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Federal Law Clarification of Lender Liability

Written by: Gregory H. Smith

Last Fall the Congress passed and the President signed the "Asset Conservation Lender Liability and Deposit Insurance Protection Act of 1996" which amended CERCLA in order to provide significant protection against environmental liability for banks, other lenders and involuntary governmental holders of contaminated property. These amendments, are the culmination of a fifteen year history of uncertainty about the nature and extent of lender liability. As a result of these amendments, federal law is now essentially consistent with State law in protecting lenders and foreclosing municipal entities from liability which otherwise might be imposed under CERCLA and RCRA.

Past Uncertainty

Liability under CERCLA attaches to "owners" or "operators" for clean up costs at sites which they owned "at the time of disposal" of hazardous substances. As originally adopted, CERCLA created a "secured creditor exemption" from strict, joint and several liability for "owners or operators" who, "without participating in the management of a vessel or facility, hold indicia of ownership primarily to protect `their` security interest in the vessel or facility."

In spite of this exemption, there was significant uncertainty about when a lender’s participation in management of a polluting facility would trigger liability under either State or federal law. Clearly, the exemption would not protect a lender who foreclosed on contaminated property taking title and acting in every respect as owner; however, for many lenders or municipalities, the mere holding of a security interest in contaminated property became practically very risky.

Through this decade, several courts have analyzed the issue of lender liability under CERCLA. In 1991, the 11th circuit in United States v. Fleet Factors Corp. 901 F 2nd 1550 (11th CIR.1990) held that a lender could be liable for participating in the financial management of a facility if it influenced hazardous waste operations. As a result of this decision, and corresponding risk to lenders who arguably have the capacity to influence a borrowers conduct, efforts began in earnest to change the law. Based upon other judicial interpretations of the secured creditor exemption, which required some actual management of the facility to lose the exemption, EPA issued its lender-liability rule in 1992.

Under that rule, EPA interpreted the creditor exemption to allow limited involvement by lenders in the owner’s activities to the point where a lender became actually involved in hazardous waste decision making, environmental compliance, or substantially all day to day management control. The EPA rule provided protection for secured creditors even after foreclosure on a contaminated site, provided that the creditor made reasonable efforts to sell the contaminated property. Unfortunately, the EPA rule and the protection it provided did not last long. In 1994, the D.C. Circuit Court struck down the EPA rule because it exceeded the agencies’ statutory authority.

The 1996 Amendment

The 1996 amendments essentially have incorporated the prior EPA rule into federal law. The amendments modify the CERCLA definition of "owner or operator" to exclude from liability a "lender that did not participate in management of a vessel or facility prior to foreclosure."

Even after foreclosure, so long as the lender or municipality makes reasonable efforts within commercially reasonable time to sell or re-lease the contaminated property, the lender does not lose it protection. As a result, federal law is now consistent with State law, which protects a lender from liability as long as it does not engage in "participation in management" and makes reasonable efforts to sell or re-lease the property.

The amendments further define participation in management to mean "actually participating in the management or operational affairs of a vessel or facility" so that the "mere capacity to influence" is explicitly rejected as a basis for imposing a circle of liability on a lender. The participation in management necessary to trigger liability includes the following:

  • Decision making control over environmental compliance so that the person has undertaken the responsibility for the hazardous substance or disposal practices of the facility;
  • Control at a level comparable to that of a manager including day to day decision making regarding environmental compliance or decision making over all or substantially all operational functions of the facility.
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In addition, the term "lender" in the new federal law has been broadly defined to include institutional lenders, private lenders and government lenders. The term "security interest" is also broadly redefined to include virtually any type of security interest connected with the loan. Finally, a new section was added to CERCLA to protect a broadly defined category of "fiduciaries" so that there liability will not exceed the assets held in their fiduciary capacity. There is protection for fiduciaries who take steps to respond to or investigate the risk of hazardous substances, unless they act negligently in that regard. The 1996 amendments also add liability protection from RCRA for lenders for contamination arising from underground storage tanks.

Amendment Implications

While the 1996 amendments to CERCLA are good news for secured creditors, there are remaining concerns. The amendments only exempt creditor liabilities as owners and operators. There are other potential categories of liability. Lenders who foreclose on contaminated property should be mindful of liability as an arranger or transporter of hazardous materials from the facilities which they come to own through foreclosure. To the extent that a lender takes over a site and engages in decisions related to clean up and disposal of hazardous materials, it may incur liability as a generator or transporter.

Accordingly, pre- and post-foreclosure secured creditors must engage in environmental decisions with extreme caution particularly to the extent they involve activities beyond the property boundary. Creditors must act cautiously with regard to whether they might be considered to be "participating in management". Although the amendments have clarified this activity to a certain extent, as with any legislation, there are uncertainties in the language which remain. Although the amendments are detailed regarding pre-foreclosure "participation in management," once a lender forecloses it becomes the owner.

After foreclosure, the creditor may hold the property for a reasonable time without incurring liability, but what the lender may do at this point without becoming an owner or operator under CERCLA is not as clear. A creditor who contributes to an actual or threatened release through its negligence may also face liability for cleanup costs. Although the CERCLA amendments do much to reduce uncertainty for creditors holding contaminated property as security, creditor foreclosure on contaminated property will undoubtedly continue to require careful examination and occur infrequently as a result of both uncertainties as to liability and difficulties in sale or re-lease of contaminated properties.

Nonetheless, the clarification of lender liability under CERCLA, coupled with the protection offered by the Brownfields program should continue to encourage investment in and redevelopment of contaminated properties.

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