Don't confuse marketable title with economic marketability.

It's no secret that environmental contamination usually affects the value of property. Unfortunately for some purchasers, such a condition generally does not impair the marketability of title, according to the courts.

This has significant ramifications. For example, one New York purchaser tried to rescind a contract before closing, after he learned that an underground oil storage tank, as well as a dry well designed to catch the run-off from several floor drains, were potential environmental hazards which required further study and possibly extensive remediation before financing could be obtained. The court rejected the purchaser's argument that the presence on the property of possible sources of petroleum discharge renders title unmarketable, despite the fact that the purchaser may be liable for the cost of clean-up and other damages under New York's Navigation Law.

"Marketable title" means the title is free from encumbrances and the purchaser can hold the land free from a probable claim by another. The court narrowly construed the definition of marketable title to apply only to existing encumbrances, and did not consider the probability of a cost recovery claim by the state and subsequent filing of an environmental lien, if the purchaser failed to undertake the clean-up. In other words, don't confuse "marketable title" with economic marketability.

New York's interpretation is consistent with other courts in the country that have held that the mere possibility that a governmental entity could attach a lien to contaminated property does not render title unmarketable, even where there exists a current, violation of law or governmental regulation. The rationale behind this position, as articulated by the federal district court for the District of New Jersey, is that expanding the definition of encumbrance to title to include environmental conditions will create uncertainty and confusion in the law of conveyance and title insurance, since a title search would not have disclosed the violation.

The District Court went on to explain that the better way to deal with environmental issues is by contract provisions which can give a purchaser full protection.

Contractual provisions which may provide a purchaser with protection include representations and warranties of the seller as to the condition of the property and the former and current use of the property; an agreement by the seller to indemnify the purchaser for environmental conditions or violations of law existing prior to closing; and an escrow agreement if contamination has been identified but cannot be cleaned up prior to closing.

From a seller's perspective, since every contract for the sale of real property includes an express or implied covenant of marketable title, a seller should expressly identify as permitted encumbrances to title facts such as the existence of known environmental contamination, violations of governmental regulations, and the inclusion of the subject property on federal or state Superfund lists.

More careful drafting of the contract will force a seller and purchaser to focus on environmental issues prior to closing, and may prevent unnecessary litigation.

(Denise D. Pursley is an attorney with Nixon, Hargrave, Devans & Doyle LLP. Her practice involves all aspects of real estate and environmental law, with particular emphasis on commercial sale, lease and lending transactions , and environmental due diligence.)