Yes this is the crux of the matter. In the real life scenario it's not related to environmental contamination. For obvious reasons I don't want to provide actual scenario facts.
There is a part of the contract that conflicts with 52.212-4(q), so the contractor basically had to chose between complying with the contract and violating state law. It unknowingly chose the former and this eventually came to light, but not from a party that is likely to bring a complaint.
My conclusion is that I should assume sovereign immunity and research laws, regs, and policy for waivers related to the specific facts of the case.