Lender Liability and Foreclosure

Many non-traditional lenders who never thought they would have to foreclose on collateral and now finding themselves confronted with that option. Thus, it is useful to review the scope of the secured creditor exemption under CERCLA, RCRA and similar state environmental laws.

The CERCLA secured creditor exemption provides that a lender who holds indicia of ownership primarily to protect its security interest will not be considered an owner of a property if it does not participate in the management of the facility. If the secured creditor forecloses on the property, it may still maintain its liability exemption so long as it takes steps to sell the property in a commercially reasonable manner so long as the lender attempts to divest itself of the facility or vessel “at the earliest practicable, commercially reasonable time, on commercially reasonable terms, taking into account market conditions and legal and regulatory requirements.”...

When EPA promuglated its Lender Liability Rule in 1992, the rule has a “bright-line test” for when lenders had acted to divest the property in in a commercially reasonably manner. That test required lenders to list the property within a certain period of time and to accept offers for “fair consideration.” Lenders who met the test were automatically deemed to have acquired indicia of ownership primarily for the purpose of protecting their security interest and therefore would fall within the protections of the exemption.

However, those regulations were vacated in 1994 and the 1996 statutory amendments to CERCLA and RCRA that amended the secured creditor exemption did not contain the "bright-line" test. In the absence of such a bright-line test, lenders will not be able to know for certain if their actions are consistent with the exemption and may find themselves subject to scrutiny by individual courts to determine if they acted “at the earliest practicable, commercially reasonable time, on commercially reasonable terms.” Many lenders have established real estate divestiture policies to govern the foreclosure and sale of collateral. It is possible that a lender might be able to point to compliance with its internal policies as evidence that it acted “at the earliest practicable, commercially reasonable time, on commercially reasonable terms.” Because of the uncertainty over what constitutes “the earliest practicable, commercially reasonable time, on commercially reasonable terms,” the real estate divestiture groups of financial institutions and lenders who are not familiar with foreclosures should work closely with environmental counsel to make sure that the lending institution does not inadvertently lose its immunity.

 

The creditor may monitor the borrower's business or take other actions that a prudent lender would typically take without forfeiting its immunity to liability. However, the secured creditor exemption does not apply when the lender exercises decision making control over the borrower's environmental compliance such as the borrower's handling or disposal of hazardous materials. Lenders have found themselves exposed to liability when their monitoring begins to approach control over the borrower’s business. Thus, lenders need to exercise caution during workouts when they become more closely monitor borrower’s operations.

It is important to note that the secured creditor exemption will not apply when the creditor’s primary motive for holding the security interest is an as an investor and not to protect a security interest. Thus, purchasers of discounted or distressed notes who are taking the notes because primarily for the income stream or investment potential could find themselves not eligible for the secured creditor exemption. As a result, note purchasers who exercise control over property such as by conducting auctions of personal property or authorizing repairs can face liability as “operators” if they do not qualify for the secured creditor exemption.

Two years ago, I reported in my newsletter on State of New York v. Fumex Sanitation et al, where the NYSDEC has filed a CERCLA cost recovery action seeking reimbursement of $500,000 in past response costs from the owner and purchaser of a mortgage note. The state also demanded that the parties implement a remedy that is estimated to cost $628,000. The NYSDEC alleged that the note holder was an "operator" under CERCLA and was not entitled to the secured acreditor exemption because it exercised decision-making control over the property by participating in negotiations with the NYSDEC and repairing the roof. The state also claimed that the note holder assumed responsibility for management of the site by collecting rent from tenants and paying real estate taxes, among other things, he repaired the roof of the building.

Thus, it is important for purchases to evaluate the environmental conditions of the collateral prior to purchasing the by note by performing an environmental site assessment report that complies with the EPA’s All Appropriate Inquiries regulation or the ASTM E1527 standard practice for phase 1 environmental site assessments. collateral to limit the possibility of environmental issues. Purchasers should also consult environmental counsel prior to taking any actions that would be suggestive of exercising control over a potentially-contaminated property.