In a decision that sent shock waves throughout the banking industry, an Arizona federal court held in January that a trustee could be liable for contamination cleanup costs under the Superfund law.

The case, City of Phoenix v. Garbage Services Co., was the first to address the Superfund liability a testamentary trustee in a traditional trustee/beneficiary relationship.

The initial decision did not say whether the trustee could be held liable for damages exceeding the trust's assets. But much to the dismay of the banking community, the court in a very recent decision finally answered that question - in the affirmative.

The court held that a trustee who has the power to control the trust property and knowingly allows it to be used for the disposal of hazardous substances" will be held personally liable for Superfund damages "to the same extent that he would be liable if he held the property free of trust."

However, the court determined, if a trustee is not the owner of property when hazardous substances are discharged, or lacks power to control the use of the trust property, then Superfund liability should be limited to the assets of the trust.

Potential trustees should take precautions in structuring trusts so as to avoid the potential liability implicit in this decision.

Landfill Land Mine

In the Phoenix case, Valley National Bank was the trustee of a testamentary trust established by Wilbur Calvin Estes.

Before his death, Mr. Estes had conveyed a landfill to four individuals, but retained an option to repurchase. After his death, Valley as trustee, exercised the option and repurchased the landfill.

At the time of the repurchase, Garbage Services Co. managed operations at the landfill, and Valley continued the arrangement for another six years. Then the landfill was closed.

During that period, Valley simply paid taxes and purchased liability insurance for the property.

Eight years later Phoenix condemned and acquired the former landfill. The city commenced cleanup of the hazardous substances that had been deposited on the site and sought contribution from Valley on the ground that the bank was the record owner when the landfill was operational, because the property was an asset of the Estes trust.

Analyzing Superfund's liability provisions, the federal court in Arizona held that an owner will be liable under Superfund when either of two circumstances prevail:

* When the owner is the one who currently holds title to the contaminated property.

* When the owner holds title to the property at the time that hazardous substances are deposited on it.

The court held that under the first circumstance, a trustee would be held liable solely because it held record title to the property. Under traditional principles of trust law, such liability would be limited to the assets of the trust estate.

However, under the second circumstance, the trustee would be liable because it made the decision to permit the property to be used for an ultrahazardous activity.

Under traditional principles of tort law, the trustee would be strictly liable for any damages caused by the ultrahazardous activity. And, under trust law, a trustee is personally liable for any torts committed during the administration of the trust.

Therefore, the court reasoned that trust and tort law dictate that a trustee should be personally liable for any strict liability that results from permitting ultrahazardous activity to take place on property that is part of the trust's assets.

General Rules

Applying its newly fashioned common law of trustee liability under Superfund, the court set forth the following general rules:

* If a trustee is the current record owner of property that had been contaminated before the trustee acquired title, the trustee's liability is limited to the assets of the trust.

* If a trustee is the owner of the property at the time hazardous substances are deposited on it, but has no power to control the use of the property, the trustee's liability is limited to the assets of the trust.

* If a trustee has the power to control the use of trust property, and "knowingly" allows the property to be used for the disposal of hazardous substances, the trustee is liable to the same extent it would be if it owned the property free of trust.

Given these general principles, it is quite clear that in order to limit its potential liability, a trustee must avoid any power of control over the trust properties.

Where this is not possible, however, it would be prudent for the trustee to avoid permitting any use of the properties that would harbor the potential for discharge - even accidental - of hazardous substances.

Since the court's reasoning was not limited to testamentary trusts, it may be applied to other trust situations as well.

Ms. Campbell heads the environmental practice of the Mudge Rose Guthrie Alexander & Ferdon law firm in New York. Ms. Hook is an associate in the same department.

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