Secured Credit Exemption Upheld

©1999 New Jersey Law Journal

In a favorable decision for the banking and lending industries, the United States District Court for the Western District of Pennsylvania recently granted summary judgment to a small savings and loan that was the target of contribution and cost recovery actions under the Comprehensive Environmental Response, Compensation and Liability Act, 42 U.S.C. §9601 (1998) ("CERCLA"). This ruling, in the case of United States v. Marvin Pesses, No. 90-0654, 1998 U.S. Dist. LEXIS 7902 (W.D. Pa. May 6, 1998), demonstrates the protections afforded to lenders by the recently amended CERCLA secured creditor exemption, particularly after a lender forecloses on or assumes ownership of property containing hazardous substances. In addition, the decision signals an end to the uncertainty regarding a lender's potential CERCLA liability for the cleanup of hazardous substances at property at which it holds a security interest, an uncertainty that derived from the now infamous decision of United States v. Fleet Factors Corp., 901 F.2d 1550 (11^th Cir. 1990).

In Marvin Pesses, the court held that Dollar Savings Association ("Dollar Savings") was exempt from liability under CERCLA's recently adopted amendments to the secured creditor exemption. See Marvin Pesses, 1998 U.S. Dist. LEXIS at *64. This amended statutory exemption was the product of the Asset Conservation, Lender Liability, and Deposit Insurance Protection Act of 1996. This Act, enacted by Congress on September 30, 1996, was the culmination of varied judicial, administrative and legislative responses to Fleet Factors, particularly that case's interpretation of when a lender incurred potential CERCLA cleanup liability.

Section 107(a)(2) of the original CERCLA statute imposed 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. §9607(a)(2)(1995)(emphasis added). 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 for lenders, the original CERCLA statute ostensibly 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. §9601(20)(A) (1995) (emphasis added). 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.

Despite this apparent protection, Fleet Factors 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 unprecedented potential CERCLA liability for lenders. Compounding the situation, in In Re Bergsoe, 910 F.2d 668 (9^th Cir. 1990), the Ninth Circuit of the U.S. Court of Appeals issued an ambiguous decision that neither rejected nor explicitly concurred with the expansive holding and troubling language of Fleet Factors. See Bernard J. Berry, Jr. and Patricia M. Greeley, Lenders Still Skittish on Superfund Liability, 128 N.J.L.J. Index Page 511 (1991).

In response to the potential scope of the Fleet Factors decision, in 1992, the Environmental Protection Agency ("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. §300.1100(c)(1)(1992). This regulation provided that a lender would not incur CERCLA liability if the lender: (1) investigates the environmental condition of collateral before taking a security interest; (2) monitors or inspects the facility; and (3) requires the borrower to comply with environmental standards. Id. Importantly, the regulation protected a lender from liability as an operator after foreclosure, as long as the lender did not participate in the management of the facility prior to foreclosure and undertook to divest itself of the property promptly after foreclosure. See 40 C.F.R. §300.1100(d) (1992). (emphasis added).

Although this regulation eliminated much of the potential for CERCLA liability deriving from Fleet Factors, the protection and certainty afforded by this regulation was short-lived. In Kelley v. Environmental Protection Agency, 15 F.3d 1100 (D.C. Cir. 1994), the Court of Appeals for the D.C. Circuit invalidated 40 C.F.R. §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). Although the Kelley court recognized that the EPA had the general authority to promulgate regulations under CERCLA, the court held that the EPA needed explicit or implicit congressional authority in order to issue regulations regarding a lender's potential liability under CERCLA. See id. The court in Kelley found that Congress had not delegated to the EPA such authority, and thus invalidated 40 C.F.R. §300.1100(c)(1)(1992).

The Kelley decision firmly placed the burden of resolving the ambiguity of a lender's potential CERCLA liability with Congress. Congress responded by passing the Asset Conservation, Lender Liability, and Deposit Insurance Protection Act of 1996, which amended and expanded CERCLA's secured creditor exemption.

This Act attempted to finally clarify and amend the extent of the secured creditor CERCLA exemption, which had been blurred by Fleet Factors and its progeny. Ironically, the language of the amended secured creditor exemption essentially paralleled the language of the EPA regulation that had been invalidated in Kelley. See 42 U.S.C. §9601(20)(E) (1998).

The amended secured creditor exemption eliminated the ambiguity that existed regarding when a lender is considered to have "participated in management" of a facility, which was created by Fleet Factors. Under the amended secured creditor exemption:

42 U.S.C. §9601(20)(F) (1998). (emphasis added).

Notably, the amended exemption explicitly overruled the ambiguous language of 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. §9601(20)(F)(i)(II) (1998).

In addition, the amended secured creditor exemption protects a lender's ability to foreclose on property contaminated with hazardous substances without jeopardizing the protection of the CERCLA secured creditor exemption. Under the amended exemption, a lender that forecloses on contaminated property will not be considered an "owner" or "operator", if that lender did not "participate in management" prior to foreclosure and, if the lender:

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.

The protections for lenders provided by the amended exemption are apparent in United States v. Marvin Pesses, No. 90-0654, 1998 U.S. Dist. LEXIS 7902 (W.D. Pa. May 6, 1998). In Marvin Pesses, the United States of America filed suit under CERCLA against twenty-six defendants to recover cleanup costs that it incurred in connection with the release of hazardous substances at the Metcoa Radiation Site in Pulaski, Pennsylvania. Id. at *3. Some of those defendants settled their claims with the United States, and then filed an action for contribution against Dollar Savings pursuant to §113 of CERCLA. Id. at *6-7.

To prevail on their §113 contribution claim against Dollar Savings, the defendants were required to establish that Dollar Savings was an "owner" or "operator" of the Metcoa site at the time of the disposal of the hazardous substances. Id. at *57. Dollar Savings filed for summary judgment as to the defendants' claims against it, arguing that it was not an "owner" or "operator" under the amended secured creditor exemption. Id. at *72.

The court stated that Dollar Savings had "the burden of establishing its entitlement to the secured creditor's exemption." Id. at *61 (citing Stearns & Foster Bedding Company v. Franklin Holding Corp., 947 F.Supp. 790, 802 (D.N.J. 1996)). In order to satisfy that burden, Dollars Savings was required to "show (1) that it did not participate in the management or operational affairs of the Site while the borrower was still in possession of it, 42 U.S.C. §9601(F)(ii), and (2) that notwithstanding its business activities at the Site, it has made commercially reasonable efforts, as soon as practicable, to divest itself of the property." Id. at *62 (citing 42 U.S.C. §9601(20)(E)(ii)).

The court found that Dollar Savings satisfied these criteria. Id. As to the first criterion, the court concluded, based upon the record before it, that Dollar Savings did not participate in the management of the site and had no influence over the tenant's processes or waste disposal practices while Marvin Pesses was in possession of the site. Id. at 66-67.

The court also found that Dollar Savings had met its burden as to the second criterion. In discussing its holding, the court referred to the history of Dollar Savings' financing of the site. Specifically, the court reasoned that the Lawrence County Industrial Authority ("LCIA"), owned the site at issue in Marvin Pesses and had obtained industrial development financing from Dollar Savings and other lenders in order to facilitate development of the site. Id. at *64. In exchange for financing, LCIA gave Dollar Savings chattel mortgages on machinery and equipment and a mortgage on the real estate. Id. at *65. LCIA then provided the loan proceeds to the tenant at the site, so that the tenant could fund development at the site. In addition, LCIA assigned the tenant's rental payments to Dollar Savings in order to pay off the mortgage. Id.

Dollar Savings declared default in 1983, when the tenant failed to make a required payment. In the interim, the tenant's creditors had compelled the tenant into Chapter 7 bankruptcy protection. See id. at *66.

Despite this default, Dollar Savings did not foreclose upon the mortgaged property. Id. at *67. Rather, Dollar Savings engaged in an active attempt to locate a new tenant at the site, by offering a similar industrial development loan structure to prospective new tenants. Id. Although Dollar Savings "entertained inquiries", no prospective tenant made a "firm, bona fide offer." Id. Further efforts to locate a new tenant were complicated by the discovery of low level radioactive material at the site in 1984. Id. at *68. Finally, in 1986, Dollar Savings determined that further efforts to obtain further payment of its loan by leasing or selling the site were futile, and so it mailed the keys to the facility at the site to the bankruptcy trustee, which had assumed the rights of the tenant under the lease. Id. at *70. Thereafter, Dollar Savings had limited inquiries regarding the site, and Dollar Savings' continuing efforts to sell or lease the property were impaired by the environmental contamination, pending litigation and an inability to gain access to the site because of the environmental contamination. Id.

The court in Marvin Pesses found that this course of conduct by Dollar Savings satisfied the requirement that Dollar Savings divest itself of the facility "at the earliest practicable, commercially reasonable time, on commercially reasonable terms, taking into account market conditions and regulatory requirements", as required by 42 U.S.C. §§ 9601(20)(E)(i)(I) (1998). Id. at *71. Although three years passed between default and the decision by Dollar Savings to divest itself of the property, the court noted that "market conditions" and certain regulatory impediments contributed to the delay, particularly the regulatory and practical impediments presented by the discovery of the radioactive material. See generally id. at *69-72. Also, the court noted that although Dollar Savings received some offers to lease or purchase the site, those offers would not significantly improve Dollar Saving's financial position in the property. See id. However, because a lender need not divest itself of property on terms that are not "commercially reasonable", the decision by Dollar Savings not to divest itself of the property by accepting those offers was not violative of the amended secured creditor exemption. See id.

Thus, Marvin Pesses demonstrates the importance of the newly adopted language of the CERCLA secured creditor exemption. In particular, the amended exemption protects a secured lender's ability to foreclose on contaminated property if the lender divests itself of that property on "commercially reasonable" terms at the "earliest practicable, commercially reasonable time". Importantly, the amended exemption explicitly includes "market conditions" and "regulatory requirements" as part of that analysis.

Because of this language in the amended exemption, lenders now enjoy significant protection from CERCLA liability, even after foreclosure. Although it has been over eight years since the Fleet Factors decision, lenders can now take solace that the uncertainty and confusion regarding a lender's potential CERCLA liability has been eliminated.

Marvin Pesses also provides instructive guidance for lenders regarding their potential liability under the comparable New Jersey statute governing the liability for discharge of hazardous wastes, the New Jersey Spill Compensation and Control Act, N.J.S.A. 58:10-23.11a. The Spill Act also contains a secured creditor exemption, which is similar to the language in CERCLA and is to be interpreted consistently with the CERCLA exemption. See Kemp Industries, Inc. v. Safety Light Corp., 857 F.Supp. 373 (1994)(interpreting N.J.S.A. 58:10-23.11g5, which is the secured creditor exemption). Therefore, the court's favorable interpretation of the CERCLA amended secured creditor exemption in Marvin Pesses will also serve as favorable instructive guidance for lenders regarding their potential Spill Act liability.