A Delicate Balance – Environmental liability in commercial leases

A recent court case highlights how seemingly innocuous decisions, rather than the more obvious overstating square footage, in real estate transactions can create major liabilities. The case looked to see whether a lessee was responsible for a share of the commercial property owner’s remediation costs after the sublessee’s dry cleaning machine leaked chemicals into the ground during a fire. The federal court ruled that the lessee would not be held liable unless there were sufficient indicia of ownership.

The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) creates liability for owners of contaminated property, among other classes. While a lessee that only subleases the property is generally not an “owner,” the lessee can be liable if it acts as a de facto owner.

The factors that create the “indicia of ownership” are:

  • The length of the lease and the control the owner retains over the property use
  • Whether the owner can terminate the lease before the term ends
  • Whether the lessee can sublease the property without owner notice or approval
  • Whether the lessee pays property costs (taxes, insurance, operation and maintenance costs, etc.)
  • Whether the lessee makes structural repairs on the property

As a result of the short lease term (20 years) and the property owner retaining traditional rights of ownership, limiting property uses, having termination right, paying some taxes, and making structural repairs, the District Court found the lessee was not a de facto owner of the property. Interestingly, the lessee’s right to sublease the property without notice to the owner did not shift any of the liability, but a lease term of 99 years may have.

Rather than simply protecting sublessors from environmental liability caused by sublessees, this decision highlights just how imperative it is to completely understand what is at stake in real estate transactions. When a lessee decides to move its operations and sublease the space to save money, the difference between environmental liability and none may be a longer lease term and no ability for the owner to terminate the lease. For a property owner, allowing sublease without requiring prior approval may result in far more environmental liability than anticipated.