When A Lender is Thinking of Foreclosure

Many "lenders" (i.e., investors, B-piece buyers, mezz lenders) who never imagined that they would be taking title to property are now finding themselves either commencing foreclosure actions or suddenly holding stock/membership interests in an entities that hold title. Because these "lenders" never thought they would foreclose, they did not take the time to learn about the secured creditor exemption or were told a fanciful story by a non-environmental lawyer or a non-lawyer who was providing legal advice. As a result, these "lenders" are not fully aware of (1) the limitations of the secured creditor exemption) and (2) post-foreclosure obligations to preserve that immunity.

Further complicating the problem is that since the lenders thought they were taking interests in AAA-rated notes, the underlying loan documents did not spell out the foreclosure procedures. At the other extreme are the indentures or trust documents that require trustees to make sure the properties are in compliance with all laws prior to commencing foreclosure.    

Many professionals will tell clients how the secured creditor MAY be able to protect them. However, I think this does a disservice to the client who is already under enormous stress from the losses it has already incurred and who may be willing to grasp at any straws regardless of how illusory or elusive to stop the bleeding.

Instead, I found it more useful to tell them that they should act as if the secured creditor exemption does not apply to them. In other words, they need to make decisions based on the idea that they may be liable simply on the basis of their naked title. 

This approach helps to focus the client on the potential environmental risks. Once the client appreciates the potential risk, we can have a more realistic discussion on its exit strategy, the scope of the diligence, and potential risk mitigation strategies.  

I am not suggesting that one unduly scare or alarm a client. Instead, I am suggesting that one should let the client know that the exemption may not apply for reasons we might not yet know and that their decision-making should be informed by the potential that this line of defense might not be available. The clients can then do what they do every day-evaluate the potential risks of a transaction.

Environmental liability is just one of the risks associated with a foreclosure. Once a client is aware that it might have such liability, it can decide what risk mitigation strategies, if any, they might want to employ based on their own risk tolerance. Sometimes, clients have walked away from the asset because of the uncertainty associated with pre-existing conditions, However, I have also had clients perform additional due diligence to try to develop potential cleanup estimates (based on what passed as an AAI-compliant report during the loan origination, this may be the first time real diligence is done on the property), explore insurance, enroll in a voluntary cleanup program, and sell the note at a reduced price. Sometimes the lender/investors have taken such a "haircut" that they have been willing to roll the dice on possible liability and take title because they think there is inherent value in the property that they or some third party may be able to realize down the road.

Lender Liability and Post-Foreclosure

Continuing our third theme on lender liability, this post will discuss post-foreclosure liability. Our prior posts discussed the scope of the liability protection during the life of the loan and during foreclosure.

The secured creditor exemption of CERCLA, RCRA and many state environmental laws provide that a lender may maintain business operations, wind down operations, take measures to preserve, protect and prepare the vessel or facility for sale or disposition, and even undertake response actions under section 107(d)(1) of CERCLA or under the direction of an OSC so long as the lender seeks to sell or re-lease (in the case of a sale/leaseback transaction) and complies with the foreclosure requirements set forth above....

Lenders have encountered their greatest risk of liability when in post-foreclosure activities. Aside from the Fleet Factors case, there are a number of unreported situations where lenders have been issued administrative orders by governmental agencies and have had to pay to perform a cleanup because of the actions they took following foreclosure. These situations have typically taken place when a borrower has gone out of business and the bank takes control of the facility in order to sell off the inventory, fixtures, machinery and equipment of the borrower subject to the bank’s lien. The bank typically does not take title to the property because of fear that it will lose its exemption, but instead hires an auction to conduct the sale of the personal property. Usually, there are barrels or drums of hazardous waste strewn about the facility and the equipment that is being auctioned off may even contain hazardous wastes. In order to avoid any suggestion that the bank or the auction had any control over hazardous wastes, the auction will often rope off the area where the drums or barrels are found. In some cases, the bidders are actually allowed to cherry-pick barrels containing useful raw materials. After the auction is conducted, the drums and barrels are then left in the abandoned facility. At some point, government authorities find out that there are abandoned drums at the facility and order the lender to pay for the removal of the materials.

Lenders will often argue that the drums containing the wastes were not part of its collateral or that the lender never exercised control over the drums because neither it nor its auctioneer ever touched or moved them. However, the definition of “release” under CERCLA includes abandonment of drums. Thus, a lender who has taken control of a facility to conduct an auction and leaves behind drums or equipment containing hazardous wastes could be deemed to have caused a threatened release of hazardous substances.

Moreover, the CERCLA Lender Liability Rule provided that while lenders were not required to take response actions in order to retain their immunity from liability, they had to comply with the law, and any actions that they did take had to comply with the NCP. Abandonment of drums or equipment would not be consistent with the requirements of the NCP and could cause a lender to lose its immunity even where it has complied with all of the aspects of the CERCLA Lender Liability Rule.

The Lender Liability Amendments, however, did not expressly address this issue of post-foreclosure NCP compliance. Thus, financial institutions should exercise extreme caution when conducting auctions and should consult with environmental counsel prior to conducting any auction at a manufacturing facility. It would also be advisable for lenders to retain an environmental consultant or environmental attorney to inspect the facility prior to arranging for the auction and probably even before taking control of the facility in order to evaluate the possible environmental liabilities that might be associated with the auction.

If the lender decides to have the hazardous wastes removed, it should try to have a representative of the borrower execute the waste manifests so that the bank would not be considered the generator of the waste. However, if no such representative is available, the bank or one of its agents would have to execute the waste manifests. Since the bank would be considered a generator of the waste under these circumstances, the lender should have its consultant select a reputable disposal or treatment facility. The financial institution could have its environmental consultant or attorney perform a regulatory review of the facility to minimize the possibility that the lender could incur liability for releases of hazardous substances at that treatment or disposal facility.

More more detailed information on lender liability, please visit my website at http://www.environmental-law.net/

Foreclosing Lender Settles Claims for Contamination Caused by Salvagers

Harwood Investment Company vs. Wells Fargo National Association, Inc (N.D.Ca) seems to combine the facts of the infamous 1988 Fleet Factors case and the HSBC case from New York, a lender agreed to settle claims that its agents caused releases of hazardous substances following foreclosure.

The defendant bank extended a $16MM loan to the Harwood Products, Inc. a lumber mill. The loan was leguaranteed by the plaintiff and the promissory note was secured by the property and equipment owned by the lumber mill. After the bank asserted that it was in default of its loan in the amount of $2.6MM, Harwood Products filed for bankrtupcy. In September 2008, the lumber mill defaulted on its loan and the bank retained an auctioneer to conduct a sale of the borrower's assets.

In December 2008, a contractor retained to provide security and dismantle equipment allegedly caused hydraulic fluid and other hazardous substances to be release. Later, the Mendoncino Couty Department of Environmental Health conducted an inspection and observed abandoned drums without secondary containment and wastewater overflowing from a dip tank along with evidence of staining on floors and near floor drains. The MCDEH determined the conditions posed an imminent and substantial endangerment and notified the regional water quality control board.

In January 2009, a purchaser of certain equipment located in the planer building was using a blow torch to dismantle equipment when a spark ignited that engulfed the building. Water from the fire suppression system and from fire fighting actions of the local fire department caused the hazardous substances to flow into surface water and the stormwater system containment system. and pread into the soil and groundwater. Following the fire, the regional water quality control board issued an abatement order requiring the borrower to implement remedial actions.

The bankruptcy case was then converted to a chapter 7 liquidation and the bankruptcy court authorized the abandonment of the facility to Willits Financial Company, Inc. in April 2009. The plaintiffs then filed a contribution and cost recovery action, alleging the bank and its agents took possession of the lumber mill in september 2008 and were responsible for the releases of hazardous substances.

The defendants filed a motion to dismiss and the parties reached a settlement. According to sources, the lumber mill was the largest employer in this rural area and the bank did not want to run the risk of having a trial before such a jury pool.

Lender Liability and Environmental Disclosure

In Robert Hull and Point Pleasant Landco v. William Lewis (No.A-005403-07T3, App. Div.6/11/09), First Fidelity had issued a loan commitment to the plaintiff in 1993 that required receipt of an acceptable phase 1. The property had been a coin-operated laundry. The bank obtained a phase 1 that concluded that there were no obvious signs of contamination and that due to relatively small amount of dry cleaning performed at site, it was unlikely that PCE was stored in sufficient quantities or USTs to be identified as a REC. The Phase 1 report contained express language that it was for the exclusive benefit of the bank and "was not intended to be, nor should be, for the benefit of any third party, including without limitation, any owner or lessee of the Property"

After reviewing the phase 1, the bank told borrower that phase 1 results were satisfactory to meet the loan commitment but did not provide the borrower with a copy of the report. The borrower then proceeded to purchase. In 2002, borrower tried to sell the land. A prospective purchaser performed a phase 2 and discovered extensive PCE and declined to proceed with the purchase.

 The borrower, now a plaintiff, filed a lawsuit against the prior owners and operators of the property was well as the bank and the consultant. The borrower/plaintiff alleged that it had relied on the bank's statement that the phase 1 was satisfactory to mean that the site was clean in proceeding to close on the property, and that the bank had a duty to advise the borrower of the specific findings of the phase 1 results and that failure was a breach of contract. Plaintiff sought reimbursement of its remediation costs.

In a ruling from the bench, the trial court granted summary judgment to the bank on grounds that there was no evidence that plaintiff had relied on the bank's satisfaction with the phase 1 report in deciding whether to purchase the property, and if it had such reliance would not have been reasonable. The court said that any "green light" by the bank might just as well been a waiver of its own requirements. The court also noted that the plaintiff's 30 day contingency period had expired two months prior to the issuance of the phase 1 report.

The appeals court affirmed, holding the issue is not whether the Bank subjectively intended the approval of the loan as an assurance that the property was free from environmental degradation, but whether the plaintiffs actually relied on this representation and whether such reliance was reasonable. The court agreed with the trial court that there was no evidence that the plaintiff had reasonably relied on the phase 1 report.

Lesson 1: This case illustrates the importance of a purchaser performing its own due diligence even if this means reviewing the phase 1 performed on behalf of the bank. A lender does not stand in the same shoes as a potential owner of property because of the secured creditor exemption. So long as a lender does not become involved in the operations of its borrower or take title through foreclosure, its liability for environmental conditions will be limited to the value of the loan. When banks held loans on their balance sheets, this potential loss was often enough to incentivize lenders to perform thorough phase 1 reports. In the era of securization, however, when the lenders would sell their loans almost immediately, lenders have been more concerned with keeping the assembly line of loan originations moving as fast as possible to maximize their fees.

The borrower, on the other hand, is going to be the owner of the property and will be first in line for any enforcement actions that may result if the land turns out to be contaminated. If the borrower is not named on the phase 1 report, it is quite likely that it will not be deemed to have engaged in an all appropriate inquiry or whatever level of due diligence may be required under a state innocent or prospective purchaser defense.

The preamble to the EPA AAI rule did state that "all appropriate inquiries investigations may be conducted by or for one person and used by another party.". But relying on a report prepared for another party may not be considered to be conducting an all appropriate inquiry under state law.

Lesson 2: Many states have statutes that require owners of property to disclose existence of contamination to prospective purchasers. Lender liability statutes in those states generally to not provide protection for common law claims or for failing to comply with the disclosure requirements. Lenders should carefully review the provisions of state lender liability laws and the scope of environmental disclosure laws as part of their loan due diligence. For example, in  2007. the Supreme Court of Missouri in Hess v. Chase Manhattan Bank (220 S.W.3d 758; 2007 Mo. LEXIS 65, 5/1/07) upheld a jury verdict finding a bank liable for common law fraud for failing to disclose the existence of an EPA investigation in a foreclosure sale. In so holding, the Court said that disclaimers in the contract did not preclude the fraud claim.
[The Bank had an obligation to disclose material information that was not discoverable through ordinary diligence and that the plaintiff could not have reasonably discovered the existence of EPA's investigation in the kind of diligence ordinarily done for real estate transactions of this kind. The bank also had failed to file the required property disclosure statement.]

Missouri had a statute compelling disclosure of any material information concerning property to be sold.  But even if a state does not have a statutory disclosure law, there may be an obligation under common law to disclose the existence of contamination or the results of prior investigations. Lenders have been held liable for improper disclosure in the past under common law theories of misrepresentation. For example, For example, in 2004 a Rhode Island Superior Court jury ruled that Fleet Bank was liable for $5.14 million in damages for failing to inform purchasers of a general store that the property drinking water was contaminated (Foote v. Fleet Financial Group) .

Another example was in 1999 when a Pennsylvania state court allowed a purchaser of contaminated land to maintain a claim for negligent misrepresentation against the bank when the bank failed to advise the plaintiff that real estate appraisal did not address environmental conditions (Seats v. Hoover, 1999 U.S. Dist. LEXIS 13379, August 18, 1999).

In 1991, the Montana Supreme Court reversed a summary judgment ruling in favor of a bank and allowed the borrower to proceed with negligent misrepresentation and constructive fraud claims against its former lender because there was a question of material fact whether the bank had created a false impression about the environmental conditions of the property (Mattingly v. First Bank of Lincoln,1997 WL 668215 (Sup. Ct. Montana, Oct. 28, 1997).

In Boyle v. Boston Foundation, Inc. ,788 F. Supp. 627 (D. Mass. 1992) a bank that failed to disclose to purchasers of contaminated property the existence of notice from a state agency ordering a cleanup at the site was not held liable for misrepresentation because of a doctrine unique to the failed financial institutions taken over by the FDIC. The agency was acting as a receiver for the failed bank. The failure to disclose material information was held to constitute an "agreement" under the D'Oench doctrine and since this was an unwritten agreement, the plaintiffs could not prevail against the FDIC. It is likely that the plaintiff would have prevailed had the bank not been in receivership

It seems that at least once a year there is a case imposing liability on a bank for inadequately disclosing environmental conditions of foreclosed property that it has sold. It is not only prudent to err on the side of full disclosure in transactions, but in emerging areas such as vapor intrusion, to look back at prior disclosures to see if they could form the basis of a claim for non-disclosure. Given the volume of foreclosures we are now seeing, I would not be surprised to see more of these cases during the next year or so.

Lenders Subject to Stormwater and Dust Enforcement Actions

As builders continue default on construction loans, states are increasing turning to banks to ensure that  partially completed developments remain in compliance with environmental laws. We have seen enforcement actions brought against banks in California, Georgia, North Carolina with unconfirmed reports in other states.

At the heart of the problem is runoff from abandoned and foreclosed residential projects. Under the federal Clean Water Act (CWA) and state versions of that law, developers and builders are required to obtain stormwater permits and implement Storm Water Pollution Prevention Plans, Best Management Plans and or Erosion Control Measures. These requirements are the reason that construction projects have those ubiquitous black and orange silt fences.

When banks foreclose on these abandoned projects, they may perform phase 1 reports that typically do not address environmental compliance. As a result, foreclosing bank is usually of the need to maintain erosion control or the cost of correcting any violations. The CWA does not have a secured creditor exemption so banks will be considered owners or operators of these properties that are responsible for complying with the full panoply of environmental laws associated with the development. Lenders that foreclose on partially completed construction sites are finding themselves saddled with fines and penalties for unpermitted sediment runoff and costs to bring the sites into compliance.

Normally. fines can range from a few hundred dollars per day to tens or hundreds of thousands depending on the severity of the violations and length of time the properties have been in non-compliance. In addition, the violations run with the land. The costs can only quickly add up and with banks foreclosing on multiple properties, the costs can scale into the millions of dollars For example, at one site near Dawsonville, a foreclosing lender has fines in excess of #4 million for inadequate erosion controls for a site that was valued at $1.97 million in 2006. The Gainesville Bank & Trust foreclosed on the property after the builders and developers of the site were convicted mortgage fraud and abandoned the development. Consequently, some banks are taking proactive steps to minimize their liability. SunTrust Banks Inc. recently implemented a comprehensive environmental compliance program for its foreclosed and repossessed properties. The bank retained two engineering firms to oversee the properties.

Georgia recently issued new General Permits for Storm Water Discharges Associated with Construction Activity  for Stand Alone projects, Infrastructure Projects  and Common Developments. Existing construction projects must submit a new NOI  within 60 days after the effective date of the new permits.  New sites that begin construction activities after the issuance date of the Permits must submit the new NOI form at least 14 days prior to beginning construction activities.  Proof of submittal of the NOI must be retained at the construction site or other readily available location.  Under the revised rules, a lender or other secured creditor who acquires legal title to a construction site must file a new NOI by the earlier to occur of (1) seven days before beginning work at the construction site or (2) thirty days from acquiring legal title to the construction site.

In North Carolina, the heads of the Departments of Commerce ,and the Environment and Natural Resources (DENR) recently issued a joint memo advising banks to contact the DENR immediately upon taking control of property. The DENR will send inspectors to the site to determine its compliance and work with the lender to bring the site into compliance, re-issued expired permits and approve acceptable sedimentation controls. If remedial measures are required, the bank would be expected to enter into an administrative order. However, following the suggested protocol will help lenders minimize fines or penalties.     

Meanwhile, in the arid southwest such as Arizona and parts of California, regulatory authorities are focusing on air pollution caused by dust from stalled construction projects. Lenders are being required to implement measures to reduce airborne dust.

The California Department of Toxic Substances has also warned lenders foreclosing on properties that that they properly dispose any hazardous materials at those sites. Abandoned construction projects frequently become dumping grounds and abandoned homes may contain quantities of hazardous materials that may have to be managed as hazardous waste according to the state.

In Florida, a lender foreclosed on six condos in a senior housing complex. One of the unit owners took out all appliances including the air conditioning. The condo association demanded that the foreclosing lender replace the air conditioning but refused. Months later, the entire unit became infested with mold forcing the bank to pay for a gut renovation.  

Then we have the ordinances that are sprouting across the country require lenders that foreclose on homes to properly maintain them or pay to demolish the structures. For example, Cathedral City recently enacted a local ordinance requiring owners of foreclosed properties to register the property with the city. Among other requirements, the ordinance requires owners to pay a $70 annual registration fee, secure the property, keep it free of debris, landscape the front and side yards to neighborhood standards, clean or drain the pool, and hire a local property manager to inspect it weekly. The town located in what was once the red-hot housing market of Riverside County has over 2,000 foreclosed properties currently sitting vacant in this California desert community. The empty houses have been vandalized, used a meth labs or simply as bases for criminal activities. Stagnant swimming pools have created breeding grounds for mosquitoes and drowning hazards.

Earlier this week, JPMorgan Chase agreed to pay Oakland, Calif. $35,000 to settle a lawsuit accusing lenders and local agents of illegally evicting tenants under the municipal “just cause” eviction law. Under the just cause ordinance, landlords and foreclosing lenders must have a specified valid reason for evicting a tenant, such as the owner moving into the unit, and give 60 days' notice.

  

In Rhode Island, the legislature recently enacted the Rhode Island Foreclosed Property Upkeep Act. It requires any financial institution that purchases a foreclosed property to post a bond with the municipality for 25 percent of the property’s assessed value, to be used to correct any code violations if the owner doesn’t take care of it. If the full value of the bond is used in the upkeep of the property, the owner has 10 days to file another bond in the same amount or have the property forfeited to the municipality.

All of these emphasizes how important it is for lenders and their consultants to carefully review the conditions of properties before a foreclosure decision is made and to plan for post-foreclosure activities not only to minimize liability but also to preserve property value.

Foreclosing Lender Not Liable

In HICKS FAMILY LIMITED PARTNERSHIP v 1ST NATIONAL BANK OF HOWELL, 2008 Mich. App. LEXIS 1444 (7/15/08, Ct. App. Mi), a state appeals court ruled that a bank that had foreclosed on property formerly operated by a defunct paint manufacturer in 1983. Defendant bank sold the property to the predecessor of the plaintiff estate.When the defendant bank acquired the property, it was contaminated with buried drums of paint and paint thinners. . The purchase agreement provided in part that "Sellers agree to have all equipment inside and out, all stock, debris and residue removed from premises at time of closing, in compliance of E.P.A. Rules & Regulations."

Defendant bank performed remedial activities from 1983 to 1996. There was evidence that a contractor hired by the defendant had damaged a barrel during remedial activities that led to another discharge. In 1997, the defendant bank requested that the site be delisted but the state of Michigan refused. In 2004, plaintiff began developing the property and discovered several additional buried drums and additional groundwater and soil remained contaminated. In December 2004, plaintiff then sought to recovery its cleanup costs from the defendant under the state superfund law and common law claims. The trial court looked to CERCLA caselaw to determine if the plaintiff PRP had a right to bring a contribution action under the state superfund law since that right was modeled after CERCLA section 113. The trial court rules that based on the then split of authority under CERCLA, the plaintiff did not have a statutory right of contribution and also dismissed the common law claims. The common law claims were dismissed because the plaintiff failed to exercise reasonable diligence in monitoring defendant's [*28] performance of the cleanup operation. The court said that even if the plaintiff did not know the particular facts concerning the buried drums or the ruptured barrel, it had sufficient grounds for knowing no later than 1997 that defendant may not have been adequately fulfilling its alleged cleanup obligations. In the absence of evidence that plaintiff made reasonable efforts to ascertain the condition of the property, the trial court determined that it was not appropriate to apply the discovery rule in this case

The appeals court affirmed the dismissal of plaintiff's various common-law claims, but reversed the dismissal of the state superfund cost-recovery claim and remanded for further proceedings. The trial court then granted defendant's motion for summary disposition because as a PRP, plaintiff was legally barred from maintaining a cost recovery claim, and even if plaintiff could properly bring an action, the evidence established that defendant was neither an 'operator' nor an 'arranger' under the state superfund law since there was no causal nexus between defendant's alleged conduct and plaintiff's response costs.

On appeal, the court ruled that the trial court had erred when it granted defendant's motion for summary disposition because of the U.S. Supreme Court ruling in United States v Atlantic Research Corp, 127 S. Ct. 2331; 168 L. Ed. 2d 28 (2007) that PRPs could bring contribution actions.

However, the appeals court held that the defendant bank was not an 'operator' or 'generator' at the site. While the defendant bank exercised control over the site when carrying out its remedial actions, the court said that plaintff had to show that the defendant must have had authority to control the operations or decisions involving the disposal of the hazardous substance, or must have assumed responsibility or control over the disposition of the hazardous substance. Since the defendant's only connection to the site was its remedial clean-up effort, the court said this was insufficient to establish the requisite nexus required for liability as an operator.

On the arranger theory of liability, the plaintiff had introduced evidence that a contractor hired by defendant ruptured a barrel during the cleanup operations in 1984 and that this was sufficient to show that defendant disposed of a hazardous substance and was responsible for an activity causing a release. However, the court ruled that defendant could not be held liable as an arranger as it did not intend the 1984 disposal.

Comment 1:

Perhaps the bank did not comply with the foreclosure rules set forth in the state secured exemption or felt it did not act retroactively. In any event, the bank was forced to defend itself as a former landowner of the property without the extra layer of protection that is provided by the expansive state secured creditor defense.

Comment 2

Lenders encounter their greatest risk of liability during post-foreclosure activities, and the HSBC case highlights the importance of a lender exercising extreme caution when winding down operations at a borrower’s manufacturing facilities. Under the 1996 Asset Conservation, Lender Liability Deposit Insurance Act, also known as the Lender Liability Amendments, a lender may maintain business operations, wind down operations, take measures to preserve, protect and prepare the vessel or facility for sale or disposition, and even undertake response actions under section 107(d) (l) of CERCLA so long as the lender seeks to sell or re-lease (in the case of a sale/leaseback transaction)and complies with certain foreclosure requirements.

Banks continue to find themselves subject to environmental issues because of the actions they took during workouts or following foreclosures. Many of these enforcement actionsinvolve administrative orders or lawsuits that are quietly settled by governmental agencies. These situations have typically taken place when a borrower has gone out of business and the bank takes control of the facility in order to sell off the inventory, fixtures, machinery and equipment of the borrower subject to the bank’s lien. The bank typically does not taketitle to the property because of fear that it will lose its exemption, but instead hires an auction house to conduct the sale of the property. Usually, there are barrels or drums of hazardous waste strewn about the facility and the equipment that is being auctioned off may even contain hazardous wastes. To avoid any suggestion that the bank or the auction had any control over hazardous wastes, the auction will often rope off the area where the drums or barrels are found. After theauction is conducted, the drums and barrels are then left in the abandoned facility. At somepoint, government authorities discover that there are abandoned drums at the facility and order the lender to pay for the removal of the materials.

Lenders should be aware that the definition of 'release' under CERCLA includes abandonment of drums. Thus, a lender who has taken control of a facility to conduct an auction and leaves behind drums or equipment containing hazardous wastes could be deemed to have caused a threatened release of hazardous substances. EPA has consistently taken the position that such action constitutes abandonment of hazardous wastes (when the borrower is insolvent) and creates generator liability for the lender. As a result, financial institutions should consult with environmental counsel prior to taking possession of a former borrower’s facility or conducting any auction at a manufacturing facility. It would also be advisable for lenders to retain an environmental consultant or environmental attorney to inspect the facility prior to taking control in order to evaluate the possible environmental liabilities that might be associated with the auction.

The financial institution could have its environmental consultant or attorney perform a regulatory review of the facility to minimize the possibility that the lender could incur liability for releases of hazardous substances at that treatment or disposal facility.

This case can be contrasted to the enforcement action  in State of New York vs. HSBC where the bank agreed to pay $850,000 in fines and reimburse environmental agencies for response costs involving a facility that was abandoned by a borrower. In this case, HSBC extended a $4.1 million loan to Westwood Chemical Corp. After the borrower defaulted, HSBC established a lockbox and directed customers to forward payments to that account. A few months later, HSBC seized Westwood’s operating funds and asked the company to prepare a plan for an orderly shutdown. As part of this request, Westwood requested approximately $60,000 to properly dispose of hazardous materials in drums, containers and wastewater tanks as well as raw materials and work in process. HSBC refused this request and also declined to follow the recommendations of its consultants to winterize the facility. During the winter, pipes from the fire suppression system burst as well as many of the containers storing hazardous materials. The contents of the drums mixed with water when the weather warmed. At some point, the local code enforcement officer became aware of the conditions and notified the New York State Department of Environmental Conservation (NYSDEC), which then referred the matter to EPA. The bankruptcy trustee then got into the act, filing a motion under section 506(c) of the bankruptcy code seeking to subordinate the bank's lien. EPA, DEC and the town also filed administrative claims seeking reimbursement of their response costs. In the fall of 2006, HSBC arranged for the sale of the property for $3 million. Approximately $2.3 million of the sales price was used to reimburse some of the costs incurred by the regulatory agencies. In its lawsuit against HSBC, the New York Attorney General asserted that HSBC was not entitled to the secured creditor exemption because it had become involved in the management of the facility when it seized the operating funds, refused to allow money to be used to properly dispose of the hazardous materials or otherwise enable the borrower to comply with its closure obligations, and failed to properly winterize the facility when it had assumed control of the building and constructive possession of the hazardous materials. The attorney general also charged that the bank had an obligation to notify the NYSDEC of the conditions at the facility.It is interesting that the defendant did not try to assert the secured creditor exemption under the Michigan superfund law which appears to be broader than the CERCLA secured exemption . In particular, foreclosing lenders may asset the exemption if they take certain steps to dispose of the property and has taken reasonable care in maintaining and preserving the real estate and permanent fixtures; provides to the department all environmental information related to the facility that is available to the lender; has complied with any order issued by the state environmental agency and if conditions on the property pose a threat of fire or explosion or present an imminent hazard through direct contact with hazardous substances, the lender has undertaken appropriate response activities to abate the threat or hazard.

Lender Foreclosing on Former Dry Cleaner Not LIable under Vt Law

Vermont Supreme Court held that a purchaser could rely on a negligently prepared phase 1 to assert the state innocent purchaser defense. In an earlier round of litigation, the lower court had ruled that the foreclosing bank that held title for seven months was not liable because the state had failed to prove that there had been a release during the time that the bank held title.

In State v Howe Cleaners, the property had been used as a dry cleaner from 1974-1996. The property was then conveyed to purchaser who converted it to a bakery. When the bakery failed, Granite Savings Bank and Trust (Granite) foreclosed and sold the property seven months later to a pizzeria. The sale was "as is" and before acquiring the property, the purchaser reviewed a phase 1 prepared for the bank.Sometime after taking title, an EPA inspector spoke with former employees of the dry cleaner and visited the property. When he raised some floor boards, he observed two tanks in the crawl space that had apparently been used to store PCE and that had leaked.

Vt then implemented response actions and sought cost recovery under the state Waste Management Act. The state argued that the successor to Granite, TD BankNorth, was liable as a person who owned the site at the time of a release. TD BankNorth argued it could not be liable because the state did not have any evidence that there had been a release during its ownership.

The state responded that it did not have to prove there was a new release but simply migration of an initial release.The trial court found that the CERCLA caselaw was not dispositive because liability under CERCLA was triggered by ownership at time of "disposal" whereas liability under the state Waste Management Act was linked to a "release". Moreover, the court found that the state definition of release was narrower than CERCLA and seemed to require an actual spill or discharge during ownership.Because there was a triable issue of fact if there was a release during the ownership of the bank, the court denied the bank's motion for summary judgment. The bank then sought to depose the state's expert on the timing of the release. However, the state refused to make its expert available. After several conferences with the court, the state still declined to make its staff available. As a result, the court issued a sanction prohibiting the state from introducing evidence of the timing of the release which effectively resulted in judgment for the bank.

The case illustrates the importance of understanding the scope of the state superfund or hazardous waste law as well as the extent of the secured creditor exemption. In other states, the bank could have been liable as a past owner and the failure of its consultant to identify the tanks could have exposed the bank to liability.