Real Estate Finance Notes 9/30/04




Environmental liability – CERCLA


The Comprehensive Environmental Response, Compensation and Liability Act imposes liability for the cost of cleanup, health assessment and health effect studies.  Owners and operators can avoid liability for cleanup costs if they are innocent purchasers, but that doesn’t mean you get off scot-free: you bought a dirty site, and the next purchaser will have to clean it up.  This will greatly reduce the value of the land.  Liability is imposed on hazardous waste generators and transporters as well as the current owner and operator when any dumping of hazardous material occurred.  This is strict liability, and it’s joint and several liability.  This is a very harsh statute!


Super fund is different from super liens.  There are certain states that have their own miniature versions of CERCLA.  Cleanup costs are said to be not only a lien against the property, but also that there is a super lien.  That is, the lien for cleaning up the environmental costs takes priority over all or some of the other liens on the property.  In particular, they take priority over mortgages.


Why do we talk about this when a lender is not responsible for the physical condition of the real estate in which it has a security interest?  “Owner and operator” is defined to exclude mortgagees.  Normally, you would say that as a lender, you’re not an owner or operator and thus do not have CERCLA liability.  But the lender loses the exemption if the lender participates in management.  But just what does that mean?  Fleet Factors defines it very broadly: participation in management is said to mean having the capacity to influence management.  If the lender could affect hazardous waste disposal conditions, then the lender could be liable.  This is very broad!  Almost every mortgage requires the mortgagor to comply with all applicable laws, including CERCLA.  That means you’re in default of the mortgage as soon as you violate CERCLA.  The lender can threaten to make the borrower pay off the whole loan.  Maryland Bank and Trust held that the security exemption existed only while the security interest existed.


In 1992, the EPA issued regulations designed to protect lenders.  These regulations define participation in management as “actual participation” and limit post-foreclosure liability as long as the lender is not itself a polluter.  The regulations set up a safe harbor: so long as within twelve months of becoming the purchaser the lender makes serious efforts to sell it, the lender will be able to take advantage of the general exemption that says lenders are not owners.  However, the 1994 case of Kelley v. EPA invalidated the regulation, saying the EPA exceeded its authority in promulgating it.  Then Congress passes a statute that basically codifies the 1992 regulation.  But Congress goes further: the lender liability exemption continues to exist and goes on to define what participation in management is for purposes of CERCLA liability.  Congress defines management in two stages: pre-foreclosure and post-foreclosure.




What if prior to making the loan, the lender requires an inspection of the premises?  42 U.S.C. § 9601(20)(F)(iii) says that any action or non-action before a security interest is created doesn’t count as management.


What if the lender requires the borrower to comply with all laws before making the loan?  Same thing.  But what about after?  This is where we got into trouble with Fleet Factors.  42 U.S.C. § 9601(20)(F)(iv)(II) says that including conditions related to environmental compliance doesn’t constitute participation in management.


What if the lender finds something bad on the land and tells the borrower to clean it up?  That’s not management under § 9601(20)(F)(iv)(V).


What if the lender reviews the borrowers financial statements after making the loan?  That’s not participation in management.


What if the lender inspects the real estate?  Nope.  Inspections and monitoring of the facility won’t constitute participation in management.  What if the lender exercises decision-making authority over environmental compliance?  That seems like the case where the lender could be liable.  § 9601(20)(F)(ii)(I) talks about exercising decision-making authority.


What if the lender takes over day to day management of the company?  Then they’re participating in management according to § 9601(20)(F)(ii)(II)(aa), even if they’re not specifically in charge of environmental decisions.


After default, what if the lender renegotiates the loan?  That won’t result in liability.  If the lender provides advice, that won’t result in liability either.


What if the lender becomes the owner of the property through foreclosure or deed in lieu or foreclosure?


What if the lender becomes the owner and continues to operate the business?


What if the lender becomes the owner, continues to operate, and continues to pollute?


What if the lender becomes the owner but does not seek to resell until 18 months later?  If you go over the 12 month period, you’re out of safe harbor, but you still could be safe if there’s a reason that you waited a year and a half before trying to market the property other than wanting to be the owner of the facility instead of just holding collateral.


When you take these together, so long as you act the way lenders usually act you’ll be exempt from CERCLA liability.  Is that a windfall to lenders?  Should they get that exemption, or should they be forced to pay and then collect from their borrower?  What’s the lender going to sell the property for?  If the lender is exempt, does it mean that the lender will sell the property for the same price that you would get if there was no CERCLA liability?  No way!  The lender is not an owner or operator, but whoever purchases from the lender will be an owner-operator.  They won’t be able to take advantage of the innocent purchaser defense.  The realization on the collateral will be reduced, and the lender suffers anyway.  Braunstein thinks that you’re just allowing the loan to proceed and letting the lender escape cleanup liability, but the lender still has a strong incentive to protect the collateral.  When the lender goes to sell the collateral, any purchaser is going to deduct the cleanup costs from what they paid.


Edwards v. First National Bank of North East


How should you advise lenders who fear liability to adjoining landowners or third parties?  You decide how much liability you have.  Then you have a receiver appointed.  You escape tort liability when you don’t become a possessor of the property.  Don’t forget that there are two options open to the lender: the lender can either foreclose on the mortgage or sue on the note.  If you have a solvent borrower, you can forget the collateral and just sue on the note, forgetting about the mortgage.


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