Responding to widespread concern that the threat of environmental liability is inhibiting the flow of credit, particularly to environmentally risky enterprises and small businesses, the U.S. Environmental Protection Agency eased a proposed rule on June 5. 1991 that it hopes will allay uncertainties in the lending and financial communities. The rule, entitled "Lender Liability under CERCLA" (the Comprehensive Environmental Response. Compensation and Liability Act of 1980, as amended by the Superfund Amendments and Reauthorization Act of 1986). defines the key components of the "security interest exemption" which has received differing judicial interpretations regarding activities that would or would not result in lender liability.
CERCLA excludes from its definition of a liable owner or operator a person who without "participating in the management" of a contaminated facility holds "indicia of ownership primarily to protect" a security interest in that facility. See 42 U.S.C. Section 960l(35).
The proposal broadly defines ownership indicia to include "evidence of interests in real or personal property held as security for a loan or other obligation.' 56 Fed. Reg. 28798. 28802 (June 24. 1991). Examples cited by the agency include mortgages. deeds of trust, legal title to property obtained through foreclosure. assignments, liens and pledges. The proposal provides that lenders must consult state law to determine whether other types of financial arrangements fall within this definition.
The proposal stresses that ownership indicia must be held primarily to protect a legally recognized security interest, as opposed to an investment, fiduciary or other non-lending interest. Examples of generally recognized forms of security interests cited by EPA include mortgages, certain liens, forms of conditional sales. installment sales, factoring agreements or accounts receivable financing arrangements, some forms of leases and consignments. and trust receipt transactions. According to the proposal, other transactions may qualify for exemption as long as they are legally recognized as security interests under applicable state law.
Participation in Management
In United States v. Fleet Factors Corp., 901 F.2d 1550. 1557 (11th Cir. 1990), cert denied, Ill S.Ct. 752 (1991), the court noted that liability could be premised upon a secured creditor's financial management of and "capacity to influence" a borrowers hazardous waste disposal practices. The proposal attempts to defuse the impact of the Fleet Factors decision by providing that CERCLA liability would not be premised upon a secured creditors unexercised capacity to influence facility operations, that the exemption would be lost if, while the borrower is still in possession, the lender either assumes decision-making control over the borrowers environmental compliance which results in a release or threatened release of hazardous substances, or exercises management-level control over environmental compliance activities.
In addition to setting forth a standard for actual participation, the proposal specifies, by way of example, permissible actions that are motivated to protect legally recognizable security interests at various points during the life of a loan.
When the borrower remains in possession and makes operational decisions concerning the management of hazardous substances, the proposal provides generally that the lender may undertake ordinary and customary loan activities to create, monitor and police its security interest and remain within the scope of the exemption. The proposal also provides that a lender may engage in workout activities designed to protect and preserve the security interest.
In a major departure from earlier drafts circulated by the EPA. the proposal does not require lenders to conduct environmental assessments of collateral prior to securing a loan. The proposal does attempt to encourage environmental inspections by providing that upon discovering that collateral is contaminated. a lender could proceed without incurring CERCLA liability. After extending the loan, the agency provides that a lender could ensure compliance with environmental laws by conducting site inspections and could require the borrower to clean up the property.
With respect to foreclosure. the proposal cautions that property must be temporarily acquired or possessed to secure the performance of the obligation in order to retain the exemption. Ac- cording to EPA, a lender may safely sell, liquidate, wind up operations, or continue the operation of the enterprise to preserve the value of the collateral, including taking environmentally responsible and mitigative actions. The proposal does not, however, address generator or transporter liability under CERCLA. Accordingly. liability may still attach if, during its temporary acquisition or possession of the property, a lender disposes of hazardous substances off-site and the disposal or transportation thereof results in a release or threatened release of hazardous substances. See 42 U.S.C. Section 9607(a)(3)- (a)(4).
Lenders seeking to retain the security interest exemption upon foreclosure must take reasonable steps to sell the property within 12 months. including listing the property for sale and advertising the property on at least a monthly basis in a suitable publication time after six months following fore- closure, lenders must respond to written, bona fide, firm offers of fair consideration within 90 days of receipt.
The proposal also addresses the potential liability of federal regulators such as the Federal Deposit Insurance Corporation and Resolution Trust Corporation that involuntarily acquire property as part of the assets of failed or insolvent lending and depository institutions. The proposal provides that, under certain circumstances, governmental takeovers of failed lending institutions would be deemed involuntary acquisitions such that governmental entities may be entitled to assert the 'innocent landowner' defense to CERCLA liability The EPA is also considering incorporating a provision into the final rule that would deem civil and criminal seizures and asset forfeitures by the federal government involuntary acquisitions for purposes of the innocent landowner defense.
Finally, the proposal provides that if EPA conducts a cleanup of a facility during the time a lender holds indicia of ownership to protect a security interest. the agency may impose a lien on the property in favor of the United States, Where EPA response actions enhance the value of the facility and the security holder is unjustly enriched upon fore- closure, the agency may seek equitable reimbursement.
Opposition to the Proposal
EPA has received over 360 comments in response to its proposal. Although the agency has characterized the comments as generally supportive, an usual alliance of consumer groups, environmentalists and the Chemical Manufacturers Association (CMA) oppose the proposal and have branded EPAs efforts a "sweetheart deal." The CMA has cautioned that selective protection of lenders will shift CERCLA liability to businesses, eroding the strict liability provisions of CERCLA and its basic premise that environmental liability should be reasonably shared by all. EPA also received comments from the New Jersey Department of Environmental Protection and Energy (DEPE) that were generally supportive of the EPAs regulatory approach, but DEPE cautioned that "an industry-specific solution via statutory amendment would unravel CERCLA liability altogether."
The proposal also has been criticized as a measure that will reduce the environmental vigilance of lenders because lenders will not be required to conduct environmental assessments prior to securing a loan. According to environmental groups. EPA conditioned eligibility for the exemption following foreclosure primarily upon the lender's bona fide purchase offers for fair consideration. Accordingly, the security interest exemption could continue for an indefinite period as long as the property was listed and advertised for sale within the time frame specified by the agency. The California Department of Environmental Protection commented that the proposal's permissiveness in this regard could be a liability trap for investors who chose to incautiously invest in and foreclose upon contaminated property for which they were not necessarily liable, yet which they could not liquidate.
Critics of the proposal also claim that lenders have not been unfairly burdened with CERCLA liabilities but are immersed in environmental paranoia. In support of this contention, the Natural Resources Defense Council cited EPA statistics revealing that in the entire history of the Superfund program, only eight lenders have been identified as potentially responsible parties out of an estimated 18,392 notice letters issued by EPA. Fogarty, The Case Against Lender Liability, 21 Envtl. L. Rep 10243. 10244 n.5 (1991)
As noted previously, the current crisis may be attributable to a perceived threat of liability as opposed to EPA enforcement statistics since most lenders participate to some degree in the actual financial management of their borrowers and, consequently, are potentially exposed to the low threshold of liability set forth in the Fleet Factors decision. According to the American Banking Association, a recent survey of over 2.000 banks suggests that lending practices have been substantially altered by the uncertainties in this area of the law.
The survey revealed that 63 percent of the banks had rejected loan applications because of possible environmental liabilities and another 43 percent had ceased lending to high-risk enterprises such as gasoline stations Further, nearly 300 banks had abandoned property held on collateral due to fear of environmental liability, and an additional 220 had incurred environmental response costs in connection with collateral property. See Banks Criticize Proposed Lender Liability Rules. World Ins. Rep. (July 19. 1991). Although a few innovative agreements have emerged in the past year in response to lender liability concerns. it is clear that a comprehensive solution to the current state of uncertainty is required.
EPA's proposal has failed to derail moves by the lending community for protective legislation due to widespread concern that the final rule may not be uniformly followed by the courts and bind third parties. Recent decisions in the area of municipal liability under CERCLA indicate that EPA policies may be successfully challenged by third parties. See. e.g., B.F. Goodrich Co. v. Murtha. 754 F. Supp. 960. 967 (D. Conn. 1991 ((denying municipalities' motion for summary judgment and noting that EPAs policy is a "guide to EPA personnel in administering Superfund and reflects EPA priorities" but does not limit a private party's claims). Although the agency does not characterize the proposal as a statement of policy. its contemplated promulgation as a legislative rule is bound to be challenged. Since "the judiciary is the final authority on issues of statutory construction." Chevron U.S.A. inc. v. Natural Resources Defense Council. Inc., 467 U.S. 837. 843 n.9 (1984), it is likely that the courts will have the last word on the parameters of the secured creditor exemption.
Another motivating force behind the clamor for statutory clarification of the lender liability controversy is that EPA failed to address the liability of trustees and fiduciaries in its proposal. Indeed, the proposal expressly limits entitlement ownership indicia which are held primarily to protect legally recognized security interests, as opposed to investment, fiduciary or other non-lending interests. Although the agency reports that it has received a large volume of comments requesting that the liability of trustees and fiduciaries be similarly limited, it appears clear that the EPA has no authority to craft a liability exemption which lacks statutory basis.
Finally, members of the lending community, including the FDIC, RTC, American Banking Association, Independent Bankers Association and Mortgage Bankers Association, have petitioned Congress for a legislative proposal that would address the environmental liability of lenders under state and federal laws other than CERCLA. The possibility that other laws may create strict liability problems for lenders was realized recently in O'Neil v. Q.L.C.R.I. 750 F. Supp. 551 (D.R.I. 1991), in which a district court refused to dismiss a claim against a credit union for aiding and abetting a violation of the Clean Water Act by its borrower.
The claim was not based on the credit union's actual or potential control over the site, but its involvement in "sham transactions involving mortgages on the property and failure to condition its loans and require the borrower to remedy the environmental problem. This case goes much further than the "management control" standard set forth in CERCLA and in the proposal since it suggests that a lender has an affirmative duty to address environmental problems as part of its lending relationship.
Legislative Alternatives
Congressional response to the plight of lenders has taken the form of several legislative alternatives to the status quo.
H.R. 1450, introduced by Congressman John LaFalce. D-N.Y., parallels EPA's proposal closely in its attempt to define specific actions lenders can take to protect their security interest without "participating in the management of the facility." Although the LaFalce Bill lacks the specificity of the EPA proposal, it has garnered the support of the lending community since it would bind third parties, would extend liability limitations to "innocent" fiduciaries and trustees who have no prior ownership, operational or managerial relationship with a facility, and would incorporate liability limitations into the Resource Conservation and Recovery Act. This bill has approximately 260 co-sponsors, but currently remains in a holding pattern in the House Energy and Commerce Subcommittee on Transportation and Hazardous Waste.
Title X of a sweeping banking and deposit insurance reform package (S. 543) was adapted from lender liability legislation (S. 651) introduced earlier this year by Sen. Jake Garn, R-Utah. The reform package was approved by the Senate Banking, Housing and Urban Affairs Committee and Title X has been referred to the Environment and Public Works Subcommittee on Superfund, Oceans and Water Protection, Title X proposes to amend the Federal Deposit Insurance Act to afford immunity from liability for pre-existing environmental contamination under federal, state or local laws to federal banking or lending agencies such as the FDIC and RTC which acquire property through the exercise of governmental functions.
In order to qualify for the protection of Title X, the agencies must not have caused or contributed to contamination. Title X would also facilitate the ability of the federal agencies to sell contaminated properties by extending immunity to first innocent purchasers and providing that the agencies would not be required to grant covenants or warranties representing that remedial action has or will be taken at the property. Finally, Title X provides that federal agencies would not be subject to environmental liens, and would be afforded immunity for a wide range of emergency response actions.
The liability limitations of Title X pertaining to insured depository institutions and other mortgage lenders were recently revised to track EPA's laundry list of permissible activities within the security interest exemption, Although, by its terms, Title X would afford lenders protection under any federal law, critics have noted that it is merely a banking bill which would provide lenders with a liability cap, limiting liability to the actual benefit, if any, received from remedial actions undertaken by another party at the site in question.
Title X faces opposition from members of the Senate who oppose a piecemeal amendment to CERCLA and prefer to wait for reauthorization in 1992. Further, there is some concern that this bill would create "environmental slumlords" by allowing federal agencies to transfer contaminated properties to insulated purchasers.
A third bill, HR. 1643, introduced by Rep. Wayne Owens, would amend CERCLA's security interest exemption to allow mortgage lenders to foreclose on collateral without incurring CERCLA liability if they comply with due diligence regulations to be promulgated by EPA. The Owens Bill also would amend CERCLA's innocent landowner defense to create a rebuttable presumption that a Phase I environmental audit conducted prior to or at the time of acquisition satisfies the requisite level of inquiry required of lenders seeking to qualify for its protections, The Owens Bill has been sharply criticized since its liability limitations are conditioned on compliance with yet-to-be-promulgated due diligence regulations.
Although members of Congress and the administration agree that the courts have expanded CERCLA liability far beyond what Congress intended in a manner that threatens to disrupt normal commercial lending practices, there is considerable debate regarding the most appropriate vehicle for change. Given the support the EPA proposal has received from the Department of the Treasury and the administration, the intense lobbying effort mounted by the business community in opposition to "special interest" lender liability proposals. and the fact that CERCLA is to be considered for reauthorization in 1992, it is unlikely that a legislative response to lender liability will be forthcoming in Congress this year. (Since July 1991, several states, including Missouri, Oregon and Illinois, have enacted legislation curtailing the liability of lenders under state environmental laws.)
EPA is currently revising its proposal in response to comments received and anticipates that the final rule could be published by the end of this year following review by the Office of Management and Budget. Even if the proposal is promulgated, however, lenders face potentially far-reaching environmentally related losses in the current legal environment. Until the quantum of risk has been clarified through legislation, the lending community's best protection may be to investigate thoroughly at the outset all properties and facilities owned or operated by potential borrowers, avoid environmentally sensitive loans and insure against the future contamination of clean property.
