On April 29, 1992, the EPA published its final rule on lender liability. The rule is an effort to restore a modicum of certainty to the lending community in the wake of the controversial 1990 decision of the United States Court of Appeals for the Eleventh Circuit in United States v. Fleet Factors Corporation.1 The rule specifies the range of permissible activities which may be undertaken by lenders and other secured creditors while still qualifying for CERCLA's so-called "secured creditor" exemption.2 While far from perfect, the EPA rule does provide secured creditors with certain objective "bright line" tests to assist in minimizing their potential liability under CERCLA for costs of cleaning up environmental contamination.
The Comprehensive Environmental Recovery Compensation and Liability Act of 1980 ("CERCLA") imposes joint and several strict liability on certain classes of responsible parties, without regard to their actual fault. These potentially responsible parties include:
(i) Current owners and operators of facilities contaminated by hazardous substances;
(ii) Owners and operators of facilities at the time the hazardous substances were released;
(iii) Persons who arrange for disposal or treatment or arrange with a transporter for disposal or treatment of hazardous substances; and
(iv) Transporters of hazardous substances.3
The History of the Exemption
The "secured creditor" exemption exempts persons who would otherwise be liable as owners or operators from liability for clean-up costs. The exemption applies to "any person who, without participating in the management of a facility, holds indicia of ownership primarily to protect his security interest in the facility."4 Questions always existed regarding the judicial interpretation of the secured creditor exemption, particularly concerning the scope of involvement which a secured creditor could have with a borrower without steping over the threshold of "participating in the management" of the borrower’s facility. However, the cases construing the exemption in the period following CERCLA's passage up through the Eleventh Circuit's issuance of the Fleet Factos decision on May 23, 1990, established that a secured creditor's involvement in financially related issues, such as monitoring the loan, inspecting, the collateral, refinancing the loan, or providing limited financial advice, would not void the exemption.5 Prior to the Fleet Factors decision, the courts fairly consistently held that a secured creditor would not be liable as a potentially responsible party unless and until: (i) the secured creditor forecloses on contaminated real property or personal property; or GO the secured creditor has become active in the day-to-day management of the borrower's facility.
Fleet Factors and Bergsoe Metals
However, widespread "fear and loathing" was created by the Eleventh Circuit’s dicta in its Fleet Factors opinion and it was perceived throughout the lending community that the rules of the game had been drastically changed. In its opinion, the Court issued its now infamous language:
. . . a secured creditor may incur § 9607(a)(2) liability, without being an operator, by participating 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 liable . . . Nor is it necessary for the secured creditor to participate in management decisions related to hazardous wastes. 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 effect hazardous waste disposal decisions.6
The fear in the short term after Fleet was that merely the presence of environmental covenants in loan documents, monitoring a borrower's financial condition or collateral, or conducting workout discussions with a borrower would trigger CERCLA liability. Secured creditors were able to draw some comfort from the Ninth Circuit Court of Appeals decision in BergsoeMetal Corporation v. EastAsiastic Company.7 In Bergsoe, the court concluded that liability is triggered not by what rights a secured creditor may have under loan documents, but rather by what a secured creditor does. The court held that a secured creditor must, as a threshold to liability, exercise actual management control before it could be held liable for activity which results in contamination. The court emphasized that having the power to get involved in management, but failing to exercise it, was insufficient to impose liability.8
The EPA Final Rule
In its final rule, the EPA sought to answer the question which it felt was left unanswered in Fleet, namely the extent to which a secured creditor could act to oversee and manage its security interest without being considered to be participating in the facility's management.9
Who is a secured creditor?
The rule allows secured creditors to foreclose on contaminated property without incurring liability for clean-up costs. The rule also allows secured creditors to police and service their loans, engage in work-out discussions and otherwise work with borrowers with contaminated collateral without being held liable for clean-up costs for its participation in the management of the borrower's operations.
As mentioned above, the exemption applies to anyone who "holds indicia of ownership primarily to protect a security interest."10 This includes holders of mortgages, liens, deeds of trust, assignments, pledges and legal and equitable title to real and personal property. The exemption also applies to sureties, guarantors, successors to holders of any of the above instruments and receivers.
What types of other lending transactions, aside from standard loan arrangements, are covered under the EPA rule? These include sale and leasebacks, conditional sales, installment sales, factoring agreements, accounts receivable financing and consignments. The test of whether a transaction qualifies for the exemption is whether the interest in a vessel or facility is created or established for the purpose of securing a loan or some other obligation. If the answer to this question is yes, the transaction will qualify under the EPA's interpretation of the secured creditor exemption. However, if the transaction is created not for the purpose of securing a loan or another obligation, but for investment, profit or any other money-making motive or purpose, it will not qualify.
The rule emphasizes that participation in management does not mean the mere capacity or ability to influence, or the unexercised right to control facility operations. Accordingly, it deals directly with the Fleet Factors dicta, which appeared to indicate that the unexercised capacity to influence the borrower's disposal practices could trigger CERCLA liability.
The Two-Prong Test for Liability
The rule establishes a two-prong test for determining what constitutes "participation in management of the borrower's facility." The first prong requires that the secured creditor exercise decision-making control over the borrower's environmental compliance. The second prong requires that the secured creditor assume or manifest responsibility for overall management of the day-to-day decision-making of the borrower's business concerning either: (a) environmental compliance or (b) all or substantially all of the operational (as opposed to financial or administrative) aspects of the borrower's business, other than environmental compliance. The second prong allows the secured creditor to participate in financial and administrative matters concerning the borrower's business. Some latitude is allowed regarding the secured creditor's involvement in the borrower's operations as long as the secured creditor does not take responsibility for the overall management of the borrower's business on a day-to-day basis. This allows a secured creditor to avoid liability for isolated involvement or advice about environmental or operational matters.
Accordingly, secured creditors should avoid taking control of the borrower's environmental compliance or substantially all of the operational management of the borrower's business. It is important for secured creditors to not violate either of the two prongs of the test in the course of servicing or policing loans or engaging in work-out discussions with troubled borrowers having contaminated collateral.
What can Can Secured Creditors Do?
Provided their conduct does not violate either branch of the two-prong test, secured creditors are free to engage in the following conduct without incurring CERCLA liability:
- Requiring the borrower to comply with all laws, codes and regulations, including environmental laws.and business. obligations.
- Monitoring and inspecting the borrower's property.
- Policing the loan and enforcing the borrower's.
- Engaging in work-out discussions and negotiations with the borrower.
- Restructuring and renegotiating existing loans.
- Requiring payment of additional interest or rent.
- Forbearance under a troubled loan.
- Requiring or exercising rights pursuant to an assignment of rents.
- Providing specific or even general financial or other advice, counseling or guidance to the borrower.
- Exercising any right or remedy the secured creditor is entitled to by law or under promises from the borrower.
What About Foreclosure?
Secured creditors are allowed to foreclose upon contaminated collateral without incurring CERCLA liability provided they abide by the guidelines set forth in the rule. Foreclosure is broadly defined to apply to secured creditors acquiring possession, as well as title, thereby covering mortgagees in possession. Foreclosure is deemed to include purchase at a foreclosure sale, acquisition or assignment of title in lieu of foreclosure, termination of a lease or other respossession, acquisition of a right to title or possession, an agreement in satisfaction of the obligation, or any other formal or informal manner by which the secured creditor acquires title to or possession of the secured property.
The exemption will continue to apply after foreclosure if the secured creditor seeks to dispose of the property in a "reasonably expeditious manner, using whatever commercially reasonable means that are relevant or appropriate concerning the property."11 A bright line test for how a secured creditor does this is by listing and advertising the property within twelve months from the time the secured creditor acquires marketable title to the property. Listing and advertising is not required, but it does provide proof of efforts made to dispose of the property.
The secured creditor can sell, liquidate and wind up the borrower's operations following foreclosure. The lender can maintain the borrower's business operations, as well as take steps to preserve and protect the assets.
A secured creditor, however, has a duty to accept an offer of fair consideration for the property. The secured creditor cannot outbid, reject or fail to consider any offer of fair consideration. Fair consideration is defined as the value of the security interest, which includes the outstanding unpaid principal, interest, rents and penalties, together with reasonable and necessary costs incurred by the secured creditor, less amounts received.12 It does not encompass the concept of fair market value because the rationale behind the secured creditor exemption is that the property serves as security for a debt, not as an investment vehicle.
The rule requires the secured creditor to act within 90 days of receipt of a written, bona fide firm offer of fair consideration. This is defined as a legally enforceable, commercially reasonable cash offer from a ready, willing and able purchaser.
The rule also contains a "Good Samaritan clause". Under this provision, a secured creditor will not incur CERCLA liability if it acts to clean up the property consistent with the National Contingency Plan, or if it conducts clean-up activities at the direction of an on-site coordinator. There is an exception from the exemption. The secured creditor will be liable for the consequences of its own negligence in conducting clean-up operations.
Shortcomings of the Rule
The rule does not provide a complete shield to secured creditors from all potential claims for liability under CERCLA. The rule applies only to a secured creditor's potential CERCLA liability as an owner or operator. It does not apply to a s cured creditor's conduct which would subject it to CERCLA liability for arranging for the disposal, treatment or transportation of hazardous substances, the so-called "generator" category of potentially responsible parties under CERCLA. The rule also does not exempt secured creditors from liability under other federal or state environmental statutes.
The biggest perceived drawback of the rule is that it applies only to EPA enforcement actions and may not insulate secured creditors from third party claims. By structuring the rule as an amendment to the National Contingency Plan, the EPA has attempted to make it binding on all third parties who might seek to impose liability upon secured creditors. This will undoubtedly be challenged within the 90-day period for challenging legislative rule-makings, although as of June 1992 no suits had been filed.
In the recently passed Georgia Superfund Act, (H.B. No. 1394), O.C.G.A § 12-8-92(7)(C), secured creditors are exempted from the definition of owner or operator under the new Georgia Hazardous Site Response Act. The Georgia legislation also exempts fiduciaries from the definition of owner and operator. The act goes into effect on July 1, 1992. The EPA rule does not explicitly cover trustees or other fiduciaries.
While certainly not a panacea to all the actual or perceived ills created by Fleet Factors, the EPA rule does restore some certainty that normal lending activities can be conducted without unreasonable fear of CERCLA liability. Since Fleet Factors is still the law of the Eleventh Circuit, it remains to be seen whether any trial courts will extend the scope of lender liability, and what weight will be given by the courts to the EPA rule, especially in the context of thirdlitigation seeking to impose a br scope of liability upon secured creditors. Although it is not perfect, the rule is a welcome step towards putting the Fleet Factors genie back in the bottle.
1 United States v. Fleet Factors Corp., 901 F.2d 1550 (11th Cir. 1990).
2 42 U.S.C. § 9601(20)(A).
3 42 U.S.C. § 9607(a)1 - (a)(4).
4 42 U.S.C. § 9601(20)(A)
5 See, e.g. United States v. Nicolet, 29 Envir. Reptr. Cas. N.A. 1851 (E.D. Pa. 1989).
x 6 901 f.2D AT 1557.
7 In re: Bergsoe Metals Corporation, 910 F.2d 668 (9th Cir. 1990).
8 901 F.2d at 672.
9 57 Fed. Reg. 18344 (1992); 40 C.F.R. 300.1100
10 42 U.S.C. § 9601(20(A)
11 40 C.F.R. 300.1100(d)(1).
12 40 C.F.R. 300.100(d)(2)(ii)(A).