CERCLA Safe Harbor for Lenders Revived

Edward K. Gross and George W. Kelly

The 104th Congress recently breathed new life into the EPA’s lender liability exemption rule (40 C.F.R. § 300.1100 et seq.; the "EPA Rule") by passing the Omnibus Reconciliation Act (Pub. L. No. 104-208 (Sept. 30, 1996); the "Act"). Effective September 28, 1996, the Act codified and enhanced provisions of the EPA Rule with respect to the lender liability exemption under CERCLA. As a result, the Act provides further protection for lenders and lessors (with some exceptions) against CERCLA liability for cleanup costs as "owners or operators" of property.

Background
Upon any release of a hazardous substance at a facility, owners or operators of that facility are strictly liable for cleanup costs under the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA") 42 U.S.C. § 9601 et seq. Liability is generally joint and several, so one party can be held accountable for any or all cleanup costs. Both the government and a private party may initiate cost recovery actions.

In order to understand the application of CERCLA to a secured loan or an equipment lease transaction, certain definitions should be considered. "Facility" is defined under CERCLA as any equipment, pipe, storage container, or any site where hazardous substances have come to be located 42 U.S.C. § 9601(9). Clearly, any equipment or other property containing hazardous substances or the surrounding soils where hazardous substances have come to be located would constitute a "facility." For the purposes of CERCLA, "hazardous substances" may include: listed and characteristic hazardous wastes, those toxic chemicals designated under the Clean Water Act, those hazardous air pollutants under the Clean Air Act, and those chemicals specifically listed under CERCLA. CERCLA excludes from the definition of "owner or operator" a person who "without participating in the management" of the contaminated property "holds indicia of ownership primarily to protect a security interest" in the contaminated property. This exclusion is often referred to as the lender liability exemption (the "Exemption"). Over the years, the Exemption had been determined by a limited number of courts to be inapplicable where: (i) a lender foreclosed on property and did not convey it until four years later and, therefore, was deemed not to be primarily protecting a security interest, U.S. v. Maryland Bank & Trust, 632 F. Supp. 573 (D. Md. 1986) and (ii) where the courts determined the lender to have been "participating in the management of the property." See U.S. v. Mirabile, 15 Env’tl L. Rep. 20,994 (E.D. Pa. 1985); see also U.S. v. Fleet Factors Corp., 901 F.2d 1550 (11th Cir. 1990). These decisions caused great concern among lenders and lessors with respect to entering into, administering or enforcing transactions involving equipment that was likely to contain or be situated on land that had been or may be exposed to hazardous substances.

EPA Lender Liability Rule
In April of 1992, the EPA responded to concerns about these court decisions and, in particular, the decision in Fleet Factors, and promulgated the EPA Rule which clarified the EPA’s position on the Exemption and other enforcement matters. In general, the EPA Rule "fleshed out" certain of the definitional terms in the Exemption and enumerated certain activities that could be conducted with respect to structuring, administering and enforcing a transaction which involved or may involve contaminated property, without forfeiting the protection of the Exemption.

Lessors particularly appreciated the EPA Rule since the drafters clearly contemplated that lessors should be entitled to the Exemption in non-true lease transactions and, perhaps, in true lease transactions as well. For example, the EPA Rule made it clear that the term "security interest," as used in the Exemption, includes lease financing transactions. 40 C.F.R. § 300.1100. In order to be protected by the Exemption, the EPA Rule provided that lessors must hold an indicia of ownership to primarily protect a security interest with tax benefits and equity residual as ancillary concerns.

After the Fleet Factors case, there was significant concern that the right to exercise certain rights, typically undertaken or afforded lenders and lessors, might constitute "participation in management" for the purposes of the Exemption and, therefore, result in a loss of the protection afforded by the Exemption. The EPA Rule, however, provided that "participation in management" means any actual participation and not the mere capacity to control any aspect of a borrower’s or lessee’s business. Some of the early cases did not always make clear that the protections of the Exemption applied to a foreclosing lender. The EPA Rule rectified this ambiguity by protecting lenders who foreclose on contaminated property so long as they attempt to resell or re-lease the property in a "reasonably expeditious manner, using whatever commercially reasonable means are relevant or appropriate." The EPA Rule was limited to CERCLA. It did not apply to state environmental laws and it was an exemption only applicable to the definition of "owner/operator" and not to "generators" or "transporters" under CERCLA. The D.C. Circuit Court overturned the lender liability rule on the grounds that EPA had no authority to issue the rule. Michigan v. EPA, 38 Env. Rep. 93 (D.C. Cir. 1993). In September 1995, the EPA announced that it would continue to follow the rule as an EPA "enforcement policy." Accordingly, the EPA Rule only applied to enforcement actions initiated by the EPA and not to suits initiated by private parties.

The Asset Conservation, Lender Liability, and Deposit Insurance Protection Act
For the most part, the amendments to the Exemption made by the Act "effectively codify" the EPA Rule. (Michigan v. Tiscornia, CA 6, No. 94-1403, 12/19/96). Some examples are provided below:

Participation in Management. Consistent with the EPA Rule, the Act eliminates the Fleet Factors’ "capacity to influence" concern. The Act defines "participation in the management" to mean actual participation in the management or operational affairs of a vessel or facility and not merely the capacity to influence or unexercised right to control. The Act also expressly excludes from characterization as "owner/operators" under CERCLA lenders who do not participate in the management of a facility. Acts by the lender prior to the creation of a security interest are not considered to be participation in the management. Further, a person who is a lender, while the borrower is in possession, will be considered to have participated in the management only if that person: (i) exercises decision-making control over environmental compliance such that the person has undertaken responsibility for hazardous substance handling, or (ii) exercises control at a level comparable to that of a manager. Specific examples of actions which are not deemed to be participation in the management include any or all of the following activities: abandoning or releasing a security interest; implementing covenants and warranties in loan transactions; monitoring or enforcing contractual terms; inspecting the facility; requiring the borrower to undertake response actions; providing financial advice to mitigate loss in value; restructuring the transaction; exercising contractual remedies; or conducting a response action.
Exemption Clearly Extended to Lessors. Significantly, the Act defines "lender" to include a "leasing or trust company that extends credit." The definition of "extension of credit" explicitly includes lease finance transactions in which the lessor does not initially select the leased vessel or facility and does not during the lease term control the daily operations or maintenance of the vessel or facility. "Security interest" is also defined to include a lease or any other right accruing to a person to secure the repayment of money.
Enforcement. A lender or lessor also will be protected under the Act from "owner/operator" liability that would otherwise result from foreclosing (or repossession and disposition under a lease) if it forecloses (or otherwise recovers the leased property) and, after foreclosure (or repossession as applicable), it sells, re-leases or liquidates the collateral or leased equipment or undertakes a response action and then sells or re-leases the collateral or leased equipment at the "earliest practicable commercially reasonable time, on commercially reasonable terms, taking into account market conditions and legal and regulatory requirements." "Foreclosure" is defined to include the purchase at sale under a judgment, decree, or power of sale; a deed in lieu of foreclosure; or repossession.

The 1996 Tiscornia Case
In the lower court case that gave rise to the unreported Tiscornia case, the state of Michigan claimed that a bank was a superfund owner/operator because it held a security interest in contaminated properties (Michigan v. EPA, 15 F.3d 1100, 38 ERC 1193 (1994).) In the Tiscornia case, the U.S. Court of Appeals for the Sixth Circuit agreed with the U.S. District Court for the Western District of Michigan that a bank should be exempt from liability as an "owner or operator" since its participation in the contaminated sites was related to financial or administrative aspects of the business, and that it did not cross over the "murky line" into the day-to-day management of the sites. The appellate court relied upon the application of the provisions of the Act when upholding the lower court’s exempting the bank from liability based on the EPA Rule. The sixth circuit also reached the same conclusion regarding Michigan’s claims under certain Michigan environmental statutes, which it analyzed under CERCLA case law.

Conclusion
Lenders and lessors can now look to the Act to give them the comfort that was once extended to them by the EPA Rule. When considering opportunities to lease or otherwise finance property that involve environmental risks, the Act can provide some guidance as to what transaction structure, administrative procedures and enforcement measures will be consistent with the CERCLA lender liability exemption. Generally, so long as (i) a lender’s or lessor’s retained interest in leased property or other interest in any related real estate is primarily for the purpose of securing the repayment to it of the loan or lease obligations, rather than speculation on the residual value and (ii) the lender or lessor does not participate in the management of the facility, it should be exempt from the strict liability provisions of CERCLA. Additionally, if the lender or lessor takes possession of the financed property or other collateral it would have to make an effort to resell or re-lease the property at the earliest practicable, commercially reasonable time after foreclosure or other repossession (which the EPA has deemed to be twelve months). The Equipment Leasing Association is presently considering technical amendments to the Act to better clarify its coverage of true lease lessors. However, lenders and lessors must be cognizant that the Act’s provisions relate only to the exemption to the definition of "owner/operator" under CERCLA. Therefore, a lender or lessor still could be held accountable if it transported or arranged for the disposal of a hazardous substance under CERCLA. Finally, it should be noted that the "safe harbor" is an exemption from liability and, therefore, the burden of proof is on the party asserting the defense (i.e., a lender or lessor). By demonstrating compliance with the EPA Rule and the Act, it would likely shift the burden of proof to the party asserting a claim that the lender or lessor was not primarily protecting its security interest or it was participating in the management of a facility. Although a review of applicable state laws is beyond the scope of this article, it should be noted that almost every state has enacted a mini-superfund bill. Each state also has its own particular lender liability provision. Some state laws contain super priority lien provisions for cleanup costs and these laws should be thoroughly reviewed.

The present trend at the state level is the enactment of voluntary cleanup programs that eliminate regulatory disincentives to cleanup and redevelop contaminated properties. Thirty states have enacted, and another four are presently considering, such legislation. As such, many of these laws provide explicit protections against liability lenders. State laws should be consulted to identify whether protection from lender liability is provided and whether such protection extends to lease financing transactions. Many state laws similarly hold lenders and lessors accountable only if they participate in the management and/or cause the contamination.