Environmental Compliance, Permitting and Cleanup Obligations: To What Extent Should They Take Precedence Over Other Obligations During and After Bankruptcy?: A. Environmental Regulation, Bankruptcy Law, and the Problem of Limited Liability

Douglas G. Baird

Editors' Summary: Although NEPA requires the preparation of an EIS for every major federal action significantly affecting the environment, federal agencies often decide in particular cases that compliance with NEPA is satisfied by preparation of EAs. Thedecision not to prepare an EIS is usually based on a finding of no significant impact. When an agency's threshold NEPA decision is challenged in court, what is the appropriate standard of review? The federal courts of appeals answer this question in at least two different ways: some circuits use the "arbitrary and capricious" standard, while others inquire into the "reasonableness" of the agency's decision. Several courts have expressed doubt that there is any genuine distinction between the rival standards, and the Supreme Court has so far declined to settle the issue. The author of this Article surveys the federal case law on this question, exploring the approach of each circuit and taking issue with those who maintain that the difference between the standards is illusory. The vital difference, the author argues, is that courts using the reasonableness standard are more likely to substitute their own judgment for that of the agency, while courts adopting the arbitrary and capricious standard tend not to second-guess an agency's decision. Because he sees an important difference between these two approaches, the author urges the Supreme Court to grant certiorari to resolve the circuit split.

Douglas G. Baird is Professor of Law at the Law School, The University of Chicago, Chicago, Illinois.

[18 ELR 10352]

When bankruptcy lawyers appear before lay people or other lawyers, we're sometimes looked at the same way as pathologists. We talk about how death is natural and beautiful, but everyone else is somewhat disgusted at how we spend our time. The image of bankruptcy lawyers as pathologists in the minds of most, however, helps to counterbalance the tendency among some bankruptcy judges and lawyers to view themselves not as pathologists but rather as miracle workers, people who can make flowers grow in the desert and bring the dead back to life. Understanding environmental law issues — or any other legal issues in bankruptcy — can begin only after we recognize the modesty of bankruptcy law's ambitions, the limits of what can be done in a bankruptcy proceeding.

Bankruptcy issues, I shall suggest, are largely procedural ones. One you pass the technical vocabulary, they are not that difficult. Do not be misled by people reciting odd vocabulary and section numbers. Bankruptcy changes how litigation goes forward, but the substantive issues, such as who should prevail over whom, are not in themselves determined by bankruptcy law. They are determined by the substantive state or federal nonbankruptcy law.

Let's consider some simple examples. First, imagine that a corporation ("Firm") owns Blackacre. Firm has managed to pollute Blackacre with every carcinogen known to mankind. State or federal law now requires Firm to clean it up. Firm must pay for bulldozers, fences, a guard on the site indefinitely, and other expenses totaling $ 200,000. Assume also that Firm owes $ 200,000 to a general creditor — perhaps a bank foolish enough to lend money to Firm, perhaps a trade creditor foolish enough to send it supplies. It could as easily be a tort victim who contracted cancer from the hazardous waste dumped at the site.¹ In any event, the firm has an obligation to the government to clean up the site and an obligation to this general creditor. Assume that once it is cleaned up, Blackacre will be worth $ 1,000 — essentially worthless. In addition, the firm has no other assets and has long ago ceased operations. The managers have fled to Rio de Janeiro, and the corporate veil cannot be pierced. The general creditor files a Chapter 7 bankruptcy petition.²

A moment's reflection will tell you what the bankruptcy judge must do. The bankruptcy judge will survey the situation and then close the case. There are no assets to distribute. Because the corporation has limited liability under state law, a bankruptcy discharge is irrelevant. In point of fact, the corporation will not receive a discharge. Unlike an individual, a corporation does not receive a discharge under Chapter 7, which governs many of these cases. Chapter 7 simply provides a mechanism whereby the corporation's creditors can be paid. The corporation does not receive a fresh start in any sense of the word. The limited liability a corporation enjoys under state law already insulates Firm [18 ELR 10353] from claims of its creditors. The basic rule inside and outside of bankruptcy is that creditors can reach every dime that a corporation has, and no more.

The problem in this case is that the debtor-corporation has no money. Neither bankruptcy nor any other legal regime can change this. You cannot get blood from a stone. Unfortunately, many of the worst polluters are hollow shells. The hard questions arise only when there is money.

Let us consider a second case, identical in all respects to the first, except that in addition to Blackacre there is $ 100,000 in a bank account. The managers are in Rio de Janeiro, the corporation is in Chapter 7, there is a general creditor who is owed $ 200,000, and the cleanup will cost $ 200,000. The bankruptcy judge is, unlike many, not overburdened, and is not apt to procrastinate. How should the judge resolve this case? What are the stakes? We may be tempted to think in terms of "automatic stays," "abandonment powers," and similar jargon. But before we do so, we should ask ourselves the basic question: Who gets the money?

In this simple case, there are three possibilities. First, the government may get it. Second, the general creditor may get it. The third possibility is that they split it, sharing pro-rata the rights to this $ 100,000. The general rule in bankruptcy is that people that are indistinguishable share pro-rata. No other bankruptcy policies are implicated here. We are in Chapter 7, and the corporation has ceased operations. It is not a matter of saving jobs, nor of providing a bankrupt with a fresh start. The only question concerns the relative rights of the general creditor and the government.

What kind of right does the state have to this $ 100,000? The nature of the obligation is to perform an act — an obligation to clean up rather than an obligation to pay money. Hence, one might argue that the obligation is not a "claim" as that word is defined in Section 101(4).³ This view is unpersuasive, however, because the Bankruptcy Code provides that only entities with "claims" can receive assets. In the example at hand, it seems absurd to deny that the government has some place in the line of those with rights to the assets. The government will not necessarily get the money, nor will it necessarily take before the general creditor. But the government certainly shall stand in line in front of the corporation and its shareholders. Leaving aside the priority question, the kind of obligation that this firm has to the government — one that rose out of its prebankruptcy existence, and that would result ultimately in an adverse judgment and loss of the firm's assets — has all the characteristics of a "claim." Such an obligation is precisely what Section 101(4) attempts to capture. In general, obligations the firm incurred because of acts it committed before the bankruptcy petition was filed are "claims" within the meaning of the Bankruptcy Code.

Both the general creditor and the government in this case (either federal or state, it doesn't matter which) have claims. How, then, shall each party's claim be assessed? The claim of the government is not a priority claim within the meaning of Section 507 of the Bankruptcy Code. There are some kinds of general claims that are given a priority, including administrative expense claims. If, in the course of assembling the bankruptcy estate's assets, one must pay a lawyer or a private detective to track them down, it is only fair that the costs of bringing those assets together are paid from off the top. The creditors benefit from the gathering of these assets and they can hardly expect anyone to help gather them at the rate of 10 cents on the dollar. After the fact you may receive only 1/10 of your usual fee, but you don't ordinarily agree to work for people who tell you in advance that they will pay you only 1/10 of what you bill them.

The cleanup obligation for past dumping is not an administrative priority. The obligation does not arise during the pendency of this bankruptcy proceeding, but rather arose from acts committed before the bankruptcy proceeding started. Nor is it an obligation incurred to preserve assets of the estate, because Blackacre is valueless. The creditors would just as soon see it disappear. And because the bankruptcy proceeding will last only a couple of hours, no expenses will be incurred by the government during this time.⁴

We are led, then, to a basic rule of bankruptcy law. In Butner v. United States,⁵ the court held that when no special bankruptcy policy is implicated, the court will simply respect whatever rights exist outside of bankruptcy, and mirror them in bankruptcy. You can see this by imagining what our example would look like if no bankruptcy opinion had been filed. Firm has polluted Blackacre, and $ 100,000 is in its bank account, but no bankruptcy petition is filed. Managers of the firm disappear to Rio de Janeiro. At this point, the general creditor sues the bank holding the $ 100,000 and says: "Give us the money." In response, the bank interpleads the government and says: "I'll give the $ 100,000 to whoever deserves it, either the general creditor or the government. I'm not taking any position on which has the better claim." The court now must decide the priority question, i.e., whether or not these two are general creditors, or whether the state has a priority right analogous to a lien under nonbankruptcy law. The question of who gets this money must be resolved without resort to bankruptcy law, because no one has filed a bankruptcy petition.

Once this nonbankruptcy priority question is resolved, the bankruptcy result follows. Bankruptcy law will respect whatever the nonbankruptcy outcome happens to be. The policy debate in this case is one that can be divorced from bankruptcy law. In the example at hand, even if there is no specific statute, under nonbankruptcy law the state will have some form of equitable lien on Blackacre. Thus, to the extent that Blackacre is worth $ 400,000 and it costs the government $ 200,000 to clean up, the government enjoys a $ 200,000 lien on Blackacre. No creditor can force a sale of Blackacre and keep all the proceeds. It must pay off the state. If the government does not clean up the site, that obligation (like a lien) survives any sale.

The federal and state governments are free to pass laws in this area that give the government greater rights. A law might hold that, to the degree that Firm pollutes the environment, the state has a lien on all of Firm's assets. A law might declare that the state has a lien on Firm's assets that trumps even the rights of secured creditors of Firms. Such a law would be somewhat unusual. Generally, when the government asserts a lien on property in order to prevail over [18 ELR 10354] secured creditors, it must make some kind of filing. Hence, if the drafter were following traditional modes of granting liens, he would write a statute granting the government a first-priority lien only to the extent that the government files before the various secured creditors. The details of these priority rules, however, are not the province of the bankruptcy lawyer. The priority question is not a bankruptcy question. The issue — whether the general creditor or the government gets the $ 100,000 in assets that is unconnected with Blackacre — arises whether or not a bankruptcy petition is filed, and nothing justifies making the answer to the question turn on the forum in which the litigation is brought.

Let me now turn to a different question. I want to look at the relationship between government regulations and the automatic stay in bankruptcy. All efforts of creditors to obtain payment are stayed when a bankruptcy petition is filed. A provision in the Bankruptcy Code states, however, that the automatic stay does not put a stop to nonmoney judgments of the state issued pursuant to the state's police or regulatory power.⁶ The Third Circuit held in Penn Terra⁷ that the order to clean up prebankruptcy wastes fell within the scope of this exception. This seems wrong. The cleanup obligations arose before the filing of the bankruptcy petition. The automatic stay is supposed to prevent depletion of the estate while priorities among prebankruptcy obligations are sorted out. It does not resolve them. The effect of declaring that the stay doesn't apply to such an obligation to clean up toxic wastes, however, does in fact resolve the priority question. To say that the debtor has an obligation to clean up the site notwithstanding the stay is to say that the government's claim takes priority over the general creditor's claim. But the automatic stay provision was never designed to decide the priority of prebankruptcy claims. Bankruptcy law, with its automatic stay, only allows claims to be sorted out. It should not itself decide them.

The provision referring to the regulatory powers of the state does have a role to play in a bankruptcy dispute. A debtor may owe obligations to the state as a result of its post-bankruptcy activities. These obligations (not pre-bankruptcy ones) are outside the stay. Take the example of a firm that produces widgets. Its factory belches smoke in violation of numerous state and federal environmental laws. Under applicable law, if it wants to continue to make widgets, it must install a $ 200,000 scrubber in its smokestack. Leaving aside any obligation to creditors and the obligation to put in the scrubber, the value of the firm is $ 250,000. In fact, the firm owes $ 200,000 to a general creditor. The state orders the firm to install the scrubber. In response, the firm files a bankruptcy petition in Chapter 11. It wants to remain intact while it sorts out its affairs with its creditors.

In such a case, the firm and the general creditor would like some bankruptcy judge to come in and say, "Well, the state is ordering you to put in the $ 200,000 scrubber. But because you need a fresh start and because you're in bankruptcy, I'll stay that order." This logic is rejected, however, by the provision in the Bankruptcy Code declaring that an automatic stay does not apply to the state when it's exercising its police or regulatory power. Whether in bankruptcy or outside of bankruptcy, if one has been ordered to install the scrubber to continue operations, the scrubber must be installed. Nonbankruptcy law offers a choice: one can liquidate the firm and divide up the assets, or one can install the scrubber and continue the firm. One cannot choose to continue the firm and not install the scrubber.

This outcome is not the result of some kind of balancing between bankruptcy's goal of rehabilitation and environmental laws. Such balancing doesn't apply. The basic purpose of bankruptcy is to provide enough breathing space so that the efforts of creditors to get paid don't destroy the firm. Nothing in the Bankruptcy Code or in the history of bankruptcy law says that people in bankruptcy shouldn't have to play by the same rules as everyone else. Bankruptcy leaves completely unaffected obligations to the state stemming from one's continued existence. These obligations should be distinguished from obligations that arose out of one's prebankruptcy existence and that continue to exist regardless of whether the firm continues to exist. If Firm dumped toxic wastes in the past and incurred a $ 200,000 obligation to clean it up, that obligation exists regardless of whether Firm continues or shuts down its operations. The case of an obligation to install a scrubber is different, because the obligation exists if, but only if, the firm continues to manufacture widgets.

An example more extreme than the one with the scrubber may help to illustrate how state regulation should affect firms in bankruptcy. Let's say Firm runs a chemistry laboratory, and it hires some investment bankers who announce that the only way Firm can stay in business and preserve jobs is if it uses the laboratory to process cocaine. There are two ways a bankruptcy judge could look at this case. First, he could balance the "bankruptcy" policy of preserving jobs and keeping the firm intact against the policy disapproving of cocaine. Under this approach, he would decide which policy was more important. On the other hand, the bankruptcy judge could say: "Wait a second, this is ridiculous! Whether you're in bankruptcy or outside of bankruptcy, you can't use your chemistry laboratory to make cocaine. Regulations continue to apply to you. You must pay the minimum wage. You can't pollute the environment. You can't violate applicable nonbankruptcy law as you continue your operations."

An environmental law that requires manufacturers to have scrubbers on their smokestacks embraces the following principle: If one cannot bear the cost of the pollution one creates, one should shut down. Nothing in bankruptcy preempts this principle. Of course, if a rule imposes costs on firms that are out of all proportion to the actual damage the firms cause, then it may be a bad rule that should be changed. Congress can amend its own law. It can also step in, preempt state laws, and pass its own rules. The Bankruptcy Code, however, was not designed to second-guess environmental law. It doesn't exist to bail out environmentalists who pass bad laws.

Let me turn to a final example that concerns an issue that is much simpler than courts have made it out to be: abandonment. Under the Bankruptcy Code, the trustee has an unqualified right to sell, use, lease, or abandon property of the estate.⁸ What does this unqualified right mean? In the last example, the Bankruptcy Code on its face gave the [18 ELR 10355] trustee the unqualified right to use the debtor's chemistry laboratory. But such a right is nevertheless qualified by nonbankruptcy regulations. The trustee can sell the debtor's machine gun, but he can't sell it to Mafiosi with criminal records — not because of some kind of balancing test but simply because the sale in bankruptcy must track nonbankruptcy rules.

What, then, about this abandonment power? Some kinds of property are not worth keeping. Property may be so heavily mortgaged or so expensive to repair that all the general creditors whom the trustee represents will be better off if the trustee throws the property away. Section 554 of the Bankruptcy Code allows the trustee to do so. Is this right, then, completely unqualified? Of course not. No one argues that a bankruptcy trustee can litter. A trustee should not be able to dispose of property in violation of state or federal law. The trustee must play by the same set of rules as everyone else. Nonbanking rules always qualify rights the Trustee enjoys under the Bankruptcy Code.

Return to the toxic wastes in Blackacre: There is a $ 200,000 cleanup cost, and the trustee decides that he should abandon Blackacre. In my view, the trustee can get rid of Blackacre if, but only if, applicable bankruptcy law allows him to free himself from any future obligations associated with ownership of Blackacre. If he cannot do so, then he can't abandon the property. Of course, to the extent that these obligations exist, one probably must take account of them in parceling shares of remaining assets.

In considering the issue of abandonment, a crucial point must be borne in mind. It was acknowledged by the Supreme Court in Midlantic Bank,⁹ although many will read the opinion otherwise. Abandoning or not abandoning the property has nothing to do with whether the government has a right to get money from the debtor. Whether the trustee abandons this toxic waste dump is completely independent of whether the debtor is still obliged to the government to pay the cleanup cost. If I run someone over with a car, I can't free myself of tort liability by throwing out the car. If I pollute Blackacre in vile and disgusting ways, I can't free myself of my obligations to the government by getting rid of Blackacre. The obligation is incurred before the filing of the petition, and it does not disappear through abandonment of the particular property.

In my view, the conflict between bankruptcy law and environmental law is largely illusory. There are some undeniably hard questions to face. Nevertheless, the basic question in a situation in which many firms have limited liability and there is not enough cash to go around can be stated without mystical incantations of bankruptcy policy. The major issue is not one of the reach of the automatic stay under § 362 or the abandonment power under § 554, but the simple one of who gets the cash. Policymakers should avoid the temptation to engage in fuzzy, case-by-case balancing of bankruptcy policy and environmental law. Clear rules benefit everyone, and we can craft such rules only with clear thinking about the logic and limits of different legal regimes. The question of who should win and who should lose when there is not enough to go around is very hard. But we can only make the question murkier and less tractable if we look to bankruptcy law for the answer.

1. Under bankruptcy law and under nonbankruptcy law, a tort victim and unsecured creditor must follow the same path in pursuit of their rights. In each case, they vindicate their rights by suing and reducing their claim to a judgment, a levy on assets.

2. 11 U.S.C. § 303.

3. 11 U.S.C. § 101(4).

4. If cleanup obligations arise after the petition is filed, they would be administrative priority claims under the rule of Reading Co. v. Brown, 391 U.S. 471 (1968).

5. 440 U.S. 48 (1979).

6. 11 U.S.C. § 362(b)(5).

7. Penn Terra Ltd. v. Department of Environmental Resources, 733 F.2d __ (3d Cir. 1984).

8. If U.S.C. §§ 363, 554.

9. Midlantic National Bank v. New Jersey Dept. of Envtl. Protection, 106 S. Ct. 755 (1986), 16 ELR 20278.