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Managing Environmental Liability During Bankruptcy

Corporations and their creditors must understand the law to manage environmental liabilities during bankruptcy.  This blog is a brief exert from the bankruptcy chapter of my book titled Managing Environmental Liability – Business Transaction and Brownfield Redevelopment.           

The bankruptcy cases of Chrysler and General Motors are examples of the growing trend toward “fast-track restructuring” through the use of section 363 to sell the debtors’ assets free and clear of liens, claims and interests, including environmental claims.  In the Chrysler case, the bankruptcy court authorized the sale of substantially all of the debtors’ operating assets free and clear of all claims and interests not expressly assumed by the purchaser, whether arising before or after the Chapter 11 filing.  For purposes of the sale, “claims and interests” included, among others, all claims or rights based on successor, environmental liability, with all such claims to attach to the proceeds of the sale.  The sale order explicitly enjoined third parties from asserting against the purchaser any and all claims and interests related to the sold assets, though it did provide a carve-out for governmental entities seeking to enforce environmental claims to which the purchaser would be subject as the post-closing owner or operator of property.  Indeed, the sale order expressly provided that the sale order not be interpreted in any way to deem the purchaser liable under a successor liability theory for violations of environmental laws or liabilities relating to any off-site waste disposal prior to entry of the sale order.         

A group of Indiana state pension funds and a coalition of consumer groups, which argued that the Chrysler sale discriminated against secured lenders and abrogated key liabilities, appealed, challenging the sweeping relief contained in the bankruptcy court’s sale order.  The Second Circuit Court of Appeals upheld the sale order.

Perhaps the most important precedent for fast-track section 363 sales was the General Motors’ Chapter 11 case which authorized a section 363 sale for substantially all of General Motors’ operating assets on substantially similar terms.

The federal government may object to proposed sales of substantially all of the assets of a debtor if they do not provide adequate assurances that environmental liabilities will be addressed or if the proposed order purports to cut-off potential successor liability of the purchaser for pre-sale penalties, pre-sale response costs or pre-sale off-site disposal by the debtor. An example of language that has been acceptable to the federal government is the following:

“Nothing in this Order or the Asset Purchase Agreement releases or nullifies any liability to a government entity under police and regulatory statutes or regulations that any entity would be subject to as the owner or operator of property after the date of entry of this Order.”

Managing Environmental Liability in Light of the EPA Guidance on Bankruptcy Proceedings

 In 1997, EPA issued a guidance document “Guidance on EPA Participation in Bankruptcy Cases” which identifies the factors EPA will consider when determining whether to participate in a bankruptcy case, including whether to pursue collection of costs or penalties against debtors who have liability under CERCLA or other environmental statutes.

One factor that EPA will consider when deciding whether to file a proof of claim is the potential amount that may be recovered as well as the priority that will be afforded to the claim. Another factor is the amount of funds available for distribution in the bankruptcy case and the priority and amount of other claims against the bankruptcy estate.

 EPA will also evaluate the resources that will have to be allocated for such things as discovery for substantiating the claim and expert testimony for developing remedial estimates. The agency indicated that the resources should be measured against the potential gain in filing a claim. For example, in a CERCLA case where there are other viable PRPs, or where other viable PRPs are already committed to undertake the cleanup, the guidance document stated that the resources needed to pursue a claim in bankruptcy against a debtor PRP may outweigh any anticipated return. Further, in CERCLA cases where the Agency has not yet selected a remedy, the resources needed to establish the likely remedy and the estimated cost of such remedy before the bankruptcy court may outweigh any anticipated return.

The guidance document also indicated that EPA may consider other factors such as the likelihood that other PRPs may not be able to recover their fair share of costs from the debtor because the contribution action may be considereda contingent claim for contribution and disallowed pursuant to section 502(e)(1). In such circumstances, EPA may elect to proceed withthe filing of a claim against the debtor PRP.

Finally, the agency will consider the usual factors that are taken into account in deciding whether to take enforcement action in a non-bankruptcy case such as the culpability of the debtor, the strength of the evidence against the debtor, the deterrence value of such action, the precedential value of such action and the interests of justice and equity.

Environmental Liability Management Strategy for Debtors

As previously discussed, there are a number of advantages that favor filingfor bankruptcy.  When a prospective debtor is confronted with environmental litiga­tionor costly cleanup orders, an immediate benefit that a debtor can gain by filing is to bring a temporary halt under the automatic or discretionary stay provisions of the code to the lawsuits and the enforcement of any judgments or perhaps injunctive cleanup orders.

Of course, the suspension of such litigation or cleanup orders will only be temporary.  However, filing could also provide the debtor with permanent relief if its environmental claims qualify as dischargeableclaims.  Because the jurisdic­tionsare split on when a claim arises, there is a strong incentive for debtors to race to the courthouse of a jurisdiction that follow the LTV and Jensen early claim accrual view since this would maximize the number of claims that are deemed pre-petition and, hence, dischargeable.

If the environmental claims are based on the debtor being a PRP at a non-owned waste disposal site, the debtor should probably file because there is a greater likelihood that those claims will be discharged.  This is because the LTV decision suggested the requirement under 28 U.S.C. 959(b) to maintain properties that a debtor owns or operates which can transform a pre-petitionclaim into a post-petition liability does not apply to waste disposal facilities that are neither owned or operated by the debtor nor to parcels no longer under the control of the debtor.

If the debtor’s environmental liability is primarily arising out of contribution of indemnity claims of a landlord or other PRPs, the majority of jurisdictions would find that these are contingent claims under the Code that are subject to disallowance or estimation.  Thus, a borrower could gain leverage to negotiate reductions in the amount of these claims and obtain complete releases for future liability.

Another advantage of filing is that a debtor will be able to consolidate all of its environmental claims in one forum before a court that may be more sympathetic to the goals of the Code.  Faced with the possible discharge or disallowance of their claims, creditors may be more open to negotiatinga cap on the amount of their environmental claims and to stretching‑out the time for completing the cleanup.

Bankruptcy may provide the debtor with several tools for funding cleanups.  A DIP may be able to find a lender who will be willing to advance money to perform a site investigation or a cleanup in exchange for additional or clean collateral and priority over other creditors.  If no such lender materializes, the debtor could try to surcharge the lender’s collateral under 506(c) or use its cash collateral to fi­nance the remediation under section 363.  The debtor could also borrow from the techniques employed in mass tort settlements and create a funding mechanism for claims that may spring into life after the plan has been confirmed.

If a debtor does elect to file, it should provide as wide a notice as possible in order to frustrate any future efforts by creditors to undo a discharge of their claim on the basis that they did not receive notice of the claim.  If the debtor does not know the identity of all the possible claimants, a descriptionof the events creating the liability should be contained in the schedule.  Obviously, a debtor will have to give great considerationin determining whether to schedule the claim of a creditor who might not otherwise become aware of the claim.  If there is a strong likelihood that the claim is dischargeable, it would seem preferable to schedule the claim.

If a site to be operated by a reorganized debtor has a number of RCRA regu­lated hazardous waste management units that may have to be upgraded or that are subject to closure, the DIP or Chapter 11 trustee should consider only operating the portion of the site that does not contain the RCRA units.  Since the inactive RCRA units would not be operated by the reorganized debtor, it is possible that 28 U.S.C. 959(b) may not apply to the inactive units, thereby relieving the reor­ganized debtor from complying with the closure requirements for those units.

The debtor could also try to use the Code to maximize the value of its assets by obtaining an order under section 363 allowing it to sell some or all of its non‑real estate assets “free and clear of all liens or claims” to enable the purchaser to avoid liability as a successor corporation.  If its most valuable asset is real estate, the debtor could try to immunize a purchaser by proposing in its reorganization plan that the bankruptcy court find that a purchaser meets the qualifications of an innocent purchases, although it is less likely that a court will issue such an order.  Instead, the transferee would likely have to workout a deal with state or federal regulators where it would cap its liability in exchange for contributing toward the cleanup.

If the property would prove to be a financial drain on the estate, a Chapter 11 trustee could try to abandon the property or reject any leasehold that poses po­tential environmental compliance problems.

Environmental Liability Management Strategies for Creditors and Landlords

There are a number of offensive strategies that creditors in general and land­lords in particular may employ to offset the favorable treatment that the Code affords debtors.

The principal question that a creditor will face is whether to file a proof of claim for unscheduled environmental obligations of the debtor.  One reason favor­ing the filing of a proof of claim is that if the environmental obligation of the debtor can be construed as a claim, a creditor runs the risk of being precluded from participating in the distribution of the debtor’s assets if it fails to file a proof of claim by the bar date and the debt is deemed to be a dischargeable debt.  By filing a proof of claim, the creditor will preserve its rights and may even be able to gain negotiating leverage if the claim is particularly large.  Where the claim is scheduled but vastly understated, it may be necessary for the creditor to file in order to protect its rights.

However, there may be circumstances where it may not be advisable for the creditor to file, particularly if the debtor is located in a jurisdiction that requires the cause of action to accrue before it can be considered a claim.  If a creditor files in such situations, it may waive its right to argue that no claim existed or to assert that it was not subject to the jurisdiction of the court.  On the other hand, if the court determines that the creditor has a contingent contribution or indemnification claim that is subject to discharge or disallowance, the creditor could forfeit its right to collect from the debtor.  On balance, it would appear that the more prudent approach would be to file a protective filing where the creditor would reserve its right to challenge the existence of the claim.  It also may make sense for the creditor to accelerate its cleanup expenditures prior to the bar date to maximize the value of the claim and to prevent it from being construed as a contingent claim.

A creditor might seek to dismiss the entire bankruptcy proceeding under sec­tion 707(a) on the ground that the environmental liability precludes administration of the estate because the debtor’s estate lacks the resources to pay for the cleanup.  A creditor could use this same argument to argue that a reorganization is not feasible and, therefore, non-confirmable under section 1129(a)(11).

Because bankruptcy courts are often perceived as pro‑debtor and favoring the objectives of the Code, a creditor should bring a motion in the district court where the bankruptcy court is located seeking to have all or part of the proceeding withdrawn from the bankruptcy court to the district court under section 157(d).  Normally, the bankruptcy petition is filed with the district court where it is then referred to the bankruptcy court for that district.  The bankruptcy court is empow­ered to issue orders and judgments on 15 listed categories of “core” proceedings and may submit proposed findings of fact or conclusions on “non-core” proceed­ings.  Under section 157(d), the reference to the bankruptcy court can be with­drawn by the district court.  The section provides for both permissive and mandatory withdrawal.  Permissive withdrawal may take place on a showing of good cause, while under the mandatory withdrawal provision, the district court must remove the proceeding from the bankruptcy court when issues are raised that involve both the Code and laws affecting interstate commerce and the matter requires a substantial and material interpretation of the other federal law.  Thus, a creditor would argue that withdrawal was necessary to determine the debtor’s environmental liability.

If the proceeding involves state environmental law, the creditor should file an action in state court and then bring a motion before the district court asking that the bankruptcy court abstain from hearing the bankruptcy proceeding.

If a landlord has a DIP or Chapter 11 trustee as a tenant, the landlord should vigorously contest any attempt to reject the lease.  Indeed, under 365(d)(1), the estate/tenant is required to comply with all of its lease obligations until the 60‑day period for rejecting or assuming the lease.  During this period, the landlord should seek to enforce any lease covenants that could compel the tenant to perform the cleanup.  If the tenant fails to perform, the landlord could declare the tenant in default and the trustee could be required under section 365 to cure the default or provide adequate assurance of future performance.  If the leasehold is essential to the debtor’s reorganization, the landlord should not consent to any waiver or extension of the 60‑day period for assumption or rejection of the lease and use the deadline as leverage to satisfactorily resolve the environmental compliance issues.  In addition, the landlord should seek to have any cleanup costs afforded administrative expense priority even if the debtor elects to reject the lease since some jurisdictions allow for priority treatment of cleanup costs even where the debtor will not be operating the property.

My practice of law has focused managing environmental liability for lenders, real estate investors, and corporations for the past 30 years.  Call or email me for more help on managing environmental liability.