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Board of Governors of the Federal Reserve System.

I would like to thank you for the opportunity to discuss the issues of lender liability under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) as well as the solutions to this problem proposed by H.R. 14550 and S.651. The issues presented in this legislation are complex, and I commend the committee for undertaking to explore them fully at this time.

As an initial matter, we strongly support the purposes of CERCLA. We all wish to live in a clean and healthy environment; however, the costs of achieving this goal are substantial. The Environmental Protection Agency has estimated that the cleanup of the 1,200 priority sites alone may exceed $30 billion. The General Accounting Office has estimated that as many as 425,000 sites may need investigation and possibly cleanup. In light of these potential costs, we have become concerned over the effect of recent court interpretations of CERCLA that have held lenders liable for the cost of the cleanup of hazardous substances found on a borrower's property. Despite an exemption in CERCLA designed to shield lenders from CERCLA liability, these decisions, in effect, place lenders in the role of policing the hazardous substance disposal activities of their borrowers. Lenders are often ill equipped to perform this function, and imposition of unlimited liability can be expected to reduce their willingness to provide credit to prospective borrowers in any business or area when there is a risk of CERCLA liability. A reduction in the availability of credit threatens the viability of these businesses and their ability to contribute to the cleanup of the environment. Consequently, we believe that the imposition of cleanup liability on lenders is counterproductive to long-term environmental goals and we support the objectives of H.R. 1450 and S.651 to limit lender liability for cleanup costs under CERCLA.

Under CERCLA, the owner or operator of a property may be held liable for the entire cost of cleaning up hazardous substances found -on a site, regardless of whether the owner or operator is responsible for the release of the hazardous substance. By its terms, CERCLA generally excludes secured lenders from this liability; however, recent court decisions have largely eroded the protection furnished by this exclusion. Courts have imposed lender liability under CERCLA when a lender secured by property forecloses on property or has "participated in the management" of its borrowers by virtue of the rights reserved by the lender under its lending and security agreements with the borrower. With the average projected cost of remedying contamination at sites on the National Priority List climbing to more than $25 million dollars, liability in CERCLA cases may far exceed the amount of the lender's original loan.

Because of the erosion of the secured lender exemption, lenders to borrowers in businesses that use or produce hazardous substances are faced with a dilemma. Lenders can actively attempt to police hazardous substance disposal by their borrowers, risking being found to have participated in the management" of the borrower and therefore liable for potential cleanup costs, or they can ignore the borrowers's activities and risk nonpayment of the loan. Further, these court decisions may discourage even normal loan collection practices out of concern that they will be found to constitute management.

Lenders already have adequate incentives to encourage their borrowers to engage in environmentally safe practices so that these borrowers will avoid CERCLA liability. However, lenders do not generally have the technical expertise to police the environmental aspects of a borrower's operations. Covenants in borrowing agreements that give lenders a voice in their borrower's activities are designed to ensure that the borrower acts prudently in financial matters and places a high priority on the repayment of the debt, not to perm- it the lender to substitute its judgment for the borrower's in technical aspects of the borrower's business.

Imposing affirmative liability for environmental cleanup costs on lenders because of the exercise of such covenants is likely to do little to prevent the pollution of the environment but is likely to interfere with the availability of credit to even prudent businesses that use hazardous substances, such as farmers, dry cleaners, service stations, and chemical and fertilizer producers. Credit is a necessity for the operation of commercial enterprises. Lenders already reluctant to extend credit to borrowers that are subject to a high risk of CERCLA liability will only be further deterred by the prospect of affirmative lender liability under CERCLA. Increased lender reluctance to provide funds to industries or areas that present a risk of CERCLA liability is likely to have a significant adverse effect on these industries or areas.

Lack of credit in these cases may also frustrate environmental interests. Companies that are unable to continue operating because they cannot obtain credit will not be able to make any contribution to the environmental cleanup costs. Consequently, the current thrust of court decisions imposing lender liability under CERCLA may actually frustrate the environmental goals of CERCLA and increase the cleanup costs that must be borne by the government.

While the Board does not have comprehensive data on lender losses due to CERCLA liability to date, clearly significant losses have already occurred. More important to the future is that data from the Federal Reserve Banks suggest that CERCLA liability is, in fact, affecting the availability of credit. Banks are developing environmental guidelines that often indicate that the lender should decline to make loans collateralized by real property when past uses may have resulted in contamination of the property or to make loans to businesses that may use or produce hazardous substances in their operations. In some cases it appears that banks are declining to make loans regardless of the safety of a borrower's handling of hazardous substances.

In addition, banks are examining property carefully before they foreclose on it and are sometimes walking away from their collateral to avoid environmental liability. This problem appears to be widespread and is not confined to industrial areas of the country or to particular types of businesses. Virtually every Federal Reserve Bank reported instances when lenders had walked away from collateral, even when the collateral was the only source of repayment for the loan. The experience of walking away from collateral to avoid CERCLA liability is likely to cause lenders to become increasingly cautious about loans to many businesses or areas, even if no actual liability has been incurred under CERCLA.

In carrying out its examination and supervisory activities, the Federal Reserve expects banking organizations to have policies and procedures in place to monitor and control the risks to which banking organizations are exposed. However, banks have experienced difficulty in determining the appropriate protective practices to minimize the potential for CERCLA liability. Lending institutions are at risk for hazardous waste liability whether they have ignored hazardous waste issues altogether or have actively attempted to monitor the safety of their borrowers' operations. The Board currently is developing guidelines for bank examiners to follow in determining whether a lending institution has adopted appropriate procedures and safeguards to recognize potential hazardous substance problems. Unfortunately, given the current state of the law, there is no clear guidance that we can provide as to how an institution can extend credit and still avoid liability.

Besides private sector liability, CERCLA raises significant issues concerning the funding of government operations. Many lending institutions that are potentially subject to CERCLA liability are federally insured through the bank and thrift insurance funds. Unlimited liability under CERCLA poses a potential threat to the capital and solvency of these institutions and in some cases could result in the costs of hazardous substance removal being borne by the bank and thrift insurance funds. We understand that the Federal Deposit Insurance Corporation (FDIC) has already incurred losses as a result of CERCLA.

Further, many agencies and instrumentalities of the federal government, such as Federal Reserve Banks, Federal Home Loan Banks, the Farm Credit System, and the Small Business Administration, are also lenders. Lender liability presents a threat to the ability of these organizations to carry out the missions assigned to them by the Congress. The Federal Reserve Banks fulfill important functions in providing adjustment credit and acting as a lender of last resort for depository institutions. In acting as lender of last resort, a Federal Reserve Bank may advance funds to a depository institution collateralized by the institution's loans, which may, in turn, be secured by real property. Should the institution fail, the FDIC, as receiver, would likely acquire the loans from the Reserve Bank and would be left holding the loans. In these cases, the FDIC would be exposed to lender liability to the same extent as the original lender.

It is not appropriate to shift the risks and expenses of environmental cleanup costs from the funds allocated by the Congress for this purpose to the bank and thrift insurance funds or to governmental instrumentalities such as the Federal Reserve Banks. Federal agencies and instrumentalities have been charged by the Congress with particular responsibilities. Their funds are intended to be used to fulfill these responsibilities, not to cover the costs of hazardous substance removal.

Any legislation to limit the application of CERCLA liability should apply to all lenders and should strive to delineate clearly those activities that will lead to CERCLA liability. H.R. 1450 and S.651 present different approaches for reducing potential lender liability problems under CERCLA for both the private and public sectors. While each bill has strong points, both bills leave unanswered questions as to what duties, if any, a lender must perform to preserve the limitation on its liability.

H.R.1450 would amend CERCLA to require that a lender exercise "actual, direct, and continual or recurrent exercise of managerial control" that "materially divests the borrower, debtor, or obligor of such control" to be held liable for cleanup costs. Lenders with a security interest in property or lenders that had acquired title to the property through foreclosure or other means primarily for the purpose of protecting a security interest would not be subject to liability. These limitations on liability would be available broadly to all lenders and would protect governmental as well as private lenders. However, under H.R.1450 it is not clear whether lenders, either private or public, would be required to perform an environmental evaluation to avoid liability. Lenders that caused or exacerbated the release of hazardous substances would continue to be liable for costs resulting from their actions. In addition, lenders would still run the risk of nonpayment from borrowers that incurred CERCLA liability.

Rather than amend CERCLA directly, S.651 would amend the Federal Deposit Insurance Act to limit the liability of mortgage lenders and federally insured depository institutions for the cost of hazardous substance removal. It appears that the liability of these lenders would be limited to the amount of the loan made by the lender or the actual benefit received by the lender from the cleanup of the property, up to the amount of the loan. S.651 also provides that mortgage lenders or insured depository institutions will not be liable for cleanup costs based on their unexercised capacity to influence the operations of a borrower. Under S. 65 1, however, a lender would lose all benefit of the exemption if it caused or contributed to the release of hazardous wastes, and it is not clear under what circumstances a lender would be considered to have caused or contributed to a release or what actions a lender must take to prevent a release. This stringent standard, juxtaposed against the severe implications of being found responsible, could be a serious inhibition to a lender's willingness to lend.

S.651 addresses the concerns of public sector lenders directly and provides protection for public sector lenders by excluding them from liability for hazardous substance removal, by extending that immunity to the next purchaser of the property, and by exempting property acquired from CERCLA liens. These provisions would improve the ability of public sector lenders to obtain repayment of their loans and would limit the extent to which the funds of these lenders are diverted to pay for hazardous substance cleanup costs.

In closing, it is in the interests of the financial and environmental communities to find a balanced solution to the lender liability issue. If this issue is not resolved, we risk a reduction in the availability of credit to any industry, area, or borrower that appears to present a risk of liability for hazardous substance removal. We also risk imposing additional costs on the bank and thrift insurance funds to pay for environmental cleanup costs that would otherwise be met from the funds allocated by the Congress for that purpose. In light of these considerations, we believe that the environmental goals of CERCLA will be furthered rather than hampered by the provisions of H.R.1450 or S.651.
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Title Annotation:Statements to the Congress
Publication:Federal Reserve Bulletin
Date:Aug 1, 1991
Previous Article:Industrial production and capacity utilization.
Next Article:Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System.

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