I. Overview
The Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended ("CERCLA" or "Superfund") is the linchpin for any discussion of environmental liabilities associated with real estate transactions. The State of Texas has adopted a similar statute, the Texas Solid Waste Disposal Act, which generally imposes the same strict liability on current owners and operators of polluted properties as well as past owners/operators that contributed to the pollution at a particular property.
CERCLA was enacted by Congress to effect the widespread cleanup of hazardous waste sites in the United States. See U.S. v. Maryland Bank & Trust Co., 632 F. Supp. 573, 576 (D.Md. 1986); S.Rep.No. 848, 96th Cong., 2d Sess. 2(1980), U.S. Code Cong. & Admin. News 1980, p. 6119. CERCLA provided a safe harbor for lenders, however, the safe harbor had ambiguities. Those ambiguities were interpreted by some courts as liability for those lenders whose security was a contaminated property. Since the enactment of CERCLA, secured lenders have faced uncertainty with respect to their exposure to environmental liability; however, in 1996, Congress clarified the exclusion of lenders from liability under CERCLA which should allow lenders to enjoy a more predictable safe harbor from environmental liabilities when protecting their security interests.
B. Liability
CERCLA's liability provision identifies four classes of persons who may be liable: (1) the current owner and operator of a facility; (2) persons who owned or operated the facility at the time of disposal of any hazardous substance; (3) persons who contracted or otherwise arranged for disposal or treatment of hazardous substances at the facility; and (4) transporters who selected the facility. These parties are commonly referred to as "potential responsible parties" or "PRPs." To establish that a particular party is liable under CERCLA, the government or private claimant must establish that the party is a member of one of the four classes, that there has been a release or threatened release of a hazardous substance from a facility, and that the claimant has incurred covered response costs.
The scope and effect of the Superfund liability provision has been expanded by judicial interpretation. It is now well established that CERCLA imposes broad, strict liability. CERCLA's liability provisions are so expansive that a PRP can only take consolation in the right to seek contribution and the possibility that he may qualify for one of the statutory defenses. Similarly, CERCLA shows very little sympathy for sellers and purchasers of real estate. Former landowners are liable if hazardous substances were disposed of on their property during the term of their ownership. Although a former landowner may contract with the buyer for indemnification, it cannot shift liability vis-a-vis the government.
C. Lender Liability
It is well established under CERCLA that "owners" and "operators" are strictly liable for environmental contamination that exists or originates from the facilities that they own or operate. CERCLA imposes strict joint and several liability on the owner and operator of any facility from which there is a release or a threatened release of a hazardous substance. See 42 U.S.C. 9607(a).
But what happens when a lender forecloses on a mortgage, the security interest in the property? While that definition encompasses "any person owning or operating (a) facility," it specifically excludes any "person, who, without participating in the management of a vessel or facility, holds indicia of ownership primarily to protect his security interest in the vessel or facility." See 42 U.S.C. 9601(20)(A). This is the "lender liability" provision. The lender exemption provides one important exception to this strict rule when a lender foreclosed its security interest and subsequently resells, transfers or assignments the property. In particular, the term "lender" (as of the 1996 amendments) includes "any person (including a successor or assignee of any such person) that makes a bona fide extension of credit to or takes or acquires a security interest from a nonaffiliated person." See 42 U.S.C. 9601(20)(G)(iv)(V) (emphasis added).
Nonetheless, the lender may still be held liable. The lender may be held liable as an "operator." Liability as an "operator" derives from a person's exercise of "control" over a facility. Determining what constituted "control" over a facility was the center of debate for many years and has drug many a lender out of the exemption and into the courtroom. The overwhelming majority of case law favored applying the "actual control" test. This test confers "operator" status on any person, including a lender, who participates in the day-to-day management of a facility's waste handling practices.
The lender liability exclusion which shelters secured lenders from liability is not an unconditional safe harbor. The security interest exclusion first began to erode in 1986 when a federal district court rejected the safe harbor argument in denying the defendant secured creditor's motion for summary judgment. U.S. v. Maryland Bank & Trust Co., 632 F. Supp. 573, 580-81 (D.Md. 1986). In the Maryland Bank & Trust case, the bank foreclosed on the property to protect its security interest and was held liable for the environmental clean-up. The court noted that (1) the bank had the option not to foreclose on the property and not to bid on or purchase the property at the foreclosure and (2) the bank retained possession of the property for four years after the foreclosure. While the Court cited these facts in denying the summary judgment for the lender, the facts were common enough that most lenders concluded that simply foreclosing on a property would lead to liability.
In 1990, the Eleventh Circuit affirmed the denial of a lender's motion for summary judgment. U.S. v. Fleet Factors Corp., 901 F.2d 1550 (11th Cir. 1990), cert. denied, 498 U.S. 1046 (1991). The secured creditor, Fleet, never foreclosed on the facility and therefore filed a motion for summary judgment. The District Court denied the motion and the Eleventh Circuit upheld that decision. The Fleet court determined that the secured creditor who never foreclosed could still be held liable solely because it participated in financial management of the facility to the degree that would indicate the capacity to influence the treatment of hazardous waste. The holding in Fleet Factors was alarming to lenders because (1) Fleet had not foreclosed on the real property, and (2) it signaled liability for secured creditors in an unforeseen way. Fleet advanced funds to a cloth printing facility, obtaining a security interest in the company's receivables, equipment, inventory and fixtures. The borrower eventually defaulted on the loans and ceased printing operations. Fleet then required the borrower to seek Fleet's approval before shipping its goods, established prices for excess inventory, dictated when and to whom goods should be shipped and determined employee layoffs. Fleet also proceeded to foreclose on its security interest and hired a contractor to auction some of the inventory and equipment "as is" and "in place." Fleet also negotiated to have another contractor "broom clean" the facility in exchange for additional equipment. The court found, if the above facts were proven, CERCLA liability would be imposed on a secured creditor under the theory of "management participation liability."
The Eleventh Circuit's reasoning on "management participation liability"follows:
A secured creditor may [incur liability] . . . by participating in the financial management of a facility to a degree indicating a capacity to influence the corporation's treatment of hazardous wastes. It is not necessary for the secured creditor actually to involve itself in the day-to-day operations of the facility in order to be liable-although such conduct will certainly lead to the loss of the protection of the statutory exception. Nor is it necessary for the secured creditor to participate in management decisions relating to hazardous waste. Rather, 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 if it so chose.
Id. at 1557-58 (emphasis added, footnotes omitted). It is this reasoning which alarmed lenders: the question of liability hinged not on the actions of the lender but on the possibility the lender could have affected the hazardous waste disposal. While some courts have questioned Fleet Factors, its real impact was on secured creditors in the other circuits where no case law existed with respect to CERCLA lender liability: the "inference of ability to affect waste disposal" left them without the certainty given by the CERCLA secured creditor exemption.
In 1992, EPA promulgated its "Final Rule on Lender Liability under CERCLA," 57 Fed. Reg. 18, 344 (April 29, 1992), which seemingly provided greater certainty in the lending industry by clarifying what activities constituted "operation of a facility." The "Final Rule" was anything but final. Only two years later, a district court held that the United States Environmental protection Agency ("EPA") had acted beyond its authority by promulgating the "Final Rule" and vacated it. Kelly v. E.P.A., 15 F.3d 1100 (D.C. Cir. 1994), cert. denied sub nom. American Bankers Assoc. v. Kelley, 115 S.Ct. 900 (1995). The court reasoned that Congress did not give the EPA the authority to interpret a statute, but rather it empowered EPA to act as a "prosecutor" and bring a question before a federal court. Id. at 1108. After the Supreme Court denied certiorari in Kelly, the EPA and the United States Department of Justice ("DOJ") issued a joint policy statement addressing the district court's holding. See "EPA, Justice Policy on CERCLA Enforcement Against Lenders and Government Entities that Acquire Property Involuntarily," (Oct. 6, 1995). The memorandum acknowledged the holding in Kelley, but it went on to say that the holding did not preclude the EPA or the DOJ from following the provisions of the "Final Rule" as enforcement policy. Meanwhile, Fleet Factors and its progeny were still good law.
D. Legislative Relief
Congress addressed the controversy surrounding the lender liability provisions under CERCLA through the Asset Conservation, Lender Liability and Deposit Insurance Act of 1996. That Act included the following amendments to the CERCLA definition:
1. The terms "owner or operator" do not include a person that is a lender that, without participating in the management of a vessel or facility, holds indicia of ownership primarily to protect its security interest in the vessel or facility. 42 U.S.C.A. 9601 (20)(e)(I).
2. The terms "owner or operator" do not include a person that is a lender that did not participate in management of a vessel or facility prior to foreclosure notwithstanding that the person actually forecloses on the vessel or facility and, after foreclosure, sells, releases, liquidates, maintains business activities, winds up operations, undertakes a response under 9607 (d)(1) of CERCLA, with respect to the vessel or facility, or takes any other measure to preserve, protect, or prepare the vessel or facility prior to sale or disposition if the person seeks to divest itself of the vessel or facility at the earliest practicable, commercially reasonable time, on commercially reasonable terms, taking into account market conditions and legal and regulatory requirements. 42 U.S.C.A. 9601 (20)(e)(ii).
3. The term "participate in management" means actually participating in the management or operational affairs of the vessel or facility and does not include merely having a "capacity to influence," or the "unexercised right to control," vessel or facility operations. 42 U.S.C.A. 9601 (20)(f)(I). The lender is considered to participate in management only if, while the borrower is still in possession of the vessel or facility encumbered by the security interest, the person exercises decision making control over the environmental compliance related to the vessel or facility or exercises control at a level comparable to that of a manager of the vessel or facility such that the person has assumed or manifested responsibility for the overall management of the vessel or facility encompassing day-to-day decision making with respect to environmental compliance or overall or substantially all of the operational functions as distinguished from financial or administrative functions of the vessel or facility other than the function of environmental compliance. 42 U.S.C.A. 9601 (20)(f)(ii).
4. The term "participate in management" does not include performing an act or failing to act prior to the time at which a security interest is created in a vessel or facility.42 U.S.C.A. 9601 (20)(f)(iii).
5. The term "participate in management" also does not include the following:
a. holding a security interest or abandoning or releasing a security interest;
b. 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;
c. monitoring or enforcing the terms and conditions of the extension of creditor or security interest;
d. monitoring or undertaking 1 or more inspections of the vessel or facility;
e. requiring a response action or other lawful means of addressing the release or threatened release of a hazardous substance in connection with the vessel or facility prior to, during, or on the expiration of the term of the extension of credit;
f. providing financial or other advice or counseling in an effort to mitigate, prevent, or cure default or diminution in the value of the vessel or facility;
g. restructuring, renegotiating, or otherwise agreeing to alter the terms and conditions of the extension of credit or security interest, exercising forbearance;
h. exercising other remedies that may be available under applicable law for the breach of a term or condition of the extension of credit or security agreement; or
I. conducting a response action under section 9607(d) of this title or under the direction of an on-scene coordinator appointed under the National Contingency Plan.
if the actions do not rise to the level of participating in management (within the meaning of clauses (20)(f)(I) and (ii).
42 U.S.C.A. 9601 (20)(f)(iii).
E. Conclusion
Since the enactment of the Comprehensive Environmental Response, Compensation and Liability Act of 1980 ("CERCLA"), secured lenders have faced uncertainty with respect to their exposure to environmental liability. Congress has clarified the exclusion of lenders from liability under CERCLA. While secured lenders should now enjoy a more predictable safe harbor from environmental liabilities for attempting to protect their security interests, the statutory exemption should not reduce the care with which a lender undertakes the task of protecting the security interest in a property that has environmental problems.