CHAPTER 3 ENVIRONMENTAL MANAGEMENT AND THE FINANCIAL COMMUNITY
| Jurisdiction | United States |
(Feb 1993)
ENVIRONMENTAL MANAGEMENT AND THE FINANCIAL COMMUNITY
First Interstate Bank of Denver, N.A.
Denver, Colorado
and Christopher L. Richardson
Davis, Graham & Stubbs
Denver, Colorado
TABLE OF CONTENTS
Page
I. Introduction
II. Sources of Lender's Risks
A. CERCLA and Lender's Liability
B. The Secured Creditor's Exemption and the Fleet Factors Case.
C. The EPA Final Rule
1. Security Interest Defined
2. Acceptable Pre-Foreclosure Activities Under the Final Rule
3. Foreclosure and Post-Foreclosure Activities
4. Implications and Concerns Over the Final Rule
D. Resource Conservation and Recovery Act ("RCRA")
E. State Statutes and Lien Laws
1. Federal Liens
2. State Lien Provisions
F. Transfer and Use Restriction
III. Institutional Lenders
A. Lenders are Risk Averse
1. Real Estate Based Loans
a. Credit Evaluation
b. Environmental Questionnaire
c. The Walking Inspection
d. The Phase I Environmental Audit
(1) Hiring a Consultant
(2) Defining the Job
e. Phase II and Phase III Environmental Assessment
f. Cost of the Phase I, II and III
2. Loan Documentation
3. Loan Administration
4. Loan Defaults
IV. Conclusion
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I. Introduction
Historically, a bank or other commercial lender would evaluate a loan request from a prospective borrower in terms of the risk of non-payment to the lender. If the prospective borrower was sufficiently wealthy and "liquid," the lender might make an unsecured loan.1 For a less credit-worthy borrower, the lender would require that the borrower pledge collateral to the lender with the expectation that, upon default, the lender could look to the collateral for payment by the foreclosure on and subsequent sale of the property.
Environmental law has changed the loan evaluation process and the risks facing a secured lender. A lender no longer only considers the current financial strength of the borrower; today, a lender must assess whether the borrower is exposed to environmental liability that could damage or destroy the borrower's business, thus impairing the borrower's ability to repay the loan. Additionally, the lender must carefully investigate the business of the borrower and the collateral offered by the borrower to determine whether the lender, upon default, would be able to look to the collateral for repayment. Finally, the lender must consider whether it could be at risk for cleanup costs through its administering of the loan. If there are risks to the lender beyond the risk of non-payment, the lender will not make the loan.
Sometimes, notwithstanding the lender's diligence, a loan is made and secured by real property that, it is later discovered, has serious environmental contamination. In these situations, the lender must avoid incurring affirmative liability for cleanup costs associated with the collateral in its workout and loan recovery process. There is a real risk that the lender may unknowingly become responsible for the cleanup of the collateral.
The purpose of this paper is (i) to define the sources and nature of the risks confronting lenders today in making, administering and collecting on loans secured by real and personal property, (ii) to summarize the existing guidelines that help the lender avoid incurring additional liability, (iii) to set forth the procedures used by lenders to manage the risks before and after a loan is made, and (iv) to discuss workout techniques and concerns.
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II. Sources of Lender's Risks
A. CERCLA and Lender's Liability.
In late 1980 Congress enacted the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA")2 in response to concern over the growing number of contaminated sites and to provide for the cleanup of "facilities" tainted by the "release" of hazardous wastes.3 CERCLA, which is administered by the Environmental Protection Agency (the "EPA"), enables the EPA (i) to identify contaminated sites and to respond to a release or threatened release of a hazardous substance, and (ii) to impose liability on four classes of "potentially responsible parties" and (iii) to create and maintain a superfund to finance the cleanup activities. The four classes of persons4 potentially responsible for cleanup costs include:
a. the current owners and operators of the facility;
b. the owners and operators of the facility at the time of the release of hazardous substances;5
c. the person that arranged for treatment or disposal of substances at the facility (generators);
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d. the person who accepts hazardous substances for transport to a disposal site (transporters).6
Any person falling within one of these four categories is a "potentially responsible party" (a "PRP"), who may be jointly and severally liable for the cleanup costs.7 Innocent owners may be strictly liable even though the contamination in question occurred years before the property was acquired and even if the activities creating the contamination were not prohibited at the time.8
The CERCLA "owner or operator" definition contains what is generally known as the "secured creditor exemption" which excludes any "person who, without participating in the management of a vessel or facility, holds indicia of ownership to protect his security interest in the vessel or facility."9 While it was initially thought that this exemption would generally protect secured creditors, the scope of the exemption has proven difficult to predict.10
In addition to the secured creditor exemption, CERCLA does provide certain other narrow defenses. If it can be shown that the contamination was caused by (i) an act of God, (ii) an act of war, or (iii) an act or failure to act by an unrelated third party, then liability may be avoided.11 Section 107(b)(3) as amended by SARA in 1986, has become known as the "innocent landowner" defense.12 Prior to the 1986 amendments, the
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innocent landowner defense was not available where the actions concerning the property were pursuant to a contractual relationship. The issue became whether the conveyance document transferring property to a new landowner would be considered a contract and thus preclude the new purchaser from using the innocent third party defense under § 107(b)(3).
The 1986 Amendments defined contract to include conveyance instruments (thus depriving the purchaser of the innocent landowner status) unless the transferee could establish that at the time the transferee acquired the property it "did not know and had no reason to know that any hazardous substance...." was disposed of on, or at, the property.13 All appropriate inquiry must be made into the previous use and ownership of the property. The due diligence hurdle is very high and as a practical matter, any property that has ever had a commercial use or is located near a commercial or industrial area, probably will make the innocent landowner defense unavailable. Experience has established that little comfort can be obtained from this provision.
B. The Secured Creditor's Exemption and the Fleet Factors Case.
The extent of the secured creditors' CERCLA exemption began to unfold in 1985. First, in In re T.P. Long Chemical, Inc., the bankruptcy court held that even if the bank had "repossessed its collateral pursuant to its security agreement, it would not be an 'owner or operator' under CERCLA" because of the exemption.14 Similarly, in United States v. Mirabile, the court held that the lender's foreclosure upon the contaminated property to protect its security interest did not transform the lender to an "owner" of the property.15
However, the Mirabile court stated that even if a lender does not foreclose on the property, it can become an "owner or operator" if it "participate[s] in the day-to-day operational aspects of the site."16 To lose the protection of the secured creditor exemption, the court indicated that the
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lender would have to participate in operations or waste disposal activities. The mere ability to control operations was not enough to impose liability.
The Mirabile decision was followed by United States v. Maryland Bank & Trust Co. which held that a lender which foreclosed on its collateral became an "owner" under CERCLA and thus liable for cleanup costs.17 The court reasoned that the foreclosure terminated the mortgage (the "indicia of ownership") and that the lender's purchase of the property at the foreclosure sale was to protect the bank's investment, not its security interest.18 In dicta, the court indicated that "[f]inancial institutions are in a position to investigate and discover potential problems in their secured properties...CERCLA will not absolve them from responsibility for their mistakes of judgment."19
The issues were further complicated in 1990 by two appellate court decisions. First came the Eleventh Circuit's decision in United States v. Fleet Factors Corp.20 In Fleet Factors, the court broadly interpreted the "owner or operator" class in holding that "a secured lender will be liable [under CERCLA] 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."21 (Emphasis added.) Thus, without being an owner of a facility, the secured creditor could be held liable if it participated in the management of the facility "to a degree indicating a capacity to influence the corporation's treatment of hazardous waste..." (emphasis added).22
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On the heels of Fleet Factors came the Ninth Circuit's decision in In re Bergsoe Metals Co. 23 which apparently rejected the "capacity to influence" test adopted in Fleet Factors. In Bergsoe, the court held "merely having the power to get involved in management, but failing to exercise it, is not enough" to create liability.24 There must be some actual...
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