Can Lenders Be Liable for Property Contamination? What Banks and Borrowers Should Know

Under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), various parties can potentially be held liable for cleanup costs (among other costs) associated with property contamination. This is true regardless of whether these parties were the original source of the contamination at issue. However, various exemptions and defenses to CERCLA liability may apply—including the secured creditor defense for lenders that finance the acquisition of contaminated properties. Learn more from the California contamination lawyers at Bick Law LLP:

The Secured Creditor Defense to CERCLA Liability: An Overview

As a general rule, lenders are exempt from liability under CERCLA as long as they do not participate in the management of the property. This is expressly stated in long-standing U.S. Environmental Protection Agency (EPA) guidance, which acknowledges that, “CERCLA Section 101(20) contains a secured creditor exemption that eliminates owner/operator liability for lenders who hold ownership in a CERCLA facility primarily to protect their security interest in that facility, provided they do not ‘participate in the management of the facility.’”

As EPA’s guidance makes clear, ensuring that a lender does not “participate in the management” of an encumbered property is essential for the secured creditor defense to apply. Under EPA’s guidance, to “participate in the management” of a facility does not include:

• Having the capacity to influence or the unexercised right to control facility operations;
• Acting or failing to act before a security interest is created;
• Holding, abandoning or releasing a security interest;
• Contractually mandating environmental compliance;
• Monitoring or enforcing contractual compliance;
• Monitoring or inspecting the facility that secures a loan;
• Requiring a borrower to act in response to a release or threatened release of a hazardous substance;
• Providing financial or other advice to a borrower, “in an effort to mitigate, prevent or cure default or diminution in value;”
• Restructuring a loan or agreeing to forbearance;
• Exercising remedies for breach of the terms of a loan; or,
• Taking responsive action under CERCLA, “provided that these actions do not rise to the level of participation in management within the meaning of the statute.”

In its guidance, EPA also makes clear that lenders can remain exempt from CERCLA liability if they need to foreclose on a property—even if this means engaging in conduct that would otherwise qualify as “participating in management.” Specifically, EPA’s guidance allows foreclosing lenders to do all of the following (provided that they did not “participate in management” prior to foreclosure) and remain insulated from liability under CERCLA:

• Maintain the borrower’s business activities;
• Wind up the borrower’s operations;
• Take responsive action under CERCLA (provided they do so under the direction of an on-scene coordinator);
• Sell, lease or liquidate the facility; and,
• Take steps that are necessary to “preserve, protect or prepare the property for sale.”

This is subject to the caveat, however, that a lender may only conduct these activities and remain insulated from liability for as long as the lender, “attempts to sell or re-lease . . . or otherwise divest itself of the property at the earliest practicable, commercially reasonable time using commercially reasonable means.”

With all of this in mind, what does constitute “participating in the management” of an encumbered property? Here, rather than providing specific examples, EPA’s guidance outlines three broad categories of “participation”:

1. “Actually” Participating in the Management of the Property

According to EPA’s guidance, “[a] lender ‘participates in management’ (and will not qualify for the exemption) if the lender ‘actually’ participates in the management or operational affairs of a facility.” While this does not provide a great deal of insight, EPA provides the clarification that “[m]erely having the capacity to influence or the unexercised right to control the facility” does not amount to “actual” participation.

2. Having Decision-Making Control Regarding Environmental Compliance

If a lender “exercises decision-making control regarding environmental compliance related to the facility and, in doing so, undertakes responsibility for hazardous substance handling or disposal practices,” then the lender can face liability under CERCLA as a party that “participates in the management” of a contaminated property. This is true regardless of whether the lender is otherwise “actually” involved in the property’s management.

3. Exercising Control “At a Level Similar to That of a Manager” of the Property

Lenders can also face liability under CERCLA if they “exercise[] control at a level similar to that of a manager of the facility.” For liability to attach in this scenario, the lender must also “assume[] or manifest[] responsibility” regarding one or both of the following:

• “[D]ay-to-day decision-making on environmental compliance;” and/or,
• “[A]ll, or substantially all, of the operational (as opposed to financial or administrative) functions of the facility other than environmental compliance.”

Here too, a lender can face liability under CERCLA regardless of whether the lender is otherwise “actually” involved in the property’s management.

Key Takeaways for Banks and Borrowers Regarding the Secured Creditor Defense to CERCLA Liability

In summary, while banks and other lenders can face liability under CERCLA, there are steps that lenders can—and generally should—take to prevent this from happening. The costs associated with remediation and other contamination-related costs under CERCLA can be substantial, and lenders should not expose themselves to these costs unnecessarily.

For borrowers, it is important to keep in mind that lenders will most likely be taking steps to avoid CERCLA liability—and understandably so. Even in the event of foreclosure, borrowers may still be on the hook in the event of EPA enforcement. Fortunately, there are other defenses to CERCLA liability as well, and, with a proactive approach, borrowers will be able to secure the protection of these defenses in many cases.

Speak with a California Contamination Lawyer at Bick Law LLP

If you need to know more about the secured creditor defense to CERCLA liability or any of the other defenses that are available, we invite you to get in touch. To speak with a California contamination lawyer at Bick Law LLP in confidence, give us a call at 949-432-3500 today.