In this current climate of loan defaults and foreclosures, lenders are becoming increasingly concerned with their potential environmental liability when deciding whether or not to accept known contaminated property as collateral for loans. While such lender concerns are understandable, lenders are afforded significant state and federal liability protection, even after foreclosure, such that existing environmental contamination currently being addressed on loan collateral should not be an impediment to lending.
CERCLA'S Original Lender Safe Harbor
Section 107(a)(2) of the original CERCLA statute imposes liability for the costs of cleanup at hazardous waste sites on 'any person who at the time of disposal of any hazardous substance owned or operated any facility at which hazardous substances were disposed.' 42 U.S.C. Sec. 9607(a)(2)(1995). This definition begged the question of whether certain practices by lenders, such as foreclosing on mortgaged property after a borrower defaults, subjected lenders to CERCLA liability as 'operators' when those practices involved property that contained hazardous substances. Fortunately the original CERCLA statute enacted a safe harbor provision for such practices, stating that the term 'operator' 'does not include a person, who, without participating in the management of a facility, holds indicia of ownership primarily to protect his security interest in the facility.' 42 U.S.C. Sec. 9601(20)(A) (1995). Because most lenders did not 'actually participate' in the day-to-day operations of a facility, even after foreclosure, this provision appeared to protect lenders from CERCLA liability as an 'owner' or 'operator'. See id.
However, the Fleet Factors case held that lenders could nevertheless incur CERCLA liability 'by participating in the 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' as an operator.' Fleet Factors, 901 F.2d at 1557 (emphasis added). The court in Fleet Factors further stated that a 'secured creditor will be liable if its involvement with the management of a facility is sufficiently broad to support the inference that it could affect the hazardous waste disposal decisions if it so chose.' Id. at 1558. Thus, Fleet Factors held that a lender could incur CERCLA liability if it merely had the capacity to influence decisions regarding decisions regarding the disposal of hazardous waste, even if that lender was not actually involved in those disposal decisions. See id. Because the standard adopted by the Fleet Factors court of having a 'capacity to influence' was inherently ambiguous and subjective, particularly after a lender had foreclosed on hazardous property, this holding created potential CERCLA liability for lenders.
In response to the Fleet Factors decision, EPA issued a regulation that set forth a specific test to determine the scope of a lender's liability under CERCLA. See 40 C.F.R. Sec. 300.1100(c)(1)(1992). However, the Court of Appeals for the D.C. Circuit invalidated that regulationin Kelley v. Environmental Protection Agency, 15 F.3d 1100 (D.C. Cir. 1994), 40 C.F.R. Sec. 300.1100(c)(1)(1992), and held that EPA did not have the authority to issue decisions that restricted private rights of action under CERCLA. See Kelley, 15 F.3d 1100 (D.C. Cir. 1994).
Asset Conservation, Lender Liability and Deposit Insurance Protection Act of 1996
Congress responded to Kelley by passing the Asset Conservation, Lender Liability, and Deposit Insurance Protection Act of 1996, which amended and expanded CERCLA's secured creditor exemption. Under the amended secured creditor exemption:
a person that is a lender and holds 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 -
(I) exercises decision making control over the environmental compliance related to the vessel or facility, such that the person has undertaken responsibility for the hazardous substance handling or disposal practices related to the vessel or facility; or
(II) exercises control at a level comparable to that of a manager of a vessel or facility, such that the person has assumed or manifested responsibility
(aa) for the overall management of the vessel or facility encompassing day-to-day decision making with respect to environmental compliance; or
(bb) over all or substantially all of the operational functions (as distinguished from financial or administrative functions) of the vessel or facility other than the function of environmental compliance.
42 U.S.C. Sec. 9601(20)(F) (1998). (emphasis added).
The amended exemption overruled Fleet Factors, stating that participating in management 'does not include merely having the capacity to influence, or the unexercised right to control, vessel or facility operations.' 42 U.S.C. Sec. 9601(20)(F)(i)(II) (1998).
The 1996 Lender Liability Amendments also added a new section 42 U.S.C. 9607(20)(E) that addresses foreclosure and protects a lender's ability to foreclose on property contaminated with hazardous substances without jeopardizing the protection of the CERCLA secured creditor exemption. Like the CERCLA Lender Liability Rule, the new subsection allows financial institutions to foreclose, re-lease (in the case of a sale/leaseback transaction) or sell its collateral so long as the lender attempts to divest itself of the facility or vessel “at the earliest practicable, commercially reasonable time, on commercially reasonable terms, taking into account market conditions and legal and regulatory requirements.” 42 U.S.C. Sec. 9601(20)(E)(i)(II) (1998).
The 1996 Lender Liability Amendments provide that a lender may maintain business operations, wind down operations, take measures to preserve, protect and prepare the vessel or facility for sale or disposition, and even undertake response actions under section 107(d)(l) of CERCLA or under the direction of an OSC so long as the lender seeks to sell or re-lease (in the case of a sale/leaseback transaction) and complies with the foreclosure requirements set forth above. Thus, assuming that a lender did not participate in the management of the facility prior to foreclosure, a lender can foreclose on contaminated property and avoid CERCLA liability if that lender 'divests' itself of the property in the manner set forth in the statute. See id. Importantly, the language of the amended secured creditor exemption under CERCLA specifically mentions current market conditions and regulatory requirements as factors in the analysis of whether a lender has divested itself of the property 'at the earliest practicable, commercially reasonable time.' See id.
New Jersey Spill Act (N.J.S.A. 58:10-23.11g)
New Jersey’s lender liability provisions are set forth in N.J.S.A. 58:10-23.11g. In 1993, New Jersey amended the Spill Act (“Amendment”) to include a safe harbor provision protecting lenders from incurring Spill Act liability merely because the lenders held indicia of ownership in real or personal property to protect a security interest. In many respects, the New Jersey statute tracks CERCLA. Interestingly, it provides very specific guidance as to what actions a lender must take after foreclosure to avoid liability.
Under the Amendment, a lender who maintains indicia of ownership primarily to protect a security interest (“holder”) is not liable for a discharge under the Spill Act as long as the lender does not participate in the management of the facility in which indicia of ownership is held after indicia of ownership is first acquired. N.J.S.A. 58:10-23.11g5.
No pre-lending act or omission is held to protect a security interest constitutes evidence of participation in management. N.J.S.A. 58:10-23.11g4.
Further, a holder is permitted to engage in a variety of post-lending activities without avoiding the safe harbor. First, a holder may engage in activities typically associated with the “policing of a loan”. These activities include requiring the borrower to clean up a facility; requiring compliance with applicable laws and regulations; securing or exercising authority to monitor or inspect the facility; securing or exercising authority to monitor or inspect the borrower’s business or financial condition; and taking other actions such as requiring the borrower to comply with any warranties, covenants, conditions, representations or promises obtained from the borrower. N.J.S.A. 58:10-23.11g4.
Second, a holder may engage in activities typically associated with the “work out” of a loan. These activities include restructuring or renegotiating the terms of the security interest; requiring payment of additional rent or interest; exercising forbearance; requiring or exercising rights pursuant to an assignment of accounts or other amounts owing to an obligor; requiring or exercising rights pursuant to an escrow agreement pertaining to amounts owing to an obligor; providing specific or general financial or other advice, suggestions, counseling, or guidance; and exercising any right or remedy the holder is entitled to by law or under warranties, covenants, conditions, representations or promises obtained from the borrower. N.J.S.A. 58:10-23.11g4.
A holder may also conduct any response action under CERCLA, the Spill Act or other State of federal environmental law or regulation without voiding the safe harbor. N.J.S.A. 58:10-23.11g4.
Indicia of ownership held after foreclosure (provided that the holder did not participate in management prior to foreclosure) will also not give rise to Spill Act liability provided that the holder undertakes to sell, re-lease property pursuant to a lease finance transaction, or otherwise divest itself of the facility in a “reasonably expeditious manner” after foreclosure. N.J.S.A. 58:10-23.11g6. The Amendment defines reasonably expeditious manner as “whatever commercially reasonable means relevant or appropriate with respect to the facility. N.J.S.A. 58:10-23.11g6(a). Commercially reasonable activity includes listing the facility with a broker, dealer, agent or advertising the facility as being for sale, on at least a monthly basis, in either a real estate or trade publication or a newspaper of general publication within 12 months from the time the holder acquires marketable title. N.J.S.A. 58:10-23.11g6(c).
However, it is important to note that under New Jersey law, a holder must sell, re-lease property held pursuant to a new lease financing transaction, or otherwise divest a facility no later than five years after the date of foreclosure or the holder is deemed to have held indicia of ownership not primarily to protect a security interest. However, a holder can avoid this determination, even after five years, if it can prove that it made a good faith effort to divest the property, obtained approval required by federal and State banking or lending laws to continue its possession of the property, and exercised reasonable custodial care to prevent or mitigate any new discharges from the facility that could substantially diminish the market value of the property. N.J.S.A. 58:10-23.11g6(d).
The lender exemption does not apply to liability for any new discharge from the facility occurring after the date of foreclosure that is caused by negligent acts or omissions of the holder. N.J.S.A. 58:10-23.11g1(e). The exemption also does not apply to liability arising out of the off-site disposal or treatment of a hazardous substance or for accepting for transportation and disposing of a hazardous substance at an off-site facility selected by the holder. N.J.S.A. 58:10-23.11g3(e).
Lastly, the Amendment does create several post foreclosure obligations upon a holder. If a holder forecloses on a facility at which it has actual knowledge a discharge occurred or began prior to the date of foreclosure, the holder must, within 30 days of the date of foreclosure, notify the DEP of the foreclosure. N.J.S.A. 58:10-23.11g7(c)1. Further, the holder must immediately notify the DEP of any new discharge at a foreclosed facility. N.J.S.A. 58:10-23.11g7(c)2.
The Law Office of Christopher D. Hopkins LLC has extensive experience in matters relating to liability or potential liability resulting from the contamination of real property and the financing of contaminated property.
About The Law Office of Christopher D. Hopkins, LLC
The Law Office of Christopher D. Hopkins, LLC is a boutique law firm located in Scotch Plains, New Jersey committed to providing the highest quality of legal services in the select areas ofreal estate, land use and environmental law. The firm is committed to working collaboratively with clients to achieve practical, cost effective results- whether it be in complex litigation, transactions, cleanups and/or development projects. The firm provides transactional and litigation counsel to a broad spectrum of clients including private and public corporations, trade associations, nonprofit institutions, banks, real estate investment trusts and individuals in New Jersey, New York and Pennsylvania.
The Law Office of Christopher D. Hopkins, LLC
1812 Front Street
Scotch Plains, NJ 07076