New environmental liability law goes into effect after lengthy swarm of controversy.

Legislation designed to clarify a commercial property owner's obligation to the lender when the land is environmentally damaged went into effect last month despite a lengthy controversy between bankers and the real estate professionals to whom they lend money.

"This bill gives financial institutions greater incentive to make commercial loans, even in the case where businesses are offering as collateral property that is known to be or has the potential to become contaminated," said Betsy Mahan, vice president and manager of government relations for First Interstate Bank of California.

Assembly Bill 1735 modifies a California law, called the "single-action rule," which establishes strict guidelines on a lender's ability to seek remuneration on a defaulted loan. According to the provisions of the long-standing legislation, the lender can initiate foreclosure proceedings or a lawsuit against the borrower, but cannot take both actions simultaneously.

The bill, introduced by Assemblyman Phillip Isenberg, D-Sacramento, and sponsored by the California Bankers Association, effectively removed the restriction, extending the right to the lender to inspect land before foreclosure proceedings, or when there is suspicion of contamination.

John Balluff, lobbyist for Wells Fargo Bank, said his bank supported the measure because environmental risks are a real concern to lenders who take great precautions in executing commercial transactions.

The new legislation takes effect when the loan in question exceeds $200,000. That is the point where amendments to the single-action rule apply.

Dwight Hansen, the California Building Industry Association's legislative advocate for finance and housing, said the intent of the bill's sponsors was to show they were not trying to target the small borrowers. Hansen's organization opposed provisions which attached responsibility for the cleanup of polluted property to the borrower.

"We indicated at that point, though we still felt there were very large problems with it, we were hopeful the financial industry would implement this new law fairly and in a manner that did not fulfill our worst nightmares," Hansen said.

The controversy centered around the real estate community's objections to any proposed changes in the single-action rule.

"They liked the ironclad right to walk away from the property," said Gregory Wilhelm, director of government relations for the California Bankers Association. To the commercial lender the issue was recovering for the outstanding balance if the borrower defaulted on contaminated property, particularly since cleanup costs could exceed what is recouped in a foreclosure sale.

AB 1735 more clearly delineated the responsibility of the borrower and its contractual obligations to the lender to make the agreement more enforceable.

Although much of the controversy has subsided since the bill's passage, a spokeswoman for the California Association of Realtors said her organization still does not support the measure. In a July statement, realtors association President Mack Powell said: "We strongly oppose this bill which will place many small property owners at risk for environmental damage caused by others."

"The passage of this legislation would allow financial institutions to tap into personal savings of innocent borrowers who already may have lost their investments in contaminated properties," he continued.

Not everyone believed more laws were the best answer. Some maintained a program initiated by the Institute of Environmental Finance in 1991 -- an organization that represents the interests of the California Bankers Association -- provided the preferred alternative: creating an insurance program to protect the lender.

The property owner would purchase an insurance policy that covers future water and soil contamination, according to a program being implemented by The Cooperative Solution Loan Program. The policy would include a warranty of up to $100 million per project. If the warranty is insufficient and the property goes into default, the policy will help pay off the lender.

"It allows the lender to walk into environmentally impaired loans as opposed to away from them, providing protection for their loan portfolio against future default," said Rebekah J. Buckles, chairwoman of The Cooperative Solution. It also eliminates a "toxic gridlock" which has prevented lenders from funding sites that are known to be contaminated, she said.