Managing Lender Environmental Liability and Collateral Value Loss

1. Lender Liability Rules
Section 101(20)(A) of CERCLA excludes from the definition of an “owner or operator” any “person, who, without participating in the management of a . . . facility, holds indicia of ownership primarily to protect his security interest in the . . . facility.”

In 1990 the Eleventh Circuit Court of Appeals applied this exemption narrowly. United States v. Fleet Factors Corp., 901 F.2d 1550 (11th Cir. 1990). Fleet Factors Corporation (Fleet) had entered into a factoring agreement with a cloth printing facility. Fleet took a security interest in the textile facility and its contents as collateral. After the debtor took bankruptcy, Fleet foreclosed on the security interest in inventory and equipment and had the collateral auctioned off. During this time period, some waste materials were disposed of improperly. However, Fleet never actually foreclosed on the real property. The question before the court, therefore, was whether Fleet was an owner or operator at the time of the waste disposal under section 9607(a)(2), or it fell under the secured creditor exemption. The Eleventh Circuit ruled that “a secured creditor will be liable if its involvement with the management of the facility is sufficiently broad to support the inference that it could affect hazardous waste disposal decisions if it so chose.” Fleet Factors, 901 F.2d at 1557-58.

This ruling generated an intense lobbying campaign to reduce the potential liability of lenders with loans to companies with contaminated properties or handling hazardous wastes. In 1996, Congress passed the Asset Conservation, Lender Liability, and Deposit Insurance Protection Act (Asset Conservation Act). This Act incorporated and legislatively approved prior EPA rules which had been declared illegal by the courts. The Act modified the CERCLA definition of “owner or operator” to exclude from liability a “lender that did not participate in management of a vessel or facility prior to foreclosure.” In 1997, the EPA issued a “Policy on Interpreting CERCLA Provisions Addressing Lenders and Involuntary Acquisitions by Government Entities,” which provided further guidance on interpreting the Asset Conservation Act.

Applying EPA policy and guidance, several factors can be gleaned. First, the secured creditor exemption removes qualifying lenders from the definition of “owner” or “operator” under CERCLA if it does not participate in management. How can a lender know if it is “participating in management?” The EPA has determined that the term “participate in management” does not include:

• merely having the capacity to influence, or the unexercised right to control facility operations;
• performing an act or failing to act prior to the time at which a security interest is created in a facility;
• holding a security interest or abandoning or releasing a security interest;
• including in the terms of an extension of credit, or in a contract or security agreement relating to the extension, a covenant, warranty, or other term or condition that relates to environmental compliance;
• monitoring or enforcing the terms and conditions of the extension of credit or security interest;
• monitoring or inspecting the facility;
• requiring a response action in connection with a release or threatened release of a hazardous substance;
• providing financial or other advice to the borrower in an effort to mitigate, prevent, or cure default or diminution in the value of the facility;
• restructuring the terms and conditions of the extension of creditor security interest, or exercising forbearance;
• exercising other remedies for the breach of the extension of credit or security agreement;
• or conducting a response action under CERCLA or under the National Contingency Plan, provided that these actions do not rise to the level of participation in management within the meaning of the statute.
42 U.S.C. § 9601(20)(F)(i), (iii) and (iv).

On the other hand, a lender “participates in management” (and will not qualify for the exemption) if the lender “actually” participates in the management or operational affairs of a facility. The EPA has determined that a lender “participates in management” if the lender, while the borrower is still in possession of the facility encumbered by the security interest:

• exercises decision-making control regarding environmental compliance related to the facility, and in doing so, undertakes responsibility for hazardous substance handling or disposal practices; or
• exercises control at a level similar to that of a manager of the facility, and in doing so, assumes or manifests responsibility with respect to:
• day-to-day decision-making on environmental compliance, or
• all, or substantially all, of the operational (as opposed to financial or administrative) functions of the facility other than environmental compliance.
42 U.S.C. § 9601(20)(F)(i)-(ii).

If there is one matter that may subject a lender to nearly unlimited environmental liability, it is the handling of hazardous substances. If a lender takes an active role in decisions relating to the disposition of hazardous wastes, or if the lender tells management that it cannot take certain actions with regard to environmental compliance, that lender may lose its exemption from liability.

After foreclosure, a lender who did not “participate in management” prior to foreclosure may generally:

• maintain business activities;
• wind up operations;
• undertake a response action under CERCLA Section 107(d)(1) or under the direction of an on-scene coordinator;
• sell, re-lease or liquidate the facility;
• or take actions to preserve, protect or prepare the property for sale.

A lender may conduct these activities provided that the lender attempts to sell or re-lease the property held pursuant to a sale or lease financing transaction, or otherwise divest itself of the property at the earliest practicable, commercially reasonable time. However, even with these protections, a lender is not totally safe in a foreclosure situation. If, as an example, a lender forecloses on an industrial facility and the facility has large amounts of hazardous wastes ready for disposal, that lender can become an “arranger” or “transporter” if it takes actions with respect to the shipment of that waste to a different facility. Once the waste has left the lender liability umbrella of protection afforded by the Act, the lender is exposed to whatever liabilities that other site (with which the lender otherwise has no creditor-debtor relationship) can create. The lender’s name may appear on shipping manifests, or the lender may make poor decisions with regard to the disposal of wastes by sending the waste to a poorly run facility.

Any actions that can be interpreted as engaging in management decisions or in the handling of waste must be approached with great caution. What will that e-mail or voice mail look like to an attorney investigating a file after the collapse of a company? If that attorney or EPA investigator is looking for additional parties with whom to share environmental liability then that e-mail, voice mail or letter may prove to be the foundation for an effort to force the lender to share liability.

A related concept that lenders should be aware of is the “responsible corporate officer” (RCO) doctrine borrowed from the federal public health protection and welfare statutes and imposed on management under the Clean Water Act. The RCO doctrine provides that a corporate officer may be held personally liable for the criminal act of a subordinate employee if the officer “had, by reason of his position in the corporation, responsibility and authority either to prevent in the first instance or promptly to correct, the violation complained of, and . . . failed to do so.” United States v. Park, 421 U.S. 658, 673-74 (1975). Courts have also applied the RCO doctrine in the civil context. See, e.g., In re Dougherty, 482 N.W.2d 485, 489 (Minn.Ct.App. 1992) (“[I]mposing liability on corporate officers is especially appropriate in the civil context.”). Under this doctrine, the government must prove “knowledge” before a defendant may be held criminally liable for a felony violation. 33 U.S.C. § 1319(c)(2). However, the Clean Water Act was amended after its enactment to include “any responsible corporate officer” in the definition of the term “person.” Pub.L. No. 100-4, § 312, 101 Stat. 7, 44 (1987) (codified at 33 U.S.C. § 1319(c)(3) (1988)). The fallout for a lender is that not only can the lender be found liable if it materially participates in management decisions, but the individuals working for the lender could face liability.

Resources:
EPA Fact Sheet: CERCLA Lender Liability Exemption Questions and Answers

http://www.epa.gov/oecaerth/resources/publications/cleanup/superfund/factsheet/lender-liab-06-fs.pdf

EPA Rule:
http://www.epa.gov/fedrgstr/EPA-WASTE/1997/July/Day-07/f17595.pdf

2. Collateral Value Loss

Even though a lender may escape liability for the cleanup of a given site, another important factor that a lender must consider is whether the value of the collateral will be impaired. Several factors can be reviewed before a lending decision is made (whether an initial loan or an additional advance or loan is being made):

• What is known about the kind of contamination on the site;
• What is the regulatory posture of the site;
• Is the EPA or state agency involved in evaluating the site;
• What is the debtor telling the lender regarding future action on the site that will be needed to bring the site into compliance;
• Is the type of contamination the kind that can lead to large cleanup costs;
• Is there any potential impact off-site with industrial, commercial, or residential neighbors;
• Are wells, wetlands, rivers, streams or other public resources potentially affected by the contamination.

An interesting fact pattern that can arise in some circumstances is whether a parcel can be split off from a larger tract of real estate. The legal question is whether a facility that includes parts of a property that have been divided or platted off of a larger property is still subject to the reach of CERCLA. A fairly comprehensive review of federal case law indicates that there is no reported case exactly fitting the proposed scenario. Instead, the cases generally hold that the definition is to be broadly interpreted and applied. One case concluded as follows:

An area that cannot be reasonably or naturally divided into multiple parts or functional units should be defined as a single “facility,” even if it contains parts that are non-contaminated. . . . Were this not the case, the statute would have defined a facility as ‘those parts of a site’ with contamination. The effects of the coarseness of this definition are mitigated by the availability of divisibility . . . and contribution. See 42 U.S.C. § 9613(f).

U.S. v. Township of Brighton, 153 F.3d 307. 313 (6th Cir. 1998). See also, Clear Lake Properties v. Rockewell Int’l Corp., 959 F. Supp. 763, 767-68 (S.D. Tex. 1977) (rejecting argument that surface structures constitute separate “facility” from subsurface soil and groundwater); and Axel Johnson, Inc. v. Carroll Carolina Oil Co., 191 F.3d 409, 417 (4th Cir.1999) (observing that a contrary approach might be illogical when taken to the extreme because it “would mean that each barrel in a landfill is a separate facility-a proposition … aptly described as ridiculous.”) (quotation marks and citation omitted); cf. Northwestern Mutual Life Ins. Co. v. Atlantic Research Corp., 847 F.Supp. 389, 396 (E.D.Va.1994) (counting entire area as “facility,” but only because each of its quadrants are contaminated). It is often said that bad cases make bad law. On this issue, none of the cases present a clear fact pattern where a specific parcel can be carved off of a Superfund site free and clear of liability.

— James Pray