Legislative Developments Provide New Protections for Secured Creditors and Fiduciaries

INTRODUCTION

Since the passage of the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA," commonly referred to as "Superfund") in 1980, and as amended in 1986, lenders and fiduciaries have been justifiably concerned about the imposition of owner or operator liability with respect to contaminated properties. As originally enacted, CERCLA included an exemption for secured parties that did not participate in the management of their borrowers' businesses. The exemption excluded from CERCLA's strict liability scheme an owner or operator "who, without participating in the management of a vessel or facility, holds indicia of ownership primarily to protect his security interest." The cases interpreting this secured creditor exemption did little to clarify the statutory language and produced conflicting rulings. Lenders faced considerable risk of CERCLA liability when they acquired an interest in a facility, whether through foreclosure or otherwise, or affected operational activities at a facility. Similar concerns were raised when the Resource Conservation and Recovery Act ("RCRA") was amended in 1984 to impose obligations upon owners and operators of underground storage tanks ("USTs").

Judicial decisions dealing with the circumstances under which lenders and fiduciaries could be held liable as owners or operators of contaminated properties or USTs failed to clearly articulate what lenders and fiduciaries could do to protect their investments without incurring liability. Furthermore, the Environmental Protection Agency's ("EPA") attempt to allay such concerns through a regulatory initiative was invalidated. As a result, federal legislation was needed to clarify the contours of "lender liability" in connection with CERCLA and RCRA. In response to such need, Congress enacted the Asset Conservation, Lender Liability and Deposit Insurance Act of 1996 (the "Lender Protection Act") as part of the 1997 Omnibus Appropriations Bill, which was signed into law and became effective on September 30, 1996. The Lender Protection Act included certain amendments to CERCLA and RCRA which affect secured creditors and fiduciaries. The Lender Protection Act resurrected EPA's lender liability rulemaking and applies to any claim that has not been finally adjudicated as of September 30, 1996.

Pennsylvania's analog to CERCLA is the Hazardous Sites Cleanup Act ("HSCA") of 1988. Like its federal counterpart, HSCA exempts, under certain circumstances, lenders from liability as owners and operators of contaminated property. HSCA's exemption enumerates certain activities that lenders may take without violating the "safe harbor" provision. Such activities include participation in or supervision of the finances or fiscal operations of an owner or operator in connection with a loan and actions taken to protect or preserve the value of the site or the operations conducted thereon. While the HSCA lender liability provision has not been subjected to judicial scrutiny like its federal counterpart, the limited decisions addressing the issue of liability under HSCA indicate that it shared many of the same shortcomings of the CERCLA analog.

In 1995, the Pennsylvania General Assembly, recognizing Pennsylvania's unique circumstance of having a multitude of abandoned and former industrial properties (commonly referred to as "brownfields"), developed the Land Recycling Program by enacting companion legislation comprised of Acts 2, 3 and 4. Act 2, the cornerstone of the Land Recycling Program, is the Land Recycling and Environmental Remediation Standards Act; Act 3 is the Economic Development Agency, Fiduciary and Lender Environmental Liability Protection Act; and Act 4 is the Industrial Sites Environmental Assessment Act. While these acts were designed to stimulate the redevelopment of brownfields, Act 3 is not limited to that purpose. It provides protection for lenders, fiduciaries and economic development authorities involved in routine transactions relating to all types of property. Additionally, while Act 3 is conceptually similar to the Federal Lender Protection Act, there are important substantive distinctions.

1. FEDERAL DEVELOPMENTS
2. 1. Lender Liability: The Need to Amend CERCLA

   2. Responding to protests from financial institutions primarily stemming from the Eleventh Circuit's decision in United States v. Fleet Factors, 901 F.2d 1550 (11th Cir. 1990), and the concern that potential environmental liability would hamper the credit market, in 1992 the EPA issued a rule (the "1992 Lender Liability Rule") to clarify the extent of lender liability under CERCLA. However, the United States Court of Appeals for the District of Columbia vacated the 1992 Lender Liability Rule in February 1994, finding that EPA had exceeded its authority in attempting through rulemaking to define liability under the statute. See Kelley v. EPA, 15 F.3d 1100, reh'g denied, 25 F.3d 1088 (D.C. Cir. 1994). In January 1995, the United States Supreme Court refused to review the case. See American Bankers Association v. Kelley, 513 U.S. 1110 (1995).

      Similarly, under RCRA the UST provisions included a "secured creditor exemption." Again, in an effort to clarify lender liability under a statutory exemption, EPA promulgated the 1995 Lender UST Rule (the "Tank Rule"). Although the Tank Rule did not undergo judicial scrutiny, the Kelley decision invalidating the 1992 Lender Liability Rule cast doubt on the validity of the Tank Rule.

      Trustees and executors shared a similar concern regarding potential owner or operator liability with respect to acquiring title to assets and their administration of those assets. Until the passage of the Act, there was no express protection for fiduciaries. And unfortunately, case law addressing the extent of a fiduciary's potential liability provided little guidance.

   3. History of CERCLA's Secured Creditor Exemption
   4. 1. Appellate Decisions on Liability of Nonforeclosing Banks

      2. On August 9, 1990, the Ninth Circuit Court of Appeals held in In re: Bergsoe Metal Corporation, 910 F.2d 668 (9th Cir. 1990), that the secured creditor exemption will be void only in circumstances where the holder of a security interest actually participates in the management of the borrower's facility. In an earlier case, United States v. Fleet Factors, 901 F.2d 1550 (11th Cir. 1990), cert. denied, 498 U.S. 1046 (1991), the Eleventh Circuit had taken the contrary position in dicta that a nonforeclosing secured lender could be liable for cleanup of a contaminated facility absent actual control if it had participated in the "financial management" of the facility to a degree sufficient to indicate the "capacity to control" waste handling operations. On remand, the district court denied Fleet's motion for summary judgment, which argued that the secured creditor's exemption would protect the lender from liability in connection with contamination caused by its auctioneer or site contractor or in connection with its off-site shipment of waste materials. U.S. v. Fleet Factors Corp., 819 F. Supp. 1079 (S.D. Ga. 1993). The trial that followed resulted in a judgment against Fleet. U.S. v. Fleet Factors Corp., 821 F. Supp. 707 (S.D. Ga. 1993).

      3. The Lender Liability Rule

      4. As previously noted, in 1992, EPA issued its Lender Liability Rule based on the secured creditor exemption originally enacted in CERCLA. The 1992 Lender Liability Rule rejected the Fleet Factors "capacity to control" analysis and expressly recognized a lender's right to engage in a broad range of nonmanagement activities for the purpose of protecting its security interest, including performance of pre-loan environmental audits, mandatory environmental remediation prior to or during the life of the loan, periodic inspection of environmental conditions and imposition of environmental technology-forcing requirements. The 1992 Lender Liability Rule also allowed a lender to engage in loan work-out activities without compromising the secured party exemption and treated foreclosure (and taking of title) as a non-ownership activity intended to protect a security interest; provided, however, that the lender undertook certain enumerated good-faith measures to sell the property.

      5. EPA/Department of Justice 1995 Policy Memorandum

      Following on the heels of the Supreme Court's refusal to entertain the appeal of the Kelly decision, EPA and the Department of Justice ("DOJ") issued a joint policy memorandum entitled "CERCLA Enforcement Against Lenders and Government Entities that Acquire Property Involuntarily." EPA and DOJ announced in this policy memorandum their intent to apply as guidance the 1992 Lender Liability Rule. However, the memorandum clearly indicates that the policy was intended solely as a guidance document for EPA and DOJ and thus would have no binding effect in the event of enforcement activities, litigation or private party disputes.

   5. Codification of the 1992 Lender Liability Rule -- Clarification of the Secured Creditor Exemption

   6. The amendments contained in the Lender Protection Act clarify the circumstances under which a secured creditor can be held responsible under CERCLA for its borrower's contamination. The Lender Protection Act also clarifies the extent of fiduciary responsibility under CERCLA and the risk of liability to secured creditors and fiduciaries under the UST provisions of RCRA.

      For lenders and fiduciaries, clarification is achieved through amendments to CERCLA's and RCRA's definitions and liability provisions. Section 2502 of the Lender Protection Act contains amendments to CERCLA's definitions and creates a new provision on fiduciary liability. Section 2503 of the Lender Protection Act applies the same lender and fiduciary provisions of CERCLA to Section 9003(h) of the Solid Waste Disposal Act, as amended by RCRA. Section 2504 of the Lender Protection Act revives the provisions, previously invalidated, in the 1992 Lender Liability Rule that apply to the involuntary acquisition of property by the government.

      The Lender Protection Act amends the CERCLA definition of "owner or operator" by adding, somewhat redundantly, at the end of the original definition an exclusion from liability for "a lender that, without participating in the management of a vessel or facility, holds indicia of ownership primarily to protect [its] security interest." See Section 2502(b) of the Lender Protection Act, codified at 42 U.S.C. §9601(20)(E)(i).

      The Lender Protection Act defines "participation in management" as actual participation in the management or operational affairs of a vessel or facility, and does not include within the definition the mere capacity to influence, or the unexercised right to control, operations. See Section 2502(b) of the Lender Protection Act, codified at 42U.S.C. §9601(20)(F). In so defining participation in management, Congress clearly rejected the analysis of Fleet Factors, where the court stated that mere capacity to influence operations could give rise to CERCLA liability on the part of secured parties. Under the Lender Protection Act, a secured party would be liable as participating in management if, while the borrower is still in possession, the secured party (1)makes environmental compliance decisions or (2)has responsibility for overall day-to-day decision-making with respect to environmental compliance or (3)has responsibility for overall operational functions other than environmental compliance. The Lender Protection Act thus defines "participating in management" in much the same way as did EPA in its 1992 Lender Liability Rule.

      The Lender Protection Act clarifies the terms "foreclose" and "foreclosure." Those terms are defined to mean to acquire or acquiring a vessel or facility through a variety of common foreclosure mechanisms, including a purchase at sale under a judgment or decree or a nonjudicial foreclosure sale; a deed in lieu of foreclosure or similar conveyance from a trustee; repossession, if the vessel was security for an extension of credit previously contracted; conveyance pursuant to an extension of credit previously contracted; or any other means of acquiring title or possession in order to protect a security interest. See Section 2502(b) of the Lender Protection Act, codified at 42 U.S.C. §§9601(G)(iii)(I)-(III).

      Finally, the Lender Protection Act specifically identifies those lenders to which the amendments apply, including insured depository institutions and their leasing or trust affiliates; insured credit unions; banks or associations chartered under the Farm Credit Act of 1971; any person making a bona fide extension of credit to, or taking or acquiring a security interest from, a nonaffiliated person; any entity that in a bona fide manner buys or sells loans or interests in loans, including the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation; an insurer or guarantor against default or a surety regarding an extension of credit to a nonaffiliated person; and title insurers that acquire a vessel or facility as a result of assignment or conveyance in the course of underwriting claims. See Section 2502(b) of the Lender Protection Act, codified at 42 U.S.C. §9601(20)(G)(iv).

   7. Permissible Activities Under the Act

   8. If a secured creditor's activities do not rise to the level of "participation in management," as defined in Section 2502(b) of the Lender Protection Act, codified at 42 U.S.C. §§9601(20)(E) and (F), it can undertake the following activities without voiding the exemption:

      1. Prior to Loan

Section 2502(b) of the Lender Protection Act, codified at 42 U.S.C. §§9601(20)(F)(iii), (iv).

The Lender Protection Act protects lessors under certain lease/finance transactions. However, a lessor cannot initially select the facility subject to the lease and cannot control the day-to-day operations or maintenance of the facility during the lease term. The lessor also is protected if the lease transaction conforms to regulations issued by the appropriate federal banking agency, appropriate state bank supervisor or regulations of the National Credit Union Administration Board. See Section2502(b) of the Lender Protection Act, codified at 42 U.S.C. §§9601(20)(G)(i)(I)-(II).

So long as a fiduciary's negligence does not cause or contribute to the release of hazardous substances, the fiduciary will not incur liability for undertaking (or declining to undertake) any of the following:

Section 2502(a) of the Lender Protection Act, codified at 42 U.S.C. §9607(n)(4).

On January30, 1997, EPA published in the Federal Register a policy statement regarding its position with respect to the cleanup and reuse of brownfields. Because one of the stated purposes of this policy is "[t]o allay the fear of potential federal pursuit of parties for cleanup of brownfields, EPA may provide varying degrees of comfort by communicating EPA's intentions toward a particular piece of property." EPA's intentions with respect to exercising its response or enforcement authority concerning a particular piece of property are communicated via "Comfort/Status Letters." However, according to the policy statement, such letters are provided for informational purposes only. Further, EPA indicated in the policy statement that it does not believe that such letters are appropriate or necessary for "typical" real estate transactions, but rather should be reserved for those instances in which the cleanup and redevelopment of brownfields are at issue. The policy statement includes four sample letters under the following categories: (1)no previous Federal Superfund interest; (2)no current Federal Superfund interest; (3)federal interest; and (4)state action.

While there is no direct correlation between the Congressional amendments to CERCLA and EPA's "Comfort/Status Letter" policy, there are benefits in recognizing the potential relationship between the two. For example, the new lender protection provisions of CERCLA may assuage some of the reservations lenders had relative to financing the acquisition and development of brownfields. Similarly, a potential purchaser/borrower may be able to achieve a greater sense of comfort with respect to potential agency interest in a site that would not otherwise be available during the course of its due diligence efforts. However, the potential purchaser/borrower (and the lender) must recognize that EPA's issuance of an apparently favorable letter is not a guarantee that enforcement actions will never be taken.

Moreover, even though brownfield initiatives currently remain a greater interest at the state regulatory level than at the federal level, some state governments are lobbying Congress for the development of a federal brownfields program. CERCLA reform has been a congressional topic of debate for several years. Currently, the issue of whether CERCLA should contain an express retroactive liability exemption for owners and operators appears to be a major stumbling block to comprehensive reform. The Republicans favor a reform package which not only eliminates retroactive application, but also includes provisions for brownfields redevelopment. However, some Democrats apparently prefer having separate brownfields legislation. Given the current congressional debate surrounding retroactive liability under CERCLA, federal brownfields legislation appears to be more likely with piecemeal CERCLA reform rather than under comprehensive amendments. Until a federal brownfields program comes to fruition, the apparent success of Pennsylvania's Land Recycling Program may be an indication of the potential benefits of understanding the indirect relationship between the "Comfort/Status Letter" policy and the new federal statutory safe harbor provisions for secured creditors.

1. PENNSYLVANIA DEVELOPMENTS
2. 1. Introduction

   2. A detailed discussion of all the acts comprising the Land Recycling Program is beyond the scope and intent of this article. Rather, the focus here is Act3. However, the importance of the entire program should not be discounted. For example, Act2 establishes, for the first time, a set process for the cleanup and reuse of industrial and commercial properties, a framework for the development of remediation standards and limitations on future cleanup liability for those satisfying the requirements it sets forth. Act4 authorizes the Department of Commerce to make grants to municipalities, local authorities, nonprofit economic development agencies and similar entities for the purpose of conducting environmental assessments of industrial sites located in those municipalities designated as distressed communities under the Business Infrastructure Development Act. In addition, pursuant to Act4 the Department of Commerce also may provide grants to cities of the first class, second class, second class A and third class to perform environmental assessments and remediation of industrial sites where industrial activity occurred before July18, 1995.

      Act 3 establishes the extent of liability for economic development authorities, fiduciaries and lenders. Because economic development agencies, fiduciaries and lenders understandably are reluctant to become involved with sites with environmental problems, one of the enumerated policies of Act 3 is to provide protection to such entities from environmental liability and remediation costs for releases and contamination caused by third parties. Such protection is provided not only to continue the use and reuse of industrial and commercial properties, but also to stimulate growth within the Commonwealth. Further, Act 3 specifically preempts all state statutory provisions and common law theories under which environmental liability may be imposed upon lenders, fiduciaries and economic development authorities. It also purportedly preempts federal statutes and regulations pertaining to employees, occupational safety and health, public safety, natural resources or the environment which may be asserted to impose liability upon lenders, fiduciaries and economic development authorities. While this aspect of Act 3 has not as yet been the subject of any challenges, the author doubts the Pennsylvania General Assembly's ability to preempt federal law.

   3. Provisions of Act 3 Applying to Lenders, Fiduciaries and Economic Development Agencies

   4. Section 13 of Act 3 states that the provisions of the Act apply to the following:

      (1) All indicia of ownership, including those presently or subsequently acquired or those acquired prior to the date of enactment that are held primarily to protect a security interest in the property;

      (2) Each fiduciary with respect to any services provided by the fiduciary, including those presently or subsequently provided and those rendered prior to the date of enactment; and

      (3) All administrative actions, actions, suits or claims against lenders, fiduciaries or economic development agencies not yet finally resolved by the department or any court or administrative hearing board having any action, suit or claim pending before it or an appeal from a lower court, regardless of when the release or interest in the subject property occurred.

      Certain provisions of Act 3 apply with equal force regardless of the type of entity. For example, under Section 7, a lender, fiduciary or economic development agency can avoid liability under any "environmental statute" or its common law equivalent by proving that a release or threatened release of a regulated substance for which such entities otherwise would be liable under other sections of Act 3 was caused by one of the following: (1)an act of God; (2)an intervening act of a public agency; (3)migration from property owned by a third party; (4)actions taken or omitted in the course of rendering care, assistance or advice in accordance with environmental acts or at the direction of the Pennsylvania Department of Environmental Protection ("Department"); or (5)an act of a third party who was not an agent or employee. Additionally, a lender will not be liable for a release or threatened release of a regulated substance if the alleged liability arises following a foreclosure and the lender exercised due care with respect to its knowledge about regulated substances and took reasonable precautions based on such knowledge against foreseeable actions of third parties and the consequences arising therefrom. Liability also may be avoided by proving any defenses which may be available under the environmental acts or at common law.

      In the event that two or more persons, acting independently, cause a distinct or single harm for which there is a reasonable basis to apportion liability according to the contribution of each person, under Section 9 a lender, fiduciary or economic development agency will be liable only for that portion of the total liability which is directly attributable to it. Hence, if a lender, fiduciary or economic development agency can demonstrate what, if any, costs are directly attributable to it, it can avoid the imposition of joint and several liability.

      Finally, while Act 3 was passed as part of Pennsylvania's brownfields legislative package, Section 10, governing the construction of this act, indicates that the legislature intended Act 3's application to be broader than simply a means of facilitating the reuse and development of industrial sites. For example, Section 10 states that Act 3 is to be liberally construed and that liability is to be based on "proximate and efficient causation." Further, Section 10 makes it clear that Act 3 preempts and eliminates all current liability standards, and that the burden of proof is upon the one seeking to hold a lender, fiduciary or economic development agency liable for response actions or damages.

   5. Lender Liability Provisions Under Act 3

   6. The scope of a lender's liability as well as the limitation of such liability is set forth in Section5. A lender who is involved in the routine practices of commercial lending (including, but not limited to, providing financial services, holding security interests, work-out practices, foreclosure or recovery of funds from the sale of property) will not be liable under any "environmental act" or the common law equivalents either to the Department or to any other person by virtue of engaging in commercial lending, unless: (1) the lender (including employees and agents thereof) directly causes an immediate release or directly exacerbates a release of a regulated substance on or from the property; or (2) the lender (including employees and agents thereof) knowingly and willfully compelled the borrower to do any action which caused an immediate release or violation of an environmental act. However, a lender's liability under Act 3 is limited to the cost of a response action which may be directly attributable to the lender's actions at the site. In addition, liability arises only if the lender's actions were the "proximate and efficient cause" of a release or violation. Moreover, under Act 3 a lender is not liable for any response action if such action arises "solely from a release of regulated substances which occurred prior to or commences before or continues after foreclosure." However, a lender will be liable for any portion of a response action directly attributable to the lender's exacerbation of a release.

   7. Fiduciary Provisions Under Act 3.

   8. A fiduciary's environmental liability under Act 3 is governed by Section 6. This section shields a fiduciary from personal or individual liability, to the Department or any other person, which may arise under the environmental acts or the common law equivalents with respect to the services provided by the fiduciary, unless:

      1. an event occurred which constituted a release of a regulated substance under the environmental acts during the time that the fiduciary's services were actively provided;

      2. as part of actively providing services the fiduciary had express power and authority to control property which was the cause of or the site of a release of a regulated substance; or

      3. according to the law or practice in effect at the time of a release, the actions or omissions of the fiduciary resulted in a release where such actions or omissions constituted gross negligence or willful misconduct.

      However, Act 3 does not prohibit claims against a fiduciary in its representative capacity.

      Notwithstanding the foregoing, a fiduciary's liability is limited to the cost of a response action which is directly attributable to the actions of the fiduciary described above. Moreover, fiduciaries will have no liability for response actions if such actions arise from a release of a regulated substance which occurs prior to, or commences before and continues after, the time the fiduciary actively provided its services. However, a fiduciary will be liable for any portion of a response action directly attributable to the fiduciary's exacerbation of a release. And, as with the lender provisions, for purposes of determining a fiduciary's liability, a release of a regulated substance discovered during the course of performing due diligence will be presumed to be a prior and continuing release. Finally, for purposes of determining whether a fiduciary is liable due to its express power and authority to control property, Section 6 indicates that such control will be deemed to be in the lessee and the lessor for leased property.

   9. Economic Development Agencies Provisions Under Act 3.

Section 4 governs the environmental liability of an economic development agency. Such an agency which holds indicia of ownership as a security interest for the purpose of development or redevelopment or to finance an economic development or redevelopment activity is protected from liability, to the Department or any other person, which may arise under the environmental acts. However, this "safe harbor" provision protects the agency only to the extent of the following:

Additionally, the protections afforded an economic agency are not lost by virtue of foreclosure or the assumption of possession of property. Moreover, an economic agency which conducts a remedial action pursuant to and in accordance with a written agreement with the Department will not be liable as an owner, operator or occupier in any action by the Department for a release or potential release of a regulated substance.

CONCLUSION

The trepidation which secured creditors and fiduciaries once experienced when dealing with environmentally problematic properties should no longer be quite as severe. Under the current federal and state regulatory regimes, secured creditors and fiduciaries now have statutory maps to chart their courses when engaging in transactions involving contaminated property. Provided such entities do not violate the "safe harbor" provisions, they should be able to reasonably assess the extent of their potential environmental liability. However, while the trend is towards "lender-friendly" legislative programs, a word of caution is warranted.

A secured creditor must still take precautions to ensure that the value of secured collateral will not be significantly diminished by contamination resulting from the operations of a borrower. Further, through covenants and indemnification provisions, the secured creditor should endeavor to require its borrower to maintain the secured property in as "clean" a state as possible. The benefits to the lender of requiring such maintenance include avoiding the accumulation of small problems which can balloon into costly cleanups; and in the event of foreclosure, the lender is not saddled with the prospect of having to remediate the property prior to resale. And, notwithstanding the limitations of a lender's potential environmental liability, there is no substitute for environmental due diligence when evaluating the "business risks" associated with a transaction. Thorough due diligence may indicate that a borrower's environmental liability exposure may impair its ability to repay a loan, thereby making the borrower a possible credit risk. Regardless of the inevitable risks associated with any transaction involving contaminated property, the recent developments discussed herein should be viewed positively by secured creditors, fiduciaries, borrowers and developers.