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New Superfund risks: uncertainties arise from a recent court decision that puts the onus on lenders for clean-up costs.


Uncertainties arise from a recent court decision that puts the onus on lenders for clean-up costs.

In recent years, the law in the area of lender liability under the Comprehensive Environmental Compensation Response and Liability Act (CERCLA), also known as Superfund, has become more clearly defined. However, U.S. v. Fleet Factors Corporation, the first federal appeals court decision addressing lender liability under Superfund, recently injected a great deal of uncertainty into this area of the law.

There are two primary ways in which secured lenders typically become liable under Superfund for the clean-up costs of the property in which they hold their security interests: by becoming the property's owner by taking title pursuant to foreclosure, or by becoming the properly's owner and/or operator by involvement with the borrower's affairs.

Although disturbing to lenders, the first type of liability has remained manageable. Lenders can avoid liability by refusing to foreclose on contaminated property or by bringing foreclosure actions but not purchasing the property at the ensuing auction.

It is the second type of lender liability that has been more troublesome to lenders and has been made worse by the recent Fleet Factors appeals court decision. This article seeks to define what has been traditionally considered permissible and impermissible lender involvement in borrower affairs under Superfund, and to indicate the impact of the Fleet Factors appeals court decision on lender liability. Finally, the article suggests precautions that secured lenders can take against this new risk.

Superfund's security interest exemption

All cases on Superfund lender liability based on lender classification as owner or operator have involved an interpretation of Superfund's security interest exemption. The security interest exemption exempts from the definition of an owner or operator of a contaminated facility, one who without participating in the management of the facility holds indicia of ownership primarily to protect their security interests in the facility. When sued for the clean-up costs of the property securing their loans, secured lenders have argued that they are entitled to the security interest exemption because they have not participated in the management of the contaminated facility. The government or private party suing the secured lender has argued the opposite.

In United States v. Mirabile, the first major case on this issue, the owners of a former paint manufacturing facility sued two lenders claiming that their participation in the management of the facility had voided their security interest exemptions, making them liable for its clean-up cost under Superfund. In interpreting the security interest exemption, the Mirabile court adopted a distinction between permissible participation by lenders in the financial management of their borrowers' facilities and impermissible participation by lenders in the operational management of their borrowers' facilities. Under Mirabile, to lose the security interest exemption, the lender must at least participate in the day-to-day operational aspects of the borrower's facility. The exemption will apply if the lender limits its activities to the financial aspect of management and does not become too embroiled in the "nuts-and-bolts, day-to-day" production aspects of the borrower's business.

The next major case on the issue of lender liability based on lender classification as owner or operator was the lower or district court decision in United States v. Fleet Factors. Fleet Factors involved an action by the United States to recover costs from Fleet Factors (Fleet), a lender, for the cleanup of its borrower's cloth printing facility. Fleet had advanced funds against the assignment of the borrower's accounts receivable. As additional collateral, Fleet held a security interest in the borrower's equipment, inventory, fixtures and realty, including the borrower's plant or facility. When the borrower defaulted on the loan, Fleet foreclosed on some of the borrower's inventory and equipment, but did not foreclose on the borrower's real property.

The U.S. took the position that Fleet was liable for clean-up costs because it had lost its security interest exemption by participating in the management of the facility. The district court ruled that most of Fleet's alleged involvement in the borrower's affairs did not void its security interest exemption. However, the district court would not dismiss the government's claim because of the government's contention that Fleet's agents had moved leaking, 55-gallon drums of toxic dyes and chemicals and disturbed asbestos pipe insulation at the facility.

Following the decision in Mirabile, the Fleet Factors district court distinguished permissible participation in the financial management of the borrower's facility from impermissible operational management of the borrower's facility. The district court interpreted the security interest exemption ". . . to permit secured creditors to provide financial assistance and general and even isolated instances of specific management advice to debtors without risking Superfund liability if the secured creditor does not participate in the day-to-day management of the business or facility either before or after the business ceases operation."

This interpretation of the security interest exemption was later followed by the court in Guidice v. BFG Electroplating and Manufacturing Company. In this case, the owner of a former metal polishing facility sued the bank which had loaned money to the former operator of the facility to construct a waste treatment facility and secured the debt with a mortgage on the realty. Based on the Mirabile and Fleet Factors district court decisions, the Guidice court held that the bank's significant involvement with the borrower's facility prior to its foreclosure constituted prudent measures undertaken to protect the bank's security interest and was insufficient to void its security interest exemption.

The Mirabile and Fleet Factors district court decisions were again followed in United States v. Nicolet Inc. In this case, the government sued the parent corporation of a subsidiary that owned and operated a contaminated hazardous waste disposal site. The government's claim against the parent corporation was based in part on lender liability because the parent held a mortgage on the contaminated property. Although the Nicolet court refused to dismiss this claim, the court held that under the security interest exemption, a secured lender who had not yet foreclosed on a contaminated facility could be held liable under Superfund only if it participated in the managerial and operational aspects of the facility. Because a genuine issue of fact existed as to the parent corporation's level of participation at the facility, the Nicolet court refused to dismiss the government's claim.

Specific exemptions

Before the Fleet Factors appeals court decision, a consensus had been formed among several federal district courts adopting the Mirabile distinction between permissible lender participation in the financial management of borrower facilities and impermissible lender participation in the day-to-day operational management of borrower facilities. Under this rule, lenders could become fairly involved in the financial aspects of their borrowers' businesses without risking Superfund liability. Lenders could take affirmative steps to safeguard and benefit from their collateral. So long as a lender concerned itself primarily with its borrower's overall financial problems rather than the borrower's smaller operational problems, the lender's involvement would not void its security interest exemption. Based on the type of lender involvement which courts had held to be permissible, lenders were able to participate in their borrower's financial affairs in the following ways:

* Monitoring cash collateral accounts; * Ensuring that receivables were

credited to the appropriate account; * Establishing a receivables reporting

system between the borrower and

the lender; * Advising the borrower on marketing

gain plans, sales gain plans and

increasing sales prices; * Discussing ways in which the

production schedule was able to meet

the sales forecast; * Collecting on the borrower's

accounts receivable; * Checking the credit of the

borrower's customers; * Contracting with an auctioneer to

auction off the inventory and

equipment of the borrower; * Receiving periodic financial

statements from the borrower; * Meeting with officials of the

borrower to be informed of such things

as the status of the borrower's

accounts, personnel changes and the

presence of raw materials; * Meeting with officials of the

borrower and actively assisting the

borrower in its application for a loan

from the Small Business

Administration; * Communicating with the state's

department of environmental

resources and local officials in an

effort to assist the borrower with

discharge compliance; * Inspecting the borrower's property

after operations had ceased to

determine the facility's general condition; * Conducting a series of meetings

with the borrower's principals

concerning the restructuring of its

loans; and * Referring a potential lessee of the

facility to the attorney representing

the borrower.

In short, lenders could be involved in their borrowers' upper level financial decisions in an attempt to ensure that their borrowers remained able to repay their loans.

New uncertainties

However, the Fleet Factors appeals court decision rejected the premise upon which such permissible lender participation was based. Under the decision, a lender will lose its security interest exemption if it participates in the financial management of the borrower to a degree indicating a capacity to affect the borrower's hazardous waste disposal decisions. The appeals court stated that a lender's capacity to influence a borrower's treatment of hazardous waste would generally be inferred from the extent of its financial involvement in the borrower's facility. Because almost any upper level financial decisions could have a ripple effect on hazardous waste disposal decisions, Fleet Factors destroys the ability of lenders to become involved in their borrower's financial affairs without risking Superfund liability. For example, a lender that takes part in its borrower's decision not to declare a dividend, risks Superfund liability because the decision causes the borrower to retain more capital with which it could improve its hazardous waste disposal methods.

The Fleet Factors appeals court decision has created a new category of liable persons in addition to owners, operators, transporters and generators by making liable those who do not rise to the level of operator but merely have the capacity to influence facility operations. The biggest problem with the decision is that it fails to provide lenders with a bright line test for determining when they will lose their security interest exemption. Never before has a case created liability for lenders who can merely be inferred to have the power to affect their borrower's waste disposal. The decision creates an inherently speculative law which will lead to extended litigation.

Fortunately, there are many reasons why the Fleet Factors appeals court decision may not pose as much of a threat to lenders as it appears. They are as follows:

First, the case is binding authority in the eleventh circuit only (i.e. Alabama, Georgia and Florida). In all other circuits it is merely persuasive authority at best.

Second, Fleet Factors may be reheard en banc. The case was decided by a quorum rather than a full appellate court panel because after oral argument but before the decision, one of the regular panel judges died. Additionally, only one of the two judges who participated in the decision was a full appellate court judge. The other judge was a senior U.S. district judge sitting by designation.

Third, like all of the decisions on lender liability based on involvement in borrower affairs thus far, Fleet Factors was not a hearing on the merits of the case but was a procedural ruling on a motion for summary judgment. For this reason, all of the government's allegations were taken as true for purposes of the ruling. The case was remanded to the district court for a hearing on the merits.

Fourth, much of what the appellate court said in Fleet Factors was dictum because it went beyond the facts at issue. The appellate court stated that if true, the government's allegations concerning Fleet's involvement at the facility (i.e., moving leaking drums of toxic dyes and chemicals and causing the release of friable asbestos) made Fleet liable under CERCLA as an operator of the facility, regardless of whether or not Fleet was liable because of its involvement in the borrower's financial affairs.

Fifth, upon remand, the district court may reject the appellate court's expansive construction of lender liability or make a narrower finding based on the specific facts before it.

Sixth, the case may be appealed to the U.S. Supreme Court or settled out of court prior to the lower court's decision on the merits.

Seventh, the case may be limited to its facts by future courts because the two principal officers of Fleet and the borrowing corporation were the same. Because the same principals influenced the affairs of both the lender and the borrower, the appeals court may have been more willing to disregard the separate identities of those entities than it otherwise would have been.

And finally, the decision may give major impetus to bills pending in Congress to protect lenders from Superfund liability.

Taking precautions

Despite its flaws, as long as the current Fleet Factors appellate court decision remains in existence, secured lenders should take certain precautions before making loans, beginning workouts or foreclosing on collateral. Unfortunately, the decision also affects existing loans, workouts and foreclosures and it may be too late to avoid lender liability in those cases. The following are some of the precautions which lenders may take to avoid lender liability in the future:

* Avoid taking security interests in

contaminated facilities if possible.

Lenders should increase their level

of environmental due diligence

before agreeing to enter into secured

transactions. If environmental

problems are identified, lenders

should consider taking a pass on the

loan. * Do not wait until after the closing to

address environmental problems. If

environmental problems are

identified and the loan still seems

attractive, the lender should

demand that the site be cleaned up

before the loan is made. If it is not

possible to do so, sufficient funds

should be placed in escrow to clean

up the site after closing. * If the loan seems attractive and

environmental problems have been

addressed, consider requiring

additional indemnities and guarantees

from the parent corporation of the

borrower and its principal

shareholders. Although environmental

problems may not exist at the time

that the loan is made, they may

occur in the future, in which case

the lender should have some type of

recourse. * Covenants in financing documents

that give the lender control over the

decisions of the borrower, especially

those involving hazardous waste,

should be used sparingly. Under

the Fleet Factors appeals court

decision, merely the lender's capacity to

influence the borrower's treatment

of hazardous waste could cause the

lender to be liable as an owner. * If the lender finances the borrower

with a continuing line of credit, the

lender may risk environmental

liability if it does not advance funds to

the borrower to clean up

environmental problems that develop.

It is apparent that the business of secured lending to environmentally active borrowers has become increasingly risky. Unless a comprehensive amendment to CERCLA is passed exempting secured lenders from liability, or unless the Fleet Factors case is rejected, things may get worse. However, by assessing environmental risks from the outset, carefully examining financing documents and monitoring interaction with borrowers, lenders can still profit from such loans.

Joseph S. Messer is an associate of the law firm of Rudnick & Wolfe, Chicago. He concentrates his practice in environmental law, with an emphasis in lender liability, lessor liability, transactional due diligence, underground storage tanks and the sale, acquisition and development of land.
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Title Annotation:Comprehensive Environmental Compensation Response and Liability Act
Author:Messer, Joseph S.
Publication:Mortgage Banking
Date:Aug 1, 1990
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