State Appeals Court Affirms Damage Award Against Bank for Sale of Contaminated Property

A New Jersey

Appeals Court

refused to disturb a $248,928 damage award against a bank involving a sale of contaminated property. The plaintiff had argued that the trial court had erred in calculating the damages flowing from the bank’s breach of contract.  

In Ritschel v. Spencer Savings Bank, SLA, 2011 N.J. Super. Unpub. LEXIS 1257 (May 16, 2011), Spencer Savings Bank had acquired a 2.78 acre vacant lot in 1990 in Fairfield Township. The parcel had been previously used by a general contractor and the bank had planned to construct a new corporate headquarters at the site. When the economy stalled, the bank decided not to develop the site. It is unclear what level of environmental due diligence the bank performed prior to acquiring the site. 

In January 2001, the plaintiff signed a contract to buy the land for $1.22MM. The plaintiff intended to erect a 32,000 sf commercial building that was projected to cost $3.6 million. During its due diligence, the plaintiff learned several diesel had been removed in the mid-1980s but no documentation was available. As a result,  the plaintiff performed a phase 2 which revealed elevated levels of VOCs. The phase 2 estimated that 60-90 tons of soil would have to be excavated at a cost of approximately $33K.

The plaintiff advised the bank of the contamination who initially offered to give the plaintiff a $33k credit against the purchase price in exchange for an indemnity in favor of the bank. The plaintiff rejected this proposal and after a period of negotiation, the parties executed an amendment to the contract that was drafted by special environmental counsel retained by the bank. The amendment provided that the bank would undertake and complete the remediation of the Property at its sole cost and expense in accordance with a remedial action plan approved by the New Jersey Department at Environmental Protection (“NJDEP”) and would obtain an NFA Letter from NJDEP.  In exchange for the bank’s promise to assume responsibility for the remediation, plaintiff agreed to waive his right to terminate the Agreement.

While these negotiations were taking place, the plaintiff entered into three leases with prospective commercial tenants including a day care. While the leases were executed, they did not have a commencement date since it was unknown when the remediation would be completed, the site sold and construction completed.

Following the contract amendment, the bank retained an environmental consultant to implement the remediation.. During the pre-remedial sampling, the bank’s consultant discovered the extent of the soil contamination significantly exceeded the original estimate. The remediation cost was estimated to approach $600,000. The bank believed it was only obligated to implement the limited remediation to address the contamination originally identified by Plaintiff’s environmental consultant. However, Plaintiff believed that Defendant agreed to remediate the entire property no matter what the cost and rejected the offer to perform a limited remediation because of the proposed daycare lease.

After the plaintiff rejected the bank’s offer to complete the limited remediation, the bank’s counsel notified plaintiff it was terminating the agreement pursuant to the section of the agreement requiring the bank to deliver good and marketable title despite the fact that Plaintiff's counsel had performed a title search and no objections.

Plaintiff filed its lawsuit, alleging the bank had breached the contract when it failed to complete the remediation.  After an eight day trial, the court ruled defendant had breached the contract and initially awarded plaintiff damages of $484,671, consisting of $98,000.00 in lost profits and $386,671.00 in out-of-pocket expenses for the cost of extra rent, architects’ fees, permit fees, site plans and attorneys fees.

After a dispute arose over the calculation of the damages, the court reduced the damage award to $248,928.61, consisting of $181,876,75 in out-of-pocket expenses and $67,051.89 in prejudgment interest. The plaintiff then appealed, arguing the trial court had improperly rejected its theory of damages but the appeals court affirmed.

CMBS Lender Kept In Case Over Questions About Environmental Disclosure

The federal district court for the Southern District of New York denied a motion to dismiss filed by Morgan Stanley Mortgage Capital, Inc (MSMC)that it failed to adequately disclose environmental conditions at a shopping center and should not be required to buy back the $81MM loan. This case has some yummy nuggets.

In this case, MSMC originated a $81MM loan to City View LLC to finance the acquisition of a shopping center in December 2006. The shopping center had been constructed on a former landfill, was required to monitor methane gas and had been subject to a number of notices of violations. In 2006, Walmart which was the largest tenant of the shopping center and occupied nearly 29% of the net square footage began complaining about methane gas. Just before the loan was closed, Wal-Mart issued a Notice of Default accusing the seller of failing to manage the methane gas and alleging that methane gas levels had reached dangerous levels.  The seller of the property and Wal-Mart then entered into a series of letter agreements where seller agreed to address the methane problem. The seller and borrower also entered into a Walmart Indemnity Agreement where the borrower agreed to assume the obligations to cure the methane problem. On the day of the closing, Wal-Mart also sent the defendant an estoppel certificate identifying the methane problem and setting forth the landlord's obligations to cure the problem. Eventually, Wal-Mart terminated its lease in 2009 and the borrower defaulted on its debt service payments.

The phase 1 had not identified any RECs. However, it had identified methane as an "item of concern". It has also disclosed that the shopping center had been constructed on a landfill, that it was required to monitor methane and that there had been notices of violations that would require at least $100K to repair.
Meanwhile,  MSMC sold the loan in May 2007 to an affiliate entity pursuant to a Mortgage Loan Purchase Agreement (MLPA). The loan was then deposited into a Morgan Stanley CMBS Trust pursuant to a pooling and servicing agreement (PSA) with the plaintiff named as Trustee.

The MLPA contained an environmental warranty that an environmental assessment had been performed and that the MSMC had no knowledge of any material and adverse environmental conditions or circumstances affecting the property that was not disclosed in the report. MSMC also warranted that there were no material defaults.

The plaintiff through the special servicer filed a complaint seeking to require MSMC to re-purchase the loan. The complaint alleged that MSMC knew the loan was in default and failed to disclose it, and also failed to disclose the adverse environmental conditions affecting the property.  Interestingly, Phase 1 did not flag methane as a REC but as an "item of environmental condition". In a motion to dismiss, MSMC asserted that it had disclosed all of the environmental risks associated with the property including that the property had been built on a landfill, required monitoring for methane, was under the supervision of the Ohio EPA and an escrow of $100K had been established tp resolve outstanding environmental violations.

However, the court disagreed, noting that the phase 1 said its purpose was to identify Recognized Environmental Conditions (RECs),  the report did not identify any RECs and characterized methane as an "item of concern". The court said that an "item of environmental concern" was not congruent with a REC, and there was a material dispute if the phase 1 had disclosed the existence of a material environmental threat.  Bank of New York Mellon Trust Company et al v. Morgan Stanley Mortgage Capital Inc., 11-0505 (S.D.N.Y. 6/27/11)

Distressed Debt and Due Diligence

I receive calls every week from consultants asking how they can involved in the due diligence arising out of the sale of distressed loans. It is true that there are billions of dollars of distressed debt and assets, and that there are funds sitting with large piles of cash waiting to pounce on distressed loans or assets. However, the picture is much more complex than the cheerleaders and talking heads are suggesting.

First, one needs to distinguish between distressed debt and distressed assets. The latter involves the hard assets (i.e., real estate) while the former involves the paper evidencing the loans that are collateralized by the hard assets.

When only paper is being exchanged, there is very little environmental due diligence. This is because the debt is being sold at distressed prices-often 20 or 30 cents on the dollar. There may be numerous reasons why the debt may be considered distressed. For example, the seller may be forced to sell the debt because it has to raise cash because of margin calls or redemptions from investors. Similarly, the bank that is holding the note may have been taken over by the FDIC who is dumping the recover as much as the cost of the takeover as possible. Likewise, the paper may have been downgraded and  the institutional investor may be required to sell the notes because it cannot hold such low rated paper. A mezzanine lender may have found its position is worthless and is willing to sell to a more senior investor. And of course, the borrower may be in default or unable to make a balloon payment at the term of expiration of the loan.  

In many cases, the note purchasers are buying deeply discounted paper say at 30 cents on the dollar and telling the borrowers that they will forgive past due loans if the borrower can pay the rest of the loan at 60 cents on the dollar. Do the math. The investor will get a 30% return!

In other instances, the borrower is current with its payments but would be unable to refinance the loan when it expires in two or three years because of tighter underwriting requirements or because the property values have dropped so much that the borrower could not get sufficiently-sized loan to pay off the existing loan. In many cases, the purchaser steps in, buys a deeply discounted note and then collects the remaining interest until the loan terminates. The investor will then walk away from the loan with another 30% or so return.
In the foregoing examples, the investors are only interested in the short-term returns on the notes and do not care about the environmental conditions of the property....provided of course they do not impair the ability of the borrower to pay the remaining or re-negotiated loan balance.

It is primarily when the original lender or an investor will actually take title to the underlying collateral (i.e., real estate) that the environmental issues will come into focus. Thus far, the bulk of the deal flow seems to have been the sale of paper and not the hard assets.

In addition to knowing the nature of the deal, it is important to understand who your client is and where they are in the capital stack or layering of debt and equity since their positioning will influence the degree of tolerance about environmental concerns.  In my next post, we will take our scorecards and check what players are in the lineup for distressed sales.    

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/

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.

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.

Bank Kept In Case On Claims For Incomplete Disclosure of Environmental Issues

In Ironwood Homes v Bowen, 2010 U.S. 58750 (D.Or. 6/14/10), purchasers of farm land subsequently discovered that the property had been used as a disposal site for tannery waste.   Plaintiffs asserted a variety of federal and state law claims against a range of defendants, including two banks that had a history of involvement in the site.

One bank served as the trustee that managed the affairs of the tannery owner, while the other bank provided financing to the plaintiffs.  The lender bank reviewed an environmental report concerning the property, but misstated the conclusions contained in the report to the plaintiffs.  In particular, the bank’s employee incorrectly described the environmental risk associated with the property as “low” and also stated that the report had concluded that no further environmental investigation was warranted.

The court denied motion to dismiss by bank on claims for fraudulent concealment and reckless misrepresentation, negligent misrepresentation, and non-gratuitous negligent advice. The court also denied the lender motion to dismiss that an indemnification in loan modification agreements released plaintiffs’ claims against the bank, ruling that if plaintiffs agreed to the modifications because they had been unaware of the bank’s knowledge about the true environmental condition of the property, the release might be considered unconscionable and therefore unenforceable. 

The court also rejected a state contribution claim brought by the trustee bank against the lender bank, holding that the contribution claim was barred because the trustee bank failed to allege that the lender bank “in any way ‘caused, contributed to, or exacerbated the release’ of contaminants or ‘hinder[ed] or relay[ed] entry to, investigation of, or removal or remedial action at’ the contaminated property.”

FHA Loan Originator Is Not liable for Failing to Test for Arsenic in Water Well

There are a line of cases where plaintiffs have tried to hold banks liable for not disclosing environmental issues known to the lender but not disclosed to the owner . Most of these cases involve foreclosure sales. However, a few involve borrowers who obtain loans to purchase property.

In Voelker v Home Office Realty,  home owners in Michigan claimed that banks involved in the FHA loan process failed to sample well water for arsenic despite knowledge that a local landfill might have impacted the drinking water supply. The plaintiffs noted that the FHA Mortgagee Letter 95-34 (July 27, 1995) requires Direct Endorsement Lenders to sample drinking water in accordance with local and state private well regulations as well as for contaminants of local concern.

The loan originator authorized retained a contractor to test the well for the usual potable water parameters. Years after buying the house, two of the plaintiffs developed cancer that they alleged was a result of exposure to arsenic in the potable water.

The trial court dismissed the claims on the grounds that alleged lender was just a loan originator and that it had no obligation to test the well water. The appeals court affirmed.

Borrowers often confuse a lender concluding that a phase 1 was acceptable from a determination that a property is "clean". The phase may identify environmental conditions that fall within a lender's risk tolerance. Indeed, during the CMBS craze, many originating banks were not concerned about environmental issues since they knew they would be selling the loans to the CMBS collective and thus were not exposed to collateral or payback risk. 

In a separate string on radon, there has been an extended exchange on why banks are not requiring radon sampling for properties located in radon zones 2 and 3 since radon is a carcinogen. This case illustrates why banks are reluctant to go go beyobd minimum environmental requirements. In this case, the plaintiff argued that the loan originator had an obligation to interpret the FHA letter to determine if additional parameters had to be tested as part of the water quality sampling. Fortunately for the loan originator, the count found it was not a "lender" for purposes of the FHA loan process and therefore had no obligation to determine what sampling was appropriate. 

Presumably, even if the loan originator could have been deemed to be a lender, it could stil have avoided liability by arguing that it relied on the expertise of the well tester to determine what parameters had to be analyzed. Of course, the FHA letter seemed to go require more than what was required under state or local drinking water regulations if there were local conditions that warranted sampling additional chemicals of concern, and the well tester might not have known about this additional FHA requirement. By ruling that the loan originator was not an FHA "lender", the court did not have to address the merits of the claims.

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.

Dirty Little (Environmental) Secrets

Nearly all state and federal environmental cleanup laws have reporting obligations. However, the circumstances and parties who have the obligation to report contamination will vary significantly. In many cases, the reporting obligations are linked to the discovery of contamination that exceeds a reportable quantity or RQ. The RQ will vary according to the particular contaminant.

At first glance, this may seem like a reasonable approach. However, when one 'digs' a little deeper, it becomes clear that the way reporting obligations are structured have actually facilitated the proliferation of brownfields and allows many sellers of corporate property to keep the presence of contamination secret. Indeed, a common provision now appearing in transactional documents is a so-called 'No Look' or 'No Hunt' clause that prevents the buyer from conducting further investigations on its property if it wants to maintain the contractual protections it obtained from the seller. In fact, it is not uncommon for  environmental lawyers to spend a significant amount of time on deals negotiating and drafting what and how information about contamination is to be disclosed.

The reason for all this is because the reporting obligations are often expressed in terms of the discharge of a certain quantity of a chemical over a certain period of time such as 24 hours. Now, back in the 1970s this made alot of sense when environmental management practices were still in their infancy and the principal problem was stopping ongoing discharges of hazardous substances.

Management of hazardous substances and wastes has significantly improved over the nearly three decades since the passage of CERCLA and RCRA so that NEW discharges from a facility are no longer the most important concern.  Instead, it is the legacy of historical contamination from these past practices that have had to continually confront.

Unfortunately, the reporting obligations often do not address purely historical contamination since (1) the regulations often use present tense gerunds such as spilling, discharging, releasing, disposing and  (2) it is difficult to determine how much of the contamination was discharged over the relevant reporting period. In otherwords, was it a drip, drip of PCB-contaminated oil from a condensor  or percolation of wastes thru an unlined lagoon over 20 years, or was there a sudden release of hazardous materials from some containment structure or container.

Another  regulatory oddity is that cleanup standards and reporting obligations are not congruent so that there could be contamination above  above cleanup levels that may not be reportable because the contamination occurred over a very long period of time yet for some chemicals there may be a discharge that requires reporting but does not result in any risk-based cleanup obligation.  

As a result, owners and sellers of property with purely historical contamination take the position that they have no obligation to disclose the presence of the contamination even if the contamination is present in concentrations that exceed applicable cleanup standards. In the absence of a regulatory driver, the owner/seller can then contractually prohibit the buyer from disclosing the contamination unless an overburdened regulatory somehow stumbles across the contamination.

Now, some academics, government legislators and judges have expressed the view that this is really not that big a problem because the marketplace can address this issue. After all, they say, a buyer can always require a seller to disclose and cleanup a site. Of course, this ignores the practical market reality that buyers may not have the leverage to extract such concessions, may not realize they need such information or that they may even want to know.

I think the absence of reporting obligations for purely historical contamination has contributed to the creation of brownfields as owners can just abandon their properties and while the local real estate market may be aware of concerns, overtaxed regulators may have no clue about the potential contamination.

My suggestion is that we link reporting obligations to cleanup standards so that if a phase 2 discovers soil or groundwater contamination, the contamination must be reported.  No more time spend on trying to figure out how much of the chemical escaped into the ground or less time for lawyers to argue over how to deal with the results of the due diligence.

I also think that all phase 2 reports should  be required to be sent to a centralized state database. Just think of all the wasted time and money that goes into repeating phase 2 reports over the years. If a consultant was able to access a database and see that sampling had been collected in the past in a certain area, it could use that information to advise its client that there is no need to sample in a particular area or that the area was already sampled and recommend sampling in other areas to better delineate the contamination.

Why are we still discovering contaminated sites nearly 30 years after CERCLA? Why havent we cleaned up more sites? Why are there so many brownfield sites? I think the inadequate reporting obiligations are a bit reason.

What do you think?    

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.

California Appeals Court Allows Claims for Inadequate Mold Disclosure Against Broker

In this case that holds lessons for brokers, foreclosing lenders and mold inspectors, a California court ruled that a purchaser may bring claims for fraud and negligent mispresentation against a listing broker.
In Sawaya v. Coldwell Banker, the plaintiff agreed to purchase a home in Glendale, California where the listing agent and buyer’s agent was Coldwell Banker Residential Brokerage Company. The purchase agreement provided that Coldwell Banker did not guarantee the condition of the property and "strongly advised" plaintiff to have a professional inspect the property, particularly to determine if mold was present. The agreement provided that the buyer had the right to conduct inspections.The buying agent was the niece of the plaintiff. According to the court’s opinion, the plaintiff had a close relationship with her niece and relied on her to inspect the property as well as to read and understand all documents. The plaintiff’s niece assured her that she would ensure inspections were proper and thorough and that plaintiff would be "protected."When she inspected the property, plaintiff noticed "a very strong, musty odor." The listing agent later told plaintiff that she had been informed by the sellers that the source of the odor was a broken toilet, and that sellers would repair the toilet and take care of the problem." The listing agent conducted a visual investigation of the property and after observing a water stain on the bedroom ceiling, she advised plaintiff to have the property inspected by a professional inspection company. The buying agent recommended that plaintiff retain Amrow Inspection Services, Inc. (Amrow), to inspect the property. Amrow inspected the property and observed moisture stains at northeast bedroom. Amrow recommend asking the seller for further information regarding the history of the damage but did not address the presence or absence of mold.Prior to the closing, the plaintiff was given a disclosure statement which stated the sellers were unaware of any mold, flooding or drainage problem or major structural damage. Plaintiff also signed a "Mold Disclosure Agreement" provided by Coldwell Banker which stated that
"every Buyer/Lessee should have a mold test performed by an environmental professional as either a separate test or an add-on to their whole house inspection. This is especially necessary if any of the inspection reports or disclosure documents indicate that there is evidence of past or present moisture, standing water or water intrusion at the property since most mold thrives on moisture. . . . Any waiver or failure on the part of a Buyer/Lessee to complete and obtain all appropriate tests, including those for mold, is against the advice of Broker." The form went on to say that by signing, the buyer/plaintiff agreed Coldwell Banker would have no further responsibility regarding the possibility of mold contamination of the property or any resulting injury. Moreover, the form contained a disclaimer that that "[n]othing any sales agent may say to [her] can change this Agreement or the advice contained [in it]."
The day before the final walk-through inspection, the plaintiff signed a "Receipt for Reports and Contingency Removal," acknowledging she had completed all inspections and reviewed all reports, and assumed any expense for repairs or corrections. At the final walk-through, plaintiff also signed a "Verification of Property Condition" where she agreed to hold harmless the broker and brokerage employees from any liability and damages arising out of the contractual obligations of the Buyer and Seller concerning the condition of the Property."
After the closing plaintiff removed wallpaper as part of her remodeling and discovered mold in the master bathroom as well as mold-related damage in the kitchen. She hired an inspector who discovered that the moisture originated from inside the wall from the unit above and from the exterior walls in the rear of the unit. After she moved in, plaintiff discovered additional water intrusion and the presence of toxic mold in wall cavities that rendered the residence is uninhabitable. Plaintiff was forced to vacate the home due to health problems resulting from mold exposure.
Plaintiff then filed suit, asserting claims of fraudulent concealment, negligent misrepresentation, failure to inspect and disclose, and breach of contract against Coldwell Banker. Plaintiff also sued her homeowners association, the seller, a former seller, and one of the inspectors, alleging the latter parties failed to disclose the home's structural damages.
In July 2008, Coldwell Banker moved for summary judgment, denying that it concealed any facts or made misrepresentations and asserting that plaintiff did not or could not rely on any representations In support of the motion. The trial court granted summary judgment to Coldwell Banker and plaintiff appealed.
On its claim for fraudulent concealment and negligent misrepresentation, the plaintiff said that Coldwell Banker had actual knowledge of certain material facts that it knew were unknown or beyond the reach of Plaintiff. These alleged material facts were that the broker knew there was improper drainage away from the exterior walls of the unit due to the placement of exterior planters causing pooling of water, that damage to the exterior wall allowed water intrusion, and that there was no effective moisture barrier along the exterior walls outside of the walls and windows of the affected rooms. Plaintiff alleged that Coldwell Banker failed to disclose these facts and intentionally or negligently misrepresented the condition of the property
The court began its analysis by stating that mere silence alone did not constitute fraudulent concealment absent a fiduciary or confidential relationship between the parties, or special circumstances that would equitably estop a person from relying on its silence or inaction, and which were sufficient to create a positive duty to speak or act. The court then explained that even absent a duty to speak, one who undertakes to speak must not suppress facts that materially qualify those stated.
Turning to the facts, the court noted that the listing broker had told plaintiff that the source of the musty odor was a broken toilet and that the sellers would "take care of the problem." The court said that listing agent should have been aware that a musty odor, water stains on the ceiling, and a leak from a broken toilet strongly suggested a mold problem. However, instead of informing plaintiff about the potential serious toxic mold problem, the court said the listing agent told the plaintiff that the sellers' repair of the broken toilet would "take care of the problem” even though fixing a leak only addresses the water problem and does not abate the mold problem. Thus, the court found there was a triable issue of fact if the listing agent lacked “reasonable ground” for believing her statement that sellers' repair of the broken toilet would take care of the problem was true. Thus, the court found she had made a negligent misrepresentation.
By the same token, the court held there was a triable issue of fact exists as to whether the listing agent fraudulently concealed a material fact from plaintiff by misleading her into thinking that repairing the toilet would take care of the problem manifested by the musty odor, water-stained ceiling, and leaking toilet.
The rejected Coldwell Banker's reliance on the "Mold Disclosure Agreement. The court noted that this form was among 40 to 50 pages of documents that plaintiff had to sign and that the plaintiff was told these were standard documents used in every real estate transaction that she should simply sign. The court said that even assuming plaintiff read and understood the "Mold Disclosure Agreement," her claim was that she was deceived by Coldwell Banker when the listing agent told her that the sellers "would take care of the problem." The court said this was an affirmative act by the listing agent that was designed to persuade plaintiff that she did not have to be concerned about the musty odor and therefore prevented Coldwell Banker from hiding behind the "Mold Disclosure Agreement."
On the breach of oontract claim, the court said that an "as is" provision in a real property sale contract is ineffective to relieve a seller and a broker of either affirmative or negative fraud such as where the seller or his agent misrepresents the then condition of the property or fails to disclose the true facts of its condition not within the buyer's reach and affecting the value or desirability of the property. The court also pointed out under the state Civil Code, brokers had a statutory obligation to disclose to a prospective purchaser all facts materially affecting the value or desirability of the property that an investigation would reveal. Because the broker was aware of a musty odor, water stains on a ceiling and a broken toilet, the court ruled that the broker breached its duty when it told the plaintiff that the repair of the broken toilet will "take care of the problem." Moreover, the problem was not addressed and as a result plaintiff bought a property that she could not live in due to the presence of toxic mold.
This case illustrates how making inaccurate statements where the speaker has no obligation can lead to liability. This can be particularly important for banks who may not be fully aware of conditions at a foreclosed property.

Tennessee Latest State to Address Stormwater Compliance for Foreclosures

As many of you know, lenders have been finding themselves subject to stormwater violations when they foreclose on uncompleted construction sites. In response, several states have issued guidance alerting lenders to their obligations when they take control of construction sites.Now, Tennessee has gone one step further and actually incorporated language into its general permit. The two key issues for lenders are if a new notice of intent (NOI) has to be filed and if the permit may be terminated.

Notice of Intent- For construction sites or portions of the sites where there is a new operator (i.e., new owner) after the initial Notice of Intent (NOI) is filed and the SWPPP has been submitted, a new NOI should be submitted as soon as practicable. The supplemental NOI must reference the project name and tracking number assigned to the initial primary permittee’s NOI.
However, if the site under the control of the new owner is inactive and all areas disturbed are completely stabilized, a new NOI does not have to be submitted. Instead, the NOI should be submitted prior to the commencement of construction by the new operator.If the transfer of ownership is due to foreclosure or a permittee filing for bankruptcy, the new owner (including but not limited to a lending institution) must obtain permit coverage if the property is inactive but not stabilized sufficiently. If the property is sufficiently stabilized, permit coverage will not be necessary until construction activity at the site resumes.Permit Termination- A permittee must request termination of coverage when the permittee no longer meets the definition of an "operator"(does not retain ownership or operational/design control of the entire site or portions of the site). Until the permit is terminated, the site must remain in compliance with this permit while a portion of a site has not been completed and is not finally stabilized. In such instances, one or more permittees must retain coverage for the unfinished portion or portions of the site.
If the new operator (e.g., lender) has no plans to engage in any construction activity in the foreseeable future, the primary permittee’s coverage may be terminated if the property is stable with perennial vegetation and sediment discharge does not have the potential to occur from the site. The permit coverage can also be terminated for portions of a permitted area that has been carved out to one or more subsequent operators who retain responsibility for site disturbance and permit coverage until final completion and stabilization. The termination of coverage will be effective when the replacement NOC has been issued to the new operator and the state has accepted a Notice of Termination (NOT) from the primary permittee.

Lawsuit by Foreclosing Bank Agst Dry Cleaners Shows how Vapor Intrusion Expands Liability

Those of you who receive the EDR Insider probably noticed the recent report about the bank that foreclosed on a residence and then filed a lawsuit against an adjacent dry cleaner and the bank acting as trustee for the estate that leased the site to the dry cleaner. This case illustrates how vapor intrusion is fast becoming a powerful tool in environmental litigation.
In Forest Park National Bank & Trust v Ditchfield, the plaintiff bank filed a lawsuit under the citizens suit provision (section 7002) of the Resource Conservation and Recovery Act (RCRA) charging that the dry cleaner has created an imminent and substantial endangerment. The lawsuit seeks an order requiring the defendants to remediate the contamination originating from the dry cleaner.
The town of River Forest desperately wants the site remediated because it is part of a Tax Increment Finance (TIF) district that is slated for redevelopment. However, redevelopment is being held up because of the contamination.
Because the town has adopted an ordinance prohibiting use of groundwater for potable purposes, it would normally be very difficult for the plaintiff to successfully bring a RCRA 7002 action since the ordinance essentially serves to prevent exposure to contaminated groundwater. However, the existence of vapor intrusion will enhance the changes of the plaintiff surviving a motion to dismiss the case.
Like this case, there are many sites where vapor intrusion is the only completed exposure pathway because the soil is covered and the groundwater is not being used for drinking water purposes. Indeed, many sites that were remediated using risk-based cleanups and that have received NFA letters yet may continue to pose risks of vapor intrusion because that pathway was not evaluated. As a result, vapor intrusion is fast becoming a favorite tool of the plaintiffs’ bar. For this reason, consultants need to consider the VI pathway even when groundwater is not being used and should carefully review data associated with previously remediated spills before identifying a former release as an HREC.