Environmental Cleanup: Who Pays the Price?
Berman, Mark N., Business Credit
While everyone agrees the cleanup of toxic waste is a national priority, no one agrees on who must pay for such an endeavor. Banks are concerned about the costs of a toxic cleanup or fines affecting a borrower's ability to repay a loan. Worse yet for the banks, court decisions have held a lender liable to pay for the cleanup if the lender acquires contaminated property through foreclosure, controls the borrower's business during a workout or liquidation, or has the ability to control the borrower's decisions about the disposal of hazardous waste.
Lenders have tried to reduce their chances of nonpayment or liability by increasing their efforts to identify risks before closing the loan, by more adequately monitoring a borrower's business during the life of the loan, and by legislative efforts to change the law. Unsecured trade creditors would do well to learn from the lender's experience and consider, in appropriate circumstances, adopting some of their approaches.
The most commonly encountered federal statute affecting the creditworthiness of a purchaser is the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA), which provides the federal government with the right to order the cleanup of polluted property or to clean the property itself. When the government incurs cleanup costs, it may recover them from the responsible parties and is given a lien on the property to secure repayment. The lien is junior to existing mortgages and security interests.
The other federal statute of particular import is RCRA, which is short for Resource Conservation and Recovery Act. Here the focus is on the creation of toxic waste. Criminal penalties are imposed on anyone who violates RCRA's restrictions on treatment, storage, and disposal.
State Regulations May Vary
State statutes come in a wide variety and present a special problem for the credit manager. A purchaser may have multiple business locations, each impacted by a different state regulatory scheme. With each state having its own version of the Environmental Protection Agency (EPA), some have followed the lead of the federal statutes and provide for hens on the contaminated property junior to existing hens to secure the repayment of costs incurred in the cleanup process.
Other states provide for a super hen which will be senior in right to liens existing on the property. The existence of the lien can be an obstacle to the owner of the property obtaining the financing necessary to undertake an expensive cleanup.
Another state approach requires a site assessment any time a property owner proposes to transfer title to a piece of commercial property. If hazardous waste is found on the site, a cleanup plan must be prepared and then implemented before the property can be transferred.
Lenders Must Be Leary
Lenders must be concerned that this collateral may be contaminated. They must also make sure they are not considered an "owner or operator" and therefore liable for the full costs of the cleanup without regard to the value of the collateral. A case called "Fleet Factors" held a lender could be liable as an owner because the lender had the capacity to control the debtor's decisions about the disposal of hazardous waste. The capacity to control grew out of provisions in the loan documentation. While the case has not been universally followed, lenders are comforted by new EPA rules announced on April 24, 1992, which eliminate the lender's exposure where its interest in the property is solely the result of the lending relationship and efforts to realize on collateral.
Essentially, if the lender does not participate in management prior to foreclosure, and follows the EPA's rules after foreclosure, it will be protected. While the EPA rules address issues on the federal level, lenders will have to wait for similar action by each state.
Lenders are best served by avoiding the problem at the inception of the loan. More and more lenders require environmental due diligence before a loan will be funded. Environmental due diligence can take the form of an environmental audit, also known as a Property Transaction Site Assessment. Lenders are also requiring new representations in their loan document about the absence of hazardous waste, the debtor's obligation to comply with environmental laws during the life of the lending relationship, and the absence of litigation over hazardous waste.
How To Head: Creditors vs. Government
Environmental laws are finding their sternest test in the bankruptcy courts, where creditor interests in recovering as much as possible plus the debtor interests in a fresh start or a successful reorganization are in contrast to the government's desire to see hazardous waste cleaned up and the costs borne by others. Only two issues involving the clash between bankruptcy and environmental laws have actually been resolved by the United States Supreme Court, and these cases have holdings.
First, in Ohio vs. Kovacs, the Supreme Court held that an individual Chapter 7 debtor could discharge the government's claim which arose from an order directing him to clean up contaminated property or pay money damages if he failed to do so. Lawyers speculate whether the "claim" would have been discharged if it did not include the alternative of monetary damages. The Supreme Court has yet to address the discharge of claims where the cleanup is yet to take place and where the government sues, not for money damages, but to force the debtor to clean up the property.
The Second Supreme Court decision was in the case of Midlantic National Bank, where it held a trustee could not abandon contaminated real estate because he had not yet complied with environmental laws which protect the public's health and safety. Subsequent lower court decisions have wrestled with the extent of compliance required before abandonment might be authorized. Does the trustee have to comply with environmental laws that may require the complete cleanup of the property, or is it satisfactory if the trustee takes those actions necessary to ensure that the contamination does not represent an imminent threat to the public safety? Also left unanswered was the question of where the trustee will find the funds to implement protective action where the estate is without funds to do so.
Trade Creditor Still Unprotected
The new EPA rules that give comfort to lenders do not apply to unsecured creditors. The best advice for the trade creditor is much the same as it always has been. Make a careful credit inquiry before extending credit, establish appropriate credit terms, and monitor the credit vigilantly. While it is not realistic for trade creditors making a credit decision to go through the same evaluation process that banks go through when making a loan, trade creditors might do well to follow the lenders' lead. If the credit is large enough, perhaps the time and expense of an environmental audit is warranted. If not, perhaps the lender can be convinced to share its due diligence with the prospective creditor.
Ask To See Environmental Report
Lenders want to see the business do well, and if there is nothing bad in the environmental report, there may be little hesitancy in sharing it. If you are lucky enough to find such a willing lender, don't be surprised when asked to sign a waiver or disclaimer such that the lender will not have exposure to the creditor who relies on a passing report, only to later find out that it was wrong. There is also the prospect of devising a more limited due diligence tailored to the type of business and the amount of credit that is being extended. Typical questions that might be added to a credit application to help evaluate the hazardous waste risk might include:
* Are there any known
hazardous waste problems
with the business at
any of its locations? Have
there been any in the past?
* Is there any litigation
pending or have there
been any penalties, fines,
or investigations involving
environmental problems against the company?
* Has anyone performed an environmental audit of
the company or any of its property? If so, please
provide a copy.
* If the company is a known hazardous waste generator,
has the company instituted any systems to
make sure it complies with environmental laws?
If so, please provide a copy of the written system
As with any credit application, it should be signed by an officer of the company who is likely to have knowledge about the subjects being investigated. Of course, there is simply no substitute for an on-site visit so that credit managers can see for themselves. The old adage that a picture is worth a thousand words is certainly applicable here. It is also no time to forget the other means by which to increase the likelihood of payment by obtaining a guaranty, a security interest in assets of the debtor, or a purchase money security interest in the actual goods being sold.
There are still many chapters to be written in the evolving debate over who is going to shoulder the costs of our nation's cleanup. While the struggle between competing interest groups continues, the creditor is best served by getting his other own house in order. There is little that can be done after the fact when you find the credit has declared bankruptcy other than to argue what the law is or should be. Isn't it much better to see that argument takes place over someone else's credit than your own?…
Questia, a part of Gale, Cengage Learning. www.questia.com
Publication information: Article title: Environmental Cleanup: Who Pays the Price?. Contributors: Berman, Mark N. - Author. Magazine title: Business Credit. Volume: 94. Issue: 9 Publication date: October 1992. Page number: 14+. © 1999 National Association of Credit Management. COPYRIGHT 1992 Gale Group.
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