Out of the Past: Poorly Drafted Indemnity Agreements Can Expose Transferors to Unexpected Future Liability for Past Operations

Recent announcements regarding the construction of major processing facilities, such as Sasol's announcement regarding its plans for an integrated gas-to-liquids and ethane cracker complex near Lake Charles (discussed in a prior post), bring to mind legal issues that have arisen in connection with such facilities in the past.  One such issue has to do with the potentially unforeseen problems with indemnity arrangements entered in connection with the transfer of such facilities.

Indemnity, of course, is an important issue when an industrial facility is sold or otherwise transferred.  This is true even of a well-run facility.  Often, after the passage of years and advances in scientific knowledge, practices that once were considered industry standard turn out, in retrospect, to have been harmful.  For this and other reasons, companies that transfer facilities often require indemnity from their transferees or demand that the transferee assume the transferor's environmental liability.  The transferor thus obtains some certainty by cutting off potential future civil liability for its past operations at the facility.  Or so it thinks.

In Louisiana, there are two basic types of obligations and corresponding rights:  real and personal.  Joslyn Mfg. Co. v. Koppers Co., 40 F.3d 750, 755-56 (5th Cir. 1994); see La. Civ. Code arts. 1763-1766.  A real right "is a right in a thing that can be held against the world."  La. Civ. Code art. 1763, cmt. b (1984) (emphasis added) (citing 1 Yiannopoulos, Property 380 (2d ed. 1980)).  The corresponding real obligation is said to "attach to the thing," or "run with the land."  See La. Civ. Code art. 1764, cmt. b (1984).  This means that the real obligation is automatically transferred to a person who acquires the property to which the real obligation is attached.  See La. Civ. Code art. 1764; Joslyn Mfg., 40 F.3d at 756.

A personal right, on the other hand, is the legal power that one person has to demand a performance from another person.  See Joslyn Mfg., 40 F.3d at 756 (quoting Yiannopoulos, La. Civ. Law Treatise, Property § 203, at 370 (3d. Ed. 1991)).  Unlike with real obligation, when property is transferred, the transferee does not assume his transferor's personal obligations with respect to the property.  See La. Civ. Code art. 1764; Joslyn Mfg., 40 F.3d at 756.

Because an obligation created by agreement is considered personal in the absence of some affirmative indication that it is intended to create a real obligation upon the land itself, an indemnity or assumption of liability usually only creates a personal obligation on the direct transferee unless the transferor is careful to include specific language evidencing an intent to create a real obligation that runs with the land.  See Joslyn Mfg., 40 F.3d at 757.  This can create unforeseen problems for a company that transfers a production facility and negotiates liability protection from its transferee.

In re El Paso Refinery, LP, 302 F.3d 343 (5th Cir. 2002), a case applying Texas-law principles somewhat similar to those discussed above, illustrates the potential problem.  Texaco operated a refinery in El Paso, Texas from 1929 until 1984, when it transferred the facility to a subsidiary, TRMI Holdings, Inc.  Id. at 346.  As part of the transaction, TRMI assumed all environmental liability with respect to the facility.  Id.  Two years later, TRMI sold the facility to El Paso Refinery, L.P.  Id.  The transaction documents included covenants that purported to prevent any subsequent owner from seeking contribution from TRMI or compelling TRMI to take any remedial action.  Id.

El Paso Refinery later filed for bankruptcy.  Id.  A group of creditors ultimately acquired the refinery, and gave notice of their intent to assert environmental and contribution claims against TRMI and Texaco.  Id. at 347.

As one of its defenses, TRMI asserted the covenants it secured when it transferred the facility to El Paso Refinery.  Id. at 354.  After analyzing those covenants, however, the Fifth Circuit concluded that they did not qualify under Texas law as "real covenants" that run with the land and bind subsequent owners.  Id. at 356-57.  They were only personal covenants that did not bind subsequent acquirers and thus did not preclude the present refinery owner's claims against TRMI or Texaco.

Of course, even where an indemnity provision does not create a real right/obligation, the transferor may still have a personal right to indemnity or other protection from its direct transferee.  That personal right is of no value, however, when the direct transferee is defunct or — as in In re El Paso Refinery — insolvent.

The In re El Paso Refinery case is an example of how a company that transfers a processing facility might not obtain the full measure of protection from future civil liability that it thought it bargained for.  Companies transferring facilities would be wise to carefully negotiate and draft the indemnity and other provisions they create to shield themselves from future liability.

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