CHAPTER 7 THIRD PARTIES TO THE DEAL: LENDER AND INVESTOR LIABILITIES AND CONCERNS
| Jurisdiction | United States |
(Nov 1988)
THIRD PARTIES TO THE DEAL: LENDER AND INVESTOR LIABILITIES AND CONCERNS
Jones, Day, Reavis & Pogue
Los Angeles, California
I. INTRODUCTION.
Although modern environmental law began in 1970 with the enactment of the Clean Air Act,1 until very recently, it was a small and esoteric specialty practice of little interest to the average real estate or corporate lawyer or to their lender and investor clients. Today environmental issues often make or break a deal because they represent the difference between a successful investment and an expensive mistake. This paper will discuss the reasons for this dramatic shift in perspective, analyze the types of environmental concerns which can affect a transaction and suggest practical steps for lenders and investors so they can avoid environmental mistakes.
A. Environmental Laws: An Overview of the Areas of Concern to Lenders and Investors.
The basic environmental areas of concern for lenders and investors can be summarized into four categories: (1) liability for the remediation of contaminated property under state or federal laws; (2) liens and superliens arising from government funded cleanups; (3) restrictions on the use and transfer of property; and (4) tort liability associated with exposure to hazardous substances.
These four areas can impact lenders and investors in three fundamental ways. First by affecting the viability of a borrower or business operation due to problems with its environmental permit or compliance status, or potential cleanup and tort liabilities; second by impairing the value of real property as collateral or an investment or the priority of a lien; and third, by placing the lender or investor at risk of direct liability for cleanup costs above and beyond the amount of the loan or investment. It is this last reason, unlimited potential liability for environmental cleanup, coupled with the extraordinarily high costs associated with remedying environmental contamination, which has lead to the recent intense interest in environmental laws and issues among financial institutions and investors.
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Traditionally a lender or investor reviews a proposed transaction to identify any issues which might impair the economic health of the borrower or company or endanger a security interest in its collateral. Viewed in this context, environmental issues are merely an additional category, albeit a complex and technical one, in this familiar review. However, in 1986 the courts dramatically increased environmental risks for lenders by holding, in United States v. Maryland Bank and Trust Company,2 that under the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA or Superfund)3 a lender may not only lose the amount of its loan, but in addition be required to pay for cleanup of the contaminated property which was collateral for the loan. Maryland Bank's loan of $335,000 suddenly became a liability of half a million dollars.
CERCLA imposes statutory liability for the costs of remediation of releases or threatened releases of hazardous substances. It is the most common basis for both government and private party litigation to recover these costs.4 Under Section 107 (a) of CERCLA5 liability may be imposed for cleanup costs upon past and present owners of a contaminated property, past and present operators, and generators and transporters of the hazardous substances. Liability under CERCLA is also retroactive, strict, joint and several.6
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Therefore it is possible for one responsible party to pay for all of the costs of remediation for a site even though it was not at fault and did not violate any law, there are other parties who are also responsible, and all of the disposal activities took place prior to the enactment of CERCLA.
In addition to CERCLA, other federal laws authorize administrative orders, injunctive relief and/or cost recovery for spills and releases of hazardous wastes and substances under more limited circumstances.7 Unlike CERCLA, these statutes generally apply to current activities such as releases from an operating hazardous waste facility and were not intended to address the historic disposal activities of businesses long vanished from the property. Finally, many states have also adopted liability schemes which parallel or
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expand upon this federal scheme8 and traditional common law liability theories such as nuisance, negligence and strict liability for ultrahazardous activities, may also provide a basis for liability.9
Liens are a familiar concern to lenders and investors because they reduce the value of the collateral for a loan or a proposed investment. Recent amendments to CERCLA, known as the Superfund Amendment and Reauthorization Act of 1986 or SARA,10 authorized a lien for the recovery of federally funded cleanup costs. Many states also have lien provisions. Some states, however, have gone beyond the traditional lien and chosen to protect their recovery of environmental cleanup costs by authorizing the imposition of a superlien which has priority over existing liens on the property including another secured lien such as a bank mortgage. Since a superlien may be imposed after a transaction has closed, a search for existing liens will not protect against this possibility. Due to the wide variation in existing lien provisions in different jurisdictions and frequent changes arising from new legislation, it is essential to evaluate the potential impacts of environmental liens upon each transaction with care.
Approximately half the states have imposed some restrictions on the transfer and use of contaminated properties in addition to federal requirements. These laws may affect the value of an investment or a lender's security interest in the collateral for a loan, delay closure of a transaction and discourage prospective buyers.
Toxic tort cases are often filed by members of the community surrounding a contaminated property or facility. In many instances the potential liabilities associated with these cases can far exceed the costs of cleanup. Lenders and investors who become liable for a cleanup may also find themselves defending a tort case as well. The risk is especially high where the lender or investor takes title to a contaminated property and hazardous substances are continuing to migrate from the property into air or drinking water.
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B. Who is Affected and What Does It Cost?
All of the participants in a transaction should be sensitive to potential environmental issues whether they risk direct liability for remedial costs, or only the loss of their investment. This includes lenders, guarantors, shareholders, venture capitalists, investors, parent corporations, real estate syndicators and developers, partners (both limited and general) and officers, directors and managers of corporations. All of these persons can be held liable under CERCLA if their activities or status qualify them as an owner or an operator of a contaminated property.11
Even if direct liability for remedial costs can be avoided, the costs of environmental remediation can be so large that they quickly exceed the value of the property or the anticipated benefit from a transaction. In 1984 an EPA study estimated that the average cost of cleanup for a hazardous waste site was $7.2 million plus an additional $4.1 million (net present value) for 30 year maintenance.12 By 1987 an EPA official estimated that EPA's average cost of cleanup was between $10 million and $12 million per site.13 Since this is an average cost, many sites are considerably more expensive. For example the current estimate for cleanup of the Stringfellow site in California is between $44 million dollars and 800 million dollars14 and remedial costs for the Colorado Rocky Mountain Arsenal are expected to cost up to $1 billion.15
EPA's National Priorities List is intended to cover the most seriously contaminated sites which are also likely to be the most expensive ones to remediate. Many more remedial actions occur at the state or local level or during the course of private transactions, but the costs are still significant and should be carefully evaluated. Often the delays associated with a cleanup can have a greater impact on a transaction than
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and should be carefully evaluated. Often the delays associated with a cleanup can have a greater impact on a transaction than the cost of the cleanup itself, particularly where government approval of the remedial action is sought or required. In California, for example, state superfund sites are categorized into small, medium and large for purposes of estimating the time and money which will be needed to complete a cleanup. A small site is estimated to take approximately 2 years and $500,000 to $1,000,000 to remediate, and a medium sized site is estimated to require 3 years 9 1/2 months and $1,000,000 to $10,000,000.16 (Neither of these estimates includes subsequent operation and maintenance).
California's state superfund program plans to oversee or perform cleanups at a total of 328 sites over five years. In addition, during this time period, approximately 9,000 potential sites will be evaluated and between 750 and 1000 new sites added to the state superfund list.17 Sites not currently scheduled for cleanup get little or no attention. Clearly many sites with environmental contamination will not be identified or addressed for many years in this context, and a lender or investor who has not required an environmental assessment may be surprised to find himself linked to a "new" superfund site.
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II. CERCLA LIABILITY FOR RESPONSE COSTS.
A. Public Policy and the Rationale for the Imposition of Liability.
Although the Maryland Bank case was probably a surprise to many lenders, it was...
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