Chapter §13.2 Lender Environmental Liability

• Jurisdiction: Washington

§13.2 LENDER ENVIRONMENTAL LIABILITY

Environmental liability for lenders under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), 42 U.S.C. §§ 9601 -9675, and the Model Toxics Control Act (MTCA), Chapter 70.105D RCW, is discussed below. It is important to keep in mind that liability for lenders may occur under other statutes such as the Resource Conservation and Recovery Act (RCRA), 42 U.S.C. §§ 6901 -6992k. For additional discussion of lender environmental liability, see §10.4 in Chapter 10 (Minimizing Hazardous Waste Liability in Real Estate Transactions) of this deskbook.

(1) CERCLA liability

"CERCLA liability has been described as 'a black hole that indiscriminately devours all who come near it.'" Long Beach Unified Sch. Dist. v. Godwin Living Trust, 32 F.3d 1364, 1366 (9th Cir. 1994) (quoting Jerry L. Anderson, The Hazardous Waste Land, 13 Va. Envtl. L.J.1, 6-7(1993)). However, CERCLA now includes a broad exemption from liability for lenders who hold indicia of ownership primarily to protect their security interest and who do not participate in management of the contaminated facility.

(a) The source of potential liability for lenders

CERCLA holds liable the current owner or operator of a facility from which there is a release, or a threatened release, of hazardous substances that causes the incurrence of response costs. 42 U.S.C. § 9607(a) (all italicized terms are broadly defined in the statute). For further discussion of these defined terms, see Chapter 3 (Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA or Superfund) of this deskbook. This liability includes all costs of removal or remedial action incurred by the government, any other necessary response costs incurred by other persons, and damages for injuries to natural resources. 42 U.S.C. § 9607(a)(4). Courts and commentators sometimes refer to CERCLA liability as "status liability" because current owners and operators are liable without regard to fault. Prior to the clarification and expansion of the lender exemption discussed below, CERCLA's broad liability scheme created concern among lenders about becoming involved with contaminated real property. Prior to the exemption, if they "participate in the management" of the borrower's property before foreclosure, they could be considered the "operator" of the facility and face liability. After foreclosure, the foreclosing lender often takes title to the real property, becoming the actual "owner" of the facility—and subject to CERCLA liability.

(b) The lender exemption from liability

From its adoption in 1980, CERCLA has excluded from its definition of "owner or operator" "a person, who, without participating in the management of a vessel or a facility, holds indicia of ownership primarily to protect his security interest in the vessel or facility." 42 U.S.C. § 9601(20)(A). This vague exemption led to a series of legal challenges and changes to the rules and policies of the U.S. Environmental Protection Agency (EPA) to address lender liability under CERCLA.

Several courts, most notably the U.S. Court of Appeals for the Eleventh Circuit, in United States v. Fleet Factors Corp., 901 F2d 1550, 1557 (11th Cir. 1990), cert, denied, 498 U.S. 1046 (1991), held that participation in management included having the "capacity to influence the corporation's treatment of hazardous wastes." To quell the subsequent lender backlash after these cases, the EPA promulgated lender-friendly rules in 1992. Natural Oil and Hazardous Substances Pollution Contingency Plan; Lender Liability Under CERCLA, 57 Fed. Reg. 18,344-01 (Apr. 29,1992).The D.C. Circuit invalidated these rules in 1994, because the EPA does not have the authority to issue binding rules with respect to CERCLA liability. See Kelley v. U.S. Envtl. Prot. Agency, 15 F.3d 1100 (D.C. Cir. 1994), cert. denied sub nom. Am. Bankers Ass'n v. Kelley, 513 U.S. 1110 (1995). This led the EPA to issue an enforcement policy explaining that it intended to apply its 1992 rule and preamble (hereinafter the "vacated rule") as guidance in its enforcement activities against lenders. Because the EPA's enforcement policy was nonbinding and did not affect contribution actions brought by third parties, the lending community sought and ultimately received liability protection from Congress, which adopted the Asset Conservation, Lender Liability, and Deposit Insurance Protection Act of 1996 (Asset Conservation Act), Pub. L. No. 104-208, div A, tit. II, subtit. E, 110 Stat. 3009 (Sept. 30, 1996), codified in 42 U.S.C. §§ 9601, 9607. The Asset Conservation Act included lender-friendly amendments to CERCLA that were nearly identical to the vacated rule. As a result, lenders now have very broad protection from CERCLA liability, and the law in this area has been well settled since adoption of the Asset Conservation Act.

To avail itself of the "lender liability exemption," a lender must not participate in management before foreclosure and must demonstrate that it holds indicia of ownership primarily to protect a security interest. The Asset Conservation Act gives content to the exemption by defining what it means to participate in management (or more accurately, what it means not to participate in management), and by making it clear that a lender does not become an owner or operator of a facility by selling, re-leasing, or otherwise divesting itself of the facility or real property in a reasonable time and on commercially reasonable terms. Even when the lender seeks to divest itself of the facility or property, it may maintain business activities and take other actions without becoming liable for cleanup costs. In other words, the ban on participation in management only applies before foreclosure. See 42 U.S.C. § 9601(20)(E).

To be considered a lender that holds indicia of ownership primarily to protect a security interest, during transactions involving the sale of a facility the lender must operate as a "person whose connection to [the] facility is simply as an arm[']s-length provider of capital otherwise free of entanglements to the site." Ga.-Pac. Consumer Prods. LP v. NCR Corp., 980 F. Supp. 2d 821, 840 (W.D. Mich. 2013).

In Georgia-Pacific, Georgia-Pacific sought to hold International Paper (IP) liable for a portion of the costs of investigating and cleaning up contamination at the Kalamazoo River Superfund Site. 980 F. Supp. 2d at 823-24. IP was the corporate successor to St. Regis Corporation, the original owner and operator of a mill responsible for disposing of hazardous materials into the site. Id. IP denied liability, arguing that St. Regis never owned or operated the mill during the period of hazardous disposal. Id. at 836. Specifically, IP asserted that St. Regis had engaged in a seller-financed sale of the mill, through a lease, to a group known as Allied Paper. Id. at 839. And even though St. Regis retained title during the period of the lease, it was primarily to protect a security interest in the mill. Id. Thus, IP argued, St. Regis and IP fell within CERCLA's lender liability exemption. Id.

The court disagreed with IP. Even assuming that St. Regis's lease transaction was a legitimate form of seller financing, the court still concluded that the primary purpose of the transaction was not to protect a security interest. Id. at 840. Rather, the primary purpose was to facilitate a series of transactions that would absolve St. Regis of both its operational and ownership responsibility for the mill. Id. The court's conclusion was based on St. Regis's extensive history as the owner/operator of the mill and its admission that it was eager to dissociate itself from mill operations. Id.

The court refused to extend CERCLA's secured-creditor exemption to St. Regis in this situation. Id. at 840-41. "[A] party, like [St. Regis], that both owned and operated a facility, cannot—and should not— easily wash itself of potential CERCLA liability simply by facilitating a transaction with seller financing." Id. at 840. In the court's view, St. Regis simply was not the type of lender that the CERCLA exemption protects. Id. The court concluded that the CERCLA exemption should be limited to lenders "whose connection to [the] facility is simply as an arm[']s-length provider of capital otherwise free of entanglements to the site." Id. St. Regis, by its own admission, was not an arm's-length provider of capital. Accordingly, the court found that IP was not eligible for the exemption. Id.

Practice Tip: Even though there is a statutory exemption to liability, lenders should still conduct a pre-lending investigation of the environmental conditions at a property. The environmental condition of the property affects the value of the collateral and, therefore, should be considered in any lending decision. In certain circumstances, the right decision for the lender is to reject the possible loan because of the environmental condition of the collateral and its effect on the value of the collateral and to avoid having to rely on the statutory exemption.

Pre-foreclosure liability—participation in management

The Asset Conservation Act clarified the meaning of "participation in management" in three ways.

First, it rejected the holding of Fleet Factors and made it clear that there must be actual participation in management or operational affairs and not the mere capacity to influence or the unexercised right to control operations. 42 U.S.C. § 9601(20)(F)(i).

Second, it describes conditions that must exist before a lender can be considered to have participated in management of a facility. A pre-foreclosure lender that holds indicia of ownership primarily to protect a security interest will only be deemed to have "participated in management" if, while the borrower was still in possession of the facility, it

(I) exercise[d] decisionmaking control over the environmental compliance related...