EPA's Lender Liability Rule: No Surprises But More Work Needed

G. Van Velsor Wolf Jr.

Mr. Wolf is a partner in the Phoenix, Arizona, firm Lewis & Roca, where his practice focuses on environmental compliance counseling, corporate and real estate transactions, and the defense of enforcement and other actions by environmental regulatory authorities at all levels. He is chairman-elect of the Environmental and Natural Resources Law Section of the Arizona State Bar. From 1976 to 1981, he was editor-in-chief of the Environmental Law Reporter. Mr. Wolf received his J.D. in 1973 from Vanderbilt Law School and his B.A. in 1966 from Yale University.

[21 ELR 10006]

After the Court of Appeals for the Eleventh Circuit issued its recent decision in United States v. Fleet Factors Corp.,¹ putting lenders under significantly greater risk for environmentally distressed collateral, both Congress and the Environmental Protection Agency (EPA) promised prompt action to clarify the "secured lender" exemption in the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA).² Although bills were introduced in both the House and the Senate, Congress adjourned without final action on either. Meanwhile, the Ninth Circuit Court of Appeals decision in In re Bergsoe Metals Corp.,³ lessened the impact of Fleet Factors somewhat, and EPA has drafted an interpretive rule that will provide some comfort to financial institutions. EPA's draft rule, however, even if it is finally adopted in its current form, leaves serious gaps that may require Congress to further fine-tune the secured lender exemption.⁴

The Secured Lender Exemption

When Congress enacted CERCLA in 1980, it recognized that commercial lenders do not necessarily have the same involvement in activities that may cause contamination as do facility owners or operators and thus should not have the same liability. Congress therefore created the "secured lender" exemption by stating that the term "owner or operator" "does not include a person, who, without participating in the management of a vessel or facility, holds indicia of ownership primarily to protect his security interest in the vessel or facility."⁵

The early court decisions, while based on peculiar facts in each case, provided workable guidance to the exemption. In United States v. Mirabile,⁶ the federal district court declined to apply the exemption to one lender that had so "overly entangled" itself in the affairs of the borrower by having its representatives advise on operations, conduct close financial monitoring, and make personnel and manufacturing decisions after bankruptcy. On the other hand, CERCLA liability did not apply to the first lienholder, which sold the facility at a sheriff's sale four months after foreclosure, and to the Small Business Administration, whose loan guarantee contract gave it the authority to make management decisions, although the authority was never exercised.

The lending industry did not really take notice of its potential liability until the 1986 decision in United States v. Maryland Bank & Trust Co.⁷ The facts behind the decision should have been less frightening, however, because the court simply sought to compensate EPA for the cleanup costs it incurred during the four years the bank held the facility after foreclosure. Otherwise, the bank would have received a "windfall" through the enhanced property value as a result of the taxpayer-financed remediation. In Guidice v. BFG Electroplating & Manufacturing Co.,⁸ the court held that a bank that held a mortgage on contaminated property was liable before it foreclosed on the property, but may be liable for CERCLA cleanup costs after it foreclosed. The court ruled that the security interest exemption does not protect a secured creditor that purchases its security interest at a foreclosure sale. The court distinguished between pre-foreclosure loan-life monitoring, which was within the exemption, and post-foreclosure failure to remediate an ongoing contamination problem.

The 1988 federal district court decision in Fleet Factors⁹ went into more detail regarding the level of management participation required for liability. Ruling on motions for summary judgment regarding the application of the secured lender exemption, the court found that there were disputed issues of fact regarding the extent of the lender's participation in management during windup and foreclosure. Nonetheless, the district court concluded that a secured creditor may "provide financial assistance and general, and even isolated instances of specific management advice to its debtors without risking CERCLA liability if the secured creditor does not participate in the day-to-day management of the business or facility either before or after the business ceases operation."¹⁰

Although the Eleventh Circuit affirmed the denial of the summary judgment motions,¹¹ the opinion rejected both what it called the "permissive standard" of the district court and the Mirabile approach. Recognizing that secured lenders may become involved in "occasional and discrete financial decisions relating to the protection of its security," the court nonetheless would apply CERCLA liability if the lender's "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."¹² The opinion asserted a standard whereby [21 ELR 10007] the exemption would not apply if the lender had the "capacity to influence [the] facility's treatment of hazardous waste."¹³

The Ninth Circuit's decision in In re Bergsoe Metals¹⁴ may have deflated some of the heightened sensitivity resulting from Fleet Factors, but a close review of the facts could make the decision distinguishable. Essentially, the Ninth Circuit found that a municipal corporation that had issued bonds to finance a lead recycling facility was not an owner when the facility went into bankruptcy. Although the municipal corporation had not formally foreclosed on the property, it held title to the facility to protect the interest of its bondholders. The Ninth Circuit expressly stated that it was not fashioning a general rule, but it specifically rejected the Eleventh Circuit's "capacity to influence" concept in Fleet Factors.

It is clear from the statute that, whatever the precise parameters of "participation," there must be some actual management of the facility before a secured creditor will fall outside the exception….

… A secured creditor will always have some input at the planning stages of any large-scale project and, by the extension of financing, will perforce encourage those projects it feels will be successful. If this were "management," no secured creditor would ever be protected.

… That a secured creditor reserves certain rights to protect its investment does not put it in a position of management. What is critical is not what rights the Port had, but what it did.¹⁵

Legislation

Almost two years ago, Rep. John LaFalce (D-N.Y.) introduced a bill to exempt a foreclosing lender from CERCLA liability unless the lender caused or contributed to the contamination.¹⁶ A revised version introduced last spring¹⁷ gained significant support in the wake of Fleet Factors. In the Senate, Jake Garn's (D-Utah) bill¹⁸ was broader in scope in that it would have amended the Federal Deposit Insurance Act¹⁹ and exempted a foreclosing lender from all potential environmental liabilities. The lender, however, would have had to implement "adequate procedures" to evaluate potential environmental risks on its collateral. If it had actual knowledge of the use of hazardous substances on the property, it would have had to take "all reasonable actions necessary to prevent the release" of such substances. During hearings on the bills last summer, portions of the business community and environmentalists expressed concern that the bills would create too easy a loophole for a special class of CERCLA potentially responsible parties. As the bills were going through various subcommittee hearings, EPA testified that it was preparing an interpretive rule regarding CERCLA's secured lender exemption.²⁰

EPA's Rule

At this writing, EPA's interpretive rule was still undergoing internal review and had not yet been published in the Federal Register. Initially, the rule notes confusion on the issue resulting from the Fleet Factors and In re Bergsoe Metals appeals court decisions and focuses on both financial institutions that lend and government loan guarantors.²¹ The heart of EPA's rule defines by broad example the key terms in the secured lender exemption. If faced with financially distressed collateral, the lender may participate in workout discussions, but all actions must be aimed at preserving the value of its security interest.²² Interestingly, the rule acknowledges that a lender may foreclose on the property, but it must then either wind up the activities expeditiously or sell the property within six months. Holding the foreclosed property for longer than six months creates the inference that the lender is holding an investment, which is not covered by the secured lender exemption, rather than simply a security interest.²³ Finally, the rule emphasizes that the lender must make a preloan investigation²⁴ and may conduct periodic loan-life monitoring to protect the financial value of the collateral. Overall, the rule emphasizes that regardless of the lender's actions, the borrower in possession must retain the ultimate authority. If the lender has "materially divested" the borrower of decisionmaking, particularly regarding hazardous substances, the lender is participating in the management of the facility and is therefore outside the exemption.

EPA's rule should not replace the need for further clarifying legislation. Passive trustees²⁵ have a legitimate claim on the exemption, but the rule seems to ignore them, unlike Rep. LaFalce's bill. The six-month holding period may unfairly paralyze attempts to resolve problem loans, particularly in parts of the country suffering a severe real estate slump. The rule apparently would only deal with potential liability to EPA rather than to other private parties, which can have significant implications in contribution actions and bankruptcy.

Conclusion

An agency-drafted interpretive rule cannot have the broad scope that a statutory correction would have. Although the string of court decisions since 1985 has attempted to provide some workable guidance, except for the unforturnate Fleet Factors decision, Congress should establish more precise contours for CERCLA's secured lender exemption. Senator Garn's bill, which reflects a solid understanding of the complex issues related to lender liability while continuing to place a proactive obligation on lenders, would be a good place to start. It could be supplemented by some of the practical guidance set out in EPA's draft interpretive rule.

1. 901 F.2d 1550, 20 ELR 20832 (11th Cir. 1990).

2. § 101(20)(A), 42 U.S.C. § 9601(20)(A), ELR STAT. CERCLA 008.

3. 910 F.2d 668, 20 ELR 21229 (9th Cir. 1990).

4. There may be an effort in Congress this year to refine the "innocent purchaser" defense. See Wolf, Emerging Contours of the CERCLA "Innocent Purchaser" Defense, 20 ELR 10483 (Nov. 1990). If so, that effort may include a refinement of the secured lender exemption.

5. CERCLA § 101(20)(A), 42 U.S.C. § 9601(20)(A), ELR STAT. CERCLA 008.

6. 15 ELR 20994 (E.D. Pa. Sept. 4, 1985).

7. 632 F. Supp. 573, 16 ELR 20557 (D. Md. 1986). For a detailed discussion of this case, see Reed, Fear of Foreclosure: United States v. Maryland Bank & Trust Co., 16 ELR 10165 (1986); see also Burcat, Foreclosure and United States v. Maryland Bank & Trust Co.: Paying the Piper or Learning How to Dance to a New Tune?, 17 ELR 10098 (1987).

8. 732 F. Supp 556, 20 ELR 20439 (W.D. Pa. 1989).

9. 724 F. Supp. 955, 19 ELR 20529 (S.D. Ga. 1988).

10. Id. at 960, 19 ELR at 20531.

11. 901 F.2d 1550, 20 ELR 20832.

12. Id. at 1558, 20 ELR at 20835. The court observed that the secured creditor need not be involved in the day-to-day operations of the facility or participate in management decisions related to hazardous waste to be liable.

13. Id.

14. 910 F.2d 668, 20 ELR 21229.

15. Id. at 672, 20 ELR at 21231 (emphasis in original).

16. H.R. 2085, 101st Cong., 1st Sess. (1989).

17. H.R. 4494, 101st Cong., 2d Sess. (1990).

18. S. 2827, 101st Cong., 2d Sess., 136 CONG. REC. S9217 (daily ed. June 28, 1990).

19. 12 U.S.C. § 1811 et. seq. Senator Garn's bill would have added a new section called the "Lender Liability Act of 1990" to exempt entities covered by the Act from "nonculpable activities."

20. Inside EPA, Aug. 10, 1990, at 1. Although EPA did not oppose the bills, it did not feel that any legislation was necessary in light of its forthcoming interpretive rule.

21. EPA's rule specifies that CERCLA's secured lender exemption is "not a loan guarantee for lending institutions and does not shift to the Superfund the cost of poor loan decisions." Draft rule, p. 6. EPA's intent in the rule is to specify the actions a lender may take and still stay within the bounds of the exemption.

22. This concept mirrors the actions of the municipal corporation in In re Bergsoe Metals.

23. Clearly, this is the lesson from Maryland Bank.

24. Acknowledging the reality of past loan decisions, EPA said that the preloan investigation was not applicable to past loans, although the standard in the lending industry is now to require some form of environmental investigation before a loan is made.

25. Such as the bond trustee in In re Bergsoe Metals.