Ignorance Is Not Bliss: What You Don't Know About Your Tenants May Hurt You


Under environmental and tort law, a landlord can be liable for the environmental contamination caused by tenants. The costs of cleaning up contamination can be enormous. Landlords must therefore adopt prudent leasing practices to minimize their liability exposure.

A commercial or industrial lease should contain much more than a simple "compliance with all existing laws" clause. Landlords should consider using the following lease clauses:

  • An indemnity clause requiring the tenant to reimburse the landlord for cleanup costs;
  • A clause specifying the standards governing a tenant's cleanup of hazardous substances;
  • A clause defining relevant environmental terms used in the leases;
  • A clause enumerating the laws with which the tenant must comply and the phrase "without limitation all other environmental laws"
  • A clause prohibiting the manufacture, storage, disposal, transportation, and use of hazardous substances on the premises;
  • A clause maintaining the landlord's right of entry onto the premises for inspection purposes;
  • A clause requiring prompt notification of correspondence from environmental agencies;
  • A clause requiring the tenant to surrender a "clean" facility;
  • A clause limiting the tenant's claims against the landlord.

A landlord should also review and improve its leasing practices. The landlord should:

  • Investigate the tenant's proposed operations;
  • Review a prospective tenant's financial statements;
  • Exercise the right of entry for periodic inspections;
  • Consider pre- and post-lease environmental inspections;
  • Require the tenant to provide insurance.

Introduction

This article discusses the potential liabilities that an owner of commercial or industrial property may face under environmental laws in the context of landlord/tenant leasing arrangements. First, the article addresses the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA"). [42 U.S.C. ' 9601-9675, commonly referred to as Superfund.] Next, it discusses general leasing practices and suggestions for lease language. Owners of commercial and industrial properties beware: in the arena of liability for environmental contamination, ignorance is not bliss.

The CERCLA Liability Scheme

CERCLA creates four classes of "covered persons" that courts, commentators, and the Environmental Protection Agency commonly refer to as "potentially responsible parties" ("PRPs"). PRPs include the following persons who have some relationship to the contamination found at a facility:

  • current owners or operators of the facility
  • owners or operators of the facility at the time at which the hazardous
  • substances were placed there
  • generators of hazardous substances found at the facility
  • transporters of hazardous substances to the facility. 42 U.S.C. Section 9607(a).

Under CERCLA, the term "owner or operator" means "in the case of a...facility...any person owning or operating such facility...." 42 U.S.C. Section 9601(20)(A). As may be expected from reading this definition, a landlord is generally considered an "owner" and a tenant is easily considered to be an "operator" (and hence PRPs) under CERCLA. A "facility" includes buildings and areas where hazardous waste is located. 42 U.S.C. ' 9601(9).

Judicial interpretation of CERCLA has resulted in the imposition, upon all PRPs, of joint and several liability for response costs at a facility and for damages to natural resources. This means that, despite its actual proportionate share of responsibility for site conditions, one PRP may be held solely liable for the entire cost to clean up the site, if the other PRPs are insolvent or are difficult to locate. Thus, CERCLA holds an owner of property liable for contamination that may have occurred many years in the past, or for contamination which it did not cause. Moreover, CERCLA places narrow limits on the defenses to liability: an act of God, an act of war, or the so-called "third party" defense.

"There shall be no liability … for a person otherwise liable who can establish by a preponderance of the evidence that the release or threat of release of a hazardous substance and the damages resulting there from were caused solely by -

  1. an act of God;
  2. an act of war;
  3. an act or omission of a third party other than an employee or agent of the defendant, or than one whose act or omission occurs in connection with a contractual relationship, existing directly or indirectly, with the defendant..., if the defendant establishes by a preponderance of the evidence:
    • he exercised due care with respect to the hazardous substance concerned, taking into consideration the characteristics of such hazardous substance, in light of all relevant facts and circumstances, and
    • he took precautions against foreseeable acts or omissions of any such third party and the consequences that could foreseeably result from such acts or omissions; or
  4. any combination of the foregoing paragraphs." 42 U.S.C. ' 9607(b).

For the third party defense to apply, a PRP must establish that the release of hazardous substances was caused solely by an act or omission of a third party with whom the PRP had no contractual relationship, that the PRP exercised due care with respect to the hazardous substance, and that the PRP took precautions against foreseeable acts or omissions of any such third party. 42 U.S.C. ' 9607(b)(3).

Courts have interpreted the term "contractual relationship" to include lease agreements; thus landlords and tenants generally may not avail themselves of this defense as against one another. Federal courts in New York recognize the ability of tenants to use the third party defense against landlords. See, e.g., United States v. A & N Cleaners and Launderers Inc., 788 F. Supp. 1317, 1335 (S.D.N.Y. 1992), where the court required the contractual relationship to be "in connection with" the hazardous substances at issue. See also Westwood Pharmaceuticals, Inc. v. National Fuel Gas Distrib. Corp ., 964 F.2d 85, 89 (2d Cir. 1992).

Even if a landlord could use a third-party defense against its tenant, the landlord would nonetheless have to demonstrate that it "took precautions against foreseeable acts or omissions" of its tenant. This requirement discourages a lessor of property from becoming an "absentee landlord": one that does not monitor its tenants' activities on a regular basis and claims ignorance of the presence of hazardous substances at the property.

"Gore" Factors

Despite the apparent inability of a landlord to shift total liability to a tenant using the third-party defense, CERCLA allows consideration of equitable (i.e., "fairness") factors in resolving contribution claims by landlords against tenants.

"Any person may seek contribution from any other person who is liable or potentially liable under section 9607(a) of this title.... In resolving contribution claims, the court may allocate response costs among liable parties using such equitable factors as the court determines are appropriate." 42 U.S.C. Section 9613(f)(1).

Among the factors a court may consider in apportioning liability are the "Gore" factors (named after then Congressmen Al Gore of Tennessee), which include:

  • the parties' ability to demonstrate that their contribution to discharge, release, or disposal of hazardous waste can be distinguished
  • the amount of hazardous waste involved
  • the degree of toxicity of hazardous waste
  • the degree of involvement by parties in generation, transportation,
  • treatment, storage, or disposal of hazardous waste
  • the degree of care exercised by parties with respect to hazardous waste concerns, taking into account the characteristics of such hazardous waste
  • and the degree of cooperation by the parties with federal, state or local officials to prevent any harm to public health or the environment.

Divisibility

In addition, if a PRP can convince a court that the harm to the property is divisible (i.e., differing injuries to the property attributable to differing sources of the injuries), a court will consider apportioning response costs among the parties. In United States v. Chem-Dyne Corp. 572 F. Supp. 802 (S.D. Ohio 1983), the court held the defendants jointly and severally liable for the United States' response costs. The court noted, however, that "each defendant is liable only for the portion of the harm he himself caused." Id. at 811.The court also noted that the "burden of proof as to apportionment is upon each defendant." Id. The parties could argue amongst themselves as to apportionment of the costs, but remained jointly and severally liable to the United States.

A tenant may be able to reduce its exposure if it meets its burden of proof as to divisibility and apportionment. For instance, a tenant may escape liability if it can show that it lacked the requisite control of the property to be an "operator" under CERCLA or that there was no "nexus" between the tenant's operation and the environmental contamination at issue. [See Robert M. Ruzzo, Coping with Environmental Liabilities in Commercial Lease Transactions , 20 REAL EST. L.J. 211, 214 (1992).]

In BCW Associates, Ltd. v. Occidental Chemical Corp., Civ. A. No. 86-5947, 1988 WL 102641 (E.D. Pa. Sept. 29, 1988), the court held that Occidental, a lessor of warehouse space, was not an "operator" of the facility because its operations were unrelated to the release of hazardous substances due to its operations' limited, confined scope. Although the warehouse showed evidence of lead contamination, and although Occidental used pigments containing lead chromate, the evidence also showed that the lead contaminating the warehouse consisted of lead sulfate, not lead chromate. Based on that evidence and on the housekeeping operations of Occidental, the court did not hold Occidental responsible "for any share of the response costs after equitable apportionment pursuant to 42 U.S.C. ' 9613(f)." [In fact, the court did not find Occidental to be an owner or operator of the warehouse. Id. at *22.]

The liability of landlords differs from that of tenants, however. Unlike a tenant, which may have a distinct, well-defined area of occupation and operation at a multi-tenant facility, the court will still consider a landlord as owner of the entire site and the landlord cannot use a divisibility argument such as that used by Occidental in BCW Associates .

In addition to the liability imposed by CERCLA, common law tort principles require the owner of real property to prevent use of the property by others in an injurious manner.

"A possessor of land is subject to liability for a nuisance caused while he is in possession by an abatable artificial condition on the land, if the nuisance is otherwise actionable, and

  • the possessor knows or should know of the condition and the nuisance or unreasonable risk of nuisance involved, and
  • he knows or should know that it exists without the consent of those affected by it, and
  • he has failed after a reasonable opportunity to take reasonable steps to abate the condition or to protect the affected persons against it." Restatement (Second) of Torts 839 (1977).

Suggested Lease Language

A commercial or industrial lease today should contain more than a simple "compliance with all existing laws" clause. The list that follows is a compilation of ideas for landlords to consider when leasing real property:

Make Tenants Bear the Costs of Environmental Cleanup

Every lease agreement should contain an indemnity clause. A landlord should require the tenant to indemnify it for cleanup costs incurred due to the release of hazardous substances. The redistribution of environmental risk must be clear and unequivocal and the indemnity clause should survive the expiry or termination of the lease. In addition to an indemnity for landlord-incurred costs, the landlord may want to impose on the tenant responsibility for the actual cleanup, or shift responsibility for the cleanup at the landlord's discretion.

Specify "How Clean is Clean"

Any clause requiring a tenant to remediate a site should specify the standards by which cleanup will be measured. State and federal cleanup standards often differ. In addition, cleanup standards may differ depending on the use of the site. For example under the Toxic Substances Control Act ("TSCA"), polychlorinated biphenyl cleanup criteria vary depending on whether the contaminated area is "restricted access" or "non-restricted" access. See 40 C.F.R. Section 761.123 .

If the tenant is in charge of the cleanup, responsibility for engaging environmental consultants should rest with the tenant, with cleanup to the landlord's satisfaction. The landlord should also maintain oversight capability.

Finally, the tenant's obligations should not be dependent upon an official notice of noncompliance. Generally, the duty to take remedial action arises upon discovery of a "trigger" level of contamination at the facility. Under Ohio's Bureau of Underground Storage Tank regulations ('BUSTR"), for example, a land owner could be expected to remediate soil containing more than 904 mg/kg of total petroleum hydrocarbon ("TPH").

Agency action at sites often depends upon whether the agency's budget and staff levels allow it to commence an investigation or prosecution. Thus, an enforcement agency may not target sites that require remediation until it has dealt with other, more contaminated, sites. The landlord should insure that the tenant's obligations under the lease arise upon the tenant's discovery of contamination justifying remedial response, not upon notice from an enforcement agency.

Clearly Set Forth Applicable Definitions

The lease should contain definitions of environmental terms, e.g., "hazardous substance," "hazardous waste," "solid waste," "pollutants," "release," "removal," "remediation," and "response." Although these definitions should be consistent with state superfund statutes and other legislation, the landlord should use as broad a definition as possible. For example, although CERCLA and many state statutes do not include liability for oil and petroleum product releases, a landlord may want its tenants to be responsible for such releases.

Enumerate the Laws with which Tenant Must Comply

As noted above, a general "compliance with all applicable laws" clause does not provide adequate protection to the landlord to cover allocation of environmental liability. Such a clause need not be deleted but should be expanded. Particularly in a state with a unique and more stringent liability scheme than CERCLA, the landlord should explicitly refer to the state superfund statutory scheme.

The lease should also list "without limitation" (i.e., "including but not limited to") all other environmental laws with which the tenant must comply and should outline who has the responsibility for obtaining permits, who must disclose violations to agencies, and who is responsible for other types of agency notifications. The lease should clearly specify which party (lessor or lessee) has the responsibility for initiating contact with environmental agencies under various scenarios. The lease could also contain specific directions with respect to certain environmental conditions: spills, transformers, aboveground and underground storage tanks, sewage discharge, air operating permits, and other circumstances giving rise to potential environmental liabilities, depending upon the specific use, history, or location of the property.

Limit the Use of the Premises

The lease should contain an express prohibition against the manufacture, storage, disposal, transportation, and use of hazardous substances on or around the leased premises. If a tenant must engage in activities involving hazardous substances, the lease should require the tenant to notify the landlord that its activities involve such substances, to covenant to act appropriately, and to indemnify the landlord. The lease should require tenants involved in hazardous substance activity to obtain and maintain insurance coverage for such activities, including the landlord as a named insured.

Maintain a Right of Entry

The lease should clearly reserve the landlord's right of entry onto the premises. If the lease prohibits the use of hazardous substances, but the tenant nonetheless uses such substances, the landlord should have some mechanism for determining such a breach. The law holds the landlord, as owner of the property, jointly and severally liable with the tenant for the costs associated with a release of hazardous substances. Thus maintaining, and periodically exercising, a right of entry will enable a landlord to "police" its tenants' operations. See Anthony J. Fejfar, Landowner-Lessor Liability Under CERCLA, 53 MD. L. REV. 157, 211 (1994), for the proposition that the Environmental Protection Agency should issue regulations outlining minimum inspection criteria for certain types of leases.

Require Copies of Correspondence from Environmental Agencies

The lease should require the tenant to notify the landlord promptly in the event that any federal, state, or local agency contacts the tenant, and to provide the landlord with copies of all correspondence, even notifications from agencies that are advisory in nature only.

Require a Clean Bill of Health at Expiration of the Lease

The lease should require the tenant to surrender a "clean" facility at the end of its term. The landlord could require the tenant to obtain an environmental site assessment that demonstrates the absence of environmental concerns at the end of the lease period. The tenant should bear the cost of such an assessment.

Limit a Tenant's Claims

Particularly in the situation in which antecedent environmental conditions preexist the tenant's leasehold term, the lease should limit the claims that a tenant may make against the landlord. The lease should not allow the tenant to make claims for consequential damages, such as loss of customers and business interruption. Any damages due the tenant by the landlord should be limited to the costs of cleanup or response.

Suggested Leasing Practices

An indemnity is only as good as a tenant's financial condition. Thus, in addition to tightening up its standard lease, a landlord should examine its leasing practices. Moreover, because the case law appears to discourage "absentee landlord" practices, the following suggestions aim to enhance the landlord's knowledge and decrease the landlord's exposure to environmental liability.

Investigate the Prospective Lessee's Proposed Operations

Learn what the tenant plans to do while occupying the premises. Determine what types of substances may be used and what types of wastes may be generated. Also determine the expected volumes of hazardous substances and the anticipated volumes of wastes that the tenant's operations will generate.

Review the Financial Condition of Prospective Tenants

Shifting the responsibility for hazardous cleanups to the tenant affords no benefits if the tenant cannot meet financial obligations. Therefore, where environmental liability issues lurk, the landlord should review a prospective tenant's financial statements prior to entering into a lease arrangement. Such a procedure should become standard for those tenants whose use of the premises will definitely include hazardous substances. Appropriate insurance, bonding, or letters of credit may substitute for a strong balance sheet. In appropriate cases, if a tenant's financial situation does not meet the landlord's criteria, the landlord could require the guaranty of a parent company.

Exercise the Right of Entry for Periodic Inspections

As noted above, the landlord's lease should contain provisions for allowing inspections of the leased premises by the landlord. In addition, the landlord must exercise such a right. If the lease allows a right of entry that the landlord does not exercise, more harm than good could result. In an apportionment situation, where a landlord had the ability to discover and take or compel remedial action but did not because it failed to inspect or inquire, a court may treat the landlord's lapse as a factor against it.

Consider the use of Pre- and Post-Lease Environmental Assessments

By periodically engaging qualified environmental consultants to conduct assessments of the facility, a landlord has a benchmark by which to measure the environmental impact of a tenant's activities. An assessment may also be useful in the event that the tenant claims that the hazardous substance or environmental condition preexisted its occupancy. By creating a "baseline" before occupancy, the assessment will support claims that the tenant is responsible for the contamination.

Assessments also serve the purpose of the periodic inspections, discussed above. Note that if a pre-lease assessment reveals preexisting environmental conditions, a savvy tenant may require the lease to allocate responsibility for such conditions to the landlord.

Require the Tenant to Provide Insurance Coverage

Landlords should require their tenants to provide property and casualty insurance. The landlord should be included as an insured party on such policies. This is particularly important for situations where a tenant will be handling hazardous substances on the premises.

Conclusion

The specter of lurking environmental liability need not haunt a commercial or industrial lessor of property. By implementing prudent leasing practices and tightening up an antiquated lease, a landlord can substantially reduce the risk of being liable for environmental contamination caused by its tenants.

Courtesy of: Barry J. Trilling, Pamela B. Schmaltz (1999)