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By THOMAS B. ALLEMAN, a shareholder in the Insurance and Environmental Practice Groups at Winstead PC

CERCLA's lender "safe harbor" provisions, how they work and what they do--and do not do--should be considered by any lender contemplating foreclosure on tainted property.

With foreclosures on many different kinds of property growing at an accelerating rate, an increasing number of lenders find themselves in the unenviable position of contemplating the prospect of actually owning brownfields or other environmentally tainted properties.

In discussing lender safe harbor provisions, it is important to remember that most states now have CERCLA-like statutes. Most provide protection for foreclosing lenders, but some do not. Caution should be exercised--and appropriate professionals consulted--before it is assumed that state law provides the same degree of protection as CERCLA.

Nonetheless, CERCLA's lender safe harbor provides a reasonable yardstick for measuring liability for environmental conditions on foreclosed or REO property.

WHEN SAFE HARBOR APPLIES

Under CERCLA's lender safe harbor provision, a lender or its privies are considered an "owner or operator" of a plant for CERCLA purposes only if it "participates in management" of the facility.

"Participat(ing) in management" is at best an elastic clause, but received wisdom as well as the statute itself states that exercising a security interest or foreclosing on property does not constitute "participat(ing) in management" so as to subject the lender to liability.

Likewise, a lender does not "participate in management" so long as it makes commercially reasonable efforts to sell the property--i.e., asks a commercially reasonable price for the property and makes appropriate efforts to sell it given the nature of the property and market conditions--even if it is initially unsuccessful in doing so.

Taking steps during the foreclosure or post-foreclosure process to operate or maintain the property, up to and including cleaning up existing contamination (or compelling the borrower to do so), does not constitute "participat(ion) in management" so long as, but only so long as, those steps do not increase the environmental risks as the property.

WHAT IT MEANS IN THE LEGAL WORLD

As an example, consider a 2007 case in the U.S. District Court, Southern District of New York, involving HSBC. After a chemical plant's owners defaulted on its loan, HSBC, the lender, insisted on a lockbox account arrangement by which it received control of all incoming funds and approved all plant expenditures.

For several months, HSBC approved routine operating expenses, including those for waste disposal. As time went on, however, HSBC froze the lockbox account, as the result of which the plant owners were forced to abandon the facility, leaving behind a substantial amount of hazardous material. The EPA ruled that HSBC's decision to cut off funds for waste management and its knowledge that the owner intended to walk away leaving the hazards unremediated if it did so constituted participation in management; HSBC had effectively controlled the handling or disposal of the hazardous materials. HSBC settled the claims for $1 million.

In another case, XDP Inc. v. Watumull Properties Corp., a corporation created a single purpose entity to operate an environmentally tainted facility it had acquired, a technique commonly relied upon in foreclosures.

It argued that corporate formalities should be respected and that, even if the SPE was liable under CERCLA as an owner, it should not be. The court found that creation of an SPE was not a "silver bullet" defense because there was evidence from which it could be inferred that the parent company had in fact directed the SPE's operations at the site.

And in United States v. 175 Inwood Assoc. LLP, a director who had been placed on the board of a company operating a site at the request of a lender to protect its interest could not escape CERCLA liability using the lender "safe harbor" because he had personally participated in site operations.

THE PRACTICAL TAKEAWAYS

What these cases remind lenders is that many of the devices routinely used as a part of the foreclosure or workout process to limit liability may not be effective when it comes to CERCLA or state environmental cleanup liability. This does not mean that lenders with brownfields portfolios are entirely without options, however.

Obviously, the best defense to later liability is careful, early underwriting for environmental risks. A part of that process should include a requirement that the borrower maintain pollution/environmental liability insurance with the lender named as an insured.

Lenders who have brownfields portfolios should also consider whether to maintain their own pollution/environmental insurance on that portfolio. While there are obviously additional and not insignificant costs associated with maintaining insurance, the costs of a single uninsured CERCLA cleanup claim can far exceed the premium costs for insurance.

Foreclosure should never be undertaken casually, and extra care should be used with environmentally suspect properties. It may sometimes be wisest to forego foreclosure altogether, but if foreclosure is the right choice, operations at the foreclosed property should be undertaken in consultation with appropriate counsel or other professionals and with constant attention to the limitations on CERCLA's safe harbor.

July 1, 2009

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