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Superfund and risk management for owners of real estate.

In 1980, the U.S. Congress passed a law that has transformed the real estate industry in this country. This law -- the so-called Superfund Act, also known as CERCLA (Comprehensive Environmental Response, Compensation and Liability Act) -- as well as a host of other federal and state environmental statutes, imposes duties, burdens and liabilities on owners of land and operators of businesses that were undreamed of 15 years ago.

Essentially, CERCLA imposes strict liability for cleanup of a contaminated site on an owner or operator of the site, or a prior owner or operator, who was responsible for the contamination. These are the so-called "responsible parties." (Though there are other classes of people who may be liable.) Although originally CERCLA was mainly a tool that enabled the federal government to sue responsible parties to recover the government's cleanup costs, or to force responsible parties to do the cleanup, private parties increasingly have used CERCLA as a means of recouping cleanup costs (so-called "response costs") or forcing cleanup by others.

A major consequence of this is that the Superfund law -- and in fact, all of the environmental law, state as well as federal -- has added a new layer of concern to every facet of real estate ownership, to real estate purchases and to the operation or conduct of real estate activities. There are heightened duties imposed on owners, sellers, buyers, lenders and operators that no onw would have anticipated.

There are only three defenses to CERCLA liability -- an act of God and an act of war being the first two. The third has come to be known as "the innocent landowner defense," and it is this defense in particular that motivates potential buyers and lenders to do their "due diligence" on a piece of property. Just in the contect of real estate sales, the due diligence required of a lender under CERCLA is mind-boggling, and often not economically feasible for smaller loan transactions. Some lenders just won't do small deals where their anticipated profits; others will do less diligence on small deals, playing the law of averages that not much will go wrong. Lenders are often urged to take a middle-ground approach: for smaller transactions, conduct an environmental "screen" -- that is, ask the bare minimum of questions yourself that are required under CERCLA, and train your loan officers to fill in the screening forms. Many lending institutions have adopted this approach, and have prepared their own screening forms.

The intent behind this screening approch is to protect the lender as much as possible in conformity with the current case law construing a lender's duty of due diligence under CERCLA. Of course, the law is in a state of flux, and yesterday's due diligence may not be today's. In an attempt to provide a uniform standard, an influential testing organization, the American Society for Testing and Materials (ASTM), reacting to pressure from the U.S. Environmental Protection Agency (EPA), has undertaken the task of creating a uniform screening document that, if used by a lender, will as a matter of law protect the lender under CERCLA.

The ASTM subcommittee on environmental assessments for commercial real estate issued two final documents this year, one being the screening document and the other a proposed standard for performing "Phase I" environmental site assessments. The proposals go a long way toward defining due diligence -- or "all appropriate inquiry" -- for purposes of the innocent landowner defense under CERCLA. It will be interesting to see how the courts, let alone the EPA, handle these ASTM documents. Will they be adopted as the standards for the level of inquiry required in real estate transactions? Perhaps. Sometimes the courts are grateful for a rule that can be applied with certainty, and the trend may be toward acceptance of any rationally based uniform standards such as those proposed by ASTM.


What does "due diligence" mean and why is it important? It is a requirement for any property purchaser who hopes to be protected from CERCLA liability under the innocent landowner defense. First, the innocent landowner defense can be invoked only by an owner who purchased the property after the hazardous substance was disposed of on the property. In other words, there can be no further release of hazardous substances onto the property during the innocent landowner's period of ownership, and the disposal that occurred cannot have been caused by an agent or employee of the owner. In addition, would-be innocent purchasers must, pursuant to CERCLA, prove that they did not know, and had no reason to know, at the time they acquired the property, that any hazardous substance had been disposed of on the property. It must also be shown that they exercised due care with respect to the hazardous substances discouvered and took precautions agains foreseeable acts or omissions of the party responsible for the disposal.

That delineates the statutory requirements of due diligence. But how does it play out in the real world? Obviously, every situation is unique. But the current state of court decisions offers very littl guidance to the would-be purchaser who wants to be sure he or she is an innocent landowner. On one end of the spectrum is the holding in International Clinical Laboratories vs. Stevens, 1990, that if the purchaser cannot see any environmental problems by walking the property, and that person has no independent knowledge of environmental problems at the propety, and the purchase price was high enough so as not to tip the purchase off to a problem, then that person has met the burden of inquiry necessary to invoke the defense. At the other end of the spectrum is BCW Assocs. vs. Occidental Chemical Corp., 1988, which held that a buyer who initiated an environmental assessment that came up clean could not invoke the innocent landowner defense where the assessment was wrong and the property was contaminated. Occupying the middle ground is U.S. vs. Serafini, 1988, which held that purchaser's duty of due diligence is to be measured by the state of good commercial or customary practices at the time of sale. This holding tracks the statutory language of CERCLA'S innocent landowner defense.


So with little to no judicial guidance, the wise purchaser of commercial property will typically conduct a so-called Phase 1 environmental assessment, which entails the non-invasive investigation on the site. "Non-invasive" refers here to a record review and a physical inspection of the site that does not involve poking holes in the ground.

Despite the fact that the phrase "phrase I" is used universally, it has no fixed form; depending on which environmental consultant one hires, the parameters of the inquiry will vary. Here too, ASTM has undertaken the task of standdardizing the meaning of "Phase I" specifically with respect to the duties imposed by CERCLA. For the time being, though, a Phase I assessment will usually at a minimum entail several actions. First the purchaser should review past and present uses of the property by inspecting the history and deed records, and conducting interview(s) with the owner. Second the purchaser will need to review governmental records of hazardous conditions, reported spills and the like at the property and the area around the property. Third, a walk through the property to insect for any obvious problems, like stained soils or abandoned drums, should be carried out. In addition to these steps, the purchaser should review past and present uses of adjacent property, review governmental records to check for the presence of underground storage tanks, and review the presence of wells, or on-site septic systems.

The outcome of the Phase I inquiry may well propel the potential purchaser into a Phase II inquiry -- that is, an invasive investigation designed to answer questions or concerns raised by Phase I. Failure to go to Phase II when issues are brought to the fore in Phase I will, of course, negate the innocent landowner defense.


Obviously, a prudent lender will want to undertake the same due diligence that is required of an owner on a property to be used as collateral, since the lender may ultimately find itself the owner of the parcel through foreclosure. The issue of whether a foreclosing lender is in fact an owner of operator for purposes of independent CERCLA liability is itself thorny, and this will be discussed below in the context of the lender liability rule.

But first, whast are the duties of parties after a property has been purchased? CERCLA tells us that owners and operators of a site are strictly liable for cleaning up their property if it is contaminated through their own activities, or the activities of their agents or employees, or the activities of other third parties with whom they have contractual relationships. But, apart from lenders, whose position is unique, exactly who is an "owner" and what are the limits of "ownership?" For example, is a shareholder of a business that owns a contaminated site an owner, and is the parent company of a corporate subsidiary that owns contaminated property an owner?

The federal courts have wrestled mightily with these issues, and the lesson the cases teach is that the answers to these question depend on a multitude of factors, not just the facts of each case. For example, is the judge inclined to develop a federal common law of ownership under CERCLA, or is the judge content to analyze the case under the traditional common law standards of corporate ownership and of piercing the corporate veil? To the extent there are any discernible trends, it appears that the courts, at least where the environment is concerned, are looking for ways to find the deep pocket, and that means extending liability under new theories to remote owners.

The same can be said of the current case law in the area of defining whos is an "operator," for purposes of imposing CERCLA liability. Anyone who controls waste disposal practices of a business, or has the capacity to control those practices, can be individually liable as an operator for contamination caused by those practices. This is the context in which corporate officers are usually held liable. One court in New Jersey recently went so far as to impose liability for cleanup on the estate of a deceased officer who during his lifetime had controlled disposal practices. The outer limits of this trend, imposing the control test to make remote parties liable as operators, is found in a 9th U.S. Circuit Court of Appeals decision in Kaiser Aluminum & Chemical Corp. vs. Catellus Development Corp., 1992. That case extended potential liability to building contractors who inadvertently moved contaminated soil from one spot to another during the course of construction. The court's theory was that the contractor was that the contractor was an "operator" of the site because it had the ability to control the physical whereabouts of the hazardous substance, even though the contractor had no knowledge that the dirt it was moving around was contaminated.


The remedy for what appears to be an unfair pinning of responsibility on parties who really did not do anything wrong is to sue the real wrongdoers for cost recovery or contribution under CERCLA. More and more cost recovery actions are being brought by purchasers of contaminated property who are forced to clean up -- at their own expense -- contamination they did not cause. The suits are brought against the wrongdoers, usually the sellers., These lawsuits are very effective in accomplishing their goals -- reimbursing the buyer for his or her out-of-pocket costs for remediation, and perhaps even for the loss of inhere value in the property.

Also, under CERCLA a purchaser can and should seek a declaratory judgment that the wrongdoer is liable for cleanup, and that all future cleanup must be undertaken by the wrongdoer. The added avantage to the declaratory judgment -- beyond the obvious cost savings--is that a declaratory judgment against the wrongdoer is conclusive against the government. Once a court has declared the wrongdoer liable under CERCLA for future response costs, it takes the owner off the hook--the EPA cannot come after the owner.

Of course, litigation costs money. Attorneys' fees in cost recovery actions can run as high as half a million dollars or more. And these are not the only financial implications to CERCLA. Investigation and cleanup are obviously major costs to contend with. Furthermore, if the government is involved and orders or oversees the cleanup, the responsible party can also be -- and usually is--saddled with paying the government's overhead costs as well. At one New Jersey Superfund site, those named as PRPs -- potenttially responsible parties -- are faced with cleanup costs as high as $300 million.

So what does a present lender do, faced with these new duties and potential liabilities? In addition to insisting on a Phase I site assessment, many lenders have come up with novel financing arrangements, the aim of which is to reduce the lender's risk. First, if a Phase I or Phase II inquiry shows a property to be contaminated, it does not automatically torpedo the deal. Some buyers and lenders will walk away from the deal, but others, hardened to the realities of our age of manufacturing, provide contingencies for cleanup in the financing documents. Frequently, buyers or lenders require either that the seller clean up before closing or that a portion of the purchase price be put into escrow to assure cleanup after closing. They require indemnification provisions that survive closing in the agreement of sale as well as in the loan documents.

The buyer and lender may seek a reduction in real estate taxes from local taxing authorities for the property during the time it remains contaminated. Interestingly, the Commonwealth of Pennsylvania has provided some relief to residential taxpayers burdened with contaminated property. The Legislature recently amended the Pennsylvania General County Assessment Law to provide that a reduction of assessed value for catastrophic loss of value will remain in effect until remediation at a property is complete. "Catastrophic loss" is defined to mean any loss in market value of real property that exceeds 50 percent. The catastrophic loss of value must be due to inclusion or proposed inclusion on the national priorities list under CERCLA or the state priority list under HSCA (the Hazardous Sites Cleanup Act), the Pennsylvania state equivalent to CERCLA. This statutory provision applies state-wide, but only to residential property owners who are not deemed responsible parties under CERCLA or HSCA.

Finally, a lender who is faced with a loan default collateralized by property that proves to be contaminated now must walk gingerly through the mine field of lender liability. A lender may want to prevent a business operating on a contaminated site from going belly-up in order to prevent a default, and insert itself into some management matters to make certain that the business is run to make a profit. In the past, if these protective activities were deemed too invasive, the courts held the lenders liable for cleanup under CERCLA as operators of the site. The broadest statement came from the 11th U.S. Circuit Court of Appeals in U.S. vs. Fleet Factors Corp., 1990. In this case, the court held that a lender could be liable if it had the capacity to influence hazardous waste disposal decisions.


The Fleet Factors case rocked the real estate an d banking industries, and prompted the EPA to propose a regulation that would define how far a lender can go to protect its lien or security interest in a business or property. The so-called "lender liability rule," after much public comment, has emerged as a guide to both lenders and the courts. Two federal courts that have ruled on the lender liability rule have held that the rule applies to bar lender liability under CERCLA in two very different scenarios -- one where the lender had no involvement in management and one where the lender had substantial involvement. It should be noted that, in the Fleet Factors case itself, the court refused to grant summary judgment to either the government or the bank using the new lender liability rule, holding that the presence of factual disputes on the issue of control required a trial. After the trial, the court in the Fleet Factors case held the lender liable for its agent's hazardous waste activities at the site, invoking the new rule.

In summary form, the new EPA lender liability rule declares that activity undertaken by the lender to protect the loan by policing it, providing advice and negotiating a workout would not be considered "participation in management" if the borrower remains in possession and control before foreclosure. In other words, the borrower must remain the ultimate decision-maker. Unexercised right to control will not deprive the lender of protection. Temporary ownership precipitated by foreclosure will not be considered participating in management if the intent is just to keep the business going until it can be sold; the property must be sold expeditiously. Nevertheless, a foreclosing lender whose affirmative waste disposal decision causes contamination will be held liable as an operator. This is exactly what happened in the Fleet Factors case.

The first case that adopted the lender liability rule, Ashland Oil Inc. vs. Sonford Products Corp., 1993, held that a foreclosing lender who held title to a contaminated site for three to four weeks to facilitate the sale of the site was not liable as an owner or operator under CERCLA. The court held, consistent with the rule, that mere ownership is not enough to create lender liability, where the lender did not actually participate in management of the business conducted at the site.

The second case is more far reaching. In Kelley vs. Tiscornia, 1993, the court held that the lender was protected by the lender liability rule even though the bank: required daily reporting of cash flow; held monthly meetings with the company's officers; refused to continue to finance the company's operations unless it made certain operational changes; recommended two particular candidates to replace the head of operations; refused to continue lending unless an outside manager was retained by the company; and financed incentive compensation to the new manager. The court held these things were insufficient to make the bank liable, measuring the activities against the EPA rule. The court found that the bank did not impermissibly control the company to make any actual decisions, even though it had the ability to exercise strong influence over the company. The court's rationale was that the company, although over a financial barrel, could always says "no" and lose the bank's financing.

One humorous footnote to the case was evidence that a bank employee had made a statement that "we," meaning the bank, had the right to fire the CEO. The plaintiff attempted to use this as proof that the bank in fact ran the company. The court rejected attaching any importance to this employee's statement, calling it a mere "Al Haig" claim. Remember after President Reagan was shot in 1981, Secretary of State Alexander Haig told everyone he was in charge? He wasn't, fo course, and the court held that neither was the bank.
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Author:Kole, Janet S.
Publication:Risk Management
Date:Nov 1, 1993
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