Several recent court decisions provide cause for optimism in the high-stakes area of environmental liability. They uphold Environmental Protection Agency regulations adopted to protect secured creditors from liability under the Comprehensive Environmental Response, Compensation, and Liability Act, or Superfund law.
In a significant 1992 decision, a federal district court in Minnesota declared that the EPA's lender liability rules (published April 29, 1992) were consistent with language exempting from the law's broad "owner and operator" liability provisions persons who, without participating in the management of a business, hold an indicia of ownership primarily to protect a security interest.
The case, Ashland Oil Inc. v. Sonford Products Corp. et al., involved a lawsuit filed by Ashland Oil to recover environmental response costs from two former tenants engaged in wood preserving operations and their lender.
In early 1983, the lender, Industry Financial Corp., foreclosed on and took title to the assets and equipment of its bankrupt borrower, including drums of hazardous substances which allegedly were leaking.
It was undisputed that Industry Financial "owned" and controlled the assets and equipment, including the leaking drums, for approximately one month before selling them to a third party. Industry Financial never foreclosed on or acquired title to the real estate.
Ashland asserted that Industry Financial was an "owner and operator" for purposes of the law's liability provisions based on its one-month "ownership" of the leaking drums and its "participation in the management" of both the initial borrower's and third-party purchaser's businesses.
In reviewing Ashland's claims, the court first upheld EPA's lender liability regulations as a reasonable interpretation of the secured creditor exception to Superfund law liability, finding that the regulations were entitled to deference as an "authoritative interpretation and application of" the law.
The court then rejected Ashland's arguments that Industry Financial had improperly participated in the management of its borrowers, or otherwise "arranged" for the disposal of the hazardous substances by acquiring title to, and then selling, the leaking drums.
In the second case, Kelley et al. v. Tiscornia et al. and Manufacturers National Bank of Detroit, the state of Michigan sued the former owners of Auto Specialties Manufacturing Co. and its lender, Manufacturers National, for contamination at two sites owned and operated by Auto Specialties.
The state sought to hold the bank liable as an owner and operator of the two sites based on the bank's alleged "participation in the management" of Auto Specialties during the time of contamination.
Significantly, the state never alleged bank participation in Auto Specialties' day-to-day management of environmental compliance matters.
The court found that the bank's close monitoring of Auto Specialties' activities, "encouraging" of Auto Specialties to follow a consolidation plan, and imposing conditions on continued financing (including the bank's insistence upon outside management) were activities well within the EPA's lender liability rule protections.
Insufficient Link Seen
In a related development, a federal district court judge in Massachusetts issued a bench ruling in November 1992 that there was insufficient evidence to link a bank to contamination at a former solvent reclamation site operated by a defaulting borrower.
In Grantors of the Silresim Site Trust v. State Street Bank and Trust Co., a private cost-recovery action was filed by the customers of the former solvent recovery business against a bank which held first, second, and third mortgages on the property.
The customers sought recovery from the bank as an "owner and operator" of the site even though the bank never foreclosed on its security interests. Indeed, it was the bank's failure to take action to put the site operator out of business through foreclosure proceedings that the plaintiffs claimed gave rise to the bank's liability.
The customers claimed that the bank allowed the operator to continue in business for years, even though the site operator was in default under the loan agreements.
According to the customers, because the bank realized that site contamination rendered the bank's security interest in the property worthless, the bank put the business "on ... artificial life support," occasionally advancing additional cash to the site operator to allow it to accept additional drums of solvent, in order to obtain additional revenues for payment on the loans.
These actions, according to the customers, evidenced a "participation in the management" of the borrower's business, thus subjecting the bank to the full range of liability.
Without, apparently, passing on the validity of EPA's new lender liability regulations, the court dismissed the customers' complaint, finding that the bank's actions did not amount to "participation in the management" of the borrower.
A Maine lender also received a reprieve from Superfund law "owner and operator" liability under a February 1993 ruling by the United States Court of Appeals for the First Circuit.
In Waterville Industries Inc. v. Maine Finance Authority, the appeals court reversed a district court holding that the Finance Authority of Maine was a "past owner" of contaminated property (at the time the property became contaminated) and, thus, liable for response costs assessed against the current property owner by the EPA.
In so doing, the appeals court determined that the finance authority, a mortgage guarantor which in bailing out a defaulting mortgagor had accepted a deed in lieu of foreclosure, was a nominal owner merely acting to protect its security interest.
The appeals court gave weight to two particular factors. First, the fact that the finance authority had, at the time it accepted the deed in lieu, immediately leased the facility back to the original mortgagor and gave the mortgagor a first option to purchase the property back for $1; and second, after the former mortgagor filed for bankruptcy and discontinued operations, the finance authority had taken prompt action to sell the property to recoup its loan (within six months).
While these decisions should provide some comfort to lenders, the EPA lender liability regulations still face direct challenges in other jurisdictions.
To be sure, the area of lender liability still has its pitfalls, and the margin of profit on most commercial loans generally does not reflect the increased risk of suit lenders face when accepting security in sites with known or potential environmental problems.
These recent court decisions provide some room for optimism for lenders holding security interests in companies which face a high risk of environmental liability.