$35M Brownfield Project Derailed by Methane Gas

Earlier this year, I discussed the BNY Mellon v Morgan Stanley Mortgage Corp where  the defendant/mortgage originator has been sued by the CMBS trust for a $80MM shopping center loan where methane gas issues led to a default. See detailed post at: http://lschnapf.blogspot.com/2011/07/cmbs-lender-kept-in-case-over-questions.html

Now we have another case involving a $35MM development loan where a bank is a plaintiff and is seeking damages from several environmental consultants for failing to anticipate methane gas problems at the development site. In this case, the development site contained two former landfills that had been closed before the current closure requirements went into effect. The defendants filed motions to dismiss the complaint and while the court agreed to dismiss some of the claims, it allowed the negligence and CERCLA claim to proceed to discovery.

In Bancorpsouth Bank v. Environmental Operations, Inc., 2011 U.S. Dist. LEXIS 117010 (E.D. Mo. 10/11/11), the City of Hazelwood (City) requested proposals to redevelop an approximate 150-acre  blighted area known as the Robertson Development Project (Site). This area formerly contained two landfills, several auto body/salvage yards, demolished residences, a gas station, petroleum bulk storage facility and some small manufacturing concerns. The City wanted to construct a warehouse and light industrial complex.

After several years, the city received an acceptable development proposal and adopted an ordinance selecting McEagle Development LC as the developer of the Property. In November 001, Geotechnology, Inc. (Geotech) prepared a phase 1 environmental site assessment (ESA) to the County of St. Louis. Interestingly, despite the fact that a large portion of the Site consisted of what was called the Edwards Landfill (Landfill), the ESA expressly provided that an evaluation of methane gas was not included within the scope of services. The ESA identified the aforementioned former uses as RECs. However, in discussing the former landfill, the report simply stated that “The vertical and horizontal extent [of the landfill] is unknown as well as the composition of on-site materials. Deleterious materials anticipated in this area (sp) and should be a consideration to both the geotechnical design of the development as well as to the environmental cleanup. The fill may facilitate (sp) utilizing a method other than probing/boring to sample both bearing capacity and contaminants. Therefore it is recommended that after a site plan has been developed, the environmental sampling and geotechnical investigation be coordinated to take place concurrently.” Unlike the phase 1 in the Morgan Stanley case, this phase 1 did not mention the potential for methane gas or flag it as an item of concern,

In October 2002, the City and Hazelwood Commerce Redevelopment Corporation (“HCRC”) entered into a Development Agreement whereby the granted HCRC the right to acquire the Site including the parcels containing the Edwards Landfill. HCRC then assigned its acquisition rights back to the City so that it could begin the process of assembling the various parcels by way of eminent domain.

Between 2003 and 2005, HCRC retained Geotech to prepare a number of sampling reports. These reports identified nine areas of concern related to the former uses. Again, the reports did not study or evaluate the potential presence of methane.

In July 2004, the Industrial Development Authority of the City of Hazelwood submitted a brownfield application to the Missouri Department of Economic Development (“MDED”). This application was approved and the project became eligible for over $6.9MM in Brownfield Tax Credits. The tax credits were later sold to a tax credit purchaser.

In April 2005, Environmental Operations Inc (EOI) and Geotech prepared a Remedial Action Plan (RAP) where Geotech would act as the oversight consultant and EOI would perform the environmental remediation activities. Pursuant to the RAP, salvaged automobiles and larger waste would be removed and disposed of off site. Building debris from former site structures would be removed and existing site structures would be surveyed for asbestos. In addition, approximately 400,000 cubic yards of landfill material would be excavated and screened. Items between six and 12 inches were to be transported to an onsite engineered cell that was to be designed with 24- inch thick clay liner and capped by 60- inch clay cap. The fine material (less than six inches) was to be used as deep fill elsewhere at the Site. The material excavated for the engineered cap was to be used for grading elsewhere at the Project. A stormwater retention basis was to be constructed on top of the engineered cell. Upon completion of all remediation activities, a final report would be prepared and submitted to the MDNR for issuance of a no further action letter. Interestingly, the RAP did refer to the presence of volatile and semi-volatile organic compounds at the Property but did not address the potential for methane gas. The RAP was amended in February 2006 to provide for pumping and discharging trapped water from within the engineered cell area. No provision was made for the accumulation of methane gas within the cell

Meanwhile Hazelwood Commerce Center LLC (“HCC LLC”) and The Signature Bank entered into a one year $11.5MM Land Acquisition Loan Agreement in October 2005. The proceeds from this loan were to be used solely to complete the assemblage of the parcels for the Project and related expenses. HCC LLC made representations that the Site was in compliance with environmental laws and that there were no Hazardous Materials (the definition included reference to flammable substances) except as disclosed in the environmental reports and the RAP.    

In June 2006, HCC LLC and EOI entered into an Environmental Services Agreement to implement the RAP. This agreement required EOI to achieve substantial completion of the landfill remediation work, other than capping the engineered cell, within seven months, and to achieve substantial completion of the cap within twelve (12) months. All other remediation work was to be completed within fourteen (14) months which would be memorialized by a No Further Action Letter from the MDNR. The agreement also provided that EOI would obtain a Premises Pollution Liability Insurance Policy (“PPL Policy”) and a Remediation Cost Contamination Insurance Policy (“RCC Policy”) with collective coverage of up to $5MM.

In June 2006, the City and HCC LLC entered into a Remediation and Development Agreement (the “Remediation and Development Agreement”) where the City agreed to enter into a Purchase and Sale Agreement (PSA) to sell the landfill site to HCC LLC. The City was to deposit the proceeds from the sale as an initial contribution to the Remediation and Development Project Trust Indenture (the “Project Trust Indenture”). The PSA was executed the same day along with Collateral Assignment of Environmental Services Agreement and Consent of Contractor that granted Signature Bank an assignment and security interest in the Remediation and Development Agreement as well as the related agreements

With the execution of the foregoing documents, Signature Bank then entered into a $35MM Development Loan Agreement in August 2006. The purpose of the loan was to pay off the pre-existing Acquisition Agreement and to fund the activities required for the Project. However, the Development Loan proceeds were not to be used to fund the remediation which was to be financed from the sale of the tax credits and the other public financing.

In April, 2008, bubbling gas was observed rising through the detention basin constructed atop the engineered cell. EOI collected measurements for methane by placing a stainless mixing bowl directly over the bubbling area for approximately five minutes and then inserting a testing device under the mixing bowl to read the content of the “trapped” air. EOI found no methane and forwarded the test results to MDNR. EOI requested that MDNR consider the potential for methane gas generation or contamination a closed issue. However, MDNR directed EOI to install gas monitoring wells which revealed the presence of explosive levels of methane not only within proximity of the engineered cell but throughout the Site.  

The borrower eventually defaulted on its loan and the successor to Signature Bank filed its complaint. The bank alleged that because of inadequate investigation and design, dangerous levels of methane gas affect large portions of the Property, further construction and sale of lots at the Project cannot proceed pending further remediation of the methane conditions. The bank estimates the additional work to address the methane gas will exceed $10 MM

I cannot imagine how three environmental firms failed to raise methane gas as a potential issue for a project involving the redevelopment of and disturbance of an old landfill. This would have been the first issue that I would have thought they would have raised.

Class Action Lawsuit for Radon Mitigation Systems Against Developer and Engineering Firm

A New Jersey court affirmed certification of a class action involving residents of a condominium complex who alleged that radon mitigation systems were improperly installed. The defendants are the developer, the engineering firm who installed the radon systems, and the condo association that was responsible for maintaining the radon mitigation systems at the villa residences.

The development known as Overlook at Lopatcong consists of 384 residential units comprised of 142 villas, 132 garden houses and 110 townhouses. The development is located in an area in New Jersey known as Tier 1 Area. New residential structures constructed in Tier 1 Areas must be equipped with fully functional radon resistant construction pursuant to N.J.S.A. 5-23-10. The villas were constructed so that every two units shared a common basement and a radon mitigation system. The town homes and garden homes each had their own systems.

The plaintiffs filed an eight-count complaint alleging defendants improperly designed, installed, maintained and tested the radon mitigation systems. Plaintiffs pled theories of negligence, gross negligence, trespass, nuisance, fraud, consumer fraud, and assault and battery; and sought injunctive relief, which included medical monitoring and periodic testing of radon levels in the residences. Plaintiffs subsequently moved for class certification.

To support their motion, plaintiffs submitted the certification of a former employee of the engineering firm assigned to the development, and three reports from their expert. The former employee stated that when many of the units were tested for radon before a certificate of occupancy was issued, the units were tested with doors and windows open as directed by a supervisor. He also said that one radon pump was used for multiple dwellings to save money, and many units had cracks in basement slabs because Segal would not pay for expansion joints.

The plaintiff also introduced evidence of design and construction flaws. The plaintiffs’ expert said some of the systems were designed with a drainage pipe that was connected to a sump pit to transfer negative pressure to the neighboring unit, thereby reducing radon in both basements. However, the experts said that if the sub-surface system filled with water, this would interfere with the negative pressure system to the other unit, thereby allowing radon levels to rise in the basement.

The plaintiffs also provided evidence that many homes did not have sealed sumps covers and that the absence of the sealed covers  prevented radon from being eliminated from the basements. The plaintiffs also showed that other homes had exterior exhaust pipes that terminated before reaching the roof or were located too close to upper story windows, allowing for reentry of radon through an open window.  The plaintiffs’ experts also said that all of the outside mounted fans that were inspected had holes drilled into the pipe under the fan, which caused a loss of efficiency and premature fan failure. In all the homes with unfinished basements that were inspected, none of the floor to wall joints or cracks were sealed. In the opinion of the experts, these and other deficiencies were sufficient to require that all units have radon tests performed.

In October 2010, the trial court certified a class of all current owners of units for negligence, gross negligence, nuisance and assault and battery claims. The court also certified a sub-class against the Condo Association of all current owners of villas for nuisance and trespass claims. The court also denied plaintiffs' motion to certify a class for fraud, consumer fraud, and the remedy of medical monitoring. In May, the appeals court affirmed the class certification. Casale v Segal & Morel et al. 2011 N.J. Super. Unpub. LEXIS 1228 (App. Div. 5/12/11).

Since radon mitigation systems are frequently used for vapor intrusion, this case could provide support for future vapor intrusion litigation.

Brokers Coming Into Cross-Hairs Over Environmental Disclosure

With property values continuing to plummet in the wake of the Great Recession, it is probably not surprising that brokers are increasingly finding themselves embroiled in lawsuits over scope of environmental disclosure. The risk is particularly heightened in states with Property Conditions Disclosure laws. Common issues involve mold, lead-paint, asbestos, radon, poor drinking water quality and leaking home heating tanks.

In an post earlier this year, I discussed how parties in residential transactions in the State of Washington are frequently taking the Ostrich approach when it comes to USTs and ignoring the tank condition for fear of further impacts on property value. Further complicating the issue is that in some states, home inspectors have no obligation to assess condition of heating oil USTs.

Following are some examples of recent lawsuits involving brokers and residential transactions:

Amethyst v. Marcus & Millichap Real Estate , 2011 Cal. App. Unpub. LEXIS 3641 (2nd AppDiv May 16, 2011)(compel arbitration)

Melgardejo v Evans, (8th Jud. Cir. Alachua Cty, Fl)(Complaint)(proximity to superfund site)

Blackmore v Re/Max, 2010 Ida. LEXIS 124 (Id. 2010)

Hall v. Hall, 2010 Mont. LEXIS 401 (Mt. 2010)

Commercial brokers are not subject to the Property Disclosure laws and plaintiffs have to show some contractual or other duty to be able to prevail against a commercial broker. A recent case illustrating this trend is  Movassate v Dudley Ridge Properties, 2011 U.S.Dist. LEXIS 15808 (N.D.Cal. 2/16/11) where the buyer discovered groundwater contamination after taking title to the property.

In New York, many real estate lawyers advise clients selling homes located in downstate counties not to complete the property condition disclosure statement but instead pay the $500 statutory penalty for non-compliance. The lawyers feel it is better for their clients to give the buyer the statutory $500 credit for not preparing the statement rather than risk unlimited liability for common law misrepresentation.

In many states, residential purchasers frequently do not have to retain counsel and simply rely on their brokers. In those states, brokers need to be very careful when preparing the forms.  It would probably be a good idea for brokers to develop relationships with environmental consultants

State Appeals Court Allows Claim To Proceed for Failing To Comply With Property Condition Disclosure Law

Plaintiff entered into agreement o purchase home for $296,900. Seller provided Buyer with a Residential Property Condition Disclosure Statement (PCDS) Report prior to the closing. Buyer did not receive a home inspection report until after the closing though buyer personally inspected home for two hours prior to closing. 

After the closing, the plaintiff learned of a heating oil tank that had been hidden by grass, rotted wood that had been newly painted and discovered termite damage when it removed the pool house floor. Plaintiff spent approximately $38K on repairs and then sold house for $440K for profit of approximately $150K. The plaintiff then sought its out-of-pocket expenses from defendant, claiming defendant had violated the PCDS law and had committed fraud.

On motion for directed verdict, trial court found there was a genuine issue of fact if the seller had disclosed material information that it knew was false, incomplete or misleading.  In addition, the court found the plaintiff had failed to conduct a reasonable examination of the Property and that this failure to review the inspection report violated its duty to exercise reasonable diligence. The court also found the plaintiffs had failed to prove damages because plaintiff had made profit on the sale of home.

Plaintiffs then appealed the PCDS ruling. The appeals court ruled that there were material questions about the reasonableness of plaintiff's inspection and amount of damages that should have gone to the jury.  

Plaintiff made nearly $150K when it sold house 18 months after taking title.  This case seems to fall into the piggish category.  Coake v Burt, 2010 S.C. App. LEXIS 245 (Ct. App. 12/1/10)

Consultants Survive Lawsuit For Negligent Investigation and Remediation of Brownfield Site

Buyer agreed to purchase former oil field in 1996 to develop for residential complex.  Contract included 40 pages detailing  remedial obligations of parties. Buyer had five years to complete investigate of property and inform seller of contamination. If cleanup exceeded $30MM, seller could take over cleanup. Contract also provided that after completion of sellers' corrective action plan, seller will have been deemed to have assigned to buyer any rights seller may have against contractors.

In 1996, buyer retained consultant (consultant 1) to investigate site and Huntington Beach Fire Dept approved remedy to remove lead-contaminated soils. In 1997, Seller retained a second consultant  (consultant 2) for $15K to remove 10 cyds of lead-contaminated soil. Later that year, seller advised the buyer that its costs were approaching $30MM threshold and that seller intended to take over cleanup to better manage costs. During soil excavation performed by the second consultant, additional lead-contaminated soil was discovered approximately 15 feet from prior excavation area. The seller then retained consultant 2 to excavate and dispose oil-contaminated soil.

Buyer claimed it had suffered $3MM in costs and sued consultant 1 for breach of consultant and negligence. Using a six-part test employed by California courts for determining if a duty exists to third parties who are not in contractual relationship with the alleged wrongdoer, the court found consultant owed no duty to buyer. The court said the first consultant had been retained by the seller and that buyer did not have right to enforce the contract as a third party beneficiary because the contract did not disclose that the seller was not the property owner. Moreover, the court said the first consultant had excavated the specific contaminated area provided in the contract and had no obligation to investigate other areas of the site. The court also noted that the buyer had the opportunity to review the work being done by the consultants and it should not be rewarded for failing to audit this work. Finally, the court said that imposing a $3MM liability on the consultant for a $15K project would not be in the public interest since such disproportionate liability would discourage consultants from engaging in such work.

This case is particularly important to purchasers, developers or lender who are relying on another party to investigate and remediate a major development site. In such instances, it is important that the "passive" party retained its own expert to actively supervise the work.

Makallon Atlanta Huntington Beach LLC v Chevron Land and Development Company, 2011 Cal. App. Unpub. LEXIS 1911 (Ct. App. 3/14/11)

Beware Those Arbitration Clauses

Transacting parties frequently provide for arbitration clauses in their agreements to resolve disputes. While these clauses can be useful they can  impair a party's ability to seek judicial relief if not carefully drafted. Such an example  was HH East Parcel, LLC v Handy & Harman, 287 Conn. 189 (2008).

In this case, the plaintiff purchased a former precious metals manufacturing facility located in Fairfield, Conn. for $8 million in December 2003. Under the purchase and sale agreement, the defendant was required to demolish all existing buildings and structures to complete remediation by December 31, 2004. The purchase agreement contained a per diem clause that required the defendant to pay the plaintiff $5000 for each day after December 31, 2004 that the defendant failed to complete the demolition and remediation as specified therein

After the defendant failed to complete the remediation by the required date, the parties entered into an environmental indemnification agreement where the defendant agreed to indemnify the plaintiff for the losses caused by the defendant's failure to complete the remediation. The indemnification agreement contained an arbitration clause that provided that any disputes between the parties regarding their respective obligations would be resolved by expedited, binding arbitration in accordance with the rules of the American Arbitration Association.

In April 2005, the plaintiff invoked the arbitration clause. At the arbitration proceeding, the defendant did not dispute its liability for breach of the purchase agreement but disputed the validity of the $5000 per Diem clause, claiming it was an unenforceable penalty. The plaintiff argued the per diem clause was a valid liquidated damage and the arbitrator agreed, finding that the damages resulting from the breach of the contract would be difficult to estimate or provide, that the parties had intended to liquidate any resulting damages, and that the amount agreed upon in the contract was not unreasonable. As a result, the arbitrator awarded the plaintiff a total of $1,670,000 in damages. The arbitrator also ordered the defendant to pay the plaintiff 6% interest on all unpaid per diem charges, and to fund and complete the demolition and remediation of the property without delay.

The defendant appealed the decision, arguing that the arbitration award violated public policy. The trial court noted that while it was required to review the award de novo, it was obligated to defer to the arbitrator’s factual findings and interpretation of the underlying contract. The court then reviewed the record to determine if the arbitrator’s findings were supported by the substantial evidence. The court concluded that the arbitrator had properly concluded that the purchase agreement contained a valid liquidated damages clause. The trial court said the arbitrator’s findings were supported by the negotiated nature of the per diem charge and the difficulties of ascertaining economic loss because of the fluctuating liens on the property and determining how long the remediation would take.

The defendant appealed, contending that the trial court improperly deferred to the arbitrator’s findings. The Connecticut Supreme Court affirmed, noting that the substantial evidence test is highly deferential and provides for a lower level of judicial scrutiny that a clearly erroneous or weight of the evidence standard of review. The court then went on to say that a clause fixing damages for a contractual breach may be a permissible liquidated damages clause when three conditions are satisfied: (1) The damage to be expected as a result of a breach was uncertain in amount or difficult to prove; the parties intended to liquidate damages in advance; and (3) the amount stipulated was reasonable so that it was not greatly disproportionate to the amount of the damage the parties envisioned would be sustained in the event of a breach of the contract.

In reviewing how arbitrator applied these principles to his factual findings, the court noted that the arbitrator had credited the testimony of the defendant's negotiator who had testified that he had initial proposed liquidated damages of $1500 during the negotiations, and then increased the amounts to $2500 before finally agreeing to $5000 with the date commencing 180 days later than the parties had originally contemplated. The arbitrator also relied on the testimony of the plaintiff's negotiator who testified that the plaintiff expected to earn $5000 per day from the property so the per diem amount was a valid proxy for damage caused by inability to use the asset acquired and the anticipated rate of return. The court also noted that the arbitrator concluded that liquidation of damages was appropriate because the party in breach retained the power to stop the damages by remediating the property.  The court said the clause was actively negotiated by sophisticated parties that had ample assistance of counsel. Finally in response to the assertion that the clause was an illegal penalty because the parties had consistently characterized it through the negotiations as a hammer or penalty, the court said it was well settled that whether a clause is a valid liquidated damage provision is a matter of the parties' intent and is not controlled by the fact that the phrase “liquidated damages” or the word “penalty” is used

Insurer of Cost Cap Policy May be Liable for Consequential Damages

In Handy & Harman v American International Group, et al, 2008 N.Y, Misc. LEXIS 7522 (Sup. Ct.-NY Cty 8/26/08), plaintiff operated a large precious metals manufacturing facility in Fairfield, Connecticut. In December 2003, plaintiff entered into an agreement to sell the property. The agreement required the plaintiff to demolish the existing structures and complete remediation within a year. In April 2004, plaintiff purchased a $2MM Cost Cap Insurance policy that had Self-Insured Retention of $4,739,030. The policy contained coverage for known contamination (Coverage K) and Unknown Pollution (Coverage L). The policy also contained coverage for third party claims with an aggregate value $10MM (Coverage A).

The policy contained an endorsement that excluded from Coverage A claims arising from Pollution Conditions that were subject of an approved Remedial Plan or that were otherwise covered under Coverages K or L but for the erosion of the SIR, exhaustion of the applicable limit of liability, or termination of coverage under Coverage K or L. However, the endorsement also provided that the exclusion did not apply to Pollution Conditions that were not related Pollution Condition which covered under Coverages K or L.

The plaintiff commenced remediation under the Remedial Action Work Plan and after it exceeded the SIR, defendant accepted coverage under Coverage K. The defendant paid the cost overruns up to the Coverage K policy limit of $2MM. In December 2004, plaintiff’s contractors discovered a previously unknown layer of materials beneath clean fill and a previously unknown underground storage tank filled with debris. The contractor also discovered contamination below a previously unknown foundation. The Connecticut Department of Environmental Protection (CTDEP) instructed the plaintiff to remediate the newly discovered contamination and plaintiff sent the CTDEP letter to defendant as notice of a Claim.

AIG claims adjuster sent a letter to plaintiff denying coverage under Coverages K and L on the ground that the coverage limits had been exhausted. One month later, the claims adjuster also denied coverage for Coverage A on the basis of the endorsement. In response, Plaintiff pointed out the defendant had overlooked the language in the endorsement that the exclusion would not apply to Pollution Conditions that were not the same or related to the contamination in the Remedial Action plan but would have been covered under Coverage K or L but for the exhaustion of the applicable limit of liability. The defendant advised plaintiff that the CTDEP letter was not a "Claim" because it did not constitute a demand. The defendant also stated that Coverage A did not apply because the pollution conditions were not unrelated to those that would have been covered under Coverages K or L.

After further correspondence did not resolve the dispute, plaintiff commenced an action for breach of contract and breach of the covenant of good faith and fair dealing. On defendant’s motion to dismiss, the court dismissed the tort claim for breach of the duty of good faith but refused to dismiss the claim for consequential damages, and that the request for attorneys' fees in the prosecution of this action is dismissed. The court said the purpose of the policy was to ensure that the business conducting the remediation had the financial resources to conduct and finish the remediation if the costs exceeded the SIR and to pay third-party claims for clean-up costs. The court said the plaintiff purchased the insurance so that it could avoid financial pressure on its business for funding the remediation. Plaintiff bargained for this policy not only so that it could be paid the policy amount, but so that it also could have "the peace of mind, or comfort, of knowing that it will be protected in the event of a catastrophe. Under the circumstances, the court said, it should have been foreseeable and understood by the defendant that it would have to respond in damages for damages to plaintiff's business if it breached its obligations under the contract. For example, the court pointed out, the site was being remediated for the purpose of redeveloping the site. By delaying and failing to investigate,  plaintiff contended that the site was further on the road to redevelopment and no longer open or easily inspected, resulting in further foreseeable harm in the form of increased costs and difficulty of proof. Thus, the court said the plaintiff had sufficiently pled that consequential damages were within the contemplation of the parties as a probable result of the breach of the policy.