Magazine article American Banker

Lender Liability Rule Leaves Questions

Magazine article American Banker

Lender Liability Rule Leaves Questions

Article excerpt

After almost a year of debate, the Environmental Protection Agency has issued its final rule governing secured-creditor liability under the Superfund law for property contaminated with hazardous substances.

The rule, effective April 29, provides secured creditors with some guidance and comfort regarding loan transactions and foreclosure actions.

However, the rule leaves open questions that require close examination of the facts to determine if the lender's actions make it liable under the law.

Since 1980, the law -- properly, the Comprehensive Environmental Response, Liability, and Compensation Act -- has protected the lender from liability if it holds an ownership interest in collateral property primarily to protect its security interest. The lender is also protected if it does not participate in the management of the property.

Lenders Adrift

But the act's failure to flesh out this test has left lenders adrift. As a result, loan or foreclosure opportunities have been forgone in order to avoid potentially crippling cleanup cost often imposed on the owner or operator of a contaminated property.

Judicial interpretation of the secured creditor exemption, such as the Fleet Factors decision, has only heightened lenders' uncertainty.

In an effort to clarify the degree of permissible lender activity, the rule establishes the following guidelines:

* The exemption protects a broad range of secured transactions where the creditor holds an ownership interest primarily to protect its security interest, such as mortgages, deed of trust, liens, surety bonds, guarantees, and lease financing interests. This list is not exclusive.

* A lender's pre-loan activities are not considered in determining whether the lender has participated in the management of the borrower.

For example, whether the lender performed an environmental audit prior to entering into the transaction is not a factor in determining liability.

Also, the lender may conduct pre-loan due diligence and take prudent steps such as environmental inspection, requiring the prospective borrower to clean up the facility as a condition for the loan, or selecting as alternative security a noncontaminated property of the borrower.

* During the course of a loan, the lender may take policing and workout actions consistent with the protection of its security interest, such as generally requiring sound environmental management and compliance with environmental laws.

However, to avoid participation in the management of the property and the loss of the exemption, the lender must avoid pervasive control that gives the appearance of exercising decision-making authority over environmental compliance and management.

* In the rule, the EPA recognizes that foreclosure is often an inevitable result of loan transactions and of protecting a security interest. …

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