The possibility of environmental liability for lenders resulting from making, administering or foreclosing on loans secured by contaminated real property has troubled the financial community for many years. Potential exposure to liability for remediation costs, damages, and penalties often has deterred lenders from entering into loans secured by properties with a history of industrial use or potential for contamination, or from exercising their rights of foreclosure. The prospect of fiduciary liability has also frustrated efforts to engage receivers and trustees to assist in the management and disposition of property subject to environmental risks.
Under the federal Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA" or "Superfund"), liability attaches to "owners or operators" of property where there has been a release of hazardous substances. The same standard applies under California's Hazardous Substance Account Act ("HSAA", often called "state Superfund"). Under both statutes, the term "owner or operator" excludes "a 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."42 U.S.C. 9601 (20)(A); Cal. Health & Safety Code 25323.5(a)(1). Judicial interpretations of this "secured creditor exemption" have created considerable uncertainty as to the risk to a lender in a number of scenarios, particularly loan workouts, foreclosures and property management, and disposition after foreclosure. Other state and federal laws imposing environmental liability generally do not address lender liability, thus adding to the uncertainty.
The problem was exacerbated in 1990 by the Fleet Factors1 decision which imposed CERCLA liability on a lender who had the mere "capacity to influence" environmental practices on the secured property. In 1992 the U.S. Environmental Protection Agency ("EPA") sought to overcome the Fleet Factors ruling and provide guidance to the lending community by enacting the so-called EPA Lender Liability Rule,2 a detailed regulation which protected lenders from CERCLA liability under specifically defined circumstances. Unfortunately, the EPA Lender Liability Rule was nullified by the Kelley3 decision in 1994.
The Ninth Circuit essentially rejected the Fleet Factors reasoning4, and in the aftermath of Kelley, it appeared that the federal courts in California were likely to apply the general reasoning of the EPA Lender Liability Rule. However, the absence of a codified legal standard continued to raise concerns. The problem required a comprehensive, legislative solution.
Legislative action at both the federal and state level has now been taken. In broad terms, both new laws are conceptually similar to the EPA Lender Liability Rule, but with a number of significant differences from that rule and from each other. From the standpoint of lenders and fiduciaries, the new laws represent a major, but less than optimal, improvement. We first address the federal legislation, HR 3610, and then California's SB 1285.
FEDERAL HR 3610
On September 30, 1996 President Clinton signed the 1996 Omnibus Appropriations Bill (HR 3610), which included the Asset Conservation, Lender Liability, and Deposit Insurance Protection Act of 1996. HR 3610 seeks to protect lenders and fiduciaries by amending CERCLA and the underground tank provisions of the federal Resource Conservation and Recovery Act ("RCRA").
Exclusion of Lenders from CERCLA "Owner or Operator" Definition
Under HR 3610, a "lender" includes, among others, federally insured depository institutions and many of their affiliates, federally insured credit unions, Farm Credit System lenders, certain private lenders, Fannie Mae, Freddie Mac, Farmer Mac and various other secondary market lenders and certain guarantors and title insurance companies.
New section 9601(20)(E)(i) excludes from the definition of "owner or operator," a lender who, without participating in the management of a property, holds indicia of ownership primarily to protect its security interest. Section 9601(20)(E)(ii) excludes a lender who has foreclosed on a property, or who, after foreclosure, sells, re-leases (in the case of a lease finance transaction), or liquidates the property, maintains business activities, winds up operations, undertakes a response action under CERCLA, or takes measures to preserve, protect, or prepare the property prior to sale or disposition, so long as the lender did not participate in the property's management prior to foreclosure. In order to preserve the protection of section 9601(20)(E)(ii), a lender who forecloses on property must seek to sell, re-lease, or otherwise divest itself of the property at the earliest practicable, commercially reasonable time, and on reasonable terms.
Sections 9601(20)(F)(i) and (ii) define "participation in management" as actually participating in the management or operational affairs of the facility, not merely having the capacity to influence or the unexercised right to control operations. While the borrower still possesses the property, a lender will be considered to participate in management only if it exercises decision-making control over environmental compliance, such that it has undertaken responsibility for hazardous substance handling or disposal, or exercises control of the facility at a level comparable to that of a manager of the facility. Acts of a lender prior to the creation of a security interest do not constitute participation in management under section 9601(20)(F)(iii).
Under section 9601(20)(F)(iv), the term "participate in management" specifically does not include:
- holding a security interest or abandoning or releasing a security interest;
- 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;
- monitoring or enforcing the terms of the extension of credit or security interest;
- monitoring or inspecting the facility;
- requiring a response action in connection with a release or threatened release of hazardous substances;
- providing advice to the borrower;
- restructuring the terms of the credit or exercising forbearance;
- exercising other remedies for the breach of the credit; or
- conducting a response action under CERCLA or under the National Contingency Plan;
provided that these actions do not otherwise rise to the level of participation in management within the meaning of the statute.
Although similar in many respects to the EPA Lender Liability Rule, HR 3610 is more abbreviated and does not provide the detailed guidelines previously set forth in the rule. For example, it is not clear from HR 3610 which "extensions of credit" made by lenders are covered or what constitutes "divestiture of acquired collateral at the earliest practicable, reasonable time." It is anticipated that EPA and the courts will provide guidance on these issues.
Partial Reinstatement of EPA Lender Liability Rule for Governmental Entities
HR 3610 adopts and reinstates the provisions of the EPA Lender Liability Rule which protected governmental entities that acquire contaminated property by operation of law or the like. In addition, HR 3610 prohibits judicial review of that portion of the EPA Lender Liability Rule. Except for this narrow reinstatement, HR 3610 does not purport to abrogate the Kelley decision or otherwise revive the EPA Lender Liability Rule on a retroactive basis.
Similar Exclusion of Lenders Under RCRA
HR 3610 also amends the underground tank provisions of RCRA by revising RCRA's definition of "owner." Amended section 6991(h)(9) provides that a person who, without participating in the management of an underground storage tank or being otherwise engaged in petroleum production, refining, or marketing, holds indicia of ownership primarily to protect a security interest, is not an "owner" or "operator." H.R. 3610 also endorses EPA's RCRA Lender Liability Rule5, which was modeled on EPA's Lender Liability Rule, and which was not challenged. The provisions added to CERCLA (sections 9601(20)(E) and (F), above) are also incorporated into RCRA. However, because California law largely governs leaking underground tank issues, this aspect of HR 3610 may have little impact on California sites.
Limitation of Fiduciary Liability
HR 3610 also attempts to protect fiduciaries by adding new sections to CERCLA and RCRA. Under HR 3610, a fiduciary's liability under CERCLA and the underground tank provisions of RCRA for releases of hazardous substances from property held in a fiduciary capacity cannot exceed the assets held in a fiduciary capacity. A "fiduciary" is a bona fide trustee, receiver, executor, administrator, and certain other types of persons acting for the benefit of others. HR 3610 contains a safe harbor provision which shields fiduciaries from personal liability for certain actions, including undertaking or directing lawful cleanups, administering property that was contaminated before the fiduciary relationship began, monitoring or inspecting property, advising the beneficiary, negotiating and enforcing environmental terms in the fiduciary agreement, terminating the fiduciary relationship or declining to take any of these actions.
A fiduciary is not protected in a number of situations. For example, a fiduciary is not protected if his or her own negligence causes or contributes to the release of hazardous substances, or if he or she is both a beneficiary and a fiduciary of the estate, acts in a capacity other than as fiduciary, or receives excessive compensation. If the fiduciary estate is actively carrying on a business for profit, or if the fiduciary acquired the property for the purpose of avoiding liability, the new protections of HR 3610 may not apply. In addition, HR 3610 does not affect liability that is independent of a person's role as a fiduciary.
Effective Date
The amendments made by HR 3610 apply to any claim that has not been finally adjudicated as of September 30, 1996, even if the transaction in question was made earlier.
CALIFORNIA SB 1285
On September 18, 1996, Governor Wilson signed Senate Bill 1285 which will limit the environmental liability of lenders and fiduciaries under almost all state and local laws in California, pursuant to new Chapter 6.96 of the California Health & Safety Code. SB 1285 has many parallels to, but is far more complicated than, the EPA Lender Liability Rule and HR 3610.
Immunity For Lenders From Environmental Liability
New Health & Safety Code section 25548.2(a) provides that, subject to numerous exceptions contained in the statute, a lender acting in the capacity of a lender shall not be liable under any state or local statute, regulation or ordinance, other than the California Hazardous Waste Control Law, to undertake a cleanup, pay damages, penalties or fines, or forfeit property as a result of the release of hazardous materials at or from property.6 Section 25548.2(a) applies to property in which the lender holds a security interest and property that the lender has acquired through foreclosure. The section also applies to property that is owned or used by the lender's borrower but is not the lender's collateral. In other words, the California law extends to unsecured, as well as secured, transactions. "Foreclosure" includes judicial or non-judicial foreclosure, taking a deed in lieu of foreclosure, and other means by which a security holder can take actual possession of the collateral.
Section 25548.2(b) permits a lender that does not participate in management of the property prior to foreclosure to take a wide variety of actions to protect its interests after foreclosure, without losing its section 25548.2(a) immunity. The list of authorized actions is similar to those authorized under HR 3610, and "participate in management" is defined in a manner similar to that under HR 3610.
To preserve the immunity under section 25548.2(b) after foreclosure, the lender must take commercially reasonable steps to divest itself of the property in a reasonably expeditious manner. This requirement is satisfied if within 12 months the lender lists the property for sale or re-lease with an appropriate broker or advertises the property on a monthly basis in a suitable real estate publication or a local newspaper of general circulation. The 12-month period begins when the lender acquires marketable title if it has moved diligently to do so after the expiration of any redemption or other waiting period, or upon foreclosure if it did not. After the first six months, the lender must not outbid, reject, or fail to act on a written, bona fide, and firm offer of fair consideration (as defined by SB 1285) for the property unless it is required to do so by other laws.
Lenders remain responsible for certain requirements which directly relate to health and safety. For instance, the lender must comply with all environmental disclosure, reporting, fencing and posting requirements. If foreclosing on property which requires continued operation and maintenance activities, deed restrictions, or monitoring, the lender must comply with those requirements unless excused by the appropriate agency. Lenders who conduct ongoing operations on the property also must comply with permitting, corrective action, release response, monitoring, and similar laws applicable to the business. In addition, if a release occurred before foreclosure, then upon taking possession, the lender must promptly suspend the relevant operations on the property, remove unreleased hazardous materials, and report the release. Another provision requires a lender to expend up to $25,000 to comply with an administrative order issued by an appropriate
If another person has undertaken cleanup of the property, the lender's immunity does not apply to the extent of the actual benefit received by the lender as a result of that cleanup. "Actual benefit" means the amount realized by the lender upon disposition of the property that results from the other person's cleanup, not to exceed the disposition proceeds less the outstanding loan obligation at the time of foreclosure plus costs of foreclosure, any subsequent lender cleanup, and property sale.
SB 1285 contains numerous exclusions from its statutory protection. For example, a lender does not qualify for the protections of SB 1285 if it contributes or causes a release by its act or failure to act. A lender that participates in management prior to foreclosure is not granted immunity; however, the lender's liability is limited to any release which occurred while the lender participated in management (there would be no such limitation under HR 3610 if the federal law applies). A lender also remains liable under the state Superfund law (the HSAA), if the lender is an arranger, generator or transporter (as opposed to an "owner or operator") under CERCLA section 107. The provisions of the act are inoperable to the extent that they are inconsistent with federal law such that the state would be penalized, lose funding or authorization if the act is enforced. The protections of the law are also unavailable to a lender "if the lender made, secured, held, or acquired the loan or obligation primarily for investment purposes." The intent of this facially troubling provision is unclear, and like some other provisions of SB 1285, may ultimately require judicial interpretation. Finally, the SB 1285 immunities apply only to lenders when acting in their capacity as such, and do not apply to a loan structured for the purpose of avoiding environmental liability.
Limitation of Liability for Fiduciaries
Again with numerous exceptions, new section 25548.3 provides that a fiduciary's liability under state and local statutes, regulations or ordinances for cleanup costs, damages, penalties or fines as a result of the release of hazardous materials at or from property held in the fiduciary estate shall be limited to, and satisfied from, assets held in the fiduciary estate. "Fiduciary" means a trustee for a trust, a bankruptcy trustee, a fiduciary under the Probate Code, a court-appointed receiver, and an assignee or trustee acting under an assignment made for the benefit of creditors.
As in HR 3610, the fiduciary cannot be both a fiduciary and beneficiary of the estate, or receive excessive compensation. Fiduciaries who carry on operations on the property remain responsible for compliance with laws applicable to the business. In order to qualify for the benefits of SB 1285, before commencing a voluntary removal or remediation action, the fiduciary must notify the appropriate agency. A fiduciary still is liable for a release caused by his or her negligent or reckless conduct. The immunity applies only to fiduciaries when acting in their capacity as such, and does not apply if the fiduciary relationship was set up for the purpose of avoiding environmental liability.
Effective Date
The changes made by SB 1285 apply to all actions filed on or after January 1, 1997, irrespective of the date of the loan.
COMMENTS
The enactment of HR 3610 and SB 1285 should significantly increase the comfort level of lenders and fiduciaries with respect to property with potential environmental problems. Lenders should be able to make, administer and collect loans with greater knowledge and ability to manage environmental risk. Similarly, fiduciaries should have greater certainty as to their exposure and that of the fiduciary estate with regard to ownership, management and sale of businesses and properties with environmental concerns. However, the new laws do not eliminate environmental liability, risk or potential compliance obligations. Lenders and fiduciaries remain responsible for their own actions and are responsible for undertaking certain emergency actions when required by a governmental entity with jurisdiction. In addition, lenders and fiduciaries must comply with operational and other requirements when owning or managing an ongoing business, and may be required to suspend operations which have resulted in contamination.
It is essential that lenders and fiduciaries review, and possibly modify, their current practices and procedures in order to take advantage of the benefits of the new laws. Because HR 3610 is now effective and SB 1285 becomes effective on January 1, 1997, lenders and fiduciaries should begin this review as soon as practicable.
1 United States v. Fleet Factors Corp., 901 F.2d 1550 (11th Cir. 1990), cert. denied 111 S.Ct. 752 (1991). [^ return to article text]
2 40 C.F.R. 300.1100 et seq.. ^
3 Kelley v. EPA, 15 F.3d 1100 (D.C. Cir. 1994). Notwithstanding the Kelley decision, EPA has continued to follow the EPA Lender Liability Rule as its internal enforcement policy. ^
4 In In Re Bergsoe Metal Corp., 910 F.2d 668 (9th Cir. 1990), the Ninth Circuit required actual management of property before the lender could be liable under CERCLA, but unfortunately gave little concrete guidance as to what activities were permissible. ^
6 This immunity does not appear to extend to negligence, trespass or other common law theories of liability. agency to abate an emergency situation where imminent and substantial endangerment exists and no other viable and responsible person has been located. ^