Seven Things Informed. Lenders Should Know About Environmental Due Diligence

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1 Seven Things Informed 1 Lenders Should Know About Environmental Due Diligence EDR Webinar Wednesday, April 13, 2016 Grady L. Shields Wyrick Robbins Yates & Ponton LLP 4101 Lake Boone Trail, Suite 300 Raleigh, NC gshields@wyrick.com

2 I. The Protections Afforded by Thorough Environmental Due Diligence 2 Main Federal Liability Concern CERCLA imposes liability on: The current owner and operator, even if they didn t cause the contamination The owner and operator at the time of disposal, even if they didn t cause the contamination Those arranging for disposal at the site Those transporting to the site, if they selected the site Joint and several liability, not limited to the value of the real estate; applies even to raw land Essentially no limit time-wise, given how causes of action accrue

3 Lender Liability Exemption (42 USC 9601(20)(E)) Originally, only provided that a secured creditor was not an owner or operator under CERCLA if without participating in the management of a vessel or facility, [a person] holds indicia of ownership primarily to protect his security interest in a vessel or facility. 42 USC 4601(20)(A) Case law quickly split on whether lenders lost the exemption by foreclosing Fleet Factors (11 th Cir. 1990), implying capacity to influence might be sufficient for participation in management control EPA adopted a lender liability rule, struck down by the D.C. Circuit in 1994 Adoption of the Lender Liability Act of

4 Lender Liability Act of 1996 Clarified that while the Borrower is still in possession of the site, the lender participates in management only if the lender: I. Exercises decision-making control over the environmental compliance related to the vessel or facility, such that the [Lender] has undertaken responsibility for the hazardous substance handling or disposal practices related to the vessel or facility; or II. Exercises control at a level comparable to that of a manager of the vessel or facility, such that the [Lender] has assumed or manifested responsibility aa.for the overall management of the vessel or facility encompassing day-to-day decision making with respect to environmental compliance; or bb.over all or substantially all of the operational functions (as distinguished from financial or administrative functions) of the vessel or facility other than the function of environmental compliance 4

5 Lender Liability Act of 1996, Continued 5 Accordingly, if a lender exercises financial or administrative control over the Borrower s operations but does not assume control over the Borrower s day-to-day environmental compliance, the Lender cannot become the owner or operator while the Borrower is still in possession

6 Lender Liability Act of 1996, Continued As long as they did not participate in management while the Borrower is still in possession, lenders are not considered owners or operators, even if they foreclose and then sell, release, liquidate the facilities, maintain business activities, wind up operations, undertake a response action, or take any other measure to preserve, protect, or prepare a site for sale or other disposition, if the lender seeks to do those things at the earliest practicable, commercially reasonable times, on commercially reasonable terms 6 The determination of commercially reasonable takes into account market conditions, and legal and regulatory requirements A lender has no liability for any act or omission occurring before a security interest is taken

7 Lender Liability Act of 1996, Continued 7 The Act creates a safe harbor list of lender activities that the Lender can undertake at any point, regardless of whether the Borrower is still in possession: Holding a security interest or abandoning or releasing a security interest Including in the terms of an extension of credit, or in a contract or security agreement relating to the extension, a covenant, warranty, or other term or condition that relates to environmental compliance Monitoring or enforcing the terms and conditions of the extension of credit or security interest Monitoring or undertaking one or more inspections of the vessel or facility Requiring a response action or other lawful means of addressing the release or threatened release of a hazardous substance in connection with the vessel or facility prior to, during, or on the expiration of the term of the extension of credit

8 Lender Liability Act Safe Harbors, Continued Providing financial or other advice or counseling in an effort to investigate, prevent or cure a default or diminution in value of the vessel or facility Restructuring, renegotiating, or otherwise agreeing to alter the terms and conditions of the extension of credit or security interest; exercising forbearance Exercising other remedies that may be available under applicable law for the breach of a term or condition of the extension of credit or security agreement Coordinating a response action under Section 107(d) of CERCLA or working under the direction of an onscene coordinator appointed under the National Contingency Plan 8

9 Caveats The exemption does not extend beyond owner and operator liability under CERCLA. Lenders can still be liable for: transport, arranging for disposal violations/requirements of permitting programs, etc. The 1996 Lender Liability Act requires commercially reasonable efforts to sell, without additional guidance. Borrows a requirement for listing for sale within 12 months of acquisition from EPA policy RCRA addresses handling, transport, storage and disposal of hazardous and non-hazardous materials, including petroleum. Typically applies only if lenders take over waste operations. RCRA incorporates CERCLA s Lender Exemption, but can leave lenders subject to liability for leaking USTs, and subject to citizens suits for an imminent and substantial endangerment to public health or the environment 9

10 10 Caveats, Continued State legislation Often somewhat similar to CERCLA, but tests can vary (e.g., in N.C., strict liability, but only for those having control over the petroleum or hazardous substance immediately prior to discharge ) Many states have their own lender exemptions, but: can leave technical minefields, such as requirements to complete an environmental assessment meeting State requirements, within 90 days of the acquisition, and filing the assessment with the State within 180 days of the acquisition (Wisconsin) often still require lenders to pay for emergency response costs Common law claims Typically not preempted by State legislation Can include trespass, nuisance, negligence

11 Federal Innocent Landowner/BFPP Defenses 11 Innocent Landowner Defense, elements: Property was acquired after the disposal of hazardous substances Despite all appropriate inquiry, party did not know or have reason to know of the presence of the hazardous substances, 42 USC 9601(35)(A)(I), 9607(b)(3) Bona Fide Prospective Purchaser Defense (for properties acquired after January 11, 2002), eight elements Initially: Disposal occurred prior to the acquisition All appropriate inquiry (starting with a Phase I Environmental Site Assessment, ASTM E , with VI) No affiliation Continuing obligations: Complying with use restrictions and controls Reasonable steps/appropriate care Cooperation, assistance and access Compliance with information requests Providing legally-required notices

12 Protecting the Lender Through Pre-Loan Diligence Looking to reduce threats to: The value of the collateral The Borrower s ability to pay, given the threat of Borrower liability. E.g., Crown Bank v Capital Development, LLC, 2014 WL (N.J. App.) (cost to address 2 leaking USTs drove Borrower into default) The Borrower s ability to pay given the level of environmental regulation applicable to the Borrower s business (e.g., generating hazardous waste or significant air emissions); has the cost of compliance been adequately factored into operating and capital projections? The threat of direct lender liability (for example, the risk of liability for a tenant s actions if a lender takes title; Whitehurst v. Heinl, 2015 WL (N.D. Ca.) (Lender settled claims related to tenant s releases of dry cleaning fluid while Lender held title, years before)) 12

13 Pre-Loan Diligence Value of the Collateral 13 Phase I Environmental Site Assessments Increasing use of Property Condition Assessments, ASTM Standard Practice E

14 Pre-Loan Diligence-Borrower s Ability to Pay Another reason to require a Phase I Environmental Site Assessment and look over the Borrower s shoulder to help make sure the Borrower qualifies for the Innocent Landowner/BFPP Defenses Make sure that the Borrower s complying with the landowner s AAI requirements, such as searching for environmental liens and Activity and Use Limitations Make sure that the Borrower s complying with the 180 day/1 year time limits on Phase I ESAs Borrower s other environmental risks - did they get Phase I ESAs on their other properties? Past properties? - do they have liability for hazardous materials shipped off-site? - have they adequately factored in compliance costs? Consider requiring an environmental audit 14

15 Pre-loan Diligence - Minimizing Risk to the Lender Phase I Environmental Site Assessments Consider not lending against higher-risk categories Environmental representations and warranties Environmental indemnities No lender liability for steps taken before the security interest attaches; no liability for due diligence activities 15

16 II. What to Look for on Borrower Representations and Warranties Warrant the environmental condition of the property Warrant the environmental compliance of the business Off-site waste disposal Non-owned and previously-owned and operated properties Require the correction of identified issues, with deadlines and a holdback Warrant that the Borrower has conducted its due diligence in compliance with the AAI Rule Warrant that Borrower has provided the Lender with all documentation on the environmental condition of the business, property, past properties and adjacent properties Borrower s agreement to provide the Lender with regular reports demonstrating environmental compliance Borrower s agreement to report releases to the Lender Borrower s agreement not to change the use of the property in such a fashion as to increase environmental risk Borrower s agreement to notify the lender of any NOVs or other notices/correspondence/claims Borrower s agreement that the loan can be called for environmental non-compliance Remediation requirements Compliance with laws, not just government authorities having jurisdiction (risk-based issue) Insurance Borrower to maintain PLL coverage Borrower to cover the cost of Lender Liability Environmental Coverage 16

17 Borrower Representations and Warranties, Continued Limit Borrower reliance Include language in loan commitments and documents to the effect that the Borrower is not entitled to rely on the findings of the Lender s consultant, and that the Lender is making no representations as to the condition of the property (Crown Bank) Pre-foreclosure due diligence Include language giving the lender the right, but not the duty, to conduct AAI prior to foreclosing, including sampling Trustee Provisions Update forms periodically (e.g., VI) Watch revisions! 17

18 III. Tips on the Use of Indemnification Agreements Remain aware that the agreements don t shield lenders from liability Fund with an escrow (not favored litigation risk), letter of credit or environmental reserve Make both the borrower and any guarantors directly liable Update forms Watch revisions! 18

19 IV. Developments in Environmental Insurance Most CGL policies now exclude environmental, but hold onto and review older occurrence policies Pollution Legal Liability ( PLL ) coverage generally is available PLL Can cover the following, giving protections Phase I ESAs may not: 3 rd party claims from sudden and gradual conditions Off-site and on-site cleanup due to contamination Claims of 1 st party or 3 rd party business interruption Arranger, transporter claims Non-owned disposal sites 19

20 PLL Policies, Continued Limits on a PLL Policy s usefulness from lenders perspective: Won t cover known conditions except for high retention Often need to foreclose to collect Policy limits may not be high enough Other Borrower sites may be included, diluting coverage Policy term may not cover entire loan period Lender may need to be named as an additional insured for cancellation notice 20

21 Lender Liability Environmental Coverage Increasing use of Lender Liability Environmental coverage Coverage for the lesser of the cost of remediation or the loan balance Coverage for the outstanding loan balance When pays outstanding loan balance, includes accrued interest from date of default and any related outstanding obligations On-site pollution conditions must be discovered during policy period for coverage to apply Pre-existing conditions can be included by endorsement if a RP is actively cleaning the site Covers losses insured lender is required to pay, including bodily injury, property damage, and cleanup costs for on-site and offsite conditions Includes cost of defense, and applies whether lender is in possession of the property or not 21

22 Lender Liability Environmental Coverage, Continued Can be written on a single site or portfolio basis; for portfolios, can be based on industry type, coverage for a particular acquisition, or on whatever other basis the lender wants Benefits: Provides protection that Phase I ESAs and PLL policies may not Augment lender s own due diligence process Fast underwriter turnaround (often less than one week) Coverage periods of up to 20 years Coverage for both retrospective and prospective claims Can include a waiver of subrogation against the borrower Be careful regarding coverage Increase in use of very limited coverages, like environmental coverage for golf courses 22

23 V. The Impact of Vapor Intrusion Fears 23 Drivers for the Focus on Vapor Intrusion: Vapor migration is included in CERCLA s definition of release Surprising results of studies in the Northeast, and resulting regulator focus VI results can vary greatly season-by-season, or even time of day Rapid changes to VI statutes and regulations, and lack of clear VI guidance State agencies are using VI to re-open old sites, even with NFA letters VI issues being found as Phase I s are updated/redone, such as for refinancings VI more of an issue given increased use of risk-based cleanups VI poses resale issues, particularly now Increases in the number of VI related lawsuits

24 Vapor Intrusion Fears, Continued VI can result in liability for the borrower even if they didn t cause the VI could for a lender too, under common law theories like nuisance, trespass, negligence 24

25 Statutory Liability for VI Issues CERCLA s due care requirements/similar state schemes; qualification for the Innocent Landowner and BFPP defenses RCRA s regulatory scheme /similar state schemes ( imminent and substantial danger ) (carve-outs from most self-audit privileges/immunities) OSHA issues Other state statutes/regulations New York (2008) (duty to warn commercial and residential tenants) California (2007) (for overlying structures, need to include maximum VOC calculations in risk assessments) Others coming 25

26 Regulatory Response on VI 26 EPA s 2013 (general) Vapor Intrusion Guidance Recommended indoor air sampling instead of modeling, and Sought to extend EPA s authority over indoor air risks to commercial and industrial settings traditionally governed by OSHA Now, Vapor Intrusion Screening Level Calculator, mostly for Superfund, Technical Guide for LUST sites

27 VI Impacts on Due Diligence 27 ASTM Standard Practice E E expressly requires environmental professionals to account for vapor mitigation or encroachment in looking for Recognized Environmental Conditions New ASTM Standard Practice E

28 VI Impacts on Due Diligence ASTM E / : Looks for vapor encroachment conditions ( VECs ) VECs are determined with reference to conditions at the property boundary Consider more detailed investigation to determine if there is intrusion into the actual building or planned building envelope 28

29 VI Considerations VI can be relatedly inexpensive to addressconsider a holdback to cover mitigation expenses 29 Is it cheaper and more effective to install an abatement system? Spell out, in advance, whether vapor sampling will be allowed during due diligence

30 VI Considerations, Continued 30 Make sure to request VI/IAQ studies done previously Including in refinancings, did the Borrower adequately consider VI at the time? You ll need to conduct this review with an eye towards today s atmosphere

31 VI Considerations, Continued 31 Update Due Diligence Policies and Approaches Be conservative! Reference including but not limited to ASTM E , E in policies

32 VI. Changes Being Driven by the Regulators 32 Increased interest/pressure from regulators regarding environmental - in a recent survey, 63% of loan officers reported being asked about environmental issues during last examination; particular focus on perceived lack of expertise at community banks SBA lending on the rise. SBA updated its guidance 5 times from August 2008 to June Now 400 pages requires Phase I ESAs for higher-risk categories based on NAICS Codes, gas stations and dry cleaners, and Phase I and Phase II ESAs on older dry cleaners (50P (H))

33 Changes Driven by the Regulators, Continued SBA denied guaranty of a loan when known contamination was revealed in the loan application; see American Enterprise Bank v. Becker, 2016 WL (Ill. App) FDIC Environmental Liability Updated Guidelines for an Environmental Risk Program, FIL Best practice have an environmental risk-program. FDIC requires of lenders it ensures, with 8 key components: Training Policies Environmental risk analysis Structured environmental risk assessment (including consideration of the AAI risk) Monitoring of the borrower s activities during the life of the loan Loan documentation Evaluation of involvement in borrower s operations, particularly given participation in management concerns Evaluation of foreclosure FDIC expects the environmental risk program to be reviewed and approved by the Board of Directors and implemented by senior management National Credit Union Administration Letter (08-CV-13) (largely tracks FDIC Guidelines) 33

34 VII. Smart Handling of Environmental Issues in Defaults 34 Secured creditor exemption doesn t protect against air emission issues (CAA) or wastewater discharges (CWA) Must make commercially reasonable efforts to sell the collateral at the earliest practical time Depends on market conditions (42 USC 9601(20)(E)(ii)(II)) As long as didn t participate in management before foreclosure, generally can: Maintain business activities Wind up operations Undertake a response action to contamination Sell, lease, re-lease or liquidate the property Take actions to preserve, protect or prepare the property for sale 42 USC 9601 (20)(E)(ii)

35 Smart Handling of Defaults, Continued Phase I ESAs (still another reason) cuts down an uncertainty left by the exemptions/safe harbors may give freedom to hold the property for investment purposes Can be provided to potential purchasers For manufacturing sites, etc., consider a compliance audit, since compliance issues aren t covered by the exemption When possible, have an operator still on site Consider avoiding taking title at all use of receiver sales, or bankruptcy sales Document actions taken, especially all efforts to sell the property Address non-compliance issues, and take steps like those necessary to protect the Lender Exemption for petroleum USTs under RCRA List the property with multiple agents Beware leaving the Borrower without adequate funding. See, e.g., HSBC USA NA (SDNY 2007) 35

36 Questions? 36 Grady L. Shields Wyrick Robbins Yates & Ponton LLP 4101 Lake Boone Trail, Suite 300 Raleigh, NC