Court Case Finds That A Lender’s Environmental Indemnity Agreement Did Not Cover Certain Costs Commonly Incurred By A Lender Following A Loan Default

In the recently decided case of VFC Partners 26, LLC v. Cadlerocks Centennial Drive, LLC, 735 F.3d 25 (1st Cir. 2013), the First Circuit Court of Appeals considered whether a lender was entitled to recover certain costs associated with environmental testing of a property under an environmental indemnity agreement. The borrower owned a mixed-use commercial and industrial property occupied by a daycare center and other tenants. The borrower entered into a loan secured by a mortgage, together with a separate assignment of leases and rents, an exceptions to non-recourse guaranty, and an environmental indemnity agreement. The indemnity agreement provided that the borrower would indemnify the lender "from and against all ... costs, ... demands, ... expenses" and other liabilities "of any kind or nature whatsoever ... sought from or asserted against" the lender in connection with the presence, release, or suspected presence or release of any hazardous material on or around the property. It further listed seven specific categories of liability, including "the cost required to take necessary precautions to protect against the release of any Hazardous Materials" in, on, or under the property.

The original lender conducted an environmental assessment prior to the closing of the loan which revealed the possible presence of PCE, a known carcinogen. The original lender later assigned the mortgage and all related loan documents and agreements to Wells Fargo Bank. The borrower then defaulted on the loan. Prior to foreclosure or taking a deed in lieu of foreclosure, Wells Fargo engaged in further environmental testing of the site. The tests identified the presence of small amounts of PCE in the soil and in the air, although none of the tests showed concentrations at hazardous levels. The lender unsuccessfully sought reimbursement for the cost of the tests from the borrower and then filed suit alleging breach of the various agreements related to the loan. The District Court held that, under the indemnity agreement, the lender was entitled to recover the majority of the costs associated with its environmental testing. The District Court did not award the lender the costs of the original testing since such testing was conducted as part of the lender's routine pre-closing due diligence, not in response to suspected environmental hazards. The District Court held the borrower liable for the lender's subsequent post-default testing costs, which were "reasonable...

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