The Consequences of the Overturning of the EPA Lender Liability Rule
Simons, Robert P., Journal of Commercial Lending
Efforts to protect lenders from environmental cleanup liability were set back when a regulation issued by the Environmental Protection Agency (EPA) in April 1992 was recently invalidated. The District of Columbia Circuit Court of Appeals set aside the EPA lender liability rule that protected a lender from liability as an "owner or operator" of contaminated property under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA).(1)
The court held that Congress in enacting CERCLA did not give the EPA authority -- by rules and regulations -- to affect the imposition of liability under CERCLA.(2) Although the EPA can seek another review of the regulation, it is more likely that the protection from liability can only be restored through legislation. However, lenders should be careful not to overreact to the court's decision because other legal authority remains in their favor.
CERCLA and the Secured Creditor Exemption
CERCLA imposes strict liability on all prior and present "owners and operators" of hazardous waste sites. As the Court of Appeals aptly stated, the statutory scheme of CERCLA "might be described as requiring parties to shoot first (clean up) and ask questions (determine who bears the ultimate liability) later." However, a safe harbor -- known as the secured creditor exemption -- was created for secured lenders. It defines owner or operator and states "such term does not include a person who, without participating in the management of a vessel or facility, holds indicia of ownership primarily to protect its security interest in the vessel or facility."(3)
But the scope of the secured creditor exemption was first questioned when secured lenders through foreclosure converted their security interests in real estate collateral into actual ownership.(4) The case that caused the greatest concern to the banking community was the well-known U.S. v. Fleet Factors Corp.(5)
In Fleet Factors, the court acknowledged that the normal business practices of secured lenders are protected from liability. But it stated that "a secured creditor will be liable if its involvement with the management of the facility is sufficiently broad to support the inference that it could affect hazardous waste disposal decisions if it so chose."(6) In other words, lenders could be held liable if they are found to participate in the management of a facility.
Influenced by both the uproar in the banking community caused by the Fleet Factors decision and the fact that the federal government routinely becomes a secured lender after taking over failed savings and loans, the EPA issued a final regulation defining the secured creditor exemption in 1992.(7) It is important to note that the EPA issued the regulation after attempts to amend CERCLA failed. The EPA rule identified factors for determining whether the lender's level of participation in management caused the lender to become liable as an owner or operator of the facility.
The EPA regulation was well received by the banking industry because it spelled out that lenders would not incur liability when undertaking investigatory actions as a part of the loan approval process, when monitoring or inspecting a facility, or when requiring that the borrower comply with environmental standards. Lenders were also permitted to engage in workout negotiations and activities, including activities that ensure that collateral facilities have not violated environmental laws.
Perhaps most important, the EPA regulation protected secured lenders that foreclosed on the collateral as long as the lenders did not participate in the facility's management before foreclosure and undertook certain diligent efforts to divest the property.
However, chemical manufacturers and the state of Michigan challenged the EPA's authority to shield lenders from environmental cleanup liability. From a policy perspective, states and other potential codefendants, such as chemical manufacturers, believed that lenders should not be immune from responsibility for cleanup in many circumstances. …