Lenders can maintain CERCLA exemption by following ownership / liability tests
Thank you to all who attended our sessions on "Environmental Management of Commercial Loans" at the California Bankers Association's 19th Annual Lenders Conference, March 19-22, 2006.
The EPA Lender Liability Rule does not encourage controlling borrowers but rather it supports proper loan management.
It may appear the EPA holds financial institutions responsible for the failings of others because lenders have attempted to be responsible in their dealings with developers on environmental issues. However, we must keep in mind that the EPA is responsible for defining and identifying responsible owners and operators in order to assign responsibility for environmental failures, which can have long-lasting and far-ranging effects.
Indeed, the EPA has, on occasion, ruled that lenders have been too involved in the daily operation of a company and, therefore, have been given the responsibility for clean up. Ongoing daily involvement, even if initiated more recently than the violations, confers responsibility because it also suggests some knowledge or awareness of the failures.
Lenders that have failed to conduct due diligence or which were not thorough in protecting their security interests have inherited huge environmental liabilities under CERCLA.
There are, however, important and appropriate lender activities as an owner or operator which are shielded from CERCLA (1980) liability under the secured creditor exemption. The Lenders Exemption provides that the term "owner" or "operator" specifically 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."
The stated purpose of the EPA Lender Liability Exemption is to define and specify the range of permissible activities a lender may conduct without exceeding the bounds of exemption.
The EPA has defined three key and identifiable elements of activities which lenders may conduct without being deemed to have exceeded the bounds of CERCLA exemption. Those elements are: "indicia of ownership"; the requirement that ownership be held "primarily to protect security interest"; and, the prohibition of secured creditors from participating in the management of a facility.
The key elements, all of which must be in place for the lender to avoid liability, are expanded for clarification:
"Indicia of ownership" is defined by the EPA rule as "evidence of interests in real or personal property." Qualifying indicia of ownership include a mortgage, deed of trust, legal or equitable title obtained through foreclosure, a guarantee of an obligation, an assignment, lien, pledge, or other right or form of encumbrance against the property.
To avail itself of the exemption, a lender must prove it holds the indicia of ownership principally for the purpose of securing payment, or performance of a loan or other obligation.
There is a two-pronged test for identifying when a lender has crossed the lines and can be deemed to be "participating in management." Activities of management the secured creditor is prohibited from include: a) exercised decision-making control over the borrower's environmental compliance; or, b) assumed overall management responsibility encompassing the day-to-day decision-making of the borrower's enterprise.
How can lenders protect their loans if they cannot exercise some control over borrowers? The EPA Lender Liability Rule does not encourage controlling borrowers but rather it supports proper loan management.
The United States Environmental Protection Agency has defined four areas where lenders can be involved in environmental inquiries and loan management without being labeled as having "participated in management" of a borrower's company.
Acceptable loan management activities from an environmental standpoint may occur:
- Before the loan transaction takes place, or at the inception of the loan
- During the tenure of the loan
- While undertaking a financial workout with a defaulting borrower
- At foreclosure and when preparing the facility for sale or liquidation
Financial institutions serious about avoiding "unacceptable participation" rulings design and implement their own Lender Loan Management Programs to coincide with the four areas of acceptable participation defined by the EPA. The two most important focused objectives of such a program are to minimize environmental liabilities throughout the life of each loan, and to maintain the Lender's Exemption when borrower viability appears to be at issue.
A solid Lender Loan Management Program addresses lender conduct from the onset of lending conversation, perhaps even before application, and all the way through to loan termination.
Look before leaping:
Lender Loan Management Program
There are several tools and a number of procedures for the various phases of loan management which comprise an effective Lender Loan Management Program.
At the inception of the loan transaction, a Transaction Screen Questionnaire (defined by the ASTM in protocol E1528-93) is used to determine if a Phase I Environmental Site Assessment will be necessary. It is rare that some form of in-depth evaluation is not required on commercial property. Furthermore, it is inaccurate and can be risky to view the Transaction Screen as a shortcut or substitute for a Phase 1 environmental site assessment because, performed according to ASTM protocol, there are many points where the screen leads directly to a full Phase 1 environmental site assessment.
An intermediate tool devised by Harris & Lee Environmental Sciences, LLC is a modified or abbreviated environmental site assessment report. It includes a summary computer data radius report, a brief site reconnaissance, and investigative inquiries into historical use. It is performed in conformance with ASTM protocol, and when performed by experienced senior personnel to draw comprehensive conclusions, it will indicate additional environmental conditions which warrant a Phase 1 environmental site assessment. Not only is the client assured costs will be kept to a minimum, the report can be expanded if considerations require additional detail. Though components of the modified assessment are done in compliance with ASTM standards, it does not technically meet ASTM standards because it is abbreviated. Even so, this abbreviated environmental site assessment will satisfy due diligence requirements for the first phase of the Lender's Exemption rule. Please email for more information.
Finally, ONLY the All Appropriate Inquiries - Environmental Site Assessment, Phase 1 Investigation satisfies the requirement for one of the three landowner liability exemptions provided by the CERCLA Brownfields Amendments. It must be performed in accordance with ASTM E 1527-05. The advantage for lenders is that these landowner exemptions protect the borrower and collateral in commercial real estate loans.
Tenant assessment vs. tenant compliance
The technical term for that time when a facility undergoes a detailed audit in which all phases of environmental compliance are investigated is "multimedia environmental compliance audit." Put simply, it means the auditor's investigation will include all areas for which the potential of contamination exists: soil, air, and occasionally, employee safety and health. The Tenant Environmental Compliance Audit examines not only the paper trail, but chronicles the actual daily practices to minute detail. It is a comprehensive audit process which is important in that it detects noncompliance with numerous and varied regulations, many of which impose heavy fines and cleanup requirements.
A Tenant Assessment is not intended to prevent the facility from minimizing fines due to faulty practices, but rather to identify and to prevent faulty management practices which are likely to create liability by extension to the Lender. An example of the difference in tenant assessment vs. tenant environmental compliance would be incorrect completion of a hazardous waste manifest, as opposed to the outright disposal of hazardous waste without any manifest. Incorrect completion of the manifest could lead to financial fines to the facility, but disposal of the hazardous waste without a proper manifest implies an illegal disposal practice which may be viewed as a criminal offense.
The assessment requires an experienced environmental auditor with a broad philosophical outlook because the hazardous waste was generated from the property, the property owner, or the lender in some cases, could be held responsible.
New vs. existing tenant
Potential environmental risk is minimized when, prior to lease development, a visit is made to the potential tenant's existing facility. A review of relevant processes and how they are presently handled is the best indicator of how the operation will be run once the tenant is situated on the new property. The hazardous waste materials management plan and tools are reviewed and a determination is made as to how well it is followed. Specific issues regarding future compliance can be identified for coverage in the lease agreement.
Lenders should expect to monitor ongoing compliance at tenant facilities on a regular and agreed upon basis. Such monitoring protects the long-term value of the property. The most important aspect of tenant monitoring is to identify and document potential environmental problems which will or may devalue the property, or cause the extension of liability ownership to the Lender.
Depending on circumstances, the EPA has assigned liability of previous owners and lenders to the current occupant of a property. However, because previous tenants and lenders can be assessed penalties, lenders are urged to have pre-evacuation and pre-lease termination assessments of the property. Doing so minimizes the owner and lender exposure by documenting the tenant's departure activities. It may, on occasion, be prudent to require a tenant to develop a comprehensive closure plan, and to police the implementation of that closure plan, as well as to monitor the effectiveness of such a plan. It is helpful to stipulate and draw a prospective tenant's attention to this lender option in the lease. The intention is that tenants who are aware they will be monitored are more likely to be well-prepared, and lease termination may be more manageable.
When Borrowers default
The EPA rule does permit a lender to take necessary steps to protect collateral. For loans threatening default or already in default, borrowers may need professional consultation, which can come at the request of the lender. Lenders may foreclose and not be considered owners for purposes of CERCLA liability. The lender may avoid liability if it undertakes to sell, release or otherwise divest itself of the property in a reasonably expeditious manner. In foreclosure, a property may be operated by a lender under the exemption so long it, as the holder, does not improperly arrange for disposal of hazardous substances at the facility or for transport and disposal at the facility.
Essentially, all EPA rules which applied to the previous tenant apply to the lender as holder in a foreclosure.
Use of expert support
The term "participating in management" as applied by EPA is broad and difficult to interpret. Expert support offering a thorough understanding of the processes and their relationship to all parties is essential to assist lenders in upholding their responsibilities without crossing the line. Technical environmental support should also include appropriate legal assistance to interpret vague language and to assist in refining procedures.
Robert S. Harris is president and senior scientist of Harris & Lee Environmental Sciences, LLC, a Santa Rosa, California environmental consulting firm serving the western United States. He holds degrees in chemistry and biochemistry, and has 32 years experience in environmental analytical chemistry and environmental toxicology. Mr. Harris has established and operated large laboratories and has developed several ground-breaking methodologies for environmental analysis, including the standard method for analysis of polychlorinated biphenyls in water, soils and oils. His firm has saved lenders, insurance, real estate and law clients millions of dollars, including conversion of waste costing $120,000 per month to a usable fuel. He can be reached by email or phone at (707) 571-8961.
Harris & Lee awarded "2009 Best Environmental Firm"
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Harris & Lee Environmental Sciences, LLC
Based in Northern California with offices in Santa Rosa and San Francisco
Santa Rosa: (707) 571-8961