Simon Tilling Tom Gillett October 31 2022 Environmental protection on insolvency: where does the balance lie? Steptoe & Johnson LLP | Environment & Climate Change - United Kingdom Simon Tilling, Tom Gillett Environment & Climate Change Tension between protecting creditors and protecting environmentEngland's approach to dateScotland's recent casesCommentWhen companies enter insolvency, the balance between protecting the interests of creditors and safeguarding the environment is often in tension. As economists talk of a UK recession, this article considers the current legal position, the potential for evolution and the impact on business owners and investors.Tension between protecting creditors and protecting environmentIn the words of its new prime minister, Rishi Sunak, the United Kingdom faces "a profound economic crisis" with "difficult decisions" ahead, but Sunak insists that "protecting our environment" is a manifesto commitment that his government will deliver. Striking that balance is a challenge, and never more so when money runs out and companies enter insolvency.Liability for environmental damage and responsibility for restoration is governed by a complex interaction of regulatory regimes and common law responsibilities, and it can often prove challenging to unpick these liabilities. When a business is solvent, there is often no need to engage in a forensic analysis: the business simply accepts responsibility and engages in a programme to address the issue at hand (whether that be a remediation programme, waste management or other harm mitigation measures). It is only when the business comes to an abrupt halt – such as when it becomes insolvent – that questions arise over who should pay to address the environmental concerns.Those questions are rarely easy to answer, and sometimes need the intervention of the courts. Recent decisions from a run of Scottish cases have considered the balance between environmental clean-ups and creditor claims and raise the question of whether older English cases, which prioritised the creditors, might be reconsidered.England's approach to dateThe leading English case is the Court of Appeal decision in Celtic Extraction(1) handed down in 1999. In that case, the insolvent business held significant amounts of waste under a licence issued by England's Environment Agency (EA), and the terms of that licence mandated certain measures to control and dispose of the waste. The insolvency practitioners (IPs) sought to disclaim the licence as "onerous property", so that they would not be bound by its demanding conditions. The EA argued that the IPs could not do so and that insolvency law should be read in light of the "polluter pays" principle when it concerns matters of environmental protection. The Court of Appeal found for the IPs, with Lord Justice Morritt concluding that:There is nothing . . . to suggest that the "polluter pays" principle is to be applied to cases where the polluter cannot pay so as to require that the unsecured creditors of the polluter should pay to the extent of the assets available for distribution among them.The cost of clearing up the waste fell to the EA, funded by the public purse.Scotland's recent casesWithin the past five years there have been cases in Scotland where the logic that the creditors are not polluters, and therefore do not need to pay, has not trumped all other considerations. Although each case is different on its own facts, there is a consistent thread, in which environmental protection is given more weight.Doonin PlantDoonin Plant Limited was also involved in waste management, under the regulatory supervision of the Scottish Environment Protection Agency (SEPA). SEPA determined that the company was depositing waste unlawfully and in 2012 it issued a notice under section 59(1) of the Environmental Protection Act 1990 requiring removal of the unlawful waste deposits. Doonin Plant did not do so. A second notice was issued in 2015, but at that point the company had become insolvent and entered liquidation. The cost of clearing the waste far exceeded the funds available for distribution to creditors, so the IPs sought directions from the court. The court was asked where the environmental liability was ranked in the hierarchy of distribution of funds. Was it a contingent provable debt or an expense of liquidation and, if an expense, should the IPs fees be prioritised?The presiding judge, Lord Doherty, found that the costs of remediation were to be paid before any distribution to the creditors – even if, as here, there would be nothing left. Doherty held that it would be rare for a court to refuse to order that the IPs' remuneration be paid in priority to the liquidation expenses, thus ensuring that IPs remain willing to take on cases with difficult environmental issues.Although Doherty noted that this was a decision based on statutory interpretation and not policy, it is notable that Doherty was prepared to interpret the environmental protection legislation by reference to the EU Waste Framework Directive 2008 and its embodiment of the "polluter pays" principle.Dawson InternationalUnlike the Doonin Plant case, where the clean-up was mandatory, the case of Dawson International(2) concerned the progress of a voluntary remediation project. It is often the case that responsible businesses will not wait to be ordered by regulators to restore environmental harm, and in the case of Dawson International, the company was engaged in a multi-year remediation programme at the point it became insolvent. To add to the complexity, the company was Scottish but the site in question was in England, under the responsibility of the EA.Among several questions put to the Scottish Court of Session in a preliminary issues hearing was the question of whether the EA had standing. The majority creditor claimed that the EA was not a creditor, nor a contingent creditor (the fact the EA had powers to issue notices did not make it one), and so could not force the continuation of a remediation project at the creditors' expense.Lord Clark sided with the EA, holding that the action of the companies could well have created a contingent liability because the company "had assumed control of knowingly contaminated subjects, failed to take reasonable measures to remediate the contamination at the site and thus knowingly permitted the continued contamination" and as such "the steps taken by the companies therefore had 'some legal effect' and put them under 'some legal duty or into some legal relationship' which resulted in them being 'vulnerable to the specific liability in question'". In such circumstances, the EA's power to serve a notice creates a legal relationship and gives the EA standing.Notably, Clark concluded that: "Otherwise, a company could knowingly cause contamination and any liability could be avoided by entering into insolvency prior to enforcement becoming possible."Clark's logic contrasts with the Court of Appeal in Celtic Extraction – a case where an existing liability to clean up waste under the terms of the waste management licence was not held to trump the creditors' interests. How the English courts address this question next time it is raised will be watched with interest throughout the United Kingdom.CommentAlthough each case is determined on its facts, there are lessons that are common to all:It is clear that the limits of the "polluter pays" principle may extend further than simply the original polluter in cases where that original polluter can no longer pay, and creditors need to pay careful attention to environmental performance and long-tail environmental risks.The regimes governing environmental liability and responsibility are complicated. Therefore, careful analysis of those liabilities is important risk management for all businesses and investors, even if those liabilities are currently being managed voluntarily.For environmental, social and governance (ESG) investments that consider a basket of wider metrics beyond purely financial indicators of performance, particular attention should be given to environmental concerns both as risk mitigation but also as opportunity. Proactively addressing legacy environmental issues and improving the environment might both improve the value of the asset and contribute to strong ESG messaging, if tackled with a full appraisal of the risks and rewards.For further information on this topic please contact Simon Tilling or Tom Gillett at Steptoe by telephone (+44 20 7367 8000) or email ([email protected] or [email protected]). The Steptoe website can be accessed at www.steptoe.comEndnotes(1)  Env L R 86.(2)  CSOH 52.