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A hazardous cleaning bill.

Environmental Liability: Must Lenders Bear Cost Of Cleaning Up Wastes?

Arkansas lenders aren't in the habit of walking away from a bad loan without trying to recover a portion of the debt through a foreclosure sale.

But that's not the case when the collateral securing the loan is an abandoned wood treatment plant polluted with a toxin known as chromated copper arsenic.

One bank had a $400,000 judgment against the former operators of the plant.

Another Arkansas institution was owed $200,000.

After seeing the extent of the contamination, both lenders chose to swallow their losses rather than enter the chain of title on the property and risk losing more dollars.

"It is amazing they would walk away from that kind of money," says Little Rock attorney Rick Ramsay. "This scares them to death, and rightfully so."

Until recently, environmentalists and government enforcement agencies were tapping often into the deep pockets of lenders to pay for the cleanup of hazardous sites.

However, an April 24 ruling by the Environmental Protection Agency has helped lower the lender anxiety level nationwide. Now, banks and thrifts will be less likely to get stuck with the liability of cleaning up polluted property that was used by borrowers to secure loans.

The change comes as welcome news for loan officers such as Chuck Cook.

"We're delighted that this potential source of liability was removed as an issue," says Cook, a senior vice president at First Commercial Bank in Little Rock.

The ruling leaves some uncertainty as to a bank's exposure as a trustee or administrator of an estate that involves a contaminated property.

Liability, though, remains linked with exercising even limited managerial control over a property, regardless of whether a lender was directly responsible for the environmental contamination.

Will that situation eventually change, too?

"No personal trustee can be held liable, and EPA will consider addressing the issue of trusts and estates," says Diane Mackey, a partner at the Little Rock Law firm Friday Eldredge & Clark. "The new EPA rule goes to great lengths to tell creditors what they can and can't do with a |contaminated~ property. The main point of the ruling was to clarify the situation created by the Fleet Factors decision."

That 1990 decision, handed down by the 11th U.S. Circuit Court of Appeals at Atlanta, sent shock waves through the nation's lending community.

The bottom line?

A secured creditor could be held liable for cleanup costs of a property on the mere premise that it had the capacity to influence borrowers' treatment of hazardous wastes.

The case added to a growing list of court decisions that sent a clear message to lenders: Get ready for trouble if a loan is secured by collateral that might be tainted by hazardous wastes or chemicals.

It also established battle lines between two areas of the federal bureaucracy, the EPA and bank regulators.

The Federal Deposit Insurance Corp. and other financial regulatory agencies argued that the legal decisions had undermined their ability to monitor lenders.

How do you factor in the potential liability of a loan secured by property that might carry a negative value? A lender could face expensive cleanup costs that exceed the value of a loan and then be stuck with a worthless piece of property.

"It makes you assess your position before you take the property back," Cook says. "If you take it back, it's buyer beware."

Such harsh realities were making it almost impossible to determine the exposure banks were carrying in their loan portfolios. And it all came in the aftermath of the savings-and-loan debacles and bank failures of the 1980s.

"It takes years to assess the cost of remediation in some cases," says Mark Grobmyer, a partner in the Little Rock law firm Arnold Grobmyer & Haley. "When the final bill is totaled, it could wipe out a bank's capital base."

A survey of 250 lenders at the 1991 American Bankers Association's Agricultural Bankers Conference at Kansas City, Mo., highlighted the problem. Almost one of every five bankers attending the conference said their institutions had to pay for cleanup costs on environmentally contaminated properties.

Pressure was put on the EPA to restore some balance as lenders made provisions to contend with the risk.

Buried Problems

One out-of-state lender foreclosed on an Arkansas property after an environmental audit determined the takeover made economic sense. The audit noted that some remediation work was necessary, but it overlooked an underground tank. It cost the lender thousands of dollars to remove the tank.

The lender incurred the added cost rather than launching a professional negligence lawsuit to recover money from the consultant who performed the audit.

Consultants often take precautions such as sheltering assets in their spouses' names in the event they should lose negligence suits.

The minimum deductible on a consulting firm's insurance coverage is $25,000, provided it can afford the premiums.

The stakes are high for reputable and unreputable companies alike.

Even participants in conventional real estate transactions have their guard up to avoid getting stuck with the cost of environmental remediation.

Little Rock commercial real estate agent Bill McClard recalls one sale in which the cautious attitude of a client paid off.

An environmental consultant supposedly inspected a property to alleviate concerns. Environmental audits can differ, though, depending on who is paying for the work. A seller wants to keep potential buyers happy. At the same time, the seller has no incentive to find problems that could threaten the transaction or generate additional costs.

If the seller is footing the bill, this can lead to a "desk-top audit" in which a seller retains a firm to do the bare minimum.

In McClard's case, the initial environmental audit said there might be an underground tank on the premises. The buyer visited the property two days before the deal was set to close and discovered there were, in fact, two underground tanks beneath a building.

The sale was delayed until additional testing could be conducted.

The results of a boring sample, paid for by the seller again, indicated there was no problem. The consultant said the tanks could be left in place and filled with slurry.

McClard's buyer remained skeptical and requested more borings to make sure there was no leakage. The additional soil samples revealed there was a problem. The tanks were leaking petroleum waste.

The underground tanks had to be cut out of a concrete floor and removed along with 45 cubic yards of dirt at a cost of $30,000 to the seller. The cost would have been higher if the clay soil around the tanks had not prevented the contamination from spreading.

"Had it not been taken care of, years from now my buyer might have had a problem," McClard says. "It's scary."

Learning Experience

Not all loan officers have a firm grasp on how to contend with this aspect of the green movement, according to Bud Finley of Cierra Inc.

Often, lenders who contact Finley's Bryant-based environmental consulting firm are working in a state of blissful ignorance. They understand what an appraisal is, but what's an environmental audit?

"When I ask some of them what they want us to do, they say, 'I don't know, just do one of those environmental things,'" Finley says. "We're sitting here with toxicologists, geologists, chemists and engineers who won't sign off on just anything."

The borrower often sees the environmental report, which can cost at least $2,500 depending on how detailed the audit is.

The initial audit should determine if there is a hazardous waste problem.

A second audit should determine the extent of the problem and the estimated cost of remediation.

The cost typically comes out of the borrower's pocket along with the costs of appraisals, surveys and more.

"We know instances in which a lender has just waived the environmental audit entirely to keep a customer's business," Finley says.

That's not the case at Worthen National Bank of Arkansas in Little Rock. Environmental audits are not considered optional at Worthen.

"We're real strict," says Max Sears, a senior vice president at Worthen. "... If we lose business over it, we're sorry, but we require it."

And for good reason.

The bank doesn't want to play Russian roulette with loans.

Worthen once took a $230,000 loss on a loan rather than pay double that amount for the cleanup costs of surface pollution on a secured property. Part of the 130-acre tract was used for manufacturing boats, and the rest was used as a dumping ground for the plant's industrial wastes.

When it came time to foreclose, bank officials visited the property and found 400 barrels of wastes, toxic waste ponds and piles of trash.

The bank was able to recover about $25,000 by having the bankruptcy trustee sell the uncontaminated part of the property.

Trouble came for another lender in the form of poultry manure spread 2-feet thick across 63 acres in north central Arkansas.

An unnamed national lender made the mistake of recovering the property through foreclosure before inspecting it. The turkey and chicken waste was responsible for nitrates polluting surface and groundwater over a wide area.

And then there was the Arkansas company that simply disposed of its industrial wastes by pouring them down the "go-away hole."

The pollution may go out of sight and mind for the moment, but the consequences -- financial and otherwise -- are bound to surface eventually.

Arkansas lenders have learned that lesson all too well.

Finding Fault

Environmental Lender Liability: The Rules Keep Changing

A recent ruling by the Environmental Protection Agency could make legal battles in the war on pollution less onerous for lenders.

Changes in the Comprehensive Environmental Response, Compensation and Liability Act allow lenders to use the "innocent landowner" defense more effectively against environmental liability claims.

Simply put, this legal position states that "if we didn't cause the mess, we shouldn't have to pay to clean it up."

Prior to the EPA ruling, lenders were being held liable for cleanup costs.

Here are five cases that previously helped shape the environmental lender liability issue:

* United States v. Maryland Bank & Trust Co.: In this 1986 decision, a bank foreclosed on a mortgaged farm and purchased it when no other bids were made at a foreclosure sale.

After the bank took title to the property, the EPA discovered the farm had been used as a hazardous waste dump. The government remediated the site under CERCLA and sued the bank to recover $550,000 in cleanup costs.

The court ruled that the bank was liable under CERCLA. An important factor was that the bank had controlled the land for almost four years at the time of the decision.

The bank paid the cleanup costs rather than incur the added costs of a trial.

* United States v. Mirabile: In this 1985 decision, several lenders were involved in financing a manufacturing facility that the EPA had to clean up.

The court ruled that a lender must be involved in the daily operations of a plant before the lender can be held accountable for hazardous waste problems.

The bank that had foreclosed on the property and sold it several months later was not liable.

Another bank had been more involved in managing the facility during an attempt to keep it open, however. The second bank paid a portion of the cleanup costs rather than incur the added cost of going to trial.

* Tanglewood East Homeowners v. Charles-Thomas Inc.: In this 1988 decision, a group of property owners sued First Federal Savings & Loan Association of Conroe, Texas, and others.

The thrift had financed the redevelopment of a wood treatment facility into a residential subdivision. The court ruled that landfill excavations amounted to improper disposal and treatment of hazardous materials.

The S&L and other defendants could end up paying the cleanup costs and the costs incurred by those who had to abandon their homes and property.

* United States v. Fleet Factors: In this 1991 decision, an appeals court ruled that a secured creditor may incur liability "without being an operator, by participating in the financial management of a facility to a degree indicating a capacity to influence the corporation's treatment of hazardous wastes."

In other words, there is liability if a secured creditor could affect hazardous waste disposal decisions if it chose to do so.

The ruling by the 11th U.S. Circuit Court of Appeals at Atlanta overturned a lower court ruling that Fleet Factors was not an owner or operator and therefore not liable for cleanup costs at a contaminated cloth printing plant.

Fleet Factors had an interest in the bankrupt plant and its equipment and inventory. Fleet Factors only foreclosed on the equipment and inventory, selling some of the recovered assets at a public auction and contracting to have the rest removed.

The EPA claimed that Fleet Factors released asbestos at the plant during its moving operations. Barrels of hazardous wastes later were discovered at the site.

* Guidice v. BFG Electroplating. In this 1989 decision, the court ruled that a lender's involvement in the financial affairs of a debtor prior to foreclosure did not make the lender liable under CERCLA.

Yet the court also ruled that the lender did become liable for cleanup costs by taking ownership of the property through foreclosure proceedings.
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Title Annotation:includes related article; environmental liabilities
Author:Waldon, George
Publication:Arkansas Business
Date:May 25, 1992
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