|
As the economic landscape changes, responsibilities for environmental cleanups are also threatening to shift. Many parties are unable to make payments on promissory notes, mortgages, indemnity agreements and other contractual obligations to remediate contaminated property, leaving lenders, property owners, and others to sort out how the remediation will be funded and who will be responsible for the costs. Some parties elect to renegotiate the terms of their indemnity or cost sharing agreements. In some cases, however, debtors may file bankruptcy or creditors may assume ownership of contaminated property.
Debtors and creditors are evaluating their options and asking questions. When the debts are secured by real property, should the creditor foreclose on contaminated property? Take it under a deed in lieu? If the debtor is going to file bankruptcy, will the creditors have any claim for cleanup costs in the bankruptcy estate? Can indemnitees take proactive steps to protect their interests before the indemnitor files for bankruptcy or breaches the indemnity agreement? Are there steps lenders can take after assuming title to the property that will minimize their liability for cleanup costs? Is an indemnitor in a better position if a regulatory agency is actively overseeing the cleanup? Does it matter which regulatory agency is overseeing the cleanup?
The answers are fact specific and depend on a host of factors, including the nature of the debt, the likely cost of the cleanup, the type of contaminants involved, and the application of different areas of law as applied to the facts. This article discusses the answers to some of these questions as applied to some common factual scenarios.
Rewriting History: When a Seller Can't Perform
Consider the following scenario: A property owner purchased contaminated property ten years ago with a covenant from the seller to conduct all necessary remediation at seller's sole expense. The seller now contacts the property owner and explains that unless the property owner agrees to assume some of the cleanup obligations, the seller can no longer honor its commitment to conduct the cleanup. What should the property owner do?
First, in most cases, the property owner will need to evaluate the likely cost of remediation going forward relative to its equity in the property. As such, the property owner will need to evaluate the following issues:(i) whether the extent of the contamination has been identified; (ii) whether a regulatory agency has approved applicable cleanup levels;(iii) whether the existing remedial approach has been approved by the regulatory agency; and (iv) whether a deed restriction will be required (or permitted) by the regulatory agency that would affect property values or the cost of the cleanup.
Second, the property owner will need to evaluate whether assuming any financial responsibility for the cleanup will impose new liabilities on the property owner over and above the cleanup costs. For example, where the contamination has migrated off-site and there is a significant potential for third party suits, the property owner must carefully evaluate how to structure its involvement in the cleanup process to minimize liability for such suits. While property owners are strictly liable for cleanup costs under certain federal and state environmental laws, they are not necessarily strictly liable for third party personal injury or property damage claims – their liability will depend on the facts and perhaps even their obligation or opportunity to prevent damages to third parties.
In situations where the property owner agrees to assume responsibility for the cleanup, or otherwise assumes control over the environmental matters pertaining to the property, the property owner should evaluate whether there is any benefit to having a legal entity separate from the property owner assume any responsibilities associated with the property. Corporate formalities are not always sufficient to insulate affiliated companies from liability, but under certain circumstances companies may successfully isolate the cleanup liability to a specific corporate entity. For example, provided a corporate parent does not manage the environmental matters of a contaminated property owned by a subsidiary or affiliate (and otherwise maintains specified corporate formalities), liability for certain cleanup responsibilities may be limited to the subsidiary or affiliate.
The property owner will also need to evaluate its position should the seller subsequently file for bankruptcy. In that case, because bankruptcy courts are more likely to enforce injunctive relief for enforcement of environmental laws than a more general claim for damages, the property owner may be in a better position if the seller is conducting the cleanup pursuant to a cleanup order rather than under a voluntary agreement with a regulatory agency. Again, this depends on the facts and, for example, whether the debtor files for a Chapter 7 bankruptcy (liquidation of the business) or a Chapter 11 bankruptcy (sale or reorganization of the business).
The property owner also needs to be aware that some agreements entered into with the seller might be unenforceable if the seller subsequently files for bankruptcy. In general, a bankruptcy trustee (a trustee appointed by the court to maximize recovery for creditors) or the debtor (the company that filed the bankruptcy) may take actions that could invalidate or impair the creditor's rights under certain types of agreements.
For example, a trustee may "avoid" an agreement entered into within ninety (90) days prior to the commencement of bankruptcy if the agreement creates more favorable terms for a creditor than the creditor would have otherwise received in a liquidation of the business in bankruptcy. In this scenario, if the seller files bankruptcy within 90 days of giving a buyer additional collateral (like a lien on another piece of property) to secure payment of the cleanup costs, a bankruptcy trustee or debtor may file a lawsuit to avoid that lien. If the lien is successfully avoided, the property owner will no longer have a security interest in that property.
Thus, if the seller appears insolventor claims to have insufficient funds to operate, the property owner should evaluate the risks of bankruptcy and discuss approaches (or specific language in any agreement with the seller) that will better protect the property owner in the event of bankruptcy. It should also be noted that once the seller files for bankruptcy, any agreement reached after the filing will have to be approved by a bankruptcy court or it is unenforceable.
Hot Potato: Transferring Responsibility
Consider a variation on this scenario: the seller informs the property owner that it cannot pay for the cleanup, and the property owner is also unable to pay for the cleanup without compromising the solvency of its going business concern. Even if the property owner ultimately concludes it must file for bankruptcy, the property owner may want to operate its business as long as possible. As such, the property owner will need to understand the likely time frames for enforcement by a regulatory agency, the options available to a regulatory agency if the property owner is unable to pay for the remediation, and the advantages or perils of filing for bankruptcy.
Different enforcement options are available to different local, state, and federal agencies – and each agency has a different process and typical time tables for overseeing completion of a cleanup. Thus, depending on which agency has oversight of the cleanup, a seller may be able to comply with agency directives for a significant period of time before the agency takes enforcement action. If the property owner fails to comply with agency directives, and the agency uses public funds to remediate the property, the agency's cleanup costs may constitute a lien on the property; in fact, depending on the regulatory agency involved, the agency may record a lien on other non-contaminated property owned by the property owner. Finally, filing bankruptcy may not provide the property owner relief from liability for cleanup costs, as some environmental liabilities cannot be discharged. All these issues must be considered before the property owner can develop an appropriate strategy for managing the cleanup liability.
The Well is Dry: A Lender's Perspective
Now assume that the property owner informs its lender that it cannot make payments under the mortgage agreement for the property – or simply fails to make payments. The lender faces a very different set of issues. A lender typically does not have cleanup liability for property it does not own or control, but will assume such liability if it forecloses on and assumes title to the property. Thus, when cleanup obligations are substantial, a lender usually has incentives to work out the debt with the debtor. If, however, these efforts are unsuccessful, a lender on contaminated property has options that are unavailable when the lender's real property security is not contaminated.
Among other things, creditors with security in real estate are limited by the so-called "one action rule," which requires the lender to foreclose on its real property security before pursuing other non-secured assets of the debtor. Where the property is contaminated, however, California Code of Civil Procedure §726.5 permits the lender to waive the contaminated real property security and forego foreclosure on the contaminated property – and instead limit itself to pursuing other non-secured assets. So the first evaluation the lender must make is whether it is worthwhile forfeiting foreclosure on the property and pursuing other assets.
In the event foreclosure or taking the property by a deed in lieu is more appealing than pursuing other assets, the lender will need to evaluate the steps that it can take to minimize liability under state and federal laws that protect lenders who foreclose on contaminated property (or take property under a deed in lieu of foreclosure). In general, under both state and federal law, the lender needs to make efforts to resell the property. While federal law requires only that the lender seek to resell the property at the earliest commercially reasonable time, state law specifies that the lender must take steps to market the property within a year of the foreclosure (or taking title through a deed in lieu).
In conclusion, when a debtor is unable to honor its contractual obligations to remediate contaminated property, both the creditor and debtor must strategize carefully to position themselves going forward to minimize liabilities. Both parties need to seek assistance from experienced attorneys who can draw on several areas of expertise (including environmental, bankruptcy, secured transactions, and real estate) to maximize value for the parties.
About the author:
Catherine W. Johnson has over 20 years of experience as an environmental lawyer. Her practice includes remediation and development of contaminated properties, brownfields, environmental due diligence, environmental reporting requirements, hazardous waste, postclosure uses of landfills, Proposition 65, OSHA appeals, asbestos notifications, air permits, asbestos premises liability, mold-related counseling and litigation, and environmental litigation to recover cleanup costs. Catherine represents clients from many industries, including homebuilders, REITs, public agencies, an agricultural cooperative, a hazardous waste recycling facility, retail and manufacturing facilities, and a national construction company. Catherine has been named as a Northern California "Super Lawyer" in the field of environmental law by the publishers of San Francisco Magazine.
About Wendel, Rosen, Black & Dean LLP:
Clients come to Wendel, Rosen, Black & Dean LLP from a broad spectrum of industries, including small startups, major corporations, and public entities. We work hard to maintain the trust and personalized attention that our clients have come to expect. While we have a strong regional name, we serve clients nationwide in many types of transactional and litigation matters.
Founded in 1909, we're proud to be one of the largest and oldest continuing law practices in the East Bay. In fact we're looking forward to celebrating our 100th Year Anniversary throughout 2009.
In July 2003, Wendel Rosen became the first law firm in the country to gain third-party certification as a "Green Business."
 |
Subscribe to this comment's feed
