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Appellate Division Case Demonstrates Importance of Carefully Negotiated Escrow Agreements

Real estate transactions involving commercial and residential properties frequently employ the use of escrow agreements to address potential environmental issues.  This practice is widespread in New Jersey and it permits properties that may have environmental issues to go to closing without first accomplishing a cleanup.  This practice is good for the buyer, good for the seller, and, in general, good for the community because it is one way to reduce the warehousing of blight and dormant properties.

These escrow agreements are often used in cases where contamination is determined to exist following a Phase I or Phase II environmental assessments.  In New Jersey, we frequently refer to pre-purchase environmental investigations as a preliminary assessment (“PA”) and a site investigation (“SI”), but for the purpose of this discussion these concepts are the effectively the same.  Both assessments are pre-purchase investigations to determine the likelihood that an environmental issue will have to be addressed post-closing.

Buyers and sellers must be very careful when they are drafting the language for these escrow agreements.  Escrow agreements are nothing more or less than contracts and they will be interpreted by a reviewing court in the same manner that contracts are interpreted.   In other words, a court will not impose obligations on either party that were not contained or clearly anticipated in the contract.  Therefore, these agreements must be very clearly written.

The need for drafting exactness was discussed in the recent Appellate Division decision of Moretran Realty, LLC v. Baldev Patel & Son, LLC, 2017 N.J. Super. Unpub LEXIS 2121 (App. Div. Feb. 17, 2017).  This case involved a real estate transaction concerning a property that seemed to have numerous potential environmental issues.  However, the escrow agreement applied only to two underground tanks that were identified with specificity, and some other contamination that may have been coming from a nearby U-Haul facility.  The agreement provided that the escrow  funds were to be released in either six months or upon U-Haul’s acceptance of cleanup cost responsibility, if that acceptance took place sooner.

As it turned out, this language worked well for the seller.  U-Haul never accepted responsibility and the two identified tanks did not require remediation.   At the conclusion of the six months, the purchaser refused to allow the escrow proceeds to be released to the seller because there were seemingly legitimate concerns about other potential contamination, none of which had anything to do with the escrow agreement.

Not surprisingly, the Appellate Division held that the funds had to be returned to the seller based on a clear reading of the escrow agreement.  Conceivably, the purchaser might have to pay for cleanup costs that more fairly should have been paid by the seller, but the narrow language of the agreed to escrow agreement controlled.  An expensive but good lesson for all of us.

Real estate transactions can be prolonged and costly, sometimes prompting parties to take shortcuts to get to closing.  However, if an environmental escrow needs to be formed, much care must be taken in drafting the agreement.  The purchaser is generally the one looking for post closure protection.  The fundamental questions that need to be asked are: Is the agreement broad enough to anticipate environmental problems that may arise?  Is the term of the agreement long enough to give time for these problems to be revealed and/or resolved?  Is the escrow adequately funded?

Undeniably, parties can get testy during contract negotiations and pressure to reach a signed contract normally exists.   No matter what, the environmental escrow agreement must be carefully tailored, because a reviewing court will not give you a better deal than the one you reached during contract discussions.

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