Type: Law Bulletins
Date: 08/10/2010

Five Steps to Protect Your Business from Being Liable for Your Supplier's or Distributor's Environmental Contamination

We’re often asked how can a business limit its liability exposure for the cost to clean up environmental contamination when entering into supplier/distributor agreements where it’s possible, maybe even likely, that some environmental contamination will result from the supplier’s manufacturing or distributor’s handling of the product?  This has been the subject of several recent cases which provide guidance on the preventative steps a business can take to protect itself.  This article describes two of the recent cases that examine liability under the federal Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) and the Clean Water Act (CWA) and lists five steps every business should consider to limit its liability exposure for a supplier’s or distributor’s environmental contamination. 

Summary of Cases

CERCLA Arranger Liability.  In Burlington N. & Santa Fe Ry. Co. v. United States, 129 S.Ct. 1870 (2009) (hereafter BNSF), the United States Supreme Court addressed this issue in the context of “arranger liability” under CERCLA.  CERCLA imposes strict liability for past and future response costs to clean up environmental contamination on four broad categories of potentially responsible persons, “PRPs,” including “arrangers.”  Arrangers are defined by statute as “any person who by contract, agreement, or otherwise arranged for disposal or treatment … of hazardous substances.”  42 U.S.C. § 9607(a)(3). 

As the Court explained in BNSF, arranger liability would plainly attach to a business if it were to enter into a transaction for the sole purpose of discarding a used and no longer useful product containing hazardous substances.  At the other extreme, the Court said it was similarly clear that no arranger liability would exist if a business was merely selling a new and useful product if the purchaser later, and unbeknownst to the seller, disposed of the product in such a way that led to contamination.  The facts in BNSF required the Court to address the gray area in between the two extremes, where the seller has some knowledge of the buyer’s planned disposal or where the motives for the “sale” are less clear.  The Court explained that cases falling into this gray area require a “fact-intensive inquiry that looks beyond the parties’ characterization of the transaction as a ‘disposal’ or a ‘sale’ and seeks to discern whether the arrangement was one Congress intended to fall within the scope of CERCLA’s strict-liability provisions.”  BNSF, at 1879.

In BNSF, the Government sought to hold Shell Oil Company and others liable to pay contribution costs toward the more than $8 million in costs the Government incurred to clean up contamination from an agricultural chemical storage and distribution facility.  Shell manufactured pesticides containing hazardous substances that were supplied to this distribution facility.  The evidence showed that Shell knew that spills and leaks occurred when its pesticides were transferred to storage tanks at the facility.  The Government latched onto this fact and argued that CERCLA’s definition of “disposal” included spills and leaks under 42 U.S.C. § 6903(3), so that Shell’s knowledge of the distributor’s spills and leaks resulted in arranger liability under CERCLA. 

The Supreme Court rejected the Government’s reasoning.  The Court held that “While it is true that in some instances an entity’s knowledge that its products will be leaked, spilled, dumped, or otherwise discarded may provide evidence of the entity’s intent to dispose of its hazardous wastes, knowledge alone is insufficient to prove that an entity ‘planned for’ the disposal, particularly when the disposal occurs as a peripheral result of the legitimate sale of an unused, useful product.  In order to qualify as an arranger, Shell must have entered into the sale of [its product] with the intention that at least a portion of the product be disposed of during the transfer process by one or more of the methods described in 6903(3).”  BNSF, at 1880. 

The evidence showed that while Shell was aware that minor, accidental spills occurred during the transfer of pesticides to storage tanks, it did not intend or arrange for such spills and it took numerous steps to encourage its distributors to reduce the likelihood of such spills.  These steps included providing distributors detailed safety manuals, requiring them to maintain adequate storage facilities, providing them discounts for implementing safety precautions, having the distribution facilities inspected by a qualified engineer, and requiring distributors to provide a self-certification that they were complying with certain laws and regulations.  For these reasons, the Supreme Court rejected the Government’s arranger liability claim. 

CWA Liability.  In Assateague Coastkeeper v. Hudson Farm, 2010 WL 2924661  (D. Md. 7/21/2010), an environmental group and others filed a citizen suit under the Clean Water Act for penalties and injunctive relief for alleged discharges of manure from Hudson Farm into a field ditch that emptied into a branch of the Pocomoke River.  Hudson Farm operated an 80,000-bird poultry farm under contract with Perdue Farms, Inc.  Hudson Farm supplied poultry to Perdue, which was known in the industry as an “integrator.”  The environmental group alleged that Hudson Farm violated the CWA by either illegally discharging contaminants without an appropriate permit or in violation of a permit.  Section 301(a) of the CWA, 33 U.S.C. § 1311(a), prohibits the discharge of any pollutant by any person from a point source into navigable waters of the United States, unless pursuant to the terms of a National Pollution Discharge Elimination System (NPDES) permit issued under Section 402 of the CWA, 33 U.S.C. § 1342.  The environmental group alleged that combined animal feeding operations (CAFOs), like Hudson Farm, are point sources under the CWA, subject to NPDES permit requirements.  Further, regulations prohibit any discharge of manure, litter, or process wastewater from the production area of a CAFO into waters of the United States.  40 CFR § 412.43(a)(1).

However, the twist was that the environmental group also asserted CWA claims against Perdue.  The environmental group argued that Perdue was just as culpable as Hudson Farms for the illegal discharges because it controlled Hudson Farm’s operations.  The United States District Court for Maryland reasoned that CWA liability may exist for both the party who performed the work resulting in the discharge as well as the party responsible for and having control over the work.  2010 WL 2924661, at *8.  The district court then denied Perdue’s motion to dismiss the environmental group’s claims because Perdue allegedly controlled nearly every aspect of Hudson Farm’s operations, including supplying breeder birds, owning their offspring, supplying all feed, fuel, and medications, and specifying barn design and climate control.  Id. at *9. 

Summary of Action Items

Based on the case law and other experiences, a business should take the following actions to avoid being found liable for a supplier’s or distributor’s environmental contamination: 

  1. Provide accurate instructions and detailed safety manuals to distributors and your customers on the proper use, handling, and disposal of your product.  Make sure that you provide the foregoing materials with each sale and retain documentation to prove that the instructions were provided.
  2. Require your supplier and distributor to have adequate storage and operation facilities to avoid accidental releases.  Perform periodic site inspections, or at least review pictures of your supplier’s and distributor’s facilities, to make sure they are adequate, and require that they have adequate storage and work facilities to carry out their operations. 
  3. Require your supplier and distributor to follow all applicable laws and employ best environmental practices.  Ask your supplier and distributor for periodic updates as to their compliance with applicable environmental laws and consider conducting, or having the supplier and distributor submit, periodic site inspection reports that provide a basis for you to believe that they are following the law and employing best practices.  You could even require, as Shell did in BNSF, that the supplier and distributor undergo periodic site inspections by an independent and qualified inspector. 
  4. Build strong contracts.  Make sure that your contracts obligate your supplier and distributor to take the above actions and adequately protect you if they fail to do so.  These steps include incorporating into your contract strong release, hold harmless, and indemnification provisions that require your supplier and distributor to step up and defend and indemnify your business from any claims.  Avoid any “battle of forms” issues by requiring that your contracts control over boilerplate terms in your supplier’s or distributor’s purchase order forms.  Include forum and choice of law requirements so that you know with certainty where and under whose law your contract will be governed.  Additionally, always consider the creditworthiness of your supplier and distributor to evaluate how much their promises are worth. 
  5. Be named an additional insured under your supplier’s and distributor’s liability insurance policies.  Require that your supplier and distributor maintain adequate insurance coverage and that you be named as an additional insured/loss payee on such policies, with no cancellation right unless you receive at least 10 days prior notice.  Just as important, make sure you request, receive, and keep copies of the insurance policies and declaration pages showing that you are listed as an additional insured in case a dispute occurs decades down the road.

To strengthen your supplier/distributor agreements, please contact Bill Wagner, Brad Schwer, or any member of Taft’s Environmental Practice Group or Business and Finance Practice Group. 

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