Environmental Alert: Avoiding Lender Liability Under CERCLA Following Foreclosure Properties

Avoiding Lender Liability Under CERCLA Following Foreclosure Properties

September, 2013

Author:
Bruce M. Flowers

Lenders are correct in being cautious when foreclosing on commercial properties where the use or storage of hazardous materials may result in liability for environmental contamination.  However, the U.S. Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA") affords protection to secured lenders from environmental liability provided that the lenders meet certain criteria.  These criteria are discussed below.

A secured lender is generally exempted from potential liability under CERCLA if: (i) pre-foreclosure the lender does not participate in management, i.e., does not exercise decision-making control over issues of environmental compliance or overall operational management, and (ii) post-foreclosure the lender holds the property only to protect its security interest, i.e., takes steps consistent with safe harbor provisions and seeks to sell, re-lease or otherwise divest itself of the asset at the earliest practicable, commercially reasonable time, on commercially reasonable terms.  As the potential for foreclosure begins once a lender acquires a secured interest in a property, lenders must from the beginning of the transaction be aware of activities that could result in future environmental liabilities.

Pre- and post-foreclosure activities related to potential environmental liabilities are further discussed below:

Pre-foreclosure:

To "participate in management" (and therefore not qualify for the exemption) a lender must actually participate in the management or operational affairs of a facility or property.  Merely having the capacity to influence or the unexercised right to control the facility or property does not constitute "participating in management" for purposes of the exemption.

More specifically, a lender "participates in management" if the lender, while the borrower is still in possession of the property encumbered by the security interest:

1. exercises decision-making control regarding environmental compliance related to the facility or property, and in doing so, undertakes responsibility for hazardous substance handling or disposal practices; or
2. exercises control at a level similar to that of a manager of the facility or property, and in doing so, assumes or manifests responsibility with respect to:

• day-to-day decision-making on environmental compliance, or
• all, or substantially all, of the operational (as opposed to financial or administrative) functions of the facility or property other than environmental compliance.

A lender does not "participate in management" if the lender, while the borrower is still in possession of the property encumbered by the security interest:

1. inspects the facility or property;
2. protects the environment from a release of contamination;
3. provides financial or other advice to prevent or cure default;
4. changes the terms of the security interest (provided these actions do not rise to a level of "participating in management" as defined above);
5. requests the borrower to clean up a property;
6. requests the borrower to comply with environmental laws and regulations;
7. monitors the property, the borrower's business or financial condition; or
8. undertakes loan "workout" activities (i.e., restructure or re-negotiate the terms of the security interest and provide financial or other advice to the borrower).

Post-foreclosure:

After foreclosure, a secured lender who did not participate in management prior to foreclosure must seek to divest itself at the earliest practicable, commercially reasonable time using commercially reasonable means.  (The Texas state version of CERCLA, the Solid Waste Disposal Act, provides that 12 months is presumed to be a commercially reasonable time.)  Also, the lender may generally: (i) maintain business activities; (ii) wind up operations; (iii) undertake a response action; (iv) sell, re-lease or liquidate the facility or property; or (v) take actions to preserve, protect, or prepare the property for sale without "participating in management".

Lenders should also be aware that while the exemptions discussed above remove qualifying lenders from potential liability under CERCLA as the "owner" or "operator" of a facility or property, the exemptions do not impact potential CERCLA liability for persons who arrange for the transportation of hazardous substances for disposal or treatment (separate and apart from owner or operator liability).

Best Practices:

A lender is prudent to be wary of potential environmental liabilities when foreclosing on a commercial facility or property, especially a facility or property where hazardous materials was stored or used, or when the lender is unfamiliar with a property.  To manage environmental risks associated with foreclosures, lenders should retain knowledgeable professionals before and after a foreclosure to guide the lender toward maximum protection from environmental liabilities.

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This Litigation Alert is a summary of recent developments in the law and is provided for informational purposes only.  It is not intended to constitute legal advice or to create an attorney-client relationship.  Readers should obtain legal advice specific to their situation in connection with topics discussed.

Copyright © 2013 Kane Russell Coleman & Logan PC.  All rights reserved.  Unless otherwise indicated, the authors are not certified by the Texas Board of Legal Specialization.

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