I. BACKGROUND
A lender’s risk of becoming directly or indirectly responsible for a borrower’s environmental liability has dramatically increased in recent years. Knowledge of provisions of environmental law and development of procedures to avoid environmental liability have therefore become increasingly important. Over 30,000 potential “superfund” sites have been identified in the United States and estimates of costs associated with the cleanup of the average “superfund” site range from 20 million to 70 million dollars.
Lenders have traditionally considered their maximum exposure for loss to consist of the dollar amount of the loan. However, assessment of environmental liabilities have greatly increased the potential loss which lenders may directly or indirectly incur. Federal environmental statutes have impacted lenders in a number of ways. Some statutes impose substantial compliance costs, penalties or cleanup costs on borrowers, thereby decreasing the likelihood that a borrower may continue to profitably operate its business and also reducing the ability of the borrower to repay his loan obligations, or decreasing or destroying the value of the collateral which the lender has taken as security for its loan. Other statutes create “super-liens” which are granted priority over previously perfected security interests or which impose hidden liens for cleanup costs, thereby impacting the value of the collateral which serves as security for the bank’s loan. Finally, some statutes, or court decisions interpreting them, have imposed cleanup costs directly upon lenders.
Courts have interpreted these environmental statutes to impose strict liability on innocent land owners for the acts of prior owners which may not have been illegal or negligent at the time of their occurrence. Lenders must therefore be increasingly aware of their potential exposure to liability associated with hazardous substances which may place lenders at far greater risk than a mere impairment of the value of collateral serving as security for a loan.
II. FEDERAL ENVIRONMENTAL STATUTES
While there are many federal laws which impose environmental requirements on businesses and other owners of property, the major federal environmental statutes consist of the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA-42 U.S.C. Sections 9601 et. seq.) as amended by the Superfund Amendments and Reauthorization Act of 1986 (SARA-Pub. L. No. 99-499) and the Resource Conservation and Recovery Act of 1976 (RCRA-42 U.S.C. Section 6901 et. seq.).
RCRA was among the early federal statutes enacted to regulate hazardous wastes. The statute, which is implemented by the Environmental Protection Agency, was designed to prevent releases of hazardous wastes into the environment and to avoid the creation of future superfund sites. The RCRA regulations include provisions for record keeping, reporting and inspection as well as elaborate technical requirements relating to the handling, transportation, disposal or treatment of hazardous wastes. RCRA forbids waste treatment or disposal, and limits waste storage, except at facilities holding appropriate permits from the EPA or a state agency. The EPA regulations under RCRA address the issue of leaking underground storage tanks. These regulations impose construction, installation, leak monitoring, insurance and financial responsibility requirements for underground tanks.
Because RCRA provided inadequate remedies for environmental liabilities unless a financially responsible owner of a waste site could be located, the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) was enacted in 1980. CERCLA continues in effect today as amended by the Superfund Amendments and Reauthorization Act of 1986 (SARA).
III. SUPERFUND LIABILITY ASSESSMENT
CERCLA, more commonly known as the “Superfund” law, is the environmental law that poses the greatest potential liability for secured lenders. CERCLA authorizes the Environmental Protection Agency (EPA) to: (1) identify sites where hazardous substances have been released into the environment; and (2) clean up such contamination and recover the clean up costs from potentially responsible parties (PRPs) or, in the alternative, order a private party to perform the cleanup.
The potentially responsible persons who may be held liable for environmental impairments consist of the following: (1) the present owners or operators of an affected site; (2) the former owners or operators of an affected site (if they owned or operated the site when the environmental impairment occurred); (3) any person who disposed of hazardous wastes at the site; and (4) any transporter of hazardous wastes to the site.
In order to establish liability for reimbursement of remedial costs, four general requirements must be met. First, there must be a release or a threatened release to the environment of a hazardous substance or something that contains a hazardous substance. Second, the release or threatened release must cause the EPA or a state to expend superfund money at the site. Third, a PRP must have disposed of a hazardous substance at the site and finally, the site must contain that type of hazardous substance.
EPA cost recovery actions under CERCLA are governed by a standard of strict liability and the scope of liability is joint and several in nature. In addition to incurring response costs and seeking recovery from PRPs, the EPA can alternatively seek to compel PRPs to perform cleanup activities if the EPA “determines that there may be an eminent and substantial endangerment to the public health or welfare or the environment because of an actual or threatened release of a hazardous substance from a facility” according to 42 U.S.C. Section 9606(a).
Actions for recovery of cleanup costs are not limited to the EPA as 42 U.S.C. Section 9607(a)(4)(B) allows parties who have incurred response costs that are “necessary” and “consistent with the national contingency plan” to seek recovery of such costs from PRPs and a PRP may also seek contribution from other PRPs.
IV. TYPES OF ENVIRONMENTAL RISKS FOR LENDERS
While the importance of governmental regulation of hazardous wastes has been a concern for public health and safety, lenders must be concerned with potential liability which arises from the improper handling of hazardous wastes by other parties. Improper handling and disposal of hazardous wastes pose risks for financial institutions in the following manner:
1. Contaminated collateral could decline in value after the discovery of the existence of hazardous waste contamination.
2. A debtor saddled with cleanup costs may default. A particular difficulty for a lender is that the cleanup costs may arise out of entirely different property or transactions separate from the one involving the lender.
3. A security interest or mortgage lien may lose its priority to a government cleanup lien.
4. A lender may be held liable to the extent of money loaned to the debtor who generated hazardous wastes.
5. A lender that forecloses on contaminated property may become directly liable as an “owner” under the Superfund law for environmental cleanup of the site.
6. A lender that, in trying to protect the value of property in which it has a security interest or to preserve the solvency of one of its borrowers, participates in the management of the borrower or becomes involved in the handling of the hazardous wastes of its borrower may be treated as an “operator” liable under the Superfund law for cleanup costs.
7. A lender may have to abandon its right to foreclose on property which is contaminated and write off the balance of a loan in order to avoid liability which accompanies direct ownership of a contaminated property. (Federal Home Loan Bank Board Thrift Bulletin 16 - February 6, 1989).
V. DETERMINATION OF LENDER LIABILITY
Generally, a bank’s status as secured lender of an owner or operator of property subsequently determined to be contaminated will not make the bank directly liable for the cost of cleaning up the site. A secured lender will not normally be deemed an owner, operator, generator or transporter of hazardous wastes for purposes of assessing liability for cleanup costs.
A. Security Interest Exemption
In addition, 42 U.S.C. Section 9601(20)(E)(i) provides a security interest exemption in stating that the term “owner or operator does not include a person who, without participating in the management of the facility, holds indicia of ownership primarily to protect his security interest in the vessel or facility.”
While the security interest exemption clearly exempts a secured party who does nothing other than receive and hold a security interest, little guidance has been provided on what constitutes an impermissible participation in the management of the facility, the effect of a secured lender foreclosing on a contaminated property or the other steps that a secured lender takes to “protect his security interest.”
While banks have attempted to make use of the exemptions under CERCLA, three major cases illustrate how banks may fall within the definition of “owner and operator” despite this security interest exemption for secured lenders.
B. Case Law Developments
In a decision by the United States District Court for Maryland, United States v. Maryland Bank & Trust Co., 632 F. Supp. 573 (D. Md. 1986), the court ruled that a bank which acquired, through foreclosure sale, property it previously held as collateral, to be an “owner and operator” of land containing hazardous wastes and subject to the same liability for cleanup. The bank argued that the institution came under the 42 U.S.C. 9601(20)(A) exemption for secured lenders. In rejecting this contention, the court noted that after purchasing the land at the foreclosure sale, a lender no longer merely “holds indicia of ownership” of the land as security since foreclosure and purchase extinguish the security interest. The court concluded that the exemption was not intended to protect a former lender currently holding title “at least, when as here, the former mortgagee has held title for nearly four years, and a full year before the EPA cleanup,” 632 F. Supp. at 579.
The decision in United States v. Mirabile, 15 Envtl. L. Rep. 20994 (E.D. Pa. September 4, 1985), illustrates another manner in which bank liability may arise. In this case, a representative of the bank had frequently visited the business facility and insisted on certain manufacturing changes and the reassignment of certain personnel. It was alleged that the bank was involved in the management of the company that disposed of hazardous wastes. In refusing to grant the bank’s motion for summary judgment, the court held that there was a genuine issue of fact “as to whether [the bank] engaged in the sort of participation and management which would bring a secured creditor within the scope of CERCLA liability,” 15 Envtl. L. Rep. at 20997.
The Eleventh Circuit Court of Appeals in U.S. v. Fleet Factors Corp. 901 F. 2d 1550, (11th Cir. 1990) held that a secured creditor may be liable for environmental cleanup costs under CERCLA, without being an owner or operator, if it participates in the management of the debtors business to the extent that it has the capacity to influence the debtor’s decisions regarding treatment of hazardous wastes, regardless of whether the secured creditor forecloses on its real estate collateral.
In Fleet Factors, the lender did not foreclose on its security, but was nevertheless held liable for cleanup costs because it participated in the management of its borrower, a cloth printing facility being liquidated in bankruptcy. During the liquidation, Fleet monitored the receivables of the facility, checked the credit of its borrower’s customers, and applied the proceeds to its loan as had been done before the bankruptcy. Some of the inventory and equipment of the borrower was sold at auction to satisfy the debt. After the auction, the Environmental Protection Agency (EPA) found hundreds of drums of toxic chemicals and serious asbestos problems at the defunct plant. The EPA claimed that Fleet’s liquidator had moved the rusting, leaking drums before the auction and that Fleet’s agent or the auction purchasers had disturbed the asbestos when the equipment was removed.
In assessing liability against Fleet, the court noted that “a secured creditor may incur...liability, without being an operator if it participates in the financial management of a facility to a degree indicating a capacity to influence the corporation’s treatment of hazardous wastes. It is not necessary for the secured creditor actually to involve itself in the day-to-day operations of the facility in order to be liabled – although such conduct will certainly lead to the loss of the protection of the statutory exemption. Nor is it necessary for the secured creditor to participate in management decisions relating to hazardous waste. Rather, a secured creditor will be liable if its involvement with the management of the facility is sufficiently broad to support the inference that it could affect hazardous waste disposal decisions if it so chose.”
The court sounded a warning to lenders in the area of environmental liability by stating as follows:
[C]reditors’ awareness that they are potentially liable under [Superfund] will encourage them to monitor the hazardous waste treatment systems and policies of their debtors and insist upon compliance with acceptable treatment standards as a prerequisite to continued and future financial support....Once a secured creditor’s involvement with a facility becomes sufficiently broad that it can anticipate losing its exemption from [Superfund] liability, it will have a strong incentive to address hazardous waste problems at the facility rather than studiously avoiding the investigation and amelioration of the hazard.
This language clearly indicates that lenders should take an active role in controlling hazardous substances; yet, once they do, they may be held liable for environmental contamination cleanup costs.
These federal court decisions which construe the security interest exemption have created confusion for lenders who attempt to protect themselves when a loan is in default. Highlighting the confusion which surrounds the issue of foreclosure to protect the lender’s security interest is a further holding in the Mirabile case where the court held that a bank which foreclosed on land containing hazardous wastes and which assigned that land to another party four months later fell within the CERCLA exemption for secured creditors.
C. Indirect Lender Liability – CERCLA Liens
While secured lenders may be held directly liable for environmental costs under CERCLA, lenders should also be aware that CERCLA cleanups can have other ramifications that could substantially impact their interests.
Under 42 U.S.C. Section 9607(1), the United States is granted a lien upon all real property belonging to a person liable for CERCLA costs and subject to or affected by a removal or remedial action. This lien remains in effect so long as costs and natural resource damages for which the person is liable remain unpaid. However, the rights of the United States under this lien are subordinated to those of other creditors whose interests were perfected prior to recordation of the government lien.
VI. AVAILABLE DEFENSES
A. Statutory Defense
Defenses to CERCLA liability are limited by 42 U.S.C. Section 9607(b)(3) to situations where the release is caused by an act of God, act of war or actions of a third party. To qualify under the “third party” defense provisions, it must be established that: (a) one or more other persons were the sole physical cause of the release; (b) the defendant was not in a contractual relationship, “directly or indirectly”, with any of those other persons; and (c) the defendant took reasonable precautions to anticipate, prevent and limit the consequences of the foreseeable acts or omissions of the other persons.
It is highly unlikely that a secured lender will benefit from the statutory defenses as it is unclear which actions will constitute due care, what precautions and consequences may be foreseeable and, in most instances, the lender may have some contractual relationship with the third party, thereby denying the applicability of the defense.
B. “Innocent Land Owner” Defense
In 1986, Congress expanded the third party defense under SARA by creating a new “innocent land owner” defense. The third party defense was further expanded by the “Brownfields Revitalization and Environmental Restoration Act of 2001” (the Brownfields Act). To take advantage of the “innocent land owner” defense, the secured creditor must demonstrate that: (1) The property was acquired after the disposal or placement of hazardous substances on, in or at the facility; (2) The secured creditor had no actual (“it did not know”) or constructive (“had no reason to know”) knowledge that the property was polluted at the time it acquired the site; (3) Reasonable steps were taken to (a) stop any continuing release; (b) prevent any threatened future release; and (c) prevent or limit any human, environmental, or natural resource exposure to any previously released hazardous substance; and (4) The secured creditor acted in a commercially reasonable way when investigating and taking the property as set forth in 42 U.S.C. Section 9601(35)(A)(i) by: (a) making all appropriate inquiry into the previous ownership and uses of the property consistent with generally accepted good commercial and customary standards and practices in an effort to minimize the liability, (b) using all in-house specialized knowledge or expertise pertaining to environmental analysis, (c) determining the relationship between the purchase price and the value of the property if uncontaminated, (d) evaluating all commonly known or reasonable ascertainable information about the property, the obviousness of the presence or likely presence of contamination on the property, and (e) the ability to detect such contamination by appropriate inspection.
The Brownfields Act also altered the “innocent land owner” defense by imposing a duty on the secured party to fully cooperate with, assist and provide access to the property to any entity (presumably including state or federal regulatory agencies) responding to a release or threat of release. The secured party must also assist in the installation, integrity maintenance and operation of any response action, comply with any land-use controls imposed by the response team and not impede the response effort.
The Brownfields Act further modified the portion of the statute of the “innocent land owner” defense statute that requires the defendant (secured party) to make “all appropriate inquiries” and the statute now states that the inquiries are to be made “in accordance with generally accepted good commercial and customary standards and practices.” Also, the law now provides that, not later than two years after the enactment of the Brownfields Act, the Environmental Protection Agency (EPA) “shall by regulation establish standards and practices for the purpose of satisfying the requirement to carry out all appropriate inquiries.” Pending the establishment of the standards and practices by regulation, two sets of provisional standards have been established by the Brownfields Act. The original set of standards regarding “all appropriate inquiries,” applies to purchases of land prior to May 31, 1997. “With respect to property purchased on or after May 31, 1997, and until the EPA administrator promulgates the regulations. . . the procedures of the American Society for testing the materials, including the document known as Standard E1527-97, entitled Standard Practice for Environmental Site Assessment: Phase 1 Environmental Site Assessment Process shall satisfy the requirements…”
C. Bona Fide Prospective Purchaser Act
The Brownfields Act also created a new category of real estate purchaser called the “Bona Fide Prospective Purchaser” (BFPP). In order to qualify as a BFPP, the purchaser must: (1) prove that all the contamination was caused before the purchaser took title to the property and that the purchaser is not affiliated with any person who is liable or may be liable for the contamination; (2) make “all appropriate inquiries” to determine whether the site may be potentially contaminated; (3) upon discovery of the release or threat of release, give all required notices, exercise appropriate care and take reasonable steps to stop any continuing release, prevent any future release and limit human and natural resources exposure to hazardous substances; and (4) cooperate, assist and provide access to any response teams and restoration efforts, comply with any land use restrictions imposed as part of a response action and comply with any subpoenas or requests issued to the purchaser by the EPA.
If the purchaser can prove that all of the foregoing requirements have been satisfied, the purchaser is a BFPP and may be exempt from liability even if, before accepting the deed to the property, it “knew or had reason to know” that the property was contaminated.
D. Contiguous Properties Defense
The Brownfields Act also added a defense for land owners whose property is contaminated by the actions of others on nearby land. Under this provision, a party is not considered the “owner or operator” of land if the contamination of their property comes from a release or threatened release of hazardous chemicals on real property belonging to another. The contiguous properties defense, like other defenses under CERCLA, can only be asserted by the landowner if it is proven that the landowner: (1) did not cause, contribute or consent to the release or threatened release; (2) is not affiliated under CERCLA for response cost, is not affiliated with another party that is potentially liable, or involved in the reorganization of the business that was potentially liable; (3) made all appropriate inquiry regarding the facility before acquisition; (4) takes reasonable steps to stop any continuing release, to prevent any future release and to prevent or minimize any human or natural resources exposure to any hazardous substance released on or from the property; and (5) fully cooperates with any response action and restoration plan, complies with any land-use restriction imposed as part of the response action, complies with all requests for information and subpoenas issued by the EPA and provides all legally required notices with respect to the discovery of hazardous substances at the facility.
In the event the inquiry reveals the possibility of contamination from nearby properties, a prospective buyer may proceed with the purchase and be exempt from liability only by satisfying the requirements of the bona fide prospective purchaser defense.
E. Environmental Due Diligence
Prior to entering into a loan transaction there are procedures which may be implemented by a bank in order to maximize the potential for asserting the “innocent land owner” defense. The secured lender should conduct environmental assessments immediately prior to the acquisition. The initial phase of the environmental assessment should consist of a chain of title search for the past 50-100 years to determine the historical use of the property. Lenders should also consider including a detailed environmental questionnaire in its loan application forms to obtain sufficient information regarding the borrower, the borrower’s history and the borrower’s business; the location and geography of the property offered as collateral; the proposed uses of the property; and the property’s proximity to environmentally sensitive areas.
Next, a visual site inspection of the property should be conducted to uncover any information which can be obtained from “walking” the property and adjoining areas. The lender should also audit the paper trail associated with the property by reviewing federal, state and local government records relating to environmental compliance and any hazardous waste or hazardous substance problems. A review of aerial photographs of the property may be helpful and interviews should be conducted with persons who may have knowledge of the property’s current and former uses.
In the event the initial level of the investigation indicates signs of hazardous substances in, on or under the property, additional inquiry may become necessary. The second level of investigation should include a chemical analysis of air, water and soil samples to determine the level of contamination if any, which may exist. If hazardous substances are discovered upon the property as a result of the lender’s investigation, further steps should be taken to determine an estimate of the amount of cleanup which will be required to clean up the property prior to consummating the loan.
F. De Minimis Settlement Agreements with Innocent Land Owners
In cases where the availability of the “innocent land owner” defense is disputed, a lender may be able to enter into a de minimis settlement agreement with the EPA. Under 42 U.S.C. § 9622(g)(1)(B), a de minimis settlement agreement involving a “minor portion of the response costs” at the site may be entered into with a potentially responsible person who: (1) is the owner of the real property on or in which the facility is located; (2) did not conduct or permit the generation, transportation, storage, treatment or disposal of any hazardous substance at the facility; (3) did not contribute to any release or threat of a release at the facility through any action or emission; and (4) had no actual or constructive knowledge that the property was used for the generation, transportation, storage, treatment or disposal of any hazardous substance.
Under the de minimis settlement agreement provisions, innocent lenders and real estate purchasers may be given an opportunity to settle with the EPA prior to, or in the early stages of litigation in exchange for access to the site, cooperation in providing information to the agency, and in some instances, a small cash payment. In exchange, the lender-land owner can expect contribution protection and a covenant not to sue from the EPA.
G. Small Business Liability Relief and Brownfields Revitalization Act of 2002/EPA “All Appropriate Inquiry” Final Rule
The “Small Business Liability Relief and Brownfields Revitalization Act of 2002” (the “Brownsfields Act”) amended the “innocent land owner defense” and also gave liability protections for continuous property owners and bona fideprospective purchasers. Under the Brownsfields Act, the EPA must develop regulations to establish standards and practices for conducting “all appropriate inquiry” into prior ownership and use of property to afford the liability protections under CERCLA.
Effective November 1, 2006, the EPA adopted its final rule regarding the “All Appropriate Inquiry” (AAI) standards under CERCLA.
AAI is critical in limiting exposure to CERCLA liability, since it is a key component to each of CERCLA’s three primary landowner liability exemptions. First, the “innocent landowner defense” protects landowners who purchase contaminated property: (1) after all contamination occurred; (2) without knowledge or reason to know of contamination; and (3) with due care. In order to establish “lack of knowledge,” purchasers must have conducted “all appropriate inquiry” into the property’s historic use. Second, “contiguous landowners” are not liable under CERCLA if (1) migrating substances were the sole cause of contamination; (2) they had no relationship with the contaminating entity; and (3) they conducted “all appropriate inquiry” prior to acquisition. Finally, “bona fide prospective purchasers” are protected if they conduct “all appropriate inquiry” in cases in which they have “reason to know” of third party contamination.
1. All Appropriate Inquiry Standards
The AAI requirements under the final rule are applicable to any party who may potentially claim protection from CERCLA liability as an innocent landowner, a bona fide prospective purchaser, or a contiguous property owner. Parties who receive grants under EPA’s Brownfields Grant Program to assess and characterize properties must comply with the AAI standards.
The AAI final rule is more specific, and the scope of investigation required more expansive, than the standards that previously applied. (ASTM Standard Practice For Environmental Site Assessment) Many of an inquiry’s activities must be conducted by, or under the supervision or responsible charge of, an individual who qualifies as an “environmental professional” as defined in the final rule. The final rule contains requirements for conducting inquiries into the previous ownership, uses, and environmental conditions of the property for purposes of qualifying for the landowner liability protections under CERCLA. The most significant additions include:
a. Establishment of specific standards for environmental professions conducting AAI activities, including experience and education thresholds. (Environmental professional is defined at Part 312-Subpart B-Section 312.10(b));
b. Expanded obligations to interview current and past owners, operators and occupants, particularly those with knowledge of past use of hazardous substances;
c. Requirement to consider any specialized knowledge or experience of the buyer;
d. Obligation to interview neighboring and near-by property owners and occupants;
e. Required visual inspection of the subject property and adjacent property for environmentally relevant information;
f. Review of historical sources of information dating back to the first developed use of the property, including but not limited to, aerial photographs, fire insurance maps, building department records, chain of title documents and land use records;
g. Obtain commonly known or reasonable ascertainable information about the property;
h. Mandatory review of federal, state, tribal and local government records, including a search for environmental cleanup liens;
i. Requirement to identify institutional controls placed on the property. (Institutional control is defined at Part 312: Subpart B-Section 312.10(d));
j. Requirement to highlight data gaps that may affect the ability to identify conditions indicative of releases or threatened releases. (Data gap is defined at Part 312: Subpart B-Section 312.10(b));
k. Consideration of whether the purchase price of the subject property does not reasonably reflect the fair market value of that property if the property were not contaminated, and if not, whether the differential in purchase price and fair market value is due to the presence of releases or threatened releases of hazardous substances; and
l. Required declaration of environmental professional.
2. Timing of all Appropriate Inquiries
AIA must be conducted within one year prior to the date of acquisition (date on which a person takes title to the property) of the subject property. AIA may include information collected for previous inquiries that were conducted or updated within one year prior to the acquisition date of the property. In addition, the final rule retains the requirement that items (b), (e), (h), and (l) above be updated within 180 days prior to the date the property is purchased.
3. Conclusion
It is anticipated that the new AAI standards will increase the cost of AAI assessments significantly. In addition, conducting the AAI “due diligence” will become more time consuming, placing the premium on acquisition planning and securing environmental counsel early in the process. The trade off to these potential increased costs and delays is the benefit of reduced environmental risk. Conducting more thorough environmental assessments with the assistance of “environmental professionals” should ultimately reduce liabilities and default risks in this complicated area of the law.
VII. FDIC ENVIRONMENTAL RISK PROGRAM GUIDELINES
The potential adverse effect of environmental contamination on the value of real property and the potential for liability under various environmental laws have become important factors in evaluating real estate transactions and making loans secured by real estate. The FDIC has issued guidelines recommending that a lending institution should have in place appropriate safeguards and controls to limit exposure to potential environmental liability associated with real property held as collateral.
A. General Requirements
The FDIC guidelines require financial institutions to prepare and implement an environmental risk program which should:
1. establish procedures for identifying and evaluating potential environmental concerns associated with lending practices and other actions relating to real property;
2. be reviewed and approved by the bank’s board of directors;
3. designate a senior officer knowledgeable in environmental matters to be responsible for program implementation; and
4. be tailored to fit the needs of the financial institution (e.g., institutions with a heavier concentration of loans to higher risk industries or localities of know contamination may require a more elaborate and sophisticated environmental risk program than institutions that lend more to lower risk industries or localities).
B. Specific Requirements
In addition to the general requirements set forth above, a bank’s environmental risk program should provide for staff training, set environment policy guidelines and procedures, require an environmental review or analysis during the application process, include loan documentation standards, establish appropriate environmental risk assessment safeguards in loan workout situations and foreclosures, and provide for continued monitoring during the life of the loan. Specific requirements under each of these categories are set forth below.
1. Training
The environmental risk program should incorporate training sufficient to ensure that the environmental risk program is implemented and followed within the institution and that the appropriate personnel have the knowledge and experience to determine and evaluate potential environmental concerns that might affect the institution. Whenever the complexity of the environmental issue is beyond the expertise of the institution’s staff, the institution should consult legal counsel, environmental consultants and other qualified experts.
2. Policies
When appropriate, loan policies, manuals and written procedures should address environmental issues pertinent to the institution’s specific lending activities. For example, the lending manual might identify the types of environmental risks associated with industries and real estate in the institution’s trade area, provide guidelines for conducting an analysis of potential environmental liability and describe procedures for the resolution of potential environmental concerns. Procedures for the resolution of environmental concerns might also be developed for credit monitoring, loan workout situations and foreclosures.
3. Environmental Risk Analysis
Prior to making a loan, an initial environmental risk analysis needs to be conducted during the application process. An appropriate analysis may allow the institution to avoid loans that result in substantial losses or liability and provide the institution with information to minimize potential environmental liability on loans that are made. Much of the needed information may be gathered by the account officer when interviewing the loan applicant concerning his or her business activities. In addition, the loan application might be designed to request relevant environmental information, such as the present and past uses of the property and the occurrence of any contacts by federal, state or local governmental agencies about environmental matters. The loan officer or other representative of an institution might visit the site to evaluate whether there is obvious visual evidence of environmental concerns.
4. Structured Environmental Risk Assessment
Whenever the application, interview, or visitation indicates a possible environmental concern, a more detailed structured investigation by a qualified individual might be appropriate. This assessment might include surveying past ownership and uses of the property, inspecting the site and contiguous parcels of property and reviewing company records for past use or disposal of hazardous materials. A review of public records might include contact with federal and state environmental protection agencies to determine whether the borrower has been cited for violations concerning environmental laws and a review of federal and state lists identifying real property with significant environmental contamination. The institution’s policies and procedures should reflect adequate consideration of the EPA’s “All Appropriate Inquiry Rule.”
5. EPA All Appropriate Inquiry Rule
The Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) establishes, among other things, additional protections from cleanup liability for a new owner of a property. The bona fide prospective purchaser provision establishes that a person may purchase property with the knowledge that the property is contaminated without being held potentially liable for the cleanup of contamination at the property. The new owner must meet certain statutory requirements to qualify as a bona fide prospective purchaser and, prior to the date of acquiring the property, undertake “all appropriate inquiries” into the prior ownership and uses of the property.
In November 2005, the EPA promulgated its “Standards and Practices for All Appropriate Inquiries” final rule (EPA All Appropriate Inquiry Rule) which establishes the standards and practices that are necessary to meet the requirements for an “all appropriate inquiry” into the prior ownership and uses of a property. The “All Appropriate Inquiry” Rule became effective on November 1, 2006.
An environmental evaluation of the property that meets the standards and practices of the EPA All Appropriate Inquiry Rule will provide the borrower with added protection from CERCLA cleanup liability, provided the borrower meets the requirements to be a bona fide purchaser and other statutory requirements. This protection, however, is limited to CERCLA and does not apply to the Resource Compensation and Recovery Act (RCRA), including liability associated with underground storage tanks, and other Federal environmental statutes, and, depending on state law, state environmental statutes. In addition, such an environmental evaluation may provide a more detailed assessment of the property than an evaluation that does not conform to the EPA All Appropriate Inquiry Rule.
As part of its environmental risk analysis of any particular extension of credit, a lender should evaluate whether it is appropriate or necessary to require the borrower to perform an environmental evaluation that meets the standards and practices of the EPA All Appropriate Inquiry Rule. This decision involves judgment and may be made on a case-by-case basis considering the risk characteristics of the transaction, the type of property, and the environmental information gained during an initial environmental risk analysis. If indications of environmental concern are known or discovered during the loan application process, an institution may decide to require the borrower to perform an environmental evaluation that meets the requirements of the EPA All Appropriate Inquiry Rule.
The decision to require the borrower to perform a property assessment that meets the requirements of the EPA All Appropriate Inquiry Rule should be made in the context of the institution’s overall environmental risk program. An environmental risk program should be designed to ensure that the institution makes an informed judgment about potential environmental risk and considers such risks in its overall consideration of risks associated with the extension of credit. In addition, an institution’s environmental risk program may be tailored to the lending practices of the institution. Thus, an institution should make its decision concerning when and under what circumstances to require a borrower to perform an environmental property assessment based on its own environmental risk program as tailored to the needs of the lending practices of the institution. Individuals involved in administering an institution’s environmental risk program should become familiar with these statutory elements. One source for information concerning the EPA AAI Rule is the EPA website at http://www.epa.gov.
6. Monitoring
The environmental risk assessment should continue during the life of the loan by monitoring the borrower and the real property collateral for potential environmental concerns. The institution should be aware of changes in the business activities of the borrower that result in a significant increased risk of environmental liability associated with the real property collateral. If there is a potential for the environmental contamination to adversely affect the value of the collateral, the institution might exercise its rights under the loan to require the borrower to resolve the environmental condition and take those actions that are reasonably necessary to protect the value of the real property.
7. Loan Documentation
Loan documents should include language to safeguard the institution against potential environmental losses and liabilities. Such language might require that the borrower comply with environmental laws, disclose information about the environmental status of the real property collateral and grant the institution the right to acquire additional information about potential hazardous contamination by inspecting the collateral for environmental concerns. The loan documents might also provide that the institution has the right to call the loan, refuse to extend funds under a line of credit, or foreclose if the hazardous contamination is discovered in the real property collateral. The loan documents might also call for an indemnity of the institution by the borrower and guarantors for environmental liability associated with the real property collateral.
8. Involvement in the Borrower’s Operations
Under CERCLA (the federal Superfund law) the institution may have an exemption from environmental liability as the holder of a security interest in the real property collateral. In monitoring a loan for potential environmental concerns, and resolving those environmental situations as necessary, the institution should evaluate whether its actions may constitute “participating in the management” of the business located on the real property collateral within the meaning of CERCLA. If the lender’s actions are considered to be participation in management, the institution may lose its exemption from liability under CERCLA.
9. Foreclosure
A lender’s exposure to environmental liability may increase significantly if it takes title to real property held as collateral. The institution should evaluate the potential environmental costs and the potential for environmental liability in conjunction with an assessment of the value of the collateral in reaching a decision to take title to the property by foreclosure or other means.
C. Conclusion
Institutions need to implement an environmental risk program in order to evaluate the potential adverse effect of environmental contamination on the value of real property and the potential environmental liability associated with the real property. Failure of an institution to evaluate potential environmental risks associated with real property may contribute to an institution’s inability to collect on its loans and affect the institution’s financial condition.
VIII. EPA RULE – CERCLA
NOTICE: In 1992, the EPA issued a “lender liability” rule which was designed to clarify the scope of the “secured creditor” exemption and to clarify what actions constituted “participation in the management” of a facility. The rule was also intended to provide a “safe harbor” for lenders with respect to the foreclosure and post-foreclosure actions which could be undertaken by a lender in connection with a troubled loan. Unfortunately, the EPA rule was invalidated by a 1994 Federal Court of Appeals decision in the District of Columbia which ruled that the EPA had exceeded its authority in promulgating its lender liability rule. However, with the passage of the Asset Conservation, Lender Liability, and Deposit Insurance Protection Act of 1996, the EPA Lender Liability Rule has essentially been reinstated. This has resulted from the adoption by the Environmental Protection Agency of a policy statement under which the EPA will use the lender liability rule as guidance in interpreting the secured creditor exemption under CERCLA.
A. Introduction
The Environmental Protection Agency (EPA) released a rule pertaining to the liability of persons maintaining indicia of ownership primarily to protect a security interest under the provisions of the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). The provisions of CERCLA generally make the owner or operator of contaminated property liable for costs incurred in environmental cleanup efforts. The EPA rule became effective on April 29, 1992, but was invalidated in 1994, only to be reinstated in essence by the Asset Conservation, Lender Liability, and Deposit Insurance Protection Act of 1996, as described above.
Lenders have traditionally taken comfort in the protections of CERCLA which exempted persons whose indicia of ownership in a vessel or facility were held primarily to protect a security interest, provided that they did not participate in the management of the vessel or facility. Unfortunately, various court decisions have raised substantial doubt among lenders as to when a security interest holder would be considered to be an owner or operator of a vessel or facility under CERCLA, and what actions a security interest holder could take to protect its interest in collateral which secured a loan, without incurring potential environmental-cleanup liability.
B. Background
The provisions of CERCLA impose liability on “owners and operators” of sites where hazardous substances have been released. However, the law contains a “security interest exemption” that excludes from liability “any person who, without participating in the management of a vessel or facility, holds indicia of ownership primarily to protect his security interest in the vessel or facility”.
Questions regarding the judicial interpretation of the “security interest exemption” provided under CERCLA have generated uncertainty within the financial and lending communities, particularly with regard to the extent to which a secured creditor may undertake activities to oversee the affairs of a person whose facility is encumbered by a security interest for the purposes of protecting the security interest, without incurring CERCLA liability.
Lenders have expressed concern over whether certain actions commonly taken by a secured creditor – such as monitoring facility operations, requiring compliance with legal requirements and compliance-related activities, refinancing or undertaking loan workouts, providing financial advice, or undertaking other similar actions that may affect the financial, management, and operational aspects of a business – can be considered to be evidence that the secured creditor is “participating in the management” of a facility.
A determination of whether or not a secured creditor is “participating in the management” of a facility, is important since such a designation will serve to void the “security interest exemption” under CERCLA. The extent to which a holder may become involved in a facility without also being considered to be “participating in its management” is not defined under CERCLA nor is it addressed in the legislative history.
The EPA rule defines “security interest exemption” in an effort to clarify and specify the range of activities that may be undertaken by a person who maintains “indicia of ownership” in a facility “primarily to protect a security interest” without such activities being considered to be “participation in the facility’s management”.
C. Scope of the Security Interest Exemption
The EPA rule provides a “security interest exemption” to any “person who maintains indicia of ownership primarily to protect a security interest in a vessel or facility, and who does not operate in the management of the vessel or facility.” Any person receiving the protections of the “security interest exemption” is not deemed to be an “owner or operator” of a vessel or facility.
1. Indicia of Ownership
The term “indicia of ownership” means evidence of a security interest or other interest in real or personal property which secures a loan or other obligation. Evidence of such interest includes, but is not limited to mortgages, deeds of trust, liens, surety bonds and guarantees of obligations, titles held pursuant to a lease financing transaction in which the leasor does not select initially the leased property, legal or equitable title obtained pursuant to foreclosure, assignments, pledges or other forms of encumbrances against property that are held primarily to protect a security interest.
2. Primarily to Protect a Security Interest
The rule further explains that “primarily to protect a security interest” means that the holder’s indicia of ownership are held primarily for the purpose of securing payment or performance of an obligation. The EPA rule reflects a clear policy statement that the rule does not protect a person who holds indicia of ownership primarily for investment purposes.
3. Participation in Management
The rule provides a two-pronged test for what constitutes “participation in management” while the borrower is still in possession of the vessel or facility. Any activities undertaken by a lender which constitute “participation in management” will void the “security interest exemption”. However, the rule specifically provides that “participation in the management” of a vessel or facility does not include the mere capacity to influence, or ability to influence or the unexercised right to control facility operations. Under the first prong of the test for participation in management, a lender holding a security interest may become liable if found to be “exercising decision-making control over the borrower’s environmental compliance, to the extent that the lender has undertaken responsibility for the borrowers hazardous substance handling or disposal practices.” A lender can be liable in this circumstance, even if its actions do not result in the release of a hazardous substance.
A lender can also be found liable under the second prong of the test for “participation in management” if the lender exercises control at a level comparable to that of a manager of the borrower’s enterprise such that the holder has assumed or manifested responsibility for the overall management of the enterprise encompassing the day-to-day decision making of the enterprise with respect to:
a. environmental compliance; or
b. all, or substantially all of the operational (as opposed to financial or administrative) aspects of the enterprise other than environmental compliance.
A lender performing operational aspects of the enterprise such as the functions of the facility or plant manager, operations manager, chief operating officer, or chief executive officer may serve to void the “security interest exemption”. Financial or administrative aspects which will not subject a lender to liability include functions such as the functions of credit manager, accounts payable/receivable manager, personnel manager, controller, chief financial officer, or similar functions.
In avoiding liability under the two-pronged test for participation in management, a lender should be careful not to take control over either: (a) the borrowers environmental compliance or hazardous substance handling or disposal practices (even if the lender’s actions do not result in a release of a hazardous substance); or (b) substantially all of the operational management of the borrower’s enterprise, other than environmental compliance, although involvement in financial and administrative aspects is allowed.
NOTE: Under the Asset Conservation, Lender Liability, and Deposit Insurance Protection Act of 1996, further statutory clarification of what constitutes “Participation in Management” has been provided as follows:
The term “Participate in Management” (1) means actually participating in the management or operational affairs of a vessel or facility; and (2) does not include merely having the capacity to influence, or the unexercised right to control, vessel or facility operations. A person that is a lender holding indicia of ownership primarily to protect a security interest in a vessel or facility shall be considered to participate in management only if, while the borrower is still in possession of the vessel or facility encumbered by the security interest, the person (a) exercises decision making control over the borrower’s compliance with environmental laws and the lender actually takes responsibility for the “hazardous substance handling or disposal practices” related to the property; or (b) exercises control at a level comparable to that of a manager of the vessel or facility, such that the person has assumed or manifested responsibility (i) for the overall management of the vessel or facility encompassing “day-to-day decision making with respect to environmental compliance” or (ii) over all or substantially all of the operational functions of the facility or vessel (as distinguished from financial or administrative functions) other than the function of environmental compliance. However, the rule also specifically provides that “participation in management” of a vessel or facility does not include: (a) holding a security interest or abandoning or releasing such a security interest; (b) monitoring or enforcing the terms and conditions of the extension of credit or security interest; (c) including in a contract or security agreement a “term or condition” that relates to environmental compliance; (d) monitoring or undertaking one or more inspections of the property; (e) requiring the borrower to clean up the property prior to or during, or upon the expiration of the term of the extension of credit; (f) providing financial or other advice or counseling in an effort to mitigate, prevent or cure default or diminution in the value of the property; (g) restructuring, renegotiating or otherwise altering the terms and conditions of the extension of credit; (h) exercising other remedies at law or in equity that might be available for the borrowers breach of any term or condition of the extension of credit or security agreement; or (i) conducting a response action under terms of Superfund.
D. Safe Harbor Activities
The final EPA rule specifies a range of activities that a lender may undertake without being deemed to have “participated in the management” of a facility which would otherwise trigger exposure to liability.
1. Pre-Origination Activities
The rule states clearly that no act or omission prior to loan origination will trigger liability, including conducting or requiring an environmental inspection, requiring the prospective borrower to clean up a vessel or facility (whether prior or subsequent to the time that indicia of ownership are held primarily to protect a security interest) or requiring compliance with any applicable law or regulation. The rule also makes it clear that a lender is not required to conduct or require an inspection to qualify for the exemption and potential liability for clean-up cost cannot be based on or affected by the failure of the lender to conduct or require an inspection.
2. Loan Servicing Activities
The rule will not consider a lender to be “participating in management” of a facility while conducting the following loan administration or loan servicing activities:
a. requiring the borrower to comply with any (not just environmental) laws, regulations and rules;
b. securing and exercising authority to monitor and inspect the property in which indicia of ownership are maintained or the borrowers business or financial condition;
c. taking other action to adequately police the loan or security interest (such as requiring a borrower to comply with any warranties, covenants, conditions, representations, or promises from the borrower); and
d. requiring the borrower to clean-up the vessel or facility during the life of the loan or security interest.
3. Loan Workouts
The rule defines “workout” to include those actions by which a holder, at any time prior to “foreclosure and its equivalents”, seeks to prevent, cure, or mitigate a default by the borrower or to preserve or prevent the diminution of the value of the security. Examples of permissible loan-workout activities which may be undertaken by a lender without losing the protections of the security interest exemption are as follows:
SPECIAL NOTE: In conducting loan servicing and workout activities, a lender must act without violating the two-pronged test for “participating in management” by assuming or manifesting responsibility for day-to-day decision making with respect to environmental compliance or substantially all operational (as opposed to financial or administrative) aspects of the borrower’s business. In other words, while there is extensive language contained in the EPA rule on permissible activities which may be exercised during the course of loan servicing or workout, secured parties must insure that they do not cross the line based on the two-pronged “participation in management” test.
4. Foreclosure Activities
For purposes of the EPA rule, foreclosure is broadly defined to include legal or equitable title acquired through or incident to “foreclosure and its equivalents.” The term “foreclosure and its equivalents” include the following:
E. Post Foreclosure Actions
1. Duty to Dispose of Property
The rule provides that the indicia of ownership held after foreclosure continue to be maintained primarily as protection for a security interest – and thus continue to be eligible for the “security interest exemption” – only if the holder seeks to dispose of the property “in a reasonably expeditious manner, using whatever commercially reasonable means are relevant or appropriate with respect to the vessel or facility, taking all facts and circumstances into consideration.” Under this rule, lenders are allowed far more latitude following foreclosure, provided that the lender did not participate in management prior to foreclosure and is diligently seeking to dispose of the property.
The rule permits a lender to sell, liquidate, and windup operations on the property and also allows the lender to “maintain business activities . . . and take measures to preserve, protect or prepare the secured asset prior to sale or other disposition.”
2. Duty to Accept Offer of Fair Consideration
The rule provides that a lender may not outbid, reject or fail to act on an offer of fair consideration for the property securing the loan. Doing so “establishes that the ownership indicia in the secured property are not held primarily to protect the security interest, unless the holder is required, in order to avoid liability under federal or state law, to make a higher bid, to obtain a higher offer or to seek or obtain an offer in a different manner.”
For purposes of this portion of the rule, fair consideration is defined as “the value of the security interest”. The “value of the security interest” is calculated as an amount at least equal to the outstanding principal owed to the lender, plus unpaid interest and rent, plus all reasonable and necessary costs incurred by the lender (including costs incident to workout, foreclosure and post-foreclosure activities such as preparing the property for sale) less any amounts received by the lender.
“Fair consideration” for a holder of a junior security interest includes the value of all of the outstanding senior security interests, plus the value of the security interest held by the junior holder. A holder may not outbid, reject, or fail to act upon within 90-days of receipt of an offer of fair consideration that is “a written, bona fidefirm offer of fair consideration for the property received at any time after 6-months following foreclosure”. The term “written bona fide firm offer” means “a legally enforceable commercially reasonable, cash offer, solely for the foreclosed vessel or facility, including all material terms of the transaction, from a ready, willing, and able purchaser who demonstrates to the holders satisfaction the ability to perform.”
The EPA rule clearly provides that a lender may trigger CERCLA liability after foreclosure, however, by arranging for disposal or treatment of hazardous substances, or by accepting hazardous substances for transportation to a disposal facility that it selects.
3. The Bright-Line Test
The EPA rule also provides a “bright-line test” by which a lender can conclusively show that it is seeking to dispose of the property in a reasonably expeditious manner. Under this “bright-line test” the holder must, within 12-months following the acquisition of marketable title: (a) list property with a broker, dealer or agent who deals with the type of property in question; or (b) advertise the property as being for sale or disposition on at least a monthly basis in either a real estate publication or a trade or other publication suitable for the property in question or a newspaper of general circulation covering the area where the property is located.
NOTE: The rule does not establish a time requirement for ultimate disposition of the foreclosed-on property as long as the holder is fulfilling the requirements of attempting to sell property in an expeditious manner.
For purposes of the “bright-line test”, the twelve-month period begins to run from the time that the holder acquires marketable title, provided that the holder, after the expiration of any redemption or other waiting period provided by law, was acting diligently to acquire marketable title. If the holder fails to act diligently to acquire marketable title, the twelve-month period begins to run on the date of foreclosure and its equivalents.
F. Impact on Trustees and Fiduciaries
The original EPA Rule did not address environmental liability for trustees or fiduciaries and did not apply to contamination associated with underground storage tanks under the Resources Conservation and Recovery Act (RCRA). However, the Asset Conservation, Lender Liability, and Deposit Insurance Protection Act of 1996 serves to limit the liability of fiduciaries under CERCLA and clarifies that the CERCLA provisions regarding secured parties and fiduciaries are subject to coverage under the EPA Rule on RCRA described below. Under CERCLA, a fiduciary is a person acting for the benefit of another party as a bona fide (a) trustee; (b) executor; (c) administrator; (d) custodian; (e) guardian of estates or guardian ad litem; (f) receiver; (g) conservator; (h) committee of estates of incapacitated persons; (i) personal representative; or (j) representative in any other capacity determined to be similar to the persons listed in (a) through (i), above.
The term “fiduciary” does not include a person acting as a fiduciary for a trust or other estate organized for the primary purpose of . . . actively carrying on a trade or business for profit, unless the trust or other fiduciary estate was created as part of, or to facilitate, one or more estate plans or because of the incapacity of a natural person. The term “fiduciary” also excludes a person acquiring ownership or control of a facility with the objective purpose of avoiding liability.
A fiduciary’s liability is limited to assets held in the fiduciary capacity. Fiduciaries will be liable if negligence of the fiduciary “causes or contributes” to the release or threatened release of a hazardous substance. In addition, the Act provides a fiduciary with a “safe harbor” from liability in its personal capacity when: (a) undertaking or directing another person to undertake a response action under CERCLA or under the direction of an on-scene coordinator designated under the National Contingency Plan; (b) undertaking or directing another person to undertake any other lawful means of addressing a hazardous substance; (c) terminating the fiduciary relationship; (d) including in the terms of the fiduciary agreement a covenant, warranty, or other term or condition relating to compliance with an environmental law, or monitoring, modifying or enforcing the term or condition; (e) monitoring or undertaking one or more inspections of the facility; (f) providing financial or other advice or counseling to other parties to the fiduciary relationship, including the settlor or beneficiary; (g) restructuring, renegotiating, or otherwise altering the terms and conditions of the fiduciary relationship; (h) administering, as a fiduciary, a facility or vessel that was contaminated before the fiduciary relationship began; or (i) declining to take any of the actions described in (b) through (h) above.
G. Conclusion
The Environmental Protection Agency (EPA) has issued a policy statement clarifying the safe harbor for lenders from liability under CERCLA. Under this policy statement, the EPA indicates that in cases where the Lender Liability Rule provides additional clarification of the same or similar terms utilized under CERCLA, EPA employees may look to the rule for guidance in interpreting the secured creditor exemption.
IX. EPA RULE – RCRA
On September 7, 1995, the EPA issued a final rule under the Resource Conservation and Recovery Act (RCRA) which limits the regulatory obligations of lending institutions and other persons who hold a security interest in a petroleum underground storage tank (UST) or in real estate containing a petroleum UST, or that acquired title or deed to a petroleum UST or facility or property on which an UST is located. The final rule also specifies conditions under which these “security interest holders” may be exempted from RCRA. The rule is designed to result in additional capital availability for UST owners by assisting them in meeting environmental requirements through improvement of their facilities.
Although adoption of this long-awaited rule addressing the liability of lenders and other secured parties is under the RCRA, the application of the rule is limited to RCRA provisions dealing with underground petroleum storage tanks and does not address other storage tanks or solid waste situations (tanks specifically excluded by statute are: farm and residential tanks of 1,100 gallons or less capacity used for storing motor fuel for noncommercial purposes; tanks used for storing heating oil for consumptive use on the premises where stored; tanks stored on or above the floor of underground areas; septic tanks; systems for collecting stormwater or wastewater; and flow-through process tanks), does not cover fiduciaries, and is not completely clear on how much protection lenders have from suits by private parties.
Under the hazardous and solid waste amendments of 1984, Congress responded to the increasing threat to ground water posed by leaking underground storage tanks by adding Subtitle I to the RCRA. Subtitle I required EPA to develop a comprehensive regulatory program for USTs storing petroleum or hazardous substances. Congress directed the EPA to publish regulations that would require owners and operators of new tanks and tanks already in the ground to prevent and detect leaks, clean-up leaks, and demonstrate that they are financially capable of cleaning up leaks and compensating third parties for resulting damages. Any person who owns or operates an UST or UST system is responsible for complying with the “technical requirements,” “financial responsibility requirements,” and “corrective action requirements” specified in the statute and regulations. These requirements are designed to ensure that USTs are managed and maintained safely, so that they will not leak or otherwise cause harm to human health and the environment. Should a leak occur, the statutory and regulatory requirements provide that the owner is responsible for addressing the problem. Under the RCRA, the term “owner” is defined to mean “any person who owns an UST used for the storage, use, or dispensing of substances regulated under Subtitle I of RCRA” (which includes both petroleum and hazardous substances) while the term “operator” means “any person in control of, or having responsibility for the daily operation of the underground storage tank.”
Under the RCRA, the term “owner” does not include “any person who, without participating in the management of an underground storage tank and otherwise not engaged in petroleum production, refining, and marketing, holds indicia of ownership primarily to protect the owner’s security interest in the tank.”
The EPA rule addresses the requirements of Subtitle I that are applicable to a person who holds a security interest in a petroleum UST or UST system, or in a facility or property on which a petroleum UST or UST system is located, from the time that the person extends the credit up through and including foreclosure and re-sale. The rule is designed provide protection from liability for a person whose only connection with a tank is as the holder of a security interest (i.e., a bank or other creditor who has made a loan to a borrower) and who has in return secured the loan by taking a security interest in the tank or in the property on which the tank is located.
The rule attempts to provide guidance on the types of activities that will qualify a lender for the security interest exemption. Any holder of a security interest whose only connection with the tank is as the bona fide holder of a security interest in a petroleum UST or UST system or in a facility or property on which a petroleum UST or UST system is located is not subject to the UST technical standards, corrective action, or financial responsibility requirements otherwise applicable to a tank owner. With respect to the potential for a holder of a security interest to become an “operator” of the tank prior to foreclosure, the holder will not typically incur liability as an “operator” if it is not involved in the day-to-day operations of the tank. Once the holder takes affirmative action through foreclosure and displaces the borrower, the holder is deemed to have taken “control” of and responsibility for the tank and may be considered a tank operator. Under such circumstances, a foreclosing holder will not be considered an UST “operator” if petroleum is not added to, stored in, or dispensed from the UST. Under the rule, a holder is allowed to empty the UST within a certain period of time after foreclosure, and undertake specified minimally burdensome and environmentally protective actions to secure and protect the UST or UST system, without becoming an “operator.” However, a holder who operates a tank by, for example, storing or dispensing petroleum following foreclosure will be subject to the full range of requirements applicable to any person operating a tank (including corrective action requirements).
The term “indicia of ownership” means ownership or evidence of an ownership interest in a petroleum UST or UST system, or in a facility or property on which a petroleum UST or UST system is located. Evidence of such an interest includes, but is not limited to a mortgage, deed of trust, or legal or equitable title obtained pursuant to foreclosure or its equivalents, a surety bond, guarantee of an obligation, or an assignment, lien, pledge, or other right to or form of encumbrance against a petroleum UST or UST system, or a facility or property on which a petroleum UST or UST system is located.
The rule further explains that “primarily to protect a security interest” means that a holder’s indicia of ownership are held primarily for the purpose of securing payment or performance of an obligation. The EPA rule reflects that the rule does not provide protection to a person who holds indicia of ownership primarily for investment purposes nor ownership indicia held primarily for purposes other than as protection for a security interest.
The rule provides the “participation in management” means actual involvement in the management or control of decision-making related to the operational aspects or day-to-day operations of an UST or UST system by the holder of ownership indicia. Participation in management does not include the mere capacity or unexercised right or ability to influence the operational aspects or day-to-day operations of an UST or UST system or facility or property on which an UST or UST system is located.
For purposes of this rule, actual involvement in the operational aspects or day-to-day operation of the UST or UST system means use of the UST to contain petroleum, and includes the storage, filling, or dispensing of petroleum contained in an UST or UST system. A holder is considered to be exercising management control or decision-making authority over the operational aspects of the UST or UST system, and therefore, participating in management, if the holder performs the functions of a plant manager, operations manager, chief operating officer, chief executive officer, and the like, unless the responsibilities for the position specifically exclude all UST operational responsibilities. However, activities which constitute administrative or financial management, or involvement in environmental compliance activities taken to protect human health and the environment do not, by themselves, constitute participation in management under this rule.
D. Actions That Are Not Participation in Management
The final EPA rule specifies a range of activities that a lender may undertake without being deemed to have “participated in the management” of an UST or UST system, which would otherwise trigger exposure to liability.
Participation in the following activities will not exclusively, in themselves, exceed the bounds of the regulatory “security interest exemption”: (a) policing the loan; (b) undertaking financial workout with a borrower where the obligation is in default or in threat of default; (c) undertaking foreclosing and winding up operations; or (d) preparing for sale or liquidation of the UST or UST system or facility or property on which the UST or UST system is located. In addition, the holder is not considered to be participating in the management by (a) monitoring the borrowers business; (b) requiring or conducting environmental compliance activities related to the UST technical standards or other federal, state or local environmental laws and regulations; (c) requiring or conducting on-site investigations, including site assessments, inspections, and audits of the environmental condition of the UST or UST system or facility or property on which the UST or UST system is located or of the borrower’s financial conditions; (d) requiring or conducting UST or UST system corrective action in compliance with federal law or applicable state requirements in those states which have been delegated authority by EPA to administer the UST program; (e) monitoring other aspects of the UST or UST system considered relevant or necessary by the holder; (f) requiring certification of financial information or compliance with applicable duties, laws, or regulations; or (g) requiring other similar actions. Although such oversight and obligations may inform and perhaps strongly influence the borrower’s management of an UST or UST system, the holder is not considered to be participating in management where the borrower continues to be in control of the day-to-day operations of the UST or UST system.
The EPA rule details two other areas of special interest regarding actions in which holders may engage without jeopardizing their security interest exemption which include administrative and financial management and actions taken to protect human health and the environment.
1. Administrative and Financial Management
Administrative and financial management activities may be engaged in by a holder in the course of managing a loan portfolio and do not exceed the boundaries of the security interest exemption. Such activities may include (a) providing financial or other assistance; environmental investigations or monitoring of the borrower’s business and collateral; (b) engaging in “loan workout” activities; (c) foreclosing on a secured UST or UST system or facility or property on which an UST or UST system is located; (d) winding down operations following foreclosure; or (e) divesting itself of the foreclosed-on property containing an UST or UST system.
2. Actions Taken to Protect Human Health and the Environment
The EPA rule clarifies that holders may voluntarily conduct site remediations as well as other environmentally beneficial activities on properties on which they hold a security interest and that both environmental compliance activities and activities that are undertaken voluntarily to protect human health and the environment will not be considered evidence of participation in the management of an UST or UST system or facility or property on which an UST or UST system is located. However, any holder undertaking these actions must do so in compliance with applicable federal law or applicable state requirements in those states that have been delegated authority by EPA to administer the UST program.
The rule provides a list of examples of activities that a holder can engage in without exceeding the bounds of the UST security interest exemption to include release response and corrective actions for UST systems, environmental site investigations, tank upgrading and replacement, leak detection, and maintenance of corrosion protection. These activities are not required of a holder as a condition for obtaining the security interest exemption as an UST “owner.” However, other activities that are not considered participation in management may be required of the holder as a condition for obtaining the security interest exemption as an UST “operator.” These activities include: tank emptying, capping and securing lines, permanent or temporary closure of an UST or UST system, and release reporting.
3. Actions Taken Throughout the Loan Transaction Process that are not Participation in Management
a. Actions at the inception of the loan or other transaction giving rise to a security interest The rule provides that actions undertaken by a holder prior to the inception of a transaction in which indicia of ownership are held primarily to protect a security interest are not considered evidence of participation in the management of the UST or UST system. As a result, consultation and negotiation concerning the structure and terms of the loan or other obligation, the payment of interest, the payment period, and specific or general financial or other advice, suggestions, counseling, guidance, or other actions at or prior to the time that indicia of ownership are first held are not considered evidence of participation in the management of the UST or UST system or facility or property on which the UST or UST system is located.
Activities that take place prior to holding indicia of ownership are not relevant for determining whether the holder has participated in the management of the UST or UST system after the time that the holder acquires indicia of ownership. In addition to such pre-loan involvement, a holder may determine to undertake or require an environmental investigation of an UST or UST system securing the loan or other obligation. Such environmental investigation may be undertaken by the holder, or the holder may require the investigation to be conducted by another party as a condition of the loan or other transaction. The rule clarifies that such an environmental investigation is not required to be undertaken to qualify for the security interest exemption, and the obligations of a holder seeking to avail itself of the exemption cannot be based on or affected by the holder’s failure to conduct or require an environmental investigation in connection with the security interest.
In the event that a pre-loan environmental investigation of an UST or UST system reveals contamination, the holder may undertake any one of a variety of responses that it deems appropriate. For example, the holder may refuse to extend credit or to follow through with the transaction or instead maintain indicia of ownership in other, non-contaminated property as protection for the security interest. Alternatively, a holder may determine that the risk of default is sufficiently slight to proceed to extend credit and maintain indicia of ownership in the UST or UST system. Additionally, the holder may require the borrower to report and clean-up the contamination as a condition for extending the loan.
Such activities are not considered to be participation in the management of the UST or UST system or facility or property on which the UST or UST system is located and a holder that knowingly takes a security interest in contaminated collateral is not subject to compliance with the RCRA Subtitle I corrective action regulatory program on that basis.
b. Loan Servicing Activities In the process of servicing a loan, a holder may undertake actions that are consistent with holding ownership indicia primarily to protect a security interest without triggering exposure to liability. These actions include, but are not limited to: (1) a requirement that the borrower clean-up a release from the UST or UST system which may have occurred prior to or during the life of the loan or security interest; (2) a requirement of assurance of the borrower’s compliance with applicable federal, state and local environmental or other laws and regulations during the life of the loan or security interest; (3) securing authority or permission for the holder to periodically or regularly monitor and inspect the UST or UST system or facility or property on which the UST or UST system is located, or the borrower’s business or financial condition, or both; (4) to comply with legal requirements to which the holder is subject; or (5) other requirements or conditions by which the holder is able to police adequately the loan or security interest, provided that the exercise by the holder of such other loan policing activities are not considered evidence of control over the operational aspects of the UST or UST system or facility or property on which the UST or UST system is located.
The authority for the holder to take any of the foregoing actions may be contained in contractual documents or other relevant documents, specifying requirements for financial, environmental, and other warrantees, covenants, and representations or promises from the borrower. The inclusion of environmental warranties and covenants is not considered to be evidence of a holder’s acting as an insurer or guarantor, and a finding of “management participation” cannot be premised on the existence of such terms or upon the holder’s actions that insure that the UST or UST system is managed in an environmentally sound manner. Since these actions are consistent with holding indicia of ownership primarily to protect a security interest, they are not considered to be participation in management under this rule.
c. Loan Workouts Under the rule, the holder is allowed to determine what actions need to be taken with respect to the UST or UST system to safeguard the security interest from loss. These actions may become necessary when, for example, a loan is in default or threat of default, and are commonly referred to as “loan workout” activities. “Loan workout” generally means those activities undertaken to prevent, mitigate, or cure a default by the obligor or to preserve or prevent the diminution of the value of the security. Loan workout activities will not take a holder outside of the scope of the security interest exemption provided that such actions do not include decision-making control over the day-to-day operation of the UST or UST system or facility or property on which UST or UST system is located.
When the holder undertakes loan workout activities, provides financial or other advice, or similar support to a financially distressed borrower, the holder will remain within the scope of the security interest exemption only so long as the holder does not participate in management as defined in paragraph C (3), hereof.
Loan workout actions that are not evidence of “participation in management” include, but are not limited to: (a) restructuring or renegotiating the terms of the security interest; (b) requiring payment of additional rent or interest; (c) exercising forbearance with regard to the security interest; (d) requiring or exercising rights pursuant to an assignment of accounts or other amounts owing to an obligor; (e) requiring or exercising rights pursuant to an escrow agreement pertaining to amounts owing to an obligor; (f) providing specific or general financial or other advice, suggestions, counseling, or guidance; and (g) exercising any right or remedy the holder is entitled to by law or under any warranties, covenants, conditions, representations, or promises from the borrower.
d. Foreclosure Activities For purposes of the EPA rule, foreclosure is defined to mean that legal, marketable or equitable title or deed has been issued, approved, and recorded and that the holder has obtained access to the UST, UST system, UST facility, and property on which the UST or UST system is located, provided that the holder acted diligently to acquire marketable title or deed and to gain access to the UST, UST system, UST facility, and property on which the UST or UST system is located. The security interest exemption will continue to be maintained provided that the holder undertakes to sell, re-lease an UST or UST system or facility or property on which the UST or UST system is located, held pursuant to a lease financing transaction (whether by a new lease financing transaction or substitution of the lessee), or otherwise divest itself of the UST or UST system or facility or property on which the UST or UST system is located, in a reasonably expeditious manner, using whatever commercially reasonable means are relevant or appropriate with respect to the UST or UST system or facility or property on which the UST or UST system is located, taking all facts and circumstances into consideration, and provided that the holder does not participate in management prior to or after foreclosure.
E. Duty to Dispose of Property
A holder cannot, under the terms of the EPA rule, reject or refuse offers for the property that represent fair consideration for the asset and still remain within the regulatory security interest exemption unless the holder is required, in order to avoid liability under federal of state law, to make a higher bid, to obtain a higher offer or to seek or obtain an offer in a different manner.
1. Duty to Accept Offer of Fair Consideration
For purposes of this rule, “fair consideration” is equal to the value of the security interest which is calculated as an amount equal to or in excess of the sum of the outstanding principal (or comparable amount in the case of a lease that constitutes a security interest) owed to the holder immediately preceding the acquisition of full title (or possession in the case of a lease financing transaction) pursuant to foreclosure, plus any unpaid interest, rent, or penalties (whether arising before or after foreclosure). The term “value of the security interest” also includes all reasonable and necessary costs, fees, or other charges incurred by the holder incident to workout, foreclosure, retention, preserving, protecting and preparing prior to sale, the UST or UST system or facility or property on which the UST or UST system is located, re-lease, pursuant to a lease financing transaction (whether by a new lease financing transaction or substitution of the lessee) or other disposition, plus environmental compliance costs (such as tank emptying, upgrading, replacement, and removal, as well as site assessment and corrective action costs); less any amounts received by the holder in connection with any partial disposition of the property and any amounts paid by the borrower subsequent to the acquisition of full title pursuant to foreclosure.
In the case of a holder maintaining indicia of ownership primarily to protect a “junior security interest,” fair consideration is the value of all outstanding higher priority security interests plus the value of the security interest held by the junior holder. In the event that a holder outbids or refuses offers from parties offering “fair consideration” for the property, the property is no longer being held primarily to protect a security interest.
The terms and conditions of any bids submitted are relevant in that a holder is not required to accept offers that would require it to breach duties owed to other holders, the borrower, or other persons with interest in the property that are owed a legal duty. In addition, the term “fair consideration” refers to an all cash offer, which is intended to ensure that this rule would not require a holder to accept a bid that contains unacceptable conditions, such as requirements for indemnification agreements, non-cash offers, “bundled” offers, and the like. In the event that a holder rejects a cash offer of fair consideration for the foreclosed-on property, or if it outbids others offering fair consideration, the holder will be considered an owner of the UST or UST system or facility or property on which the UST or UST system is located in the same manner as any other purchaser.
The rule’s provisions defining “fair consideration” and specifying when the foreclosing holder may reject or outbid offers for the property were formulated to reflect the amount that the holder may bid at the foreclosure sale, or not reject during the foreclosure sale or thereafter, in order to recover on its loan or other obligation. In addition, there may be multiple security interests in a borrower’s property held by secured creditors, which the definition of “fair consideration” must account for. Therefore, for a senior creditor, the term “fair consideration” means a cash amount that represents a value equal to or greater than the outstanding obligation owed to the holder (including the fees, penalties and other charges incurred by the holder in connection with the property). “Fair consideration” further indicates that the amount that will recover the holder’s “security interest” in the property may vary depending on the seniority of the loan or other obligation that is being foreclosed upon. Specifically, a junior creditor may be required to outbid senior creditors in order to recover the value of its loan or other obligation. The definition of “fair consideration,” therefore, distinguishes between what junior or senior creditors may bid or not reject for purposes of maintaining the exemption. In addition, in order to avoid liability under law, the foreclosing holder may be required to seek an amount at the foreclosure sale that is greater than the outstanding obligation owed to the foreclosing holder or to sell the property in a different manner; therefore, this rule does not require a holder to accept an offer of “fair consideration” if to do so would subject the holder to liability under federal or state law.
2. Bright-Line Test
While a holder may use whatever means are reasonable and appropriate for marketing foreclosed-on property to establish that it is seeking to divest itself of property in an expeditious manner, the EPA has established the following “bright-line” test that a holder may choose to use to definitely establish that it continues to hold indicia of ownership primarily to protect a security interest, and is not an “owner” of foreclosed-on property for purposes of complying with the UST regulatory requirements. Under the “bright-line” test a holder must, within twelve months following foreclosure, list the property with a broker, dealer, or agent who deals with the type of property in question, or advertise the property as being for sale or disposition on at least a monthly basis in either a real estate publication or a trade or other publication suitable for the property in question, or a newspaper of general circulation (defined as one with a circulation over 10,000, or one suitable under any applicable federal, state, or local rules of court for publication required by court order or rules of civil procedure) covering the area where the property is located. Holders satisfying these criteria are considered to have complied with the requirement that it is seeking to sell or otherwise divest the property in an expeditious manner. A holder choosing to avail itself of this “bright-line” test will be able to provide clear and unambiguous evidence that it is not the UST or UST systems “owner” following foreclosure, for purposes of complying with the UST regulatory requirements.
The EPA regulation does not impose a time requirement for the ultimate disposition of foreclosed-on property. Provided that the property is being actively offered for sale by the holder and no offers of fair consideration are ignored, outbid, or rejected, foreclosed-on property may continue to be held by the holder without the holder being considered an “owner” of the UST or UST system or facility or property on which the UST or UST system is located.
In order to avoid losing the protection of the security interest exemption, a holder must act upon a written, bona fide, firm offer of fair consideration for the property within 90 days of receipt of the offer. The requirement to “act upon” an offer does not mean that a purchase transaction must be completed within the 90-day time period. Rather, the holder must consider the offer, which may include, but is not limited to, responding to the offer and/or initiating a purchase transaction within 90 days. If at any time after six months following the acquisition of marketable title the holder outbids, rejects or does not act upon within 90 days of receipt of a written, bona fide, firm offer of fair consideration for the property, the holder will lose the protection of the rule.
For purposes of this rule, a “written, bona fide, firm offer” is a legally enforceable, commercially reasonable offer, including all material terms of the transaction, from a ready, willing, and able purchaser who demonstrates to the holder’s satisfaction the ability to perform.
F. Winding-Up Operations After Foreclosure
A holder that forecloses on an UST or UST system with ongoing operations may wind up the UST or UST system’s operations without also being considered to be participating in management. Winding up activities by a foreclosing holder are protected because, without such protection, foreclosure would not be possible where practical or commercial necessity dictates that the foreclosing holder undertake such actions. For purposes of this rule, “winding up” in the post-foreclosure context includes those actions that are necessary to close down an UST or UST system’s operations, secure the site, and otherwise protect the value of the foreclosed assets for subsequent sale or liquidation. In winding up an UST or UST system, a holder may undertake all necessary security measures or take other actions that protect and preserve an UST or UST system’s assets, including steps taken to prevent or minimize the risk of a release or threat of release of the UST or UST system’s contents.
G. Liability of a Holder as an Operator
1. Pre-Foreclosure Operation
Prior to foreclosure, it is the borrower, not the holder, who generally is in control of, or has responsibility for, the daily operation of an UST or UST system, and is subject to the full range of requirements applicable to operators of USTs. During this time period, a holder is permitted to conduct those activities related to its financial and administrative obligations of managing a loan portfolio, as well as environmental compliance activities and activities undertaken voluntarily to protect human health and the environment in compliance with federal law. The holder in this position will not lose its ability to take advantage of the regulatory security interest exemption as a result of engaging in these activities. If the holder becomes engaged in the daily operation of an UST or UST system, however, it becomes subject to the full range of requirements applicable to operators of USTs or UST systems.
2. Post-Foreclosure Operation
Once a holder has foreclosed on an UST or UST system or facility or property on which the UST or UST system is located, it displaces the borrower and could become engaged in the day-to-day operation of an UST or UST system merely by storing product in the UST or UST system. The EPA rule considers an UST to be in use and in operation if petroleum is added to, dispensed from, or stored in the UST. Therefore, except as provided in this rule, a holder cannot continue to use, store, dispense, or fill petroleum in an UST or UST system after obtaining marketable title and access to the UST or UST system or facility or property on which the UST or UST system is located without incurring Subtitle I liability (unless there is another operator available as described below).
However, a holder is not barred from taking affirmative actions to ensure that a tank is no longer in use, by demonstrating that the tank is no longer storing, dispensing or being filled with petroleum. This can best be demonstrated by emptying tanks which are acquired through the foreclosure process. In order to qualify for the exemption, it is essential for a holder to empty all tanks that it knows about or should know about shortly after undertaking foreclosure unless there is another operator who takes responsibility for complying with the UST regulatory requirements. To comply with this requirement, all product must be removed from the UST or UST system so that only one inch of residue remains. To ensure that the UST system has been adequately secured, vent lines must be left open and functioning, and all other lines, pumps, manways, and ancillary equipment must be capped and secured.
An exception to the foregoing requirements is that tanks can remain in use if there is someone who is available to take responsibility as an operator for compliance with the Subtitle I requirements. This would apply in situations when a lessee is willing to continue operating an UST or UST system as the “operator,” in compliance with Subtitle I, while a holder is in possession of the UST or UST system or facility or property on which the UST is located. In cases where an operator (other than the holder) exists who is in control of and has responsibility for the daily operation of UST, and who can be held responsible for compliance with the UST regulatory requirements, the holder would not be considered to be the operator.
In foreclosure, to avoid being an “operator” of the UST in addition to emptying and securing the UST or UST system, a holder must also comply with the Subtitle I requirements for either temporary or permanent closure, in order to retain the security interest exemption. A holder choosing to permanently close its UST or UST system, must do so in accordance with the provisions of §§ 280.71 through 280.74, Subpart G-Out of Service UST Systems and Closure, except the holder is not required to perform corrective action if contamination is discovered. If the holder chooses to temporarily close its tanks, the holder is required to maintain corrosion protection and report any known or suspected releases from the UST system. Release detection is not required as long as the UST system is empty. A foreclosing holder who fails to satisfy the conditions established in this rule for retaining the security interest exemption, could be an “operator” under the Subtitle I regulations, and therefore, would be subject to the full panoply of Subtitle I regulatory obligation applicable to all operators of tanks, including the corrective action regulations.
a. Time Frame for Emptying USTs and Securing UST Systems A holder wishing to take advantage of the security interest exemption must empty its known tanks within 60 days after foreclosure, or within 60 days after the effective date of this rule, whichever is later, or within another reasonable time frame as specified by the implementing agency.
b. Unknown Tanks A holder can continue to obtain the protections of the security interest exemption by emptying an unknown UST within 60 days after discovering it or within 60 days after the effective date of this rule, whichever is later, or within another time frame as specified by the implementing agency.
c. Permanent Closure USTs that are emptied, secured and placed in temporary closure for the temporary period of time for which they are possessed by a holder do not need to be permanently removed or permanently closed in place in order to protect human health and the environment. As a result, a holder may retain the regulatory security interest exemption by temporarily closing but not permanently closing its USTs and UST systems. However, if a holder is unable to dispose of an UST property within 12 months, it must conduct a site assessment if the USTs are older and do not meet new tank performance standards. For purposes of this provision, the 12 month period begins to run from the effective date of the rule or from the date on which the UST or UST system is emptied and secured, whichever is later.
d. Release Report Requirements Following Foreclosure Upon foreclosure, a holder taking advantage of the regulatory exemption from corrective action regulations must nevertheless comply with the requirement that the discovery of any releases from the UST be reported to the implementing agency. A holder is therefore responsible, following foreclosure, for reporting to the implementing agency, any discovery of released regulated substances, or any suspected release at an UST site or in the surrounding area.
e. Financial Responsibility Requirements A holder who maintains ownership rights on an UST or UST system primarily to protect a security interest will not be treated as an “owner” or “operator” for purposes of being subject to the financial responsibility requirements of Subtitle I, provided the holder satisfies the conditions contained in this rule.
Under this rule, a holder is exempted for corrective action as an operator after foreclosure if it ensures that the tanks no longer store petroleum and it complies with the temporary or permanent closure requirements specified in this rule. In these situations, where the holder is not liable for corrective action and where the tanks are empty and pose little threat of release, it would serve no useful purpose to require a holder to demonstrate compliance with the financial responsibility requirements for corrective action.
f. Outstanding Loans and Loans in Foreclosure Upon the Effective Date of the Rule Holders of existing as well as future security interests, including those in foreclosure upon the effective date of this rule, fall within the rules protective ambit as long as the holder satisfies the conditions contained in this rule for the regulatory security interest exemption.
H. Conclusion
The EPA rule became effective on December 6, 1995. While the protections of the security interest exemption have not been extended to other parties such as trustees, and the issue of the lenders protection from litigation related to underground tanks initiated by private parties is not covered by the rule, these provisions should provide greater certainty to lenders in dealing with UST facilities.
X. LOAN DOCUMENTATION
The provisions in loan documents are important in preserving, for the lender, the protection of the innocent land owner defense and in limiting the risks of the transaction for the lender. The representations, warranties and covenants contained within the loan documents should be directed to protect the lender. The lender should be interested in addressing six specific areas in its loan documents:
1. Compliance with environmental laws;
2. Use of property and facilities;
3. Condition of property;
4. Notice of environmental problems;
5. Right of inspection;
6. Indemnification and hold harmless clause.
The “compliance with laws” covenant is intended to insure that the borrower remains in compliance with relevant environmental laws during the term of the loan. The “use of property and facilities” clause is intended to limit the types of activities which the borrower can undertake at the facility. The “condition of property” provision requires the borrower to keep the site in an uncontaminated fashion and to clean up any releases which may take place. The “notice of environmental problem” provision is intended to insure that the lender will be notified of any environmental problems which could materially affect the value of the collateral.
The “right of inspection” provision provides the lender with an absolute right to inspect the property and physically check the soil and facility. This provision further may require the borrower to represent annually that it continues in compliance with the environmental loan covenants. Finally, the “indemnification and hold harmless” clause provides an additional degree of protection from any loss, expense or damage associated with environmental liabilities, subject to the solvency of the borrower.
XI. LEAKING UNDERGROUND STORAGE TANKS (LUST)
The current attention to the Leaking Underground Storage Tank (LUST) issue can be traced to the explosion in the number of neighborhood gasoline stations built in the 1950s and 1960s. The majority of tanks installed at these facilities were not protected from the corrosion inherent in underground installation. While some of these tanks have been repaired or replaced, many of them remain in service or were abandoned when these gasoline stations were converted to other uses.
Many of these existing or abandoned tanks have experienced leaks or will leak before they are repaired or replaced. The effects of leaks from defective tanks can be devastating as leaked gasoline may contaminate the soil and the ground water surrounding the tank. Gasoline will contaminate drinking water and pose substantial health hazards for those who are exposed to it through drinking water or through inhalation of toxic vapors.
In response to the LUST problem, Congress enacted Subtitle 1 of the Hazardous and Solid Waste Amendments of 1984, 42 U.S.C. Section 6991 et. seq. This legislation developed a comprehensive regulatory program for underground storage tanks which required owners to notify state agencies of the existence of any underground tanks in use at that time, and of any new tanks placed in service thereafter. Additionally, the EPA promulgated technical regulations setting standards for the installation, maintenance, operation and closure of underground storage tanks. These regulations also impose additional financial requirements and record keeping obligations on tank owners.
The new regulations require a phased-in system of leak detection and leak prevention construction standards for existing tanks based on their age. Within ten years, all petroleum tanks must be protected from corrosion and equipped with devices to prevent spills and overfills. Any systems unable to meet the required standards must be closed.
Furthermore, financial responsibility requirements for tank owners are also being phased in. The regulations require most underground tank operators to demonstrate financial responsibility for the cost of cleaning up leaked product and of compensating others for bodily injury and property damage resulting from a tank leak. Many operators will need to demonstrate coverage of at least 1 million dollars per incident. The date for compliance with the financial requirements ranges from January 24, 1989, for the largest tank owners, to October 26, 1990, for all other tank owners. Under these financial responsibility requirements, a tank owner may demonstrate responsibility through insurance policies, a state cleanup fund, risk retention group coverage or self-insurance.
A. Petroleum Products & Hazardous Substances Storage & Handling Act
In response to EPA regulations regarding underground storage tanks, the Nebraska Legislature in 1986 adopted the “Petroleum Products and Hazardous Substances Storage and Handling Act,” Neb.Rev.Stat. Sections 81-15,117 to 81-15,127, which establishes a program of storage tank registration and inspection as a preventative measure and a comprehensive leak cleanup program as a responsive measure to the problems associated with leaking underground storage tanks.
B. Petroleum Release Remedial Action Act
In addition, the 1989 Nebraska Legislature enacted the “Petroleum Release Remedial Action Act” in response to federal regulations which require owners of underground petroleum storage tanks to obtain up to $1,000,000 in financial responsibility to protect against cleanup costs in the event of a petroleum spill. As a result of these regulations, many tank owners have encountered difficulties in obtaining insurance coverage or have found premiums for such insurance to be unaffordable. This Act also established a state fund which may be drawn against by eligible tank owners and operators in order to obtain reimbursement for costs incurred in cleaning up petroleum spills. Pursuant to amendments to this law, with the passage of LB 409 during the 1991 Legislative Session, the state fund has been expanded to authorize payment for claims related to “third-party liability”.
The Petroleum Release Remedial Action Act establishes the petroleum release remedial action cash fund which is available to reimburse tank owners and operators who are responsible for a petroleum spill for up to $975,000 in cleanup costs. This cash fund is created by the imposition of a fee on owners of underground storage tanks and by the assessment of a per gallon fee upon distributors, importers or refiners who sell, use or distribute petroleum products in Nebraska. Except as provided below, any person seeking reimbursement from the cash fund is responsible for the first $10,000 of cleanup costs and for 25% of any additional cleanup costs not to exceed an additional $15,000.
Responsible persons who sell no less than 2,000 gallons of petroleum and no more than 250,000 gallons petroleum during the calendar year immediately preceding the first report of the release, or who stored less than 10,000 gallons of petroleum in the calendar year preceding the first report of the release, qualify for different treatment with regard to the applicable deductible. The deductible for these responsible persons is $5,000, plus 25% of the remaining costs of the remedial action, not to exceed a total of $10,000. This means that the maximum deductible for the small marketer/retailer or storer is $15,000 with the deductible for everyone else remains at $25,000.
Under the Act, a responsible person who has taken remedial action in response to a release first reported after July 17, 1983, may make application to the Department of Environmental Quality (DEQ) for reimbursement of cleanup expenses or third party claims. The term “responsible person” includes (1) an operator who is defined as a person in control of or having responsibility for the daily operation of a tank or (2) an owner who is defined as (a) in the case of a tank in use on or after November 8, 1984, or brought into use after such date, any person who owns a tank used for storage, use or dispensing of petroleum; and (b) in the case of a tank in use before November 8, 1984, but not longer in use on such date, any person who owned such tank immediately before the discontinuation of its use. An exemption from the definition of owner, which should benefit secured lenders under state law, provides that “owner shall not include a person who without participating in the management of a tank, and otherwise not engaged in petroleum production, refining, and marketing; (a) holds indicia of ownership primarily to protect his or her security interest in a tank or a lienhold interest in the property on or within which a tank is located; or (b) acquires ownership of a tank or the property on or within which a tank is located; (1) pursuant to a foreclosure of a security interest in the tank or of a lienhold interest in the property; or (2) if the tank or the property was security for an extension of credit previously contracted, pursuant to a sale under judgment or decree, pursuant to a conveyance under a power of sale contained within a trust deed or from a trustee or pursuant to an assignment or deed in lieu of foreclosure.”
The Act will allow a secured lender, in limited circumstances, to qualify as a “responsible person” without assuming responsibility or liability for remedial action.
Under these circumstances, a secured lender may voluntarily propose to implement remedial action or to pay a third-party claim, and without assuming liability for the cleanup, become eligible for reimbursement associated with cleanup costs or third-party claims related to spills from tanks which are no longer in operation as of November 8, 1984. This “responsible person” designation becomes important in the event that the original owner of a tank no longer in use after November 8, 1984, fails to apply to the DEQ for reimbursement and will enable a secured party to cleanup the property and restore it to its original value while retaining the ability to be reimbursed for such expenses.
The definitions contained in the Act further provide a “security interest exemption” which provides an exclusion from liability under state law in the event that a secured lender holds evidence of ownership merely by the existence of a security interest in the tank or in the real estate upon which the tank is located. This “security interest exemption” will serve to provide a secured lender with flexibility by determining the expenses associated with cleanup costs prior to becoming an “owner” of the tank through foreclosure or other related legal proceedings. In the event that the anticipated cleanup costs are greater than the amounts eligible for reimbursement from the remedial release action cash fund, the secured lender may elect not to foreclose and avoid being designated as an “owner” for purposes of assuming liability for cleanup costs. In the alternative, if the cleanup costs are such that the lender may be reimbursed in full from the fund subject to the $25,000 deductible, the secured lender may determine that taking ownership to the property through foreclosure or other related legal actions is the most appropriate course of action to follow. As indicated above, a significant change in the Act involves the inclusion of authority for the cash fund to pay claims for “third-party liability”. A third-party claim is a judgment against a responsible person obtained by another party for compensation for bodily injury and property damage caused by a release first reported after January 1, 1990. In order for this claim for third-party liability to be payable, a lawsuit would have to be filed against the responsible person, and the state would have to obtain notification of the service of summons for the action within 10 days of the service.
Even though a third-party liability claim includes property damage caused by release first reported after January 1, 1990, the cause of action (actual damage to the third-parties property or person) must have occurred after the effective date of the Act, which is April 26, 1991. Also, the authority for the payment of third-party liability claims out of the fund has a sunset provision which requires that in order for payment to be made, the cause of action for the damage must be filed on or before December 31, 1998.
Third-party liability claims are subject to the same deductibles and other conditions of payment as remedial action reimbursement claims.
C. Petroleum Products – Covenant Not to Sue
During the 2001 Session of the Nebraska Legislature, lawmakers enacted LB 461, portions of which are commonly referred to as the “Covenant Not To Sue” law. Incorporated into Nebraska laws as Neb.Rev.Stat. §§ 81-15,124.05 – 81-15,124.07, the law is designed to ease concerns over the transferability and financing of property which has been contaminated by a leaking underground storage tank and to increase the likelihood that such property can be returned to productive use.
1. Certificate of Completion
The provisions of § 81-15,124.05 authorize the Department of Environmental Quality (Department), upon completion of an approved remedial action plan, to issue to the responsible person a “certificate of completion” stating that no further remedial action needs to be taken at the site relating to any contamination for which remedial action has already been taken in accordance with the approved remedial action plan. The certificate of completion may be conditioned upon compliance with any monitoring, institutional, or technological controls that may be necessary and which were relied upon by the responsible person to demonstrate compliance with the remedial action plan. The certificate of completion must be issued in a form which can be filed for record in the real estate records of the county in which the remedial action took place and the responsible person must file the certificate of completion and notify the Department within 10 days after issuance as to the date and location of the real estate filing.
2. Covenant Not to Sue
Upon issuance of a certificate of completion to a responsible person by the Department, a covenant not to sue arises by operation of law. The effect of a covenant not to sue is to release the responsible person from liability to the state and from liability to perform additional environmental assessment, remedial activity, or response action with regard to the release of a petroleum product for which the responsible person has complied with the requirements set forth in paragraph II above. The covenant not to sue will be voided (a) if the responsible person fails to conduct additional remedial action as required under paragraph V below; or (b) if a certificate of completion is revoked by the Department under paragraph VI below, or if the responsible person fails to comply with the monitoring, institutional, or technological controls, if any, upon which the certificate of completion is conditioned.
3. Effect of Covenant Not to Sue
A covenant not to sue arising under this law, unless otherwise voided, bars suit against any person who acquires title to property to which a certificate of completion applies for all claims of the state or any other person in connection with the petroleum products which were the subject of an approved remedial action plan. In addition, a person who purchased a site prior to May 31, 2001, is released upon the issuance of a certificate of completion (or upon the issuance of a no further action letter pursuant to § 81-15,186) from all liability to the state for cleanup of contamination that was released at the site covered by the certificate of completion (or the no further action letter) before the purchase date, except (a) for releases or consequences that the person contributed to or caused; (b) for failure by such person to comply with the monitoring, institutional, or technological controls, if any, upon which the certificate of completion is conditioned; or (c) in the event the certificate of completion is revoked by the Department for any of the reasons described under paragraph VI, below.
4. Additional Remedial Action
A certificate of completion issued by the Department shall require the responsible person to conduct additional remedial action in the event that any monitoring conducted at or near the real property or other circumstances indicate that (a) contamination is reoccurring, (b) additional contamination is present for which remedial action was not taken according to the remedial action plan, or (c) contamination from the site presents a threat to human health or the environment and was not addressed in the remedial action plan.
5. Revocation of Certificate of Completion
A certificate of completion will be revoked if the Department demonstrates by a preponderance of the evidence that any approval provided under the law was obtained by fraud or material misrepresentation, knowing failure to disclosure material information, or false certification to the Department. A copy of any notice of revocation of the certificate of completion must be filed by the Department in the real estate records of the county in which the remedial action took place within 10 days following such revocation.
6. Transfers to Affiliates
In the event that a responsible person transfers property to an affiliate in order for that affiliate to obtain a benefit to which the responsible person (transferor) would not otherwise be eligible under the law or to avoid an obligation under the law, the affiliate shall remain subject to the same obligations and obtain the same level of benefits as those available to the responsible person (transferor) under the law.
7. Reimbursement for Remedial Action
Any person entitled to the protections of the covenant not to sue or eligible to be released from liability pursuant to the issuance of a certificate of completion or a no further action letter who is ordered by the Department to take remedial action shall be eligible for reimbursement as a responsible person pursuant to § 66-1525 and shall not be required to pay the first cost or percent of the remaining cost as provided in § 66-1523(1) unless such person contributed to or caused the release or failed to comply with the monitoring, institutional, technological controls, if any, imposed by the Department.
8. Non-Admission of Liability
Section 84-15,124.07 provides that (a) participating in a remedial action plan does not constitute an admission of liability under the laws of this state, the rules and regulations adopted pursuant to law, or the ordinances and resolutions of any political subdivision or an admission of civil liability under statutory or common law of this state; (b) the fact that a responsible person has participated in a remedial action plan is not admissible in any civil, criminal, or administrative proceeding initiated or brought under any law of this state other than to enforce the provisions of the Petroleum Products and Hazardous Substance and Handling Act; and (c) participating in a remedial action plan shall not be construed to be an acknowledgment that the conditions of the affected area identified and addressed by the remedial action plan constitute a threat or danger to the public health or safety or the environment.
9. Conclusion
In many cases, the inability or unwillingness of the Department to provide a meaningful “letter of no further action” or to “release” a contaminated property which has been satisfactorily remediated, increases the reluctance of lenders to finance purchases of such property and decreases the willingness of prospective purchasers to acquire such property. Passage of the “Covenant Not To Sue” law should serve to ease these concerns, although lenders and prospective purchasers must still be aware of the multitude of federal laws under which environmental liability could potentially be imposed.
For more information about Petroleum Remediation Program, please go to the Nebraska Department of Environmental Quality website (http://deq.ne.gov/NDEQProg.nsf/Home.xsp) and search for “Petroleum Remediation Program.”
XII. CONCLUSION
The assessment of lender liability pursuant to environmental laws is a rapidly growing area of concern for lenders and their counsel. Appropriate precautions in the form of environmental assessments, proper loan documentation and monitoring of activities conducted upon a lenders’ collateral are most important in minimizing the lenders’ exposure to liability.
Please note that the material contained herein is not intended to serve as a comprehensive discussion on all aspects of environmental liability, but rather to familiarize bankers with the precautions to be taken to minimize exposure to environmental liability. Environmental Counsel and consultants should be contacted for additional advice on any transaction in which assistance is desired.
The Nebraska Department of Environmental Quality maintains a comprehensive listing of consultants/engineering firms organized by the environmental services they provide. The listing is made available through the Department of Environmental Quality’s website at http://www.deq.state.ne.us/.