More on That Ticking Sound: Environmental Risks and Lender Safe Harbor under CERCLA
Environmental issues loom large in the context of a real estate workout or a foreclosure. This was a lesson "learned" in the '80s. (A lesson that often even "glowed" in the dark.) So, here's another topic from our "ticking sound" series covering insurance issues...and now, environmental issues . . .
Few acronyms have more power to raise a lender's blood pressure than CERCLA. Since its passage in 1984, the specter of CERCLA or "Superfund" environmental liability probably has had more negative impact on lending transactions than any other single factor. With the return of hard times and the likelihood of foreclosure on brownfields or other "environmentally challenged" properties going up . . . actually way up, it is past time to remind ourselves about CERCLA's lender safe harbor provisions and how they affect the foreclosure process. In doing so, we also need to remember that most states now have CERCLA-like statutes, some of which contain safe harbor provisions, but others of which do not. CERCLA's lender safe harbor gives a good idea of how most of these work, but some are different, so caution should be used – and a professional consulted – before assuming that the overlap is complete.
CERCLA's lender safe harbor provision, a lender or its privies is considered an "owner or operator" of a plant for CERCLA purposes only if it "participates in management" of the facility. "Participat[ing] in management" is at best an elastic clause, but received wisdom as well as the statute itself states that exercising a security interest or foreclosing on property does not constitute "participat[ing] in management" so as to subject the lender to liability. Likewise, a lender does not "participate in management" so long as it makes commercially reasonable efforts to sell the property – i.e., asks a commercially reasonable price for the property, makes appropriate efforts to sell it given the nature of the property and market conditions – even if it is initially unsuccessful in doing so. Taking steps during the foreclosure process to operate or maintain the property, up to and including cleaning up existing contamination (or compelling the borrower to do so, do not constitute "participat[ion] in management" so long as, but only so long as, those steps do not increase the environmental risks as the property.
At the moment the lender actively starts making decisions that increase environmental hazards or prevent a borrower in possession from fixing an environmental problem, however, the lender is in active danger of losing the safe harbor protection. Take for example United States v. HSBC USA NA, Ltd., 07-3160 (S.D.N.Y., May 31, 2007). HSBC loaned money on a chemical plant, whose owners went into default. HSBC insisted on a lockbox account arrangement by which it received control of all incoming funds and approved all plant expenditures. For several months HSBC approved routine operating expenses, including those for waste disposal. As time went on, however, HSBC locked down the lockbox account, as the result of which the plant owners were forced to abandon the facility, leaving behind a substantial amount of hazardous material. EPA ruled that HSBC's decision to cut off funds for waste management and its knowledge that the owner was going to walk away leaving the hazards unremediated constituted participation in management because HSBC had effectively controlled the handling or disposal of the hazardous materials. HSBC settled the claims for $1 million.
While the result in HSBC is the exception rather than the rule with respect to today's "lender safe harbor," it does remind lenders that they must pay careful attention to the entire decision-making process in the context of lending to or foreclosure on a property with environmental issues. The very slipperiness of CERCLA's definition of "participat[ing] in management" counsels strongly in favor of obtaining professional consultation at pertinent points in the post-default/foreclosure process. The million dollar fine in HSBC ought to seal the deal.
If you have any questions or war stories, please post a comment.
