State Enforcement of Environmental Laws Against Bankrupt Entities

James D. Morris

Editors' Summary: The rationalization of conflicts between environmental law and bankruptcy law continues. The recent emergence of a substantial body of state and federal law imposing financial liability on businesses for the cleanup of hazardous wastes has brought environmental lawyers into the realm of bankruptcy with increasing frequency. Attempts to mix the two bodies of law often produce conflict, because the laws serve distinct purposes. Two of the disputes have risen to the Supreme Court, but major issues remain. The author reviews the interaction of state environmental enforcement and the bankruptcy principles governing stays of actions to recover money from the bankrupt, the extent to which state enforcement claims may be discharged in bankruptcy, and abandonment by the trustee in bankruptcy of liability-ridden hazardous waste sites owned by the estate in bankruptcy. He concludes that bankruptcy law should not be an insuperable obstacle to force the cleanup of sites owned by bankrupt entities, especially in light of the Court's recent decision in Midlantic National Bank v. New Jersey Department of Environmental Regulation, which held that the trustee may not abandon such sites.

Mr. Morris is Assistant Counsel in the Pennsylvania Department of Environmental Resources' Eastern Region Office in Philadelphia.

[16 ELR 10143]

One of the most persistent and intractable problems plaguing state police power regulators has for years been posed by bankrupt polluters. When the Bankruptcy Reform Act of 1978 became law, the requirement that a company actually be balance-sheet insolvent was dropped from the prior statute.¹ Thus, even companies with the financial ability to comply with state environmental laws — e.g., the Manville Corporation or A.H. Robins, Inc. — can now interpose the federal Bankruptcy Code in the effort to evade both their creditors and state police power obligations.² This article discusses the impact on state environmental enforcement actions, under the revised Bankruptcy Code, of the automatic and discretionary stays, the dischargeability of state police power obligations, and emerging limitations on the bankrupt's abandonment of polluted property.

The Automatic Stay

The filing of a bankruptcy petition generally operates to work an automatic stay against the commencement or continuation of judicial and administrative proceedings that are designed to collect money or property from the bankrupt.³ The automatic stay is statutory and requires no action for perfection beyond the filing of the bankruptcy petition. Service of the bankruptcy petition upon a plaintiff is not required for the stay to be effective as to that person.⁴ Actions taken in violation of the automatic stay, such as issuance of execution process on a money judgment against the bankrupt, are without legal effect and may be punished by contempt.⁵

The automatic stay is clearly intended to give the bankrupt an opportunity to marshal its assets for purposes of orderly distribution to its commercial creditors. It was never intended to thwart state police power enforcement [16 ELR 10144] actions, and it never is properly so applied. Congress explicitly exempted a substantial range of such actions from bankruptcy court interference. For example, there is no stay against the commencement or continuation of criminal actions against bankrupts.⁶ Most important, however, to state regulators are the provisions that no stay exists respecting "the commencement or continuation of an action or proceeding by a governmental unit to enforce such government unit's police or regulatory power"⁷ or respecting "the enforcement of a judgment, other than a money judgment, obtained in an action or proceeding by a governmental unit to enforce such governmental unit's police or regulatory power."⁸ In general, these provisions exempt enforcement actions brought by state environmental agencies against bankrupt polluters.⁹

The salient distinction between state police power enforcement actions not subject to the automatic stay and those that are stayed hinges on whether the action under scrutiny is actually an effort to collect money from the bankrupt. The state must stand in line with other creditors to get its share of the bankrupt's financial assets.¹⁰ However, the mere fact that it may cost a great deal of money to comply with an administrative enforcement order, for example, requiring the cleanup of an abandoned strip mine, does not make such an order an effort to collect money.¹¹ On the other hand, an injunction not requiring compliance with state environmental laws, but rather seeking enforcement of a money judgment is subject to the automatic stay.¹² The state's attempt to recoup from the bankrupt its costs of cleaning up the strip mine falls into this category.¹³

As noted earlier, violation of the automatic stay is punishable by contempt.¹⁴ However, this power is far from plenary, and states have far less to fear from the contempt sanction wielded by bankruptcyjudges than they do from the same tool in the hands of the Article Three judiciary. A bankruptcy judge "may not enjoin another court or punish a criminal contempt not committed in the presence of the judge of the court or warranting a punishment or imprisonment."¹⁵ The limited nature of the bankruptcy court's contempt power is realistically part of any state agency consideration of enforcement options against bankrupt polluters: in the worst case scenario, an abusive bankruptcy judge may not jail state officials for "violating" the Bankruptcy Code when those officials proceed under the pellucid exceptions to the automatic stay, found in §§ 362(b)(4) and (b)(5).¹⁶

However, for the more timid state regulator, or for the state regulator whose police power cause of action is less explicitly within the clear purview of one of the two exceptions, declaratory relief can be sought from the bankruptcy court. Even if the bankruptcy court does declare the automatic stay to be in effect as to a proposed state enforcement action, the state agency can petition for relief from the stay, as may any ordinary commercial creditor.¹⁷ The weakness inherent in seeking any relief — declaratory or otherwise — from a bankruptcy court is manifold: those courts view their principal function as supervising the orderly distribution of the bankrupt's assets to its creditors in accord with statutory priorities. By and large, the bankruptcy courts have not viewed enforcement of state environmental protection laws as within their charge and have repeatedly shown themselves to be without experience and woefully ignorant of the purposes and requirements of these laws.¹⁸

Discretionary Stays

Assuming the state agency has successfully launched its enforcement action without the interposition of the automatic stay by the bankrupt or its creditors, the bankrupt may seek a discretionary stay pursuant to § 105(a) of the Bankruptcy Code.¹⁹ Under that provision, the bankruptcy courts have the power to stay actions, including state environmental protection lawsuits, if such stays are necessary or appropriate to carry out other provisions of the Bankruptcy Code.²⁰ Unlike the automatic stay, which arises by operation of law, the discretionary stay should be granted only after an on-the-record, trial-type, adjudicatory hearing in which the traditional rules for securing a preliminary [16 ELR 10145] injunction are applied to the bankrupt's request for a stay.²¹

Discretionary stays have been granted where an enforcement action is likely to threaten the assets of the bankrupt estate and deprive creditors of legitimate priority.²² However, where the bankrupt is currently violating state or federal environmental law, courts have been more reluctant to grant discretionary stays. Section 105 stays have been denied where there were current violations of the Resource Conservation and Recovery Act²³ and its associated regulations,²⁴ and where the bankrupt was in current violation of mining regulations.²⁵

Section 105 stays have also been granted in situations where they afforded bankrupts relief at the expense of the public health, safety, and welfare.²⁶ This sort of ruling is particularly frustrating to state agencies, especially in view of the provision of the Judicial Code governing the powers and duties of court-appointed trustees in bankruptcy, which provides in pertinent part that:

… a trustee, receiver or manager appointed in any cause pending in any court of the United States, including a debtor in possession, shall manage and operate the property in his possession as such trustee, receiver or manager according to the requirements of the valid laws of the State in which such property is situated, in the same manner that the owner or possessor thereof would be bound to do if in possession thereof.²⁷

It appears that the congressional intent was to require the bankrupt to comply with state laws during the pendency of federal insolvency proceedings. Thus, state agencies may well argue that § 959(b) renders illegal any § 105 stay where the bankrupt is in current violation of state environmental law.²⁸

Dischargeability

The dischargeability in bankruptcy of state law environmental obligations was rendered problematical by the Supreme Court in its 1985 decision in Ohio v. Kovacs.²⁹ Under ordinary circumstances, the bankrupt debtor is discharged from all debts incurred prior to the filing of the bankruptcy petition.³⁰ Debts are broadly defined in the Bankruptcy Code, need not be reduced to a sum certain or a judgment, and may be contingent, unliquidated, unmatured, and disputed claims for money. Prior to Kovacs, many states maintained that the bankrupt's obligation to comply with an injunction or a quasi-injunctive order requiring affirmative action to clean up pollution, but no direct payment of monies to the state, could not qualify as a "debt" as defined in the Code. In Kovacs, however, the Supreme Court ruled that Ohio's pre-petition injunction requiring cleanup of a hazardous waste site was a dischargeable debt where the bankrupt had been dispossessed from the site by a receiver appointed by a state court essentially to recover Ohio's expenses for rehabilitating the site. If not a perfect example of the axiom that bad facts make bad law, then the somewhat complicated facts in Kovacs have certainly made unclear law. The Supreme Court also cautioned that it was not ruling that discharge in bankruptcy would shield Kovacs from prosecution for violation of Ohio law, that it was not ruling that an injunction prohibiting the addition of illegal waste to the site would be dischargeable, and that it was expressing no view on the result in the case if the state court receiver had not dispossessed Kovacs from the site. Particularly in view of the Supreme Court case on abandonment,³¹ decided only one year after Kovacs, it is probably safe to assume that an injunction simply requiring cleanup of a site, but no money payment to the state is, if a debt at all,³² a nondischargeable one.

Abandonment

As a general rule, on motion by the trustee or any party in interest, after notice and a hearing, property of the bankrupt estate which is "burdensome to the estate" or of "inconsequential value and benefit to the estate" may be abandoned by the trustee pursuant to § 554 of the Bankruptcy Code.³³ However, the abandonment provision of the Bankruptcy Code does not empower the trustee, or the bankruptcy court, to avoid compliance with other applicable nonbankruptcy law. Enen in Kovacs, the Supreme Court stressed that "anyone in possession" of a hazardous waste site "must comply with the environmental laws … that person or firm may not maintain a nuisance, pollute the waters ofthe state or refuse to remove the source of such conditions."³⁴

[16 ELR 10146]

In Midlantic National Bank v. New Jersey Department of Environmental Protection,³⁵ however, the Supreme Court took this line of reasoning light years further. There, the trustee sought to abandon hundreds of thousands of gallons of illegal toxic waste at sites in New Jersey and New York. With characteristically blindfolded vision, the bankruptcy court and the district court agreed with the trustee that the right of abandonment was absolute, despite the fact that the condition of the affected real estate violated a panoply of New York and New Jersey environmental protection laws. The Third Circuit reversed the courts below,³⁶ and the Supreme Court affirmed in a thoughtful opinion, holding that:

[i]n light of the Bankruptcy trustee's restricted pre-1978 abandonment power and the limited scope of other Bankruptcy Code provisions, we conclude that Congress did not intend for § 554(a) to pre-empt all state and local laws. The Bankruptcy Court does not have the power to authorize an abandonment without formulating conditions that will adequately protect the public's health and safety. Accordingly, without reaching the question whether certain state laws imposing conditions on abandonment may be so onerous as to interfere with the bankruptcy adjudication itself, we hold that a trustee may not abandon property in contravention of a state statute or regulation that is reasonably designed to protect the public health or safety from identified hazards. Accordingly, we affirm the judgments of the Court of Appeals for the Third Circuit.

The Midlantic National Bank decision is of obvious importance to state environmental enforcement agencies, since bankruptcy is no longer available as a remedy for the insolvent polluter who simply wishes to walk away from the problem he creates, for example, with an illegal hazardous waste dump or an abandoned and unreclaimed strip mine. However, just as significant for state regulators is the Supreme Court's recognition that the interests of state environmental enforcement may override those of the bankrupt and its creditors. Only a year earlier, confronted with the opportunity to adopt the same reasoning on the dischargeability issue in Kovacs, the Court had failed to do so. Midlantic National Bank thus suggests that Kovacs has far less breadth than seemed to be the case on issuance of the opinion in 1985.

There are important unanswered questions for the states in the wake of Midlantic National Bank. It is all well and good that we now know that the bankrupt cannot abandon his hazardous waste dump without first reclaiming it. Who, however, is to foot this bill when the bankrupt runs out of resources prior to completing the rehabilitation? That challenge now confronts the bankruptcy courts, the private bankruptcy bar, and the states, and one can only hope that the ingenuity of these judges and practitioners will be equal to the task.

Conclusion

Two recent decisions of the Supreme Court have begun to resolve conflicts between the federal Bankruptcy Code and state and federal environmental laws, but important questions remain to be answered. Although it seems clear that state environmental enforcement orders are not subject to the automatic stay imposed by § 362 of the Bankruptcy Code on actions to enforce money debts, bankruptcy courts still may disrupt enforcement with discretionary stays. The bounds of this discretionary authority have not yet been mapped. The extent to which obligations imposed in state enforcement actions are dischargeable in bankruptcy has not been definitively established either. In Kovacs, the Supreme Court indicated that some injunctions may be discharged, but that others might not. Again, the exact limits of dischargeability are not clear, although the Court's decision in Midlantic National Bank suggests that injunctive requirements imposed without taking possession of the property are not discharged. States can be expected to pursue this line of argument in future bankruptcy litigation.

1. Pub. L. 95-598, 92 Stat. 2604 (1978), codified at 11 U.S.C. §§ 101-151326 (commonly referred to as the Bankruptcy Code). See Drabkin, Moorman, & Kirsch, Bankruptcy and the Cleanup of Hazardous Waste: Caveat Creditor, 15 ELR 10168 (1985) (hereinafter cited as Bankruptcy Article). The text accompanying note 5 of the Bankruptcy Article explains this key distinction between the current law and its predecessor.

2. See generally "Environmental Protection and Bankruptcy Rehabilitation: Toward a Better Compromise," 11 ECOLOGY L.Q. 671, 672-677 (1984).

3. 11 U.S.C. § 362(a). See Bankruptcy Article, supra note 1, at 10172; Comment, Bankruptcy and Environmental Regulation: An Emerging Conflict, 13 ELR 10099 (1983) (hereinafter cited as Bankruptcy Comment); Aaron, Bankruptcy Stays of Environmental Regulation: Harvest of Commercial Timber as an Introduction to a Clash of Policies, 12 ENVT'L L. 1 (1981).

4. In re Miller, 22 Bankr. 479 (D. Md. 1982); In re Eisenberg, 7 Bankr. 683 (E.D.N.Y. 1980).

5. See, e.g., Borg-Warner Acceptance Corp. v. Hall, 685 F.2d 1306, 1308 (11th Cir. 1982); In re Johnson, 16 Bankr. 193 (M.D. Fla. 1981).

6. See 11 U.S.C. § 362(b)(1); In re Davis, 18 Bankr. 701, 702 (D. Del. 1982), aff'd, 691 F.2d 176 (3d Cir. 1982). This provision is of obvious value to states that have strong criminal enforcement options. See, e.g., the Pennsylvania Solid Waste Management Act, 35 P.S. § 6018.606 and the Clean Streams Law, 35 P.S. § 691.602. The only exception to the provision is judicially created, to deal with "criminal" proceedings that are really disguised collection efforts. In re Reid, 9 Bankr. 830, 832 (M.D. Ala. 1981).

7. 11 U.S.C. § 362(b)(4).

8. 11 U.S.C. § 362(b)(5).

9. See S. REP. NO. 989, 95th Cong., 2d Sess. 52, reprinted in 1978 U.S. CODE CONG. & AD. NEWS 5787; 5838; H.R. REP. NO. 595, 95th Cong., 2d. Sess. 343, reprinted in 1978 U.S. CODE CONG. & AD. NEWS 5963, 6299; Penn Terra Ltd. v. Department of Environmental Resources, 733 F.2d 267, 274, 14 ELR 20475, 20478 (3d Cir. 1984).

10. Bankruptcy Comment, supra note 3 and cases discussed therein.

11. Penn Terra Ltd. v. Department of Environmental Resources, 733 F.2d 267, 274, 14 ELR 20475, 20479 (3d Cir. 1984). See also Ohio v. Kovacs, 105 S. Ct. 705, 711, 15 ELR 20121, 20123 (1985); United States v. ILCO, Inc., 48 Bankr. 1016, 15 ELR 20562 (N.D. Ala. 1985); In re Corco, No. 5-8401153E, slip op. at 16 (Bankr. W.D. Tex. May 17, 1985).

12. Ohio v. Kovacs, 105 S. Ct. 705, 710-711, 15 ELR 20121, 20123 (1985). It should be noted that a governmental agency may enter a money judgment against a bankrupt bur may not initiate efforts to collect it, e.g., issuance of execution process. See S. REP. NO. 989, 95th Cong., 2d Sess. 52, reprinted in 1978 U.S. CODE CONG. & AD. NEWS 5787, 5838; H.R. REP. NO. 595, 95th Cong., 2d Sess. 343, reprinted in 1978 U.S. CODE CONG. & AD. NEWS 5963, 6299.

13. See supra note 10.

14. See, e.g., Federal Mortgage Investment v. Camelia Builders, Inc., 550 A.2d 47 (2d Cir. 1976); Borg-Warner Acceptance Corp. v. Hall, 685 F.2d 1306, 1308 (11th Cir. 1982); In re Pyramid Restaurant Equipment Co., 24 Bankr. 455 (W.D.N.Y. 1982).

15. 28 U.S.C. § 1481. See also FED. R. BANKR. P. 9020.

16. For any one naive enough to believe that abuse of discretion by some bankruptcy judges has not been a serious problem for some states, see Penn Terra Ltd. v. Department of Environmental Resources, 733 F.2d 267, 274, 14 ELR 20475, 20479 (3d Cir. 1984). There, the bankruptcy court had considered a contempt petition against two lawyers for the Pennsylvania Department of Environmental Resources before concluding (in a decision reversed by a unanimous panel of the Third Circuit) that a substantial fine against their client was warranted.

17. 11 U.S.C. § 362(e).

18. See, e.g., Penn Terra Ltd. v. Department of Environmental Resources, 733 F.2d 267, 14 ELR 20475 (3d Cir. 1984); In re Canarcio Quarries, Inc., 466 F. Supp. 1333 (D.P.R. 1979).

19. 11 U.S.C. § 105(a).

20. See, e.g., Penn Terra Ltd. v. Department of Environmental Resources, 733 F.2d 267, 273, 14 ELR 20475 (3d Cir. 1984); In re Professional Sales Corp., 48 Bankr. 651 (N.D. Ill. 1985), appeal pending.

21. See S. REP. NO. 989, 95th Cong., 2d Sess. 51, reprinted in 1978 U.S. CODE CONG. & AD. NEWS 5837; H.R. REP. NO. 595, 95th Cong., 2d Sess. 342, reprinted in 1978 U.S. CODE CONG. & AD. NEWS 6298; In re Corco, No. 5-8401153E, slip op. (Bankr. W.D. Tex. May 17, 1985).

22. In re Bel Air Chateau Hospital, Inc., 611 F.2d 1248 (9th Cir. 1979); In re Mason, 18 Bankr. 817, 824 (W.D. Tenn. 1982); In re Professional Sales Corp., 48 Bankr. 651 (N.D. Ill. 1985), appeal pending.

23. 42 U.S.C. §§ 6901-6987, ELR STAT. 42001.

24. In re Corco, No. 5-8401153E, slip op. (Bankr. W.D. Tex. May 17, 1985).

25. In re Sawanee Land, Coal and Cattle, Inc., No. 83-G-010-E, slip op. (N.D. Ala. Aug. 4, 1983).

26. See Turner Brothers, Inc. v. Oklahoma Department of Mines, No. 85-0053 (Bankr. E.D. Okla. Mar. 12, 1985), where the bankruptcy court issued a § 105 stay which relaxed state surface mine reclamation requirements to assist a Chapter 11 reorganization.

27. 28 U.S.C. § 959(b).

28. 28 U.S.C. § 959(b) also requires compliance with federal law, Haberern v. Lehigh & N.E.R.R.W., 554 F.2d 581, 585 (3d Cir. 1977); Carpenters Local Union No. 2746 v. Turney Wood Products, Inc., 289 F. Supp. 143 (W.D. Ark. 1968). This is a subtle but important point for states administering delegated federal programs such as the NPDES permit system, Federal Water Pollution Control Act § 402, 33 U.S.C. § 1342, ELR STAT. 42421, or the primacy program under the Federal Surface Mining Control and Reclamation Act, 30 U.S.C. § 1201, ELR STAT. 42401.

29. 105 S. Ct. 705, 15 ELR 20121 (1985).

30. 11 U.S.C. § 727(b).

31. Midlantic National Bank v. New Jersey Department of Environmental Protection and O'Neill v. City of New York, 16 ELR 20278 (U.S. Jan. 27, 1986).

32. 11 U.S.C. § 101(4).

33. 11 U.S.C. § 554. See also Bankruptcy Rule 6007. Section 554 codifies prior judge-made law on abandonment under the former Bankruptcy Act, Midlantic National Bank v. New Jersey Department of Environmental Protection, 16 ELR 20278 (U.S. Jan. 27, 1986). See generally 4A COLLIER ON BANKRUPTCY (KEY OFF)«70.42¨(KEYWORD) (14th ed.). See also Ottenheimer v. Whitaker, 198 F.2d 289 (4th Cir. 1952); In re Lewis Jones, Inc., 1 Bankr. Ct. Dec. 277 (E.D. Pa. 1974); In re Chicago Rapid Transit Co., 129 F.2d 1 (7th Cir.), cert. denied, 317 U.S. 683 (1942); but see In re Adelphi Hospital Corp., BANKR. L. REP. (CCH), P6682 at 856 (2d Cir. 1978).

34. Ohio v. Kovacs, 105 S. Ct. 705, 711-712, 15 ELR 20124 (1985). This language is completely consistent with the obligations imposed under 28 U.S.C. § 959(b).

35. Midlantic National Bank v. New Jersey Department of Environmental Protection and O'Neill v. City of New York, 16 ELR 20278 (Jan. 27, 1986).

36. In re Quanta Resources Corp., 739 F.2d 912, 14 ELR 20563 (3d Cir. 1984); In re Quanta Resources Corp., 739 F.2d 927, 14 ELR 20572 (3d Cir. 1984).