A bill with significant consequences for the banking and lending communities became law on September 30, 1996, when President Clinton signed the Omnibus Consolidated Appropriations Act for fiscal year 1997. Contained in the budget measure are provisions that essentially codify the 1992 rule promulgated by the Environmental Protection Agency ("EPA") to define when financial institutions and lenders will become liable for environmental cleanup costs associated with a property serving as collateral for a loan.
CERCLA's Unclear "Secured Creditor Exemption"
The Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA") imposes liability for environmental cleanup costs on owners of contaminated property. CERCLA's definition of the term "owner," however, excludes those who, without participating in the management of the property, hold indicia of ownership primarily to protect a security interest. This exemption is known as the "secured creditor exemption."
Unfortunately, like many statutory provisions, the language of the secured creditor exemption is somewhat unclear and ambiguous. Because the phrases "participating in management" and "indicia of ownership" are not defined in CERCLA, confusion existed as to under what circumstances these criteria were met.
Exactly when a lender could be held liable for cleanup costs became the subject of much litigation. In 1990, the Eleventh Circuit Court of Appeals in United States v. Fleet Factors Corp. suggested the extension of CERCLA liability for a lender's capacity to affect a borrower's hazardous waste disposal decisions. That is, a bank could be held liable for environmental cleanup costs merely on the basis that its loan agreement with the borrower included provisions which allowed the bank to influence the borrower's environmental decisions. Understandably, the court's opinion had a chilling effect on real estate lending, for many lenders feared the onset of an expanded scope of liability.
EPA's Unsuccessful Attempt to Clarify the Exemption
In an effort to clarify the secured creditor exemption and to address the concerns of lenders, EPA issued a lender liability rule in 1992. Pursuant to this rule, lenders would lose their secured creditor exemption and become liable for environmental problems only if they participated in management either by taking responsibility for the borrower's hazardous substance handling or disposal practices or by assuming overall management responsibility encompassing the borrower's daily decisionmaking. According to the EPA rule, participation in the management of a facility did not include the mere capacity or ability to influence facility operations, as Fleet Factors had held; rather, some actual participation in management was required to invalidate the exemption. The rule also allowed lenders to foreclose, take steps to preserve the value of the collateral, and retain possession of the premises without becoming subject to liability, provided the property was offered for sale in a timely manner and that reasonable offers of purchase were not rejected.
The D.C. Circuit Court of Appeals vacated the EPA rule in February 1994, holding that EPA had overstepped its statutory rulemaking authority when defining and limiting lender liability. Although EPA announced that the rule would continue to serve as a policy statement to deter agency enforcement actions against lenders, and court decisions subsequent to Fleet Factors limited the circumstances under which lenders were likely to lose the protection of the secured creditor exemption, lenders still believed that they remained susceptible to private cost recovery actions brought by potentially responsible parties seeking contribution from deep financial pockets.
CERCLA Finally Amended to Protect Lenders
Notwithstanding that many states, including New Jersey, have passed their own legislation to limit the liability of banks and other lenders for costs associated with cleaning up contaminated properties when borrowers default, federal legislation providing similar protection was lacking until this past September. On September 30th, 1996, the omnibus spending bill, which contains a provision that essentially codifies EPA's 1992 rule, was signed into law.
The new law amends CERCLA to exclude from the definition of "owner or operator" lenders who did not participate in management of a facility prior to foreclosure, notwithstanding that they foreclosed on the facility and, after foreclosure, sold, re-leased, or liquidated the facility, maintained business activities, brought operations to a close, undertook a response action, or took any other measure to preserve, protect, or prepare the facility prior to its sale or disposition.
The amendment further defines the phrase "participation in management" to refer to actual participation in the management or operational affairs of a facility; specifically excluded is the capacity to influence, or the unexercised right to control, facility operations. Under the law, a lender holding indicia of ownership primarily to protect a security interest will be deemed to have participated in management only if it: (1) exercised decisionmaking control over the borrower's environmental compliance activities (i.e., undertook responsibility for the hazardous substance handling or disposal practices related to the facility); or (2) exercised control at a level comparable to that of a facility manager for the overall management of the facility encompassing day-to-day decisionmaking with respect to environmental compliance, or for all of the operational functions (as distinguished from financial or administrative functions) of the facility.
The new measure also details what actions a lender may take to address environmental hazards and contamination on property serving as collateral. "Participation in management" does not include the following:
holding a security interest or abandoning or releasing a security interest;
including in the terms of an extension of credit a covenant, warranty or other term or condition relating to environmental compliance;
monitoring or enforcing the terms and conditions of the extension of credit or security interest;
requiring a response action to address the release or threatened release of a hazardous substance in connection with the facility;
providing financial or other advice in an effort to mitigate, prevent or cure default or diminution in the value of the facility;
restructuring, renegotiating or otherwise agreeing to alter the terms and conditions of the extension of credit or security interest;
exercising other remedies that may be available under applicable law for the breach of a term or condition of the extension of credit or security agreement; or
conducting a response action under CERCLA section 107(d) or under the direction of an on-scene coordinator appointed under the National Contingency Plan.
Practical Effect of CERCLA Amendment
Although some will hail the new law as long-awaited protection for lenders against claims brought by the government and third parties, as a practical matter, this protection has existed at both the federal and state level for some time. As discussed above, EPA's application of the vacated rule as policy and the courts' reluctance to follow the dicta in Fleet Factors have provided reassurance to concerned lenders. Therefore, even without federal legislation, secured lenders have had some level of guidance in delineating the boundaries of lender liability for the past few years.
Furthermore, in New Jersey, secured creditors have been able to operate comfortably within the well-defined borders of the State's Spill Compensation and Control Act (the "Spill Act") since 1993, when the legislature amended the Spill Act with a provision comparable to the EPA rule. Like the EPA rule, the Spill Act's lender liability provision is more specific than the new CERCLA amendment with regard to a lender's liability in a foreclosure situation. That is, the Spill Act provision specifies the means and procedures by which a lender may hold indicia of ownership as a protection for a security interest after foreclosure without incurring liability. Thus, the modest practical effect of the new law will be to codify the existing policy and case law addressing the circumstances under which lenders will be liable for contamination of property which they hold as collateral.
