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Minimizing Environmental Liabilities in Bankruptcy Reorganizations

Neither federal bankruptcy nor federal environmental statutes address the interaction between the two areas of law. As a result, there are many questions as to how bankruptcy reorganization affects a debtor’s environmental clean-up liabilities and obligations. However, our recent experiences, as well as observations from several recent high-profile bankruptcies involving environmentally distressed properties, suggest that successful environmental creditors’ cases require not only skilled advocacy with an understanding of the complex interplay between environmental law and bankruptcy law, but also artful negotiations informed by the underlying legal context. This article discusses strategies that environmental creditors—such as an owner of property adjacent to contaminated property that is owned or operated by a bankrupt potentially responsible party (PRP) or a landlord of a property on which the tenant is a bankrupt PRP—can employ to minimize the leftover environmental liability following the debtor’s bankruptcy reorganization.

Certain environmental creditors inevitably fare better than others in terms of maximizing the debtor’s responsibility to undertake or fund environmental clean-ups. Although the relative success of an environmental creditor is dependent on a number of factors, favorable outcomes are more likely with well-articulated (and favorable) facts, as well as the creditor’s ability to navigate the underlying statutory schemes and employ effective strategies in light of the statutory context. For example, one key observation is that bankruptcy does not provide a blanket release from all environmental obligations. Generally, bankruptcy releases the debtor from liability only for “claims,” which the Bankruptcy Code defines as a “right[] to payment.” Thus, a debtor will only be discharged from an environmental obligation that can be reduced to a right to payment.

If the environmental statute under which liability is being imposed authorizes the regulator to perform the clean-up itself and seek reimbursement from the responsible party, the liability or obligation is considered capable of being reduced to a right to payment and is dischargeable in bankruptcy regardless of whether the government has the right to obtain an injunction requiring the PRP to perform the clean-up.  For example, the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) enables the regulator to either require the PRP to perform environmental remediation or to perform the remediation itself and obtain reimbursement from the PRP. In contrast, the Resource Conservation and Recovery Act (RCRA) enables the regulator to require the PRP to perform the clean-up but does not allow the regulator to perform the clean-up and seek reimbursement from the PRP.  In Ohio v. Kovacs, 469 U.S. 274 (1985), the Supreme Court held that the regulator’s option to perform the remediation and receive reimbursement from the debtor (as under CERCLA) amounted to a dischargeable claim. In contrast, in U.S. v. Apex Oil, 579 F. 3d 734 (7th Cir. 2009), the Seventh Circuit held that because RCRA does not provide an option to perform the remediation and receive reimbursement, the remediation obligation was not a dischargeable claim.

However, even where an obligation to perform remediation may constitute a dischargeable claim, there may be effective strategies to minimize the leftover environmental liability following discharge. For example, if the debtor continues to own the contaminated property during bankruptcy, it must continue to comply with environmental laws during the pendency of the bankruptcy and cannot use its pending bankruptcy as an excuse for violating environmental laws. Specifically, Section 362 of the Bankruptcy Code which provides for an automatic stay of proceedings against the debtor during the bankruptcy does not remove the ability of an enforcement agency to use its police powers to require the debtor to take actions to remedy a condition that represents a violation of an environmental law.

Similarly, Section 503 of the Bankruptcy Code classifies as administrative expense penalties imposed for, and costs incurred to remedy, environmental violations while in bankruptcy. Thus, a regulator has the ability to levy and receive full payment on penalties in connection with the violation during bankruptcy by the debtor of environmental laws. Furthermore, many courts have read the Supreme Court’s opinions in Kovacs and Midlantic National Bank v. New Jersey Department of Environmental Protection, 474 U.S. 494 (1986), as requiring the debtor to incur expenses in complying with environmental laws, including to remedy existing contamination, and such expenses are accorded administrative expense priority. These expenses are entitled to top priority and must be paid in full before other claims are paid.  As such, it is particularly important to identify the strongest environmental causes of action (or causes of action under police power authorities) that can withstand discharge or be accorded administrative expense priority. Armed with this information, environmental creditors can engage with regulators by, among other things, providing legal support and impressing upon the regulator the potential impending harm that may be caused by an environmental condition if the debtor is not required to pay to remedy the condition.

It is also extremely important to develop the strongest technical team to identify and evaluate environmental conditions and determine compelling arguments for protection of the environment, which can in turn trump the debtor’s discharge agenda. A strong case describing the magnitude and risk of the impending environmental harm may enable the environmental creditor to convince the trier of fact that a continuing, non-dischargeable obligation exists for environmental protection or to convince a regulator that a continuing condition exists that should be addressed during bankruptcy (and be accorded administrative expense priority).

Faced with non-dischargeable environmental obligations, a debtor/PRP will often resort to the transfer of the property (and cleanup funds) to a trust that will be responsible for remediating the property. The debtor will be able to address its liability (and that of the reorganized debtor) through a settlement agreement negotiated among interested parties. While non-governmental authorities will rarely have a direct voice in these negotiations, coordinating with federal, state, local, and quasi-governmental regulators may enable the environmental creditor to indirectly impact the negotiations. Moreover, identifying sympathetic bankruptcy trustees, creditor, shareholder, and bond counsel representatives, and even EPA representatives and United States Attorneys can assist in pursuing claims and supporting adversary proceedings, such as proceedings by a regulator to enjoin a debtor from violating environmental laws.

A thorough understanding of the interaction between bankruptcy and environmental legal frameworks is necessary but not sufficient to maximizing an environmental creditor’s recovery. Our recent experiences tell us that successful environmental creditors’ cases also require artful negotiations, strategic partnering and coalition building. To be successful these efforts also require a strong technical team to evaluate environmental conditions and present compelling arguments regarding the need to remediate these conditions for protection of the environment. Developing strong legal, strategic, and technical positions is the cornerstone of establishing negotiating parameters to maximize recovery in the environmental bankruptcy.

Matthew Dombroski is an Associate with law firm Manatt, Phelps & Phillips, LLP in New York, practicing in the Energy, Environment & Natural Resources and Real Estate & Land Use groups. He regularly counsels clients on environmental matters relating to corporate and regulatory compliance. Mr. Dombroski can be reached at (212) 790-4556 or mdombroski@manatt.com.

Mark D. Johnson, Partner in Manatt, Phelps & Phillips’ Los Angeles office, has extensive trial and arbitration experience in a wide-variety of environmental matters. He routinely counsel clients on compliance with environmental statutes and regulations, hazardous waste clean-up projects and environmental issues in the bankruptcy context. Mr. Johnson can be reached at (310) 312-4279 or mjohnson@manatt.com.

Ted Wolff is a Partner in Manatt, Phelps & Phillips’ New York office and focuses his environmental practice on litigation and transactional work. He represents creditors and debtors in regard to environmental matters in bankruptcy and specializes in corporate compliance counseling. Mr. Wolff can be reached at (212) 790-4575 or twolff@manatt.com.

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