Third Quarter 2005

Landlord May Recover Loss of Use Damages for Uncertainty

Holland & Knight Newsletter
Bonni F. Kaufman

On June 28, 2005, the United States Court of Appeals for the Third Circuit decided Jaasma v. Shell Oil Company, (No. 02-CV-4677), a case with important implications for owners and lessees of environmentally impacted properties. The Court determined that a landlord could recover loss of use damages from its tenant during the time period after the property was cleaned up but before the issuance of a final No Further Action (NFA) letter from the regulatory agency. In this case, it took the State of New Jersey over two years after sampling was conducted to approve a cleanup and issue a No Further Action letter for the property. During that time period, the landlord claimed that it could not sell or rent the property at its fair market value. The Court found that the landlord could recover damages for the “period of uncertainty which may occur after the cleanup is physically completed, but before the property has been certified as compliant with all environmental regulations.” Slip Opinion at 14.

Facts

The landlord, Alice Jaasma, owned a 1.3 acre parcel in West Paterson, New Jersey, which she leased to Shell Oil in 1988. The lease contained provisions requiring Shell and its assignee to remove all gasoline, waste oil and fuel oil tanks from the premises upon termination and restore the property to its original state. In addition, the lease required Shell to comply with all applicable environmental laws and indemnify the lessor against any claims arising out of violations of environmental laws or any contamination attributable to Shell.

In October 2001, one week before the end of the lease, Shell removed its underground storage tanks and discovered petroleum contamination adjacent to the tanks. Three months after the lease terminated, Shell prepared an Underground Storage Tank Closure Remedial Action Investigation Report that indicated that the tanks had been removed and that 6,500 tons of soil was removed and replaced with clean fill.

In April 2002, the New Jersey Department of Environmental Protection (NJDEP) acknowledged receipt of the report but requested re-sampling of the property due to technical deficiencies in the sampling. The sampling was not completed until September 2003. NJDEP issued a final NFA letter in February 2004, almost three years after the original cleanup, stating that the groundwater and soil met the applicable environmental standards and no further action was required.

Legal Analysis

In its claim, the landlord did not dispute that the contaminant levels were actually compliant with environmental standards as of October 31, 2001. However, she alleged that due to the ongoing NJDEP review and the uncertainty surrounding the environmental status of the property, she was not able to sell or rent the property at fair market value for the 28-month period from the termination of the lease until NJDEP issued the No Further Action letter. In support of the claim, she presented evidence that three different realtors advised her that she would not receive fair market value for the property during that period, as she could not warrant the condition of the property to prospective purchasers without an NFA.

The Third Circuit found that Shell had breached the lease agreement by failing to comply with all environmental laws and by failing to return the property to its original state. The Court held that a reasonable fact finder could determine that compliance with “all applicable environmental laws” includes the obligation to produce reports and evidence necessary for NJDEP to issue an NFA. The Court did not decide whether an NFA is per se required, but that the duty to return the property to its “original state” encompasses the duty to leave the property free from the kind of impediments that would render it unmarketable. Based on Jaasma’s proffer that three realtors told her that she could not sell the property at market price without an NFA and that several prospective buyers had made the NFA a condition for sale, the Court believed that a fact finder could reasonably find that the property was not fully marketable prior to the issuance of the NFA.

In addition, the Court found that the language of the lease and the parties’ course of dealing presented jury questions as to whether the defendants had a duty under the lease to obtain an NFA following the discharge of contaminants from the tanks.

Loss of Use as the Measure of Damages

Once the Court established that the landlord had a claim for breach of contract, it had to determine whether “loss of use” could be used as a measure of damages. It found that under both New Jersey law and the common law of property “loss of use or lost rental value [is] the proper measure of damages when land is temporarily unusable, but then later returned to its original state.” Slip Opinion at 14, citing 8 Thompson on Real Property §67.06(a) (2) at 119-20 (David A. Thomas ed. 1994).

However, the more difficult question was whether damages for loss of use are available during the period of uncertainty which may occur after the cleanup is physically complete, but before the property has been certified as compliant with all environmental regulations.

Relying in part on a decision by the United States Court of Appeals for the Seventh Circuit in NRC Corp. v. Amoco Oil Co., 205 F.3d 1007 (2000), the Court reasoned that the District Court had erred below when it limited its assessment of damages to diminution of value or cost of remediation, ignoring damages for temporary loss of use. (In the Seventh Circuit case, the Court had allowed recovery of loss of use damages during the time period after state approval of the corrective action plan but before remediation was completed, reasoning that lenders would not loan on the property without guarantees that the remediation was working.) The Third Circuit held that even in the absence of actual pollution, a claim for loss of use is cognizable “for the period of uncertainty following a pollution incident, particularly where that uncertainty is due to ongoing investigation by the state environmental agency.” Slip Opinion at 16.

The Future

The Jaasma opinion will likely be followed by other state and federal courts as it relies not only on New Jersey law, but the common law of property and federal common law. Given the often lengthy time period required for state and federal approval of NFA or site closure letters, tenants can expect to be liable for damages during the period of regulatory approval of a cleanup, no matter how long that period may be. On the other hand, landlords should find comfort in the fact that they can recover their property’s fair market rental value during the lengthy regulatory approval process.

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