The Legal Case Against Lender Liability

John P. C. Fogarty

John P. C. Fogarty, an attorney in Environmental Protection Agency's Office of Enforcement, is the Chair of the Agency's Lender Liability Rule Workgroup. The opinions expressed in this Dialogue are solely those of Mr. Fogarty, and do not necessarily represent those of the U.S. EPA.

[21 ELR 10243]

Are lenders' fears of Superfund liability justified? The conventional wisdom holds that they are. However, this hasty judgment may not be able to withstand legal scrutiny.

Substantial protection from liability for lenders is already provided by § 101(20)(A) of the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA).¹ This section excludes from the definition of "owner or operator" a person whose indicia of ownership in a facility are held to protect a security interest, provided that the security holder refrains from "participating in the management" of the facility. The focus of the lender liability debate concerns the types of activities that are considered evidence of "management participation" that would potentially subject a lender to CERCLA liability.

The 11th Circuit's opinion in United States v. Fleet Factors Corp.² is asserted to increase substantially the likelihood that Superfund liability will be imposed on lenders who hold security interests in facilities contaminated by hazardous substances. The case is claimed to establish an overly broad standard of "management participation" and to present an unacceptably high level of uncertainty for lenders acting to protect their security interests. Accordingly, lenders fear that "ordinary" business loans carry with them an unacceptably high risk of CERCLA liability. This fear of liability is, in turn, cited as one of the factors fueling the recent credit crunch.³

To allay these fears of liability, in August 1990 the Environmental Protection Agency (EPA) pledged to promulgate expeditiously a rule that would clarify CERCLA's security interest exemption. The Agency's proposal, sent to the Office of Management and Budget (OMB) just over a month later, was greeted with a small dose of criticism — some of it in this space.⁴ The Agency has since revised the rule following comments received during the interagency review process, and has submitted the revised rule to OMB. As of this writing, although it has not yet been cleared by OMB for release, a document purporting to be EPA's revised rule has been leaked to the press by non-EPA sources. Just as with the Agency's initial effort, this unofficially released version will undoubtedly be the subject of new critiques.

Since the Fleet Factors decision, how best to address the lender liability "problem" has been the subject of extensive debate. Largely overlooked, however, is a considered assessment of whether the fears of liability are legally well-grounded. Such fears may not be warranted by existing case law.

Unquestioned Assumptions

To be fair, the lending community is currently under siege, its institutions reeling from an inordinately high rate of loan defaults and bad investment decisions. These troubles, combined with an ailing economy, have resulted in a surge of bank insolvencies and failures. The estimated cost of the savings and loan bailout increases with each revision. Formerly aggressive bank managers are now cautious and have responded by tightening credit to financially dubious ventures. Regulators are clamping down on risky lending practices. Viewed through the lens of economic anxiety, the specter of CERCLA liability looms large.

Those questioning the credibility of the CERCLA liability threat often point to the paucity of cases in which banks are held or even alleged to have voided the security interest exemption. To some, this indicates that the whole lender liability issue is built on conjecture and supposition.⁵ Yet this rejoinder is not dispositive; it may be that the legal threat is real, but is not often applied. Further, even though EPA may prudently exercise its enforcement discretion, unfounded private party suits against lenders remain a continuing threat. In this regard, lender liability may be likened to a caged gorilla: while it has not been a threat in the past, if let out of its cage the effect on an already weakened lending industry may be too much to bear.

The assumption apparently held by both sides to the debate is that Fleet Factors has in fact limited the scope of the § 101(20)(A) exemption, and that the increased liability threat is credible. The lending community sees this as an undesirable outcome because it unfairly imposes the costs of cleanup on otherwise innocent lenders. Others view the increased threat of liability as an appropriate incentive for lenders to ensure that their borrowers run "clean" operations. However, the holding and opinion in Fleet Factors cannot fairly be read to support either conclusion. Put simply, nonculpable lenders are not — and have not been — unfairly forced to pay for Superfund cleanups.

The Legal Basis of Lender Liability

Through more than ten years of Superfund litigation, the § 101(20)(A) security interest exemption has been construed only a handful of times, of which the Fleet Factors decision has probably received the most attention. Read closely, however, the narrow holding of Fleet Factors does not seem to add much to the decision law. What Fleet Factors has added to the mix is a sense of uncertainty, and many read the decision as a departure from earlier cases interpreting [21 ELR 10244] the exemption. Fleet Factors is often cited as establishing as the standard of liability a lender's mere capacity to influence the facility's hazardous waste practices. On this basis, the 11th Circuit's opinion is considered to be in conflict with the more recent opinion of the 9th Circuit in In re Bergsoe Metal Corp.,⁶ as well as with prior cases. Although this view of the case law is not without its supporters,⁷ it is not persuasive.

There are several key points to understanding the Fleet Factors opinion that are often overlooked. The first is its specific holding. The 11th Circuit simply affirmed the district court's denial of summary judgment on the basis that there were outstanding factual issues regarding the extent of Fleet's involvement with the Swainsboro Paint Works (SPW) facility. Fleet at one time held a security interest in SPW's property under a series of "factoring" agreements, and eventually Fleet foreclosed on some inventory and equipment upon SPW's default. However, the government's case against Fleet had nothing to do with Fleet's one-time status as secured creditor, nor did it involve the state of title to the SPW facility. Instead, the government's theory was a rather routine and mundane assertion that Fleet was an operator of the SPW facility. Fleet somewhat curiously interposed its prior status as a security holder as a defense to its current status as an operator, and summary judgment motions were filed by both sides. Because factual issues remained outstanding, the motions were denied.

Second, and perhaps more importantly for purposes of the debate, is the language that has been seized upon as problematic: specifically, that a security holder might not be entitled to the exemption if it possessed the "capacity to influence the … treatment of hazardous wastes."⁸ This suggests that the mere unexercised capacity to influence the management of a facility, without more, is a sufficient basis on which to impose liability on a security holder. This suggestion omits key language, however, that biases the entire analysis: the Fleet Factors court's standard of liability, in full, is whether a security holder actually participates in the financial management of a facility to a degree indicating a capacity to influence the treatment of hazardous wastes.⁹ Integral to this standard is the concept that the security holder must actually be involved in the facility's operations to some extent as a precondition to voiding the exemption. In other words, the security holder must first become involved in the facility's management and the level of involvement must be sufficient to support an inference, at least for purposes of summary judgment, that the security holder could have influenced the facility's hazardous waste practices. The mere capacity to do so, without more, is a wholly insufficient basis for liability to attach under the Fleet Factors analysis.

The central question for determining whether a security holder has voided the § 101(20)(A) exemption is not whether it possesses the mere capacity to become involved in a facility's management, but how much influence on management is actually exercised by a security holder, and whether it is enough to be considered "management participation." Fleet Factors answered this question by drawing the line at a lender's ability to influence hazardous waste practices. Whatever may be said of this standard, it is at least clear that in the absence of any involvement, the exemption cannot be voided. Yet this is the result that is often argued that Fleet Factors has reached — that the mere capacity to influence management decisions, without more, is sufficient to void the exemption.¹⁰ The plain language of the case sharply contradicts this conclusion.

In this respect, Fleet Factors is not an anomalous holding, nor is it at all inconsistent with Bergsoe Metal, as is sometimes argued.¹¹ Consistent with Fleet Factors, the Bergsoe Metal court held that it did not matter what rights a security holder may have had or what it might have done, but what the security holder in fact did.¹² The chief difference between the two cases is that in Fleet Factors the security holder had become involved in the facility's operations, while in Bergsoe Metal the holder of the security interest was not involved to any extent in the facility's management.

Stripped of all excess verbiage, the conclusion that the Fleet Factors opinion increases the potential exposure of lenders cannot be drawn from the pages of the opinion itself. While certain elements of the few district court cases decided prior to Fleet Factors and Bergsoe Metal are arguably less than consistent, when viewed as a whole they indicate a generally uniform approach. In the pre-foreclosure context, these cases indicate that it is permissible for a lender to become involved in the financial affairs of a borrower, to provide financial and even isolated instances of operational advice that fall short of day-to-day management, to negotiate new loan terms, and to engage in similar financially related activities, all without necessarily being considered "management participation" sufficient to void the exemption.¹³ In the post-foreclosure context, the courts have tended to focus on whether the foreclosure action is consistent with realizing on the security interest (and thereby remaining within the exemption), or whether the foreclosed-on collateral is held in furtherance of an investment interest (and thereby falling outside of the exemption).¹⁴

Conclusion

Cases construing the § 101(20)(A) security interest exemption establish that lenders are permitted to monitor, facilitate, and realize on their loans, without substantially increasing the chance that they would incur liability for contamination they could not have otherwise controlled nor foreseen. The Fleet Factors decision is not a departure from this line of cases, nor does it establish a new, more restrictive standard of liability for lenders. Quite the opposite, it clearly affirms that a lending institution, as the [21 ELR 10245] holder of a security interest, cannot be held liable as the owner or operator of a facility unless it actually becomes involved in its operations in some way. Anything less than this is insufficient to void the exemption.

1. 42 U.S.C. § 9601(20(A), ELR STAT. CERCLA 008.

2. 901 F.2d 1550, 20 ELR 20832 (11th Cir. 1990), cert. denied, No. 90-504 (U.S. Jan. 14, 1991).

3. See generally Amicus Brief of the National Council of Savings Institutions, et al., and Amicus Brief of American Bankers Ass'n, et al., Fleet Factors Corp. v. United States of America, U.S. No. 90-504 (petition for cert. field Sept. 21, 1990).

4. Wolf, EPA's Lender Liability Rule: No Surprises But More Work Needed, 21 ELR 10006 (Jan. 1991).

5. See, e.g., Crying Wolf: Lender Liability at Superfund Sites (Southern Finance Project Sept. 1990). Whether the threat is real or perceived, however, is largely immaterial: a choke on the flow of credit to environmentally risky enterprises is likely to be the norm until the fears are dispelled through regulation, legislation, or — If and when developed — hard facts.

6. 910 F.2d 668, 20 ELR 21229 (9th Cir. 1990).

7. See supra note 3.

8. 901 F.2d at 1557, 20 ELR at 20835.

9. Id.

10. Amicus Brief of the National Council of Savings Institutions, et al., Fleet Factrs v. United States, at 6.

11. Petition for Writ of Certiorari to the U.S. Court of Appeals for the Eleventh Circuit, Fleet Factors v. United States, at 7; Wolf, supra note 4, at 10007.

12. 910 F.2d at 672, 20 ELR at 21231.

13. See, e.g., In re Bergsoe Metal, 910 F.2d at 668, 20 ELR at 21229; Guidice v. BFG Electroplating & Manuf. Co., 732 F. Supp. 556, 20 ELR 20439 (W.D. Pa. 1989); United States v. Mirabile, 15 ELR 20994 (E.D. Pa. 1985).

14. See, e.g., United States v. Maryland Bank & Trust Co., 632 F. Supp. 573, 16 ELR 20557 (D.M. 1986); United States v. Mirabile, 15 ELR at 20994; In re T.P. Long Chem. Co., 45 Bankr. 278, 15 ELR 20635 (N.D. Ohio 1985).