what control it needs over the remedy and the site to adequately protect its interest. 5. In defining the scope of the assessment, particular circumstances regarding the property or the business must be considered. These factors may include: a. Type of property being acquired, i.e. rural, residential or industrial; b. Surrounding neighborhood, i. e. rural, residential or industrial; c. Sophistication of seller and buyer; d. Past uses of the property; e. Compliance history of the site; and f. Money and time available for the assessment. Co ENVIRONMENTAL ASSESSMENTS. 1. Over the past several years, standards have been developed as to what actions should be taken as part of a Phase I environmental assessment. Fannie Mae, Fannie Mac and a number of lending institutions have developed guidelines for Phase I assessments. These standards are designed to satisfy the innocent landowner defense requirements under Superfund. They are also becoming a standard method of operation in business and industry. 2. A committee of the ASTM (formerly named the American Society for Testing and Materials) currently is considering a new guide intended to establish a national standard for Superfund due diligence for commercial property transactions. The proposed ASTM standard sets up a two step process for investigating properties. a. The first step is completion of a Transaction Screening Checklist. The checklist is a questionnaire regarding the current 6-7

condition of the property, historic uses of the property, and a review of records. The checklist is a detailed document with questions followed by guidance comments. This checklist can be performed by any person. b. If the answers to all of the questions on the Transaction Screening Checklist are no and no problems are found in the records review, then the proposed ASTM standard says that no further investigation is required, all appropriate inquiry has been conducted and innocent landowner status has been established. c. If, however, any question on the Transaction Screening Checklist is answered in the affirmative or if any question is left unanswered without adequate explanation, a presumption exists that further inquiry is needed: which may include a Phase I environmental assessment prepared in accordance with ASTM guidelines or a lesser inquiry directed at specific issues raised by the checklist. d. A Phase I environmental assessment, if needed, is to be performed by an environmental professional. The assessment includes a records review, a site reconnaissance, and interviews with relevant persons with knowledge. The guidance also establishes a standard format for any report on the assessment. 3. The hiring of technical consultants is generally appropriate to conduct a Phase I environmental assessment as usually some degree of technical expertise is needed. The technical consultant is not only likely to be knowledgeable about local assessment techniques but can also provide a well documented report which is good evidence of the buyer's exercise of due diligence in investigating the property. a. A number of environmental consulting firms are available, each having various types of expertise, including engineering, geological, hydrogeological, and the like. For some properties, it may be advisable to have an interdisciplinary team conduct the assessment. b. Factors which are relevant to the selection of the consultant include the size and reputation of the firm, location, availability of personnel to meet the assessment schedule, cost, and 6-8

familiarity with site location and applicable regulations. c. Contractual issues often exist with regard to hiring the consultant. The most likely of these are the scope of the indemnity obligation of the consultant in case of professional negligence and the scope of work to be performed by the consultant. In most instances, it is appropriate to limit the liability of the consultant to the amount of the consultant s errors and omissions insurance or other insurance which covers professional negligence. Incorporation by reference of accepted standards for conducting Phase I assessments, such as the ASTM draft guidelines, can adequately define the scope of work. 4. Because the purpose, nature and results of environmental assessments involve legal issues, it is often advisable to retain an environmental attorney. The attorney identifies which environmental laws and regulations may be relevant to guide the assessment. After the environmental consultants have completed their technical review, the attorney reviews the facts collected and any written reports drafted regarding the assessment to insure that the proper legal conclusions are drawn. Based on the results of the assessment, the attorney will have a key role in advising the client of potential liabilities and insuring appropriate contractual protection. 5. The information gathered in an assessment may include information the seller or buyer is interested in keeping confidential. This is particularly true with regard to the legal opinions and conclusions regarding environmental liabilities drawn from the factual information. Systems can be implemented limiting access to the documents or findings of the investigation which will allow confidentiality to be maintained. D. AUDITING AND COMPLIANCE POLICIES, 1. A number of companies have now instituted internal compliance auditing programs and other policies to assure compliance with environmental regulations. (For a greater discussion of these, see Chapter 2.) The implementation of these policies generates information regarding 6-9

environmental compliance and potential liabilities which is of particular interest to a potential buyer. The scope of any Phase I assessment should now be broad enough to discover such information. 2. The advent of internal compliance audit is a positive benefit in that they are designed to avoid violations of environmental laws and regulations. Properly implemented, these policies and programs reduce the risk of environmental problems and their attendant liabilities. Reduction of potential liabilities makes transactions involving companies or properties subject to those policies easier to handle from an environmental standpoint. 111. LENDER INTERESTS AND POLICIES A. THEORIES OF LENDER LIABILITY. 1. CERCLA imposes liability on the current owners of contaminated property. However, CERCLA exempts from cleanup liability a lender holding a security interest in contaminated property, provided that the lender does not participate in the management of its borrower's business. 42 U.S.C.A. S 9601(20)(A). 2. The North Carolina Inactive Hazardous Waste Site Act specifically exempts from liability owners of property who obtained title through a security interest in the property. The North Carolina ground water regulations, 15A NCAC 2L, contain a similar exemption. 3. The courts, however, have adopted a very broad theories of liability in eroding protections for lenders.. a. In United States v. Marvland Bank & Trust, 632 F. Supp. 573 (D. Md. 1986), the court held that when a bank forecloses and takes title to property, the "indicia of ownership" defense no longer applies and the lender may be liable as an owner of the property. bo In United States v. Fleet Factors Com., 901 F.2d 1550 (11th Cir. 1990), the 11th Circuit Court of Appeals decided that a lender may lose the benefit of the CERCLA secured creditor 6-10

exemption by taking actions which, until then, had been generally viewed as reasonable and appropriate to protect the secured interest. According to the court, a lender who participates in the financial management of a company to the level that indicates the capacity to influence the borrower's treatment of hazardous waste can be held liable as an operator, even if it did not exercise that influence. The case was remanded and the district court recently determined that the lender was liable under CERCLA. U.S. v. Fleet Factors, No. 687-070 (S.D. Ga. Feb. 19, 1993). 4. Banks have also been held liable where they were the owner of the property at the time contamination occurred, even if they are no longer the owner. Guidice v. BFG Electroplatinq and Manufacturina Co., 732 F.Supp. 556 (W.D. Pa. 1989). 5. Lenders also can be liable under CERCLA as operators if they exercise excessive control over their borrowers. The exact contours of what conduct by a lender does or does not subject it to environmental liability as an operator have not been clearly determined. B. RESULTING LENDER POLICIES AND RISK AVOID- ANCE * 1. Lenders will continue to require detailed environmental information and assurances. 2. Lenders will probably continue to follow policies which either prohibit or restrict loans on properties which presently or in the past have been involved with industries with a greater risk of environmental problems. For such policies to be successful they must: a. Define the type of loan it applies to; b. Establish a procedure for identifying riskprone businesses or properties; c. Establish procedures to be f,ollowed once a risk has been identified; and d. Develop guidelines for documenting loans. ' 6-11

3. Banks and other lenders now routinely require a Phase I environmental assessment on any loan secured by real property. 4. Banks have also begun looking for other sources of collateral in addition to or instead of real property. 5. Some banks have developed environmental questionnaires which seek complete information on past, current and future operations of the borrower. These questionnaires usually require production of all relevant documents. Full and accurate completion of the questionnaires is often made into a representation or warranty in the loan documents. 6. In the loan documents, lenders now require a number of standard representations, warranties and covenants. A number of these are also required in purchase/sale agreements between private parties which are discussed in Section IV of this chapter. In addition, lenders often include provisions addressing the following: a. Due on sale clauses; b. Acceleration of the loan if an environmental problem is discovered; c. Requiring additional security if environmental problems develop; d. Leasing restrictions on the property so that a loan on a property currently operated by a clean industry does not become occupied by one that could cause environmental problems; e. Any clean-up costs incurred by the lender increase the principal balance of the loan; f. The lender is given access to the property and environmental records during administration of the loan; and g. All loans are recourse loans. C. THE ENVIRONMENTAL PROTECTION AGENCY RULE. 1. In response to narrow judicial interpretations of the ttsecured creditor exemption," EPA issued on April 23, 1992 a final 6-12

rule interpreting this exemption and clarifying the activities a lender can engage in prior to making the loan, during the life of the loan, and after foreclosing on contaminated property without incurring the risk of cleanup liability under CERCLA. 2. Under the lender liability rule, a lender is participating in the management of its borrower's business and can be subject to liability under CERCLA if: a. the lender exercises control over the borrower's hazardous substance handling or disposal practices, or b. the lender assumes control or responsibility for the overall management of the day-to-day operations of the business with respect to environmental compliance matters or operational (as opposed to financial or administrative) matters. 3. No act or omission by the lender prior to acquiring its security interest will void the exemption, including negotiating with the borrower, giving financial advice to or counseling the borrower, requiring the prospective borrower to clean up the property and to comply with environmental laws, or performing or requiring an environmental assessment or audit of the property. 4. During the life of the loan, the lender may undertake the following acts without voiding the exemption: a. requiring the borrower to clean up the property and to comply with environmental laws; b. securing authority from the borrower to periodically monitor and inspect the property; c. conducting loan workouts, including restructuring the terms of the loan or security interest ; d. exercising rights pursuant to an assignment of accounts or an escrow agreement; or e. providing guidance, suggestions or specific or general financial or other advice 6-13

5. As long as the lender has not participated in the management of its borrower's business prior to foreclosure, the lender may foreclose, purchase and operate the property after foreclosure without voiding the exemption if it is acting to protect its security interest and takes reasonable means to dispose of the property. There is no time limit on how long the lender can hold the property, but the lender will be considered to have acted in a reasonable manner in trying to dispose of the property if within 12 months after acquiring the property it lists the property with a broker, dealer or agent and advertises the property as being for sale. 6. The lender will lose the exemption if it refuses any bid or offer at the foreclosure sale that would allow it to recover the amount owed by the borrower. The lender also will lose the exemption if after six months after acquiring the property it rejects or does not act within 90 days on any offer that would allow it to recover the amount owed by the borrower. 7. Even with the EPA lender liability rule, lenders still face risks of environmental liability and other problems. a. The rule offers no protection for the unsecured lender. b. While the rule limits EPA's ability to recover cleanup costs from the secured lender, it presently is unclear whether the rule will limit the rights of third parties to pursue cost recovery actions against this lender. c. Lenders still are subject to potential liability under other federal or state laws and regulations. Many states, for example, have enacted statutes similar to CERCLA. d. The rule does not address the potential CERCLA liability of a trustee or other fiduciary holding legal title to contaminated property in his or her capacity as a trustee or fiduciary. e. The protection of the rule does not transfer to a secured lender's purchaser, and without such protection, it will be difficult for lenders to find buyers for contaminated property. 6-14

.. Da PENDING CONGRESSIONAL CONSIDERATIONSa 1. In the last two sessions of Congress, legislation has been introduced that would define what actions have to be taken in order to qualify for the innocent landowner defense. This bill affects lenders with regard to foreclosures or other situations where they would take title to property that may be contaminated. 2. Legislation has been proposed in both the Senate and the House that would specifically exempt banks, financial institutions and other lenders from liability under CERCLA as an owner where title is obtained through foreclosure or deed in lieu of foreclosure. This protection would apply whether or not any investigation of the environmental condition of the property was undertaken by the lender prior to taking title. Neither proposal would provide guidance or protection for lenders from operator liability. IVa CONTRACTUAL ALLOCATION OF LIABILITY A* RELEASE VERSUS INDEMNITY. 1. Although the factors involved in negotiations between a buyer and a seller can be endless, the basic interests of the two parties usually remain constant throughout. In a perfect world, the buyer would like to obtain a complete, fully funded indemnity from the seller for any environmental problems that exist on the property. Likewise, in a perfect world, the seller would like to obtain a complete release from the buyer for any environmental problems on the property. Unfortunately, negotiations are never conducted in a perfect world. 2. In some instances, the buyer and seller may share liability for an environmental condition in that the cause of the condition is attributable to activities that occurred both before and after closing. Although the parties have a shared interest in this condition, the particular interests are also distinct. The seller's concern is often to control the remedial action in order to limit its cost. The buyer's concern is more with the immediate and future impact of the remedy, the interference caused by the 6-15

remedial action and how the remedial action impacts the site's future operations. 3. The strategies of the buyer and the seller will be affected by many factors, including the f 01 lowing : a. Past uses of the site and the likelihood of latent contamination; b. The seller's history of compliance with environmental laws and regulations; c. The seller's financial viability to respond to future liabilities; d. The buyer's intended use of the site; e. The existence and scope of any contamination found on site or at neighboring properties; and f. The timing for remediating any contamination found by the environmental assessment. 4. For any transaction involving real estate or industrial facilities, the parties should consider certain key provisions in the purchase agreement for allocating environmental liability. These can include the following: a. Warranties and representations and the time limits on them; b. Indemnification clauses, including monetary and time limits; c. Security for the seller's indemnification obligations; d. Survival of warranties, representations and indemnification obligations regarding environmental conditions; e. Assumption of environmental liability by the responsible party; f. Allocation of expenses where parties share liability for environmental conditions; g. Cooperation between the parties on matters where the parties share environmental liabilities; and 6-16

h. Rights of contribution between the parties for clean up costs incurred. B e DEAL STRUCTURING MECHANISMS. 1. Leasing vs. Purchasing. If the environmental assessment uncovers facts which indicate that contamination at the site is likely, leasing the site may be considered. Leasing will not protect the lessee from Superfund liability as the lessee may be liable under Superfund as the operator at the site. However, the lessee may argue that its liability is limited to its activities at the site. As a practical matter, the governmental agencies will more likely look to the owner of the site for clean up liability. In negotiating the terms of the lease, however, the parties will face many of the same issues as in negotiating a purchase agreement. 2. Subsidiary Corporation to Hold Title. If business reasons justify it, the buyer may establish a separate subsidiary to hold title to the purchased site. This may limit the liability of the parent corporation or shareholders for environmental matters. However, if the subsidiary corporation's only purpose is to minimize the parent's or shareholder's environmental liabilities, the courts may hold the parent company or shareholders liable under Superfund. 3. Financial Assurance For Contingent Liabilities. As part of the environmental assessment or the negotiations, the buyer may consider whether the seller's insurance will cover environmental conditions arising from past actions related to the site. This device is not very helpful in minimizing liability exposure because of the uncertainty regarding environmental insurance coverage. Alternatively, the buyer may insist that the seller establish a trust fund, escrow agreement, letter of credit or other arrangement to cover contingent future liability and to provide some assurance of its financial capability to do so in the future. 4. Scope of Representations and Warranties. The following general environmental matters may be considered by the parties in determining the 6-17

appropriate scope of warranties and representations in the agreement: a. Whether there has been, or is threatened, any spill or release at the site of any hazardous substances, pollutants or contaminants; b. Whether the site has been used by seller or any prior owner for the treatment, storage of disposal of hazardous substances or hazardous waste; c. Whether seller has obtained all federal, state and local environmental licenses, permits or approvals with regard to the site and its operations ; d. Whether the seller has complied with all the terms and conditions of such licenses and permits; e. Whether the seller has properly completed and submitted to the federal, state and local governmental agencies all required environmental filings, reports and notices regarding the site and its operation; f. Whether seller is in compliance with all federal, state and local environmental laws, ordinances, rules, regulations, orders, judgments or decrees relating to the site; g. Whether there are any civil, criminal or administrative proceedings or investigations pending against the seller with regard to the site and its operations or whether any have been threatened by any government, governmental agency or third party; h. Whether the seller is aware of any fact or circumstance that may give rise to any future civil, criminal or administrative proceedings or investigation with respect to the site; and 1. Whether the seller has furnished the buyer with all information regarding environmental conditions at the site or seller's use the site. 5. Scope of Indemnification Obligations. In negotiating the indemnity language of the agreement, the buyer will obviously seek broad indemnification protection with regard to environmental liabilities; the seller will seek 6-18

to limit its liabilities. Other issues in negotiations include the duration of the indemnification obligations and whether it is necessary to have some type of financial assurance regarding seller's obligations. Once determined, the scope of the indemnification obligation should be clearly stated in the purchase agreement. Typical indemnity coverage includes : a. The breach or inaccuracy of any representation, warranty or covenant in the agreement; b. Any violation of federal, state or local laws, regulations or ordinances regarding environmental matters; c. Loss or damage to any property, including the site, due to environmental contaminants at the site; d. Injury to or death of any person due to environmental contaminants at the site; e. Injury to or adverse effects on the environment due to environmental contaminants at the site. 6. Opinions of counsel are also appropriate with regard to whether or not specific laws have either been complied with or do or do not apply to the seller. C. SPECIAL APPLICATION TO ASSET PURCHASES. 1. Under traditional corporate law, a company buying the assets of another company did not take on the liabilities of that company, including environmental liabilities, unless one of the following exceptions applied: a. The buyer expressly or impliedly assumed the liabilities of the seller; b. The transaction constitutes a de facto merger because the seller's enterprise continues, there is continuity of shareholders, the seller ceases operations, liquidates and dissolves as soon as legally and practically possible, and the buyer assumes the obligations of the seller 6-19

necessary for the uninterrupted continuation of business operations. e. The buyer is a "mere continuationt1 of the seller; or d. The transaction was entered into for fraudulent purposes. 2. In 1984, EPA's assistant administrator for enforcement and compliance monitoring issued a memorandum entitled IILiability of Corporate Shareholders and Successor Corporations for Abandoned Sites under the Comprehensive Environmental Response, Compensation or Liability Actt1 (the "EPA Memorandumw1). The EPA Memorandum advocated the adoption of a products liability concept known as the llcontinuity of the enterprise" or "continuity of business operationf1 theory. Under this theory, liabilities are imposed on the successor corporation "if the successor corporation continues essentially the same manufacture or business operation as its predecessor corporation, even if no continuity of ownership exist between them." 3. A number of courts have now begun to accept the continuity of enterprise theory advocated by EPA. In applying this test, the courts consider whether or not the successor corporation: a. Retains the same employees; b. Retains the same supervisory personnel; e. Retains the same production facilities in the same location; d. Continues producing the same products; e. Retains the same name; f. Maintains a continuity of assets and general business operations; and g. Holds itself out to the public as a continuation of the previous corporation. 4. To avoid successor liabilityundertradition legal theories, the only option was an asset purchase structured to avoid one of the exceptions to that rule. Similar actions still need to be taken today in order to avoid 6-20

successor liability. However, due to the application of the continuing business enterprise theory, further precautions must be taken. Possible actions to consider include: a. Purchasing less than all the assets so that the selling corporation can remain in existence for some limited purpose. b. Changing the management of the company so that there is no continuity of officers or directors. To satisfy this, more than just one or two changes in officers and directors would have to be made. c. Changing the business or product line of the company once the assets are purchased. d. Obtainingsufficientindemnities, guaranties or other financial protections in order to absorb any environmental liability that might be imposed at a later date. 5. The problem with a number of these suggestions is that they are inconsistent with good business practices. In most situafions, it does not make sense to purchase assets and then change management, employees or the nature of the business in terms of the product line and operations. If such actions are going to be taken, most likely the purchase price of the assets will have to be reduced since the historic earnings and income stream may not be achievable. Vm SPECIAL BANKRUPTCY CONCERNS A. ABANDONMENT OF PROPERTY. 1. The trustee for a bankrupt company is charged with protecting its assets for the benefit of its creditors. 2. In many situations, a real property asset can be contaminated and the cost of clean up can exhaust the monies and assets available to other creditors.. 3. The Bankruptcy Code does allow the trustee to abandon property which is a burden on the bankrupt's estate. 6-21

4. Courts have generally determined that where the property does not present an imminent threat to public health or the environment, the trustee can abandon the property. However, where those conditions are not satisfied, the trustee must use the resources of the bankrupt estate to pay for investigation and cleanup of the contamination. B. DISCHARGEABILITY OF CLAIM8. 1. When a business goes into a Chapter 11 reorganization, any claims against that corporation are discharged at the end of the bankruptcy. 2. A court has now ruled that response costs payable under CERCLA are claims which can be discharged in bankruptcy. In re Chateauuav CorrD., 944 F.2d 997 (2d Cir. 1991). In Chateauaay, the court held that where the releases resulted from conduct by the company prior to filing for bankruptcy, future cleanup costs relating to those releases were a contingent claim that could be discharged in bankruptcy. Where the amount of the claims could not be fully determined until after the bankruptcy case was concluded, the claims would be estimated in accordance with the provisions of the Bankruptcy Code. 3. Chateauaav only applied to releases or threatened releases that occurred prior to the bankruptcy filing. Any response costs due to a release which occurred after the bankruptcy filing would not be discharged. Likewise, claims for injunctive relief would not be discharged. 4. These considerations are important in trying to structure properly funded indemnity clauses in acquisition agreements and in dealing with other parties at Superfund sites, especially where a potentially bankrupt party may be a major contributor to the site. 6-22