Seven Things to Keep in Mind about Treatment of Environmental Liabilities in Bankruptcy
By Tom Mounteer
For debtors seeking to reorganize under Chapter 11 of the Bankruptcy Code, creditors with claims against reorganizing debtors, and purchasers of assets in bankruptcy court-administered sales, this alert flags seven things to keep in mind about the treatment of environmental liabilities in bankruptcy.
I. Bankruptcy Doesn’t Excuse Compliance with Environmental Rules
While a Chapter 11 debtor remains in possession of its assets, the debtor must comply with all environmental rules that govern its assets’ operations. Debtors must abide by all the conditions in their air emissions and water discharge permits and all hazardous waste management rules.
Bankruptcy Code Section 362’s automatic stay of administrative and judicial proceedings provides a reorganizing debtor breathing room.
The situation is a little more complicated when it comes to government agencies’ pursuit of penalties for noncompliance. Administrative or judicial proceedings to fix penalty amounts are not subject to the automatic stay.
The same principles govern efforts to collect a potentially responsible party’s share of Superfund site cleanup costs. The government’s action against a debtor to fix its share of costs can proceed but an effort to collect a money judgment is stayed.
II. Cleanup Cost and Environmental Damage Claims Are Dischargeable as General, Unsecured Claims
Chapter 11 reorganizations provide debtors with a fresh start by extinguishing—“discharging” in bankruptcy terms—“claims” that arose before the debtor filed bankruptcy.
Environmental liabilities treated as “claims” will be discharged by plan confirmation.
Environmental liabilities can include such things as cleanup costs (either at the debtor’s own site or at disposal sites the debtor sent waste to) or environmental damage the debtor’s operations caused to adjoining property. Bankruptcy courts typically treat such liabilities as general, unsecured claims.
Even unknown and uncertain hazardous substance release response costs are dischargeable claims. The bankruptcy of a major industrial company illustrates the impact of this rule. EPA may file a proof of claim for tens of millions of dollars in response costs at the many Superfund sites to which EPA knows an industrial debtor sent its waste. EPA may believe those sites represent only a fraction of the sites at which the debtor might have sent its waste. Despite the uncertainty, plan confirmation discharges the debtor’s cleanup liability for unknown response costs at unknown sites.
The rule holds for environmental damages sought in tort actions as well. Tort claims for property damages that adjoining landowners brought in state court after confirmation of an oil and gas producer’s reorganization plan were discharged, even where the property owners did not know the debtors’ operations had had impacts on their properties.
III. Cleanup Cost Claims Arise When the Spill Occurred
In order for cleanup liabilities to be discharged by confirmation of a plan of reorganization, the claim must have arisen before the debtor filed bankruptcy. This rule makes determining when the claim arose critical.
Bankruptcy courts generally hold that cleanup liability arose when a spill occurred. Environmental liability will have arisen—and thus be a dischargeable claim—if the release or threatened release occurred prior to bankruptcy.
The effect of this rule is to protect reorganized entities that receive claims years after a court confirmed their bankruptcy plan. The rule does not depend on whether, for example, adjoining property owners had knowledge of the damage the release did to their property
IV. Injunctive Obligations Endure for Reorganizing (and Reorganized) Debtors
The specific type of environmental relief sought affects whether an environmental liability is considered a “claim.” Unlike cleanup cost claims or claims for compensation for environmental damages just discussed, demands for injunctive relief are not “claims” and are not dischargeable.
There is substantial authority establishing that cleanup orders (i.e., injunctions) are not claims and, therefore, will not be discharged. These can be either orders issued by government agencies or judicial injunctions obtained by private parties to address on-going hazardous substance releases.
This rule is particularly important for leaking underground petroleum storage tanks. The federal statute governing leaking tanks (and the many state statutes patterned after it) provides private parties only injunctive relief to compel a cleanup. The statute does not allow the harmed party to incur the cleanup costs itself and then sue for reimbursement. Reorganization will not discharge a debtor’s obligation to perform a cleanup where the claimant obtains an injunction.
Reorganizations in which a debtor emerges from Chapter 11 in possession of its assets are less frequent than other outcomes, for example, asset sales under Bankruptcy Code Section 363 discussed below. In rare situations in which the debtor emerges in possession of its assets, the reorganized debtor will retain environmental liability for the pre-petition environmental condition to which an injunction applies.
V. Where Multiple Remedies Exist, Government Agencies Can Choose Their Remedies
Government agencies can choose the form of relief they pursue and, thus, determine whether the debtor’s environmental liability is a dischargeable claim. The federal Superfund statute as well as state “mini-Superfund” statutes typically provide the government two forms of relief: (1) actions for recovery of response costs or (2) for injunctions to compel the responsible party to perform the cleanup. (Private parties can only seek to recover response costs under the Superfund statute.)
Take the example of a former gravel pit in which paint sludge waste was disposed. Under the Superfund statute, the federal government had two alternatives for cleaning up the pit. The government could have cleaned up the gravel pit first and then sued the debtor to recover its costs. Or, the government could have issued an order to the debtor to perform the cleanup.
Where the gravel pit continued to constitute a hazard and the government issued an order, the order was not a claim, and thus could not be discharged. In the gravel pit example, the court was unsympathetic to debtor’s argument that the government could have used its alternative cost-recovery authority. The court declined the debtor’s request to convert the order into a claim. As long as the cleanup order was valid, the debtor remained liable.
Courts have reached similar results where state agencies avail themselves of injunctive remedies under state laws that provide alternative cost-recovery remedies.
VI. To Earn Priority as “Administrative Expenses” Environmental Costs Need to Benefit the Debtor’s Estate
Creditors have an interest in seeing their environmental claims categorized as “administrative expenses.” The Bankruptcy Code grants priority to the payment of administrative expenses, which it defines as the “actual, necessary costs and expenses of preserving the estate.”
If, for example, after the debtor’s bankruptcy filing, the government incurs cleanup costs at property the debtor held during its reorganization, the government’s costs would be entitled to administrative priority.
VII. For Contaminated Property They Acquire in Section 363 Asset Sales, Purchasers Should Seek to Qualify as Bona Fide Prospective Purchasers
Purchasers of assets from a debtor in bankruptcy rely on the protection of Bankruptcy Code Section 363, which allows debtors to sell assets “free and clear” of their attendant liabilities.
What if the acquired asset is itself contaminated? That is, what if releases of hazardous substances occurred not as a result of waste shipments to an off-site disposal facility but occurred on the industrial property the purchaser is buying? Does a 363 asset purchaser avoid liability for the environmental condition of the asset it acquires?
To protect itself from liability for environmental contamination at an industrial facility it acquires, a 363 purchaser needs more protection than the Bankruptcy Code provides. To avoid liability, a purchaser of contaminated property in a Section 363 asset sale needs to qualify as a “bona fide prospective purchaser” under the Superfund statute.
While there are nuances to qualifying as a bona fide prospective purchaser, there are two core requirements. First, before the purchase, the buyer must conduct “all appropriate inquiry” into the property’s environmental condition.
Depending on their situation, reorganizing debtors, creditors of such debtors, and purchasers of bankruptcy assets will want to keep in mind these aspects of how environmental liabilities are treated in bankruptcy.