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The murky waters of Superfund liability.

The Federal Environmental Protection Agency (EPA) in a friend act toward lenders took regulatory action to attempt to reduce the risk that a lender could be held liable for environmental contamination on its borrower's property. EPA's recent issued rules re resent a dramatic improvement in that agency's understanding of real estate-secured lending, and EPA deserves lenders' support. However, the Superfund law itself must be changed to give lenders the necessary assurance that a court will not - despite EPA's views - find a lender liable.

Environmental contamination is an extremely serious problem. It is difficult to argue with the proposition that those who pollute should pay for the needed cleanup, but determining who belongs in that category is much more difficult than appears at first glance. Congress and other legislatures have addressed this issue with inartfully drawn statutes, simply thrusting the problem into the laps of agencies and courts with little clear guidance.

As a result, administrators of the agencies charged with enforcing laws such as Superfund and judges are forced to make difficult decisions as to where liability should rest. Despite many commendable efforts by these officials, the real estate industry faces many inconsistent, contradictory and often counterproductive rulings. Some of those rulings have contributed to the now widely visible "credit crunch" that has been exacerbating the weakness in the economy, which the Bush White House recognized when it exempted from its regulatory freeze, earlier this year, the rules that EPA issued to clarify lenders' liability under Superfund.

Lenders profit by charging borrowers for the use of the money loaned. The return expected by a lender is carefully negotiated with the borrower, and it represents the parties' expectations of what the lender ought to earn in light of the risks attendant to the loan. Lenders accordingly strive to reduce uncertainties that may affect repayment of the loan.

Pollution is costly. Cleanups can cost more than the subject properties are worth (even after cleanup). An unanticipated, post-hoc finding that a lender is liable as a responsible par can drastically undercut its expected return on a loan. Liability, such as that described in the Fleet Factors opinion, destroys any hope of projecting returns on a loan: not only might the lender be forced to forgo the bargained-for interest return on the principal, but the lender also could lose that principal and even be required to pay additional sums for a cleanup.

The best means (in fact, the only truly effective one) of addressing some of the acknowledged shortcomings in the statutes is through legislative amendment. Without congressional action, any further regulatory activity or litigation can only exacerbate the problem. Neither of them will reconcile existing, disparate trends or prevent other inappropriate court decisions.

The problem

The Comprehensive Environmental Response, Compensation, and Liability Act of 1980 CERCLA, or more commonly known as Superfund) has long been known for its vague terminology and for being inartfully drafted legislation. The possibility of misguided and incorrect interpretation of such a statute is obvious. This has been exemplified by the history of judicial treatment of CERCLA's secured-party exemption - the critical legal linchpin in determining lender liability

Superfund's definition of the term "owner or operator" specifically excludes a person who, without participating in the management of a ... facility, holds indicia of ownership primarily to protect his security interest in the ... facility." The courts that have had occasion to interpret this provision (the secured-party exemption) have issued inconsistent, even contradictory decisions.

In Guidice v. BFG Electroplating and Manufacturing Co., Inc., 732 E Supp. 556, 561 (WD Pa. 1989), the court indicated that the secured-party exemption "permit[s] [a nonforeclosing] secured creditor |to provide financial assistance and general, and even isolated instances of specific management advice to its 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.'" The court suggested that, in a preforeclosure setting, "a high liability threshold (i.e., one that is more permissive of activities by the creditor prior to the attachment of liability) will enhance the dual purposes of protection of the [creditors'] investments and promoting [Superfund's] policy goals."

Another court held that "a mortgagee can be held liable under [Superfund] only if the mortgagee participated in the managerial and operational aspects of the facility in question" (United States v. Nicolet, Inc., 712 F. Supp. 1193,1205 [ED Pa. 1989]). That distinction was followed in United States v. Mirabile, 15 Env. L. Rep. 20992 (ED Pa. 1985):

The reference to management of the "facility," as opposed to management of the affairs of the actual owner or operator of the facility, suggests once again that the participation which is critical is participation in operational, production or waste disposal activities. Mere financial ability to control waste disposal practices of the sort possessed by the secured creditors... is not... sufficient for the imposition of liability.

In early 1990, another court stated that "[a]though interpreted broadly, [Superfund] requires that a person be actively participating in the management of the facility to be held liable for the disposal of hazardous wastes. The |mere ability to exercise control as a result of the financial relationship of the parties is insufficient for liability to attach. The entity must actually exercise control.'" (United States v. Consolidated Rail Corporation, 729 E Supp. 1461, 1468 [Del. 1990], quoting from the Mirabile opinion).

On May 23, 1990, the U.S. Court of Appeals for the Eleventh Circuit (the first appellate court, rather than trial court, to address the scope of the secured-party exemption) issued an opinion that stunned real estate-secured lenders and their counsel. That court ruled that under Superfund, a lender can be held liable for environmental contamination at a property that serves as collateral for a loan, if it "participat[ed] in the financial management of a facility to a degree indicating a capacity to influence the [borrower's] treatment of hazardous wastes.... [A] secured lender will be liable if its involvement with the management of the facility is sufficiently broad to support the inference that it could [have] affect[ed] hazardous waste disposal decisions if it [hadl so chose[n]" (United States v. Fleet Factors, 901 F. 2d 1550, 1557-1558).

That formulation of the scope of the secured-party exemption presented an existing or potential secured lender with a Hobson's choice: If the lender has or takes a security interest in the borrowers property, it can avoid oversight of, or involvement in, its borrower's hazardous-substance-management practices, yet later find itself liable for contamination on the property if the lender is deemed to have been capable of preventing that contamination; or it could oversee and direct its borrower's practices so as to prevent or require cleanup of contamination. However, in so doing the lender becomes liable for errors in those practices, because in doing so it "participat[es] in the management of [the] facility" and thereby undermines its qualification for the secured-party exemption. Such a choice is in fact no choice at all. An unsecured lender need not make that choice, but unsecured credit is less satisfactory for a lender, more expensive for a borrower and, therefore, less desirable.

The Eleventh Circuit wanted to create ate an incentive for creditors to be the nation's environmental police in respect to their borrowers' practices. But that conflicts with lenders' general goal of not meddling in their borrowers' practices. That general goal is founded on at least the following two sound bases: 1) lenders are in the business of and more expert at lending than they are at operating their borrowers' businesses or running hazardous-substance-handling seminars; and 2) interference by lenders in borrowers' businesses can provide the basis for the imposition of common law lender liability. The important policies embodied in the Superfund statute cannot be enforced or policed by lenders deputized by the courts, as the Eleventh Circuit intended.

Several months after the Eleventh Circuit released its Fleet Factors decision, the Ninth Circuit took an entirely different approach when it stated the following: "That a secured creditor reserves certain rights to protect its investment does not put it in a position of management. What is critical is not what rights the [creditor] ha[s], but what it [does]."

The judicial authority on the scope of the secured-party exemption has left the state of that exemption very unclear. The threat of liability for their borrowers' contaminated properties can freeze lenders' decision-making. The Bush White House recognized as much last January when it exempted from a regulatory freeze EPA's effort to address the issue.

Until Fleet Factors was released, congressional inaction to clarify the exemption was of less immediate concern to lenders because courts uniformly refused to impose liability on a nonforeclosing lender that did not actually participate in a borrower's management. The Eleventh Circuit's decision stands in stark contrast to the decisions of other courts prior and subsequent to Fleet Factors, yet that court's status in the federal court system has created fear that its holding would be followed in other contexts.

Lenders' concern about the impact of the Fleet Factors liability standard is not limited to government-sought cleanup contributions (EPA was the plaintiff in the Fleet Factors case). The threat of private-party actions under Superfund and other statutes (such as state analogues to Superfund) may be greater. After all, the government has internal policies and guidelines that will affect its decisions and strategies; those policies and guidelines may be known in advance and a lender can take them into account. A lender might even be able to negotiate a de minimis settlement with the government prior to acquiring title by foreclosure.

Private parties have varying goals, however, that may not be guided by the concerns that public officials bring to bear. In view of the obvious multiplicity of possible private claims, lenders' need for a greater level of certainty regarding liability is even more acute in the private-suit context than in terms of government actions. As it stands, such private claims are being advanced.

The state of the secured-party exemption must be clarified so as to enable lenders to loan money with less concern that they may become liable for environmental damage even when they play no role in management. The state of the law now is too uncertain in light of Fleet Factors.

Proposed solutions

Shortly after Fleet Factors was released, Congress began to hear and react to lenders' pleas for relief from the implications of that decision. Bills to amend Superfund so as to negate the impact of that decision were introduced in the House of Representatives and the Senate. Fearing that efforts to address the lender-liability issue could make Superfund the target of wholesale amendment, EPA criticized the decision and, at an August 1990 congressional hearing, announced an intention to redress the decision's breadth by means of regulation.

EPAS announcement had the desired effect; then-pending legislative proposals to amend Superfund in order to address lenders' concerns lost momentum. Efforts to incorporate the substance of the Senate bill [that previously had been introduced by Senator Jake Garn (R-UT)] in the omnibus banking-reform legislation were fruitless; when impending congressional adjournment raised the risk of a failure to reauthorize that bailout and fund the almost-bankrupt savings and loan bailout, extraneous measures, including those relating to Superfund, were dropped by the conference committee. Superfund was reauthorized for three years without substantive change. Other proposals, including Congressman John J. LaFalce's (D-NY) efforts in the House to provide more certainty for the secured-party exemption, fell by the wayside as well. No other legislative proposal to address the issue has been successful to date.

On April 24, 1992, EPA issued rules, as promised, to ameliorate the impact of Fleet Factors EPA proposed to bring relief to lenders by defining in its rules certain terms that appear in Superfund's secured-party exemption and other parts of the law. EPA's method of correcting the Eleventh Circuit's misreading of Superfund in Fleet Factors is to interpret several terms in [sections] 10 1 (20) (A) of the statute: "indicia of ownership," "primarily to protect [a] security interest" and "participating in the management of a ... facility." EPA did so by means of an amendment of the National Oil and Hazardous Substances Pollution Contingency Plan (contingency plan) required by [sections] 105 of Superfund. EPA cited that statutory provision as well as [sections] 115 as its authority.

Two parties (petitioners), (Michigan and the Chemical Manufacturers Association) have asked the Unit States Court of Appeals for the District of Columbia Circuit to review the rules. EPA's rules may not be upheld on review. Whether or not they are upheld, they may not be binding on a court entertaining a third-party cost-contribution action. Thus, they do not address all lender concerns.

EPA's rules confer substantive rights and obligations upon parties to loans and other transactions and effects distinctions that the petitioners argue distort the language of Superfund. Under well-established court precedents, such rules constitute legislative rule[s]" as opposed to "interpretative rule[s]."

At least two consequences flow from the fact that the rules are legislative rather than interpretative: the procedural steps EPA must follow are different; and the scope of judicial review is different. EPA followed the formal notice-and-comment requirements appropriate for adoption of legislative rules. How will these rules fare upon judicial review? Will they be upheld by the court on appeal pursuant to [sections] 113 (a) of Superfund? Even if upheld in that context, will they provide to lenders the protection that EPA intended in the context of private-party contribution suits?

EPA's rules will not

provide the comfort lenders


Even if the rules are upheld by the U.S. Court of Appeals for the District of Columbia Circuit in the face of the petitioners' challenges, they may not be followed in other contexts. EPA's views, as expressed in the rules, may receive less deference in the context of a private-party cost-contribution. In a private-party action, a district court described a comparable EPA policy (one that addressed whether operators of municipal solid waste disposal sites are potentially liable under Superfund) as follows: "The policy is a guide to EPA employees in administering the Superfund and reflects EPA priorities.... It does not limit a private party's claims" (B.F. Goodrich Co. v. Murtha, 754 E Supp. 960, 967 [Conn. 1991]).

Another court has stated that the liability provisions of [the statute] are independent of any ... requirements" of the government funding mechanism established by Superfund (that mechanism is also called Superfund) (State of New York v. General Electric Company, 592 E Supp. 291, 302 [NDNY 1984]). Thus, it is not certain that by amending the contingency plan EPA can effect changes in the scope of liability under Superfund for secured parties. That lingering doubt currently presents an unacceptable risk for secured lenders in light of the magnitude of loss that could result from a finding of liability.

Pitfalls in the rules

The rules also contain pitfalls that may trap not just the unwary but the educated party as well. While recognizing that the ability to foreclose on collateral, even if that collateral is contaminated, is a critical element of a secured party's position, EPA places significant constraints on that party subsequent to its acquisition of title. For example, the secured party cannot reject, after six months have elapsed from its acquisition of title, "an offer of fair consideration for the... facility," without risking loss of the exemption. What is a "written, bona fide, firm offer" that must be accepted (if it is at least equal to fair consideration) according to the rules? Under EPA's rules, a bona fide firm offer is "a legally enforceable, commercially reasonable, cash offer for the... facility, including all material terms of the transaction, from a ready, willing and able purchaser who demonstrates to the [secured party's] satisfaction the ability to perform."

The fear of being second-guessed after the fact as to whether a party making such an offer is "ready, willing and able" or "ab[le] to perform," in light of the magnitude of the liability that can attach if the protection of the exemption is lost, is a very sobering concern. Other gray areas in the rules present similar quagmires.

Legislative action

There remains a pressing need on the part of lenders for more certainty as to the scope of the secured-party exemption and related subjects. Federal agencies involved in loan programs and loan guaranty arrangements have a similar need, as do those participating in the government resolution of failed thrift institutions and similar programs. EPA's rules will not provide that assurance and certainty.

The need on the part of the lending industry is heightened due to the tremendous role of the secondary market. Loans are sold and purchased routinely. The lender holding the mortgage today may be very different from the lender that originated a loan. A lender in the locale of the collateral may have originated the loan, but might sell it later to a lender thousands of miles That loan may even be packaged in pool and sold, in a public offering, to many investors, each of whom will own a small, undifferentiated interest in each loan in the pool.

A standard such as the one in Flee Factors can make the new lender (or group of "lenders") liable for contamination if the lender's rights contained in the loan agreement merely "support the inference that [the lender] could affect hazardous waste disposal decisions" by the borrower. Such remote lenders are only able to control what actually occurs; their relationship with the borrower mandates that they have some contingent rights to act in defense of their loan investment but that they not interfere in day-to-day operations. The Ninth Circuit recognized that those types of contingent rights are almost universal in secured loans. "[N]early all secured creditors have these rights. That a secured creditor reserves certain rights to protect its investment does not put it in a position of management. What is critical is not what rights the [creditor] ha[s], but what it [does]."

In fact, the secondary market is such a significant factor that Congress should consider making the Superfund lender-liability standard (as set out in In re Bergsoe Metal Corporation, for example) applicable to all similar environmental-liability statutes, both state and federal. That would promote lender confidence in loans on properties that may have some environmental contamination (even though unknown), wherever located.

An additional risk created by the present uncertainty over the scope of the secured-party exemption is that it invites inventive litigants to press upon courts novel theories of lender liability. In O'Neil v. Q.L.R.C.L, Inc., 750 E Supp. 551 (RI 1990), the court permitted amendment of a complaint to include allegations that a real estate-secured lender aided and abetted a violation of an effluent standard promulgated under the Federal Water Pollution Control Act because it knew of the [violation] and could have conditioned the loans [it extended] on the fixing of the sewage problem." That a lender must mandate certain corrective environmental measures in order to avoid liability for a preexisting environmental problem is a frightening development for lenders.

EPA's effort is laudable, but the ultimate impact of its rule is still unknown. The new Congress must address these issues by means of an amendment to Superfund. The LaFalce and Garn proposals from the prior Congress both contained laudatory provisions that could greatly reduce the existing level of concern. Congress should revisit this issue. Legislative enactment of the substance of EPA's rules into the Superfund statute would introduce a great deal of certainty now absent from a critical Superfund provision.
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Author:Lauer, Steven A.
Publication:Mortgage Banking
Date:Dec 1, 1992
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