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.

Ct Rules Costs Eligible For Reimbursement Under Cost Cap Policy Must be Paid Prior to Termination Date

In Federal Insurance Company, v. Cherokee Ardell, LLC., et al 2011 U.S. Dist. LEXIS 32516  (D.N.J. 3/28/11), the shareholders of Ardell Industries, Inc. ("Ardell") entered into an agreement in 1989 to sell the American Razor Blade Corp. ("ARB") site to Ardell Acquisition Corporation. The contract was then assigned to American Safety Razor Company ("ASR"), a company affiliated with Ardell Holdings, Inc. The transaction triggered the requirements of what was then known as the New Jersey the Environmental Cleanup Responsibility Act ("ECRA") (n/k/a the Industrial Site Recovery Act ("ISRA"). Because the site was contaminated, Ardell entered into an Administrative Consent Order ("ACO") with the NJDEP to allow the sale to proceed.

In 1996, ASR and Ardell filed insurance claims with Federal Insurance Company ("Federal") to recover their cleanup costs. Federal subsequently entered into a Settlement Agreement and Release whereby Federal assumed responsibility for the remedial environmental cleanup of the contaminated. Federal then retained the services of Cherokee Environmental Risk Management ("CERM") to assist with the investigation and remediation of the Site. In May 1998, Federal and CERM entered into an agreement ("1998 Remediation Agreement") whereby CERM created an entity Cherokee Ardell, L.L.C. ("Cherokee") to assume responsibility for the cleanup. Pursuant to the 1998 Remediation agreement, Cherokee obtained two insurance policies from American International Specialty Lines Insurance Company ("AISLIC"). The first policy was a $2MM Cleanup Cost Cap Policy with a term of ten years and a Self-Insured Retention ("SIR") of $766,015. The second policy was a Pollution Legal Liability Select Policy (“PLL”) with a limit of $2MM per incident and aggregate limit of $5MM. Federal was named as an additional insured in both policies.

In May 2001, Cherokee notified AIG Domestic Claims, Inc. ("AIGDC") that the clean-up costs under the Cost Cap Policy were approaching the SIR. AIGDC informed Cherokee of acceptance of coverage under both policies. However, by 2006 the remediation had still not been completed. ASR notified Federal that ASR dissatisfied with the pace of the remediation project and that ASR was receiving pressure from NJDEP. ASR then sent a second letter claiming that Federal was in breach of the 1996 Settlement Agreement. Cherokee forwarded these letters to AISLIC and submitted a notice of claim under the PLL policy based on the potential ASR lawsuit. In December 2006, AISLIC accepted coverage under the PLL Policy subject to a reservation of rights.

In August  2007, ASR sent Federal a draft of a complaint, alleging breach of contract, breach of duty of good faith, and violation of the New Jersey Environmental Rights Act. Federal forwarded the draft complaint to Cherokee and AISLIC. Federal then independently settled with ASR  In October 2007, AISLIC notified Federal and Cherokee that it was withdrawing its acceptance of defense because the claims in the ASR Letters fell outside the definition of “Loss” as defined in the PLL Policy. A week later, Federal terminated the 1998 Remediation Agreement with Cherokee and retained the services of Shaw Environmental Corp. ("Shaw") to take over the remediation project.

In June 2008, Federal filed a breach of contract action against Cherokee and sought indemnification under the policies from AISLIC. Cherokee also filed a cross claim against AISLIC for indemnification. AISLIC then filed a motion for partial summary judgment claiming that it was not obligated to reimburse Federal or Cherokee under the Cost Cap Policy. Federal and Cherokee sought summary judgment on their PLL claims.

At the time of the lawsuit, AISLIC had reimbursed Cherokee a total of $594,375 under the Cost Cap Policy and had not issued reimbursements for expenses under the PLL. AISLIC argued that the $928,103 sought by the Federal and Cherokee were incurred after the Termination Date and therefore not covered. AISLIC additionally argued that Federal and/or Cherokee failed to satisfy the condition that Cleanup Costs be reported prior to the Termination Date.

In contrast, Federal and Cherokee argued that under the Cost Cap Policy, AISLIC had a "continuing duty" to indemnify for costs that were "first incurred" before the Termination Date even if the costs were expended and paid after that date. They noted that since the operative word used in Coverage A was "incurs" rather than "pays" or "expends," a precise reading of the policy meant that an insured does not have to actually pay for the costs and expenses but rather only become liable to pay for the costs during the policy term. They also argued that the Cost Cap Policy is a traditional claims-made insurance policy where the policy payment obligation is triggered by the insured's claim for coverage rather than the insured parties' payment of expenses.

The court agreed with AISLIC, ruling that that the Cost Cap Policy covered only those expenses which Federal and Cherokee incurred, expended, paid for and reported within the policy period. The court said that from a plain reading of the Coverage A language as a whole and in conjunction with the definition of the term "Loss," it was clear that the Cost Cap Policy covered only those expenses which Federal and Cherokee incurred, expended, paid for and reported within the ten-year policy period

With respect to PLL Policy, Federal and Cherokee asserted that the 2006 ASR claims gave rise to a “Loss” and additional Clean-Up Costs related to compliance with the ACO and ECRA. However, the Court found that there was a question of fact whether Federal and Cherokee were “legally obligated” by statute or governmental order to pay expenses based upon the claims brought by ASR. Instead, the Court found that the nature of costs sought by Federal appeared to arise from its contractual agreement with ASR to remediate the site and not directly from environmental laws. Thus, the court denied Federal’s cross-motion for summary judgment

Federal subsequently filed a motion for reconsideration. Following a denial of that motion, the parties settled the case.  

State Appeals Court Affirms Damage Award Against Bank for Sale of Contaminated Property

A New Jersey

Appeals Court

refused to disturb a $248,928 damage award against a bank involving a sale of contaminated property. The plaintiff had argued that the trial court had erred in calculating the damages flowing from the bank’s breach of contract.  

In Ritschel v. Spencer Savings Bank, SLA, 2011 N.J. Super. Unpub. LEXIS 1257 (May 16, 2011), Spencer Savings Bank had acquired a 2.78 acre vacant lot in 1990 in Fairfield Township. The parcel had been previously used by a general contractor and the bank had planned to construct a new corporate headquarters at the site. When the economy stalled, the bank decided not to develop the site. It is unclear what level of environmental due diligence the bank performed prior to acquiring the site. 

In January 2001, the plaintiff signed a contract to buy the land for $1.22MM. The plaintiff intended to erect a 32,000 sf commercial building that was projected to cost $3.6 million. During its due diligence, the plaintiff learned several diesel had been removed in the mid-1980s but no documentation was available. As a result,  the plaintiff performed a phase 2 which revealed elevated levels of VOCs. The phase 2 estimated that 60-90 tons of soil would have to be excavated at a cost of approximately $33K.

The plaintiff advised the bank of the contamination who initially offered to give the plaintiff a $33k credit against the purchase price in exchange for an indemnity in favor of the bank. The plaintiff rejected this proposal and after a period of negotiation, the parties executed an amendment to the contract that was drafted by special environmental counsel retained by the bank. The amendment provided that the bank would undertake and complete the remediation of the Property at its sole cost and expense in accordance with a remedial action plan approved by the New Jersey Department at Environmental Protection (“NJDEP”) and would obtain an NFA Letter from NJDEP.  In exchange for the bank’s promise to assume responsibility for the remediation, plaintiff agreed to waive his right to terminate the Agreement.

While these negotiations were taking place, the plaintiff entered into three leases with prospective commercial tenants including a day care. While the leases were executed, they did not have a commencement date since it was unknown when the remediation would be completed, the site sold and construction completed.

Following the contract amendment, the bank retained an environmental consultant to implement the remediation.. During the pre-remedial sampling, the bank’s consultant discovered the extent of the soil contamination significantly exceeded the original estimate. The remediation cost was estimated to approach $600,000. The bank believed it was only obligated to implement the limited remediation to address the contamination originally identified by Plaintiff’s environmental consultant. However, Plaintiff believed that Defendant agreed to remediate the entire property no matter what the cost and rejected the offer to perform a limited remediation because of the proposed daycare lease.

After the plaintiff rejected the bank’s offer to complete the limited remediation, the bank’s counsel notified plaintiff it was terminating the agreement pursuant to the section of the agreement requiring the bank to deliver good and marketable title despite the fact that Plaintiff's counsel had performed a title search and no objections.

Plaintiff filed its lawsuit, alleging the bank had breached the contract when it failed to complete the remediation.  After an eight day trial, the court ruled defendant had breached the contract and initially awarded plaintiff damages of $484,671, consisting of $98,000.00 in lost profits and $386,671.00 in out-of-pocket expenses for the cost of extra rent, architects’ fees, permit fees, site plans and attorneys fees.

After a dispute arose over the calculation of the damages, the court reduced the damage award to $248,928.61, consisting of $181,876,75 in out-of-pocket expenses and $67,051.89 in prejudgment interest. The plaintiff then appealed, arguing the trial court had improperly rejected its theory of damages but the appeals court affirmed.