In our current economy, foreclosures still remain a common concern for commercial property owners and lending institutions.  While property seizure is intended to protect secured lenders by giving them the opportunity to sell the property and recoup their investment, this protection may be both a blessing and a curse if not handled carefully.  Properties contaminated with hazardous materials can significantly complicate the foreclosure process.  Often, the intricacies of federal and state environmental laws create additional liabilities for lenders if they get too involved in site operations.

The U.S. Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”) affords protection to secured lenders from environmental liability provided that the lenders meet certain criteria.  The Act’s definition of “owner or operator” does not include “a person that is a lender that did not participate in the management of” the property prior to foreclosure and provides several factors in assessing such participation.   A lender participates in the management of the property if, while the borrower is still in possession (i.e., prior to foreclosure), the lender:

  • Exercises  decisionmaking control over the environmental compliance…such that the person has undertaken responsibility for the hazardous substance…or
  • Exercises control at a level comparable to that of a manager…such that the person has assumed or manifested responsibility—
    • For the overall management… encompassing day-to-day decisionmaking with respect to environmental compliance; or
    • Over all or substantially all of the operational functions…other than the function of environmental compliance.

42 U.S.C. §9601(20)(E) and (F).  

Lenders may often find themselves with a difficult decision—either they protect their asset and step in to take control of a property destined for foreclosure or they wait until the foreclosure is complete to ensure that they do not run afoul of the lender exemption under CERCLA. 

Some lenders are also trying to proactively protect themselves by various procedures at different stages of the lending.  As Russ Banham points out in, “Foreclosed Properties May Come With Environmental Liabilities” (Business Insurance  June 2, 2013), lenders can do the following to protect themselves: incorporate contractual protections in the lending documents; purchase environmental impairment liability, pollution legal liability, secured creditor impaired property, or lender collateral environmental insurance; or insist on the borrower naming the lender on an environmental insurance policy or buying an environmental policy for which the borrower pays the premiums.  Lenders may also be wise to conduct environmental assessments prior to approving a commercial mortgage.  Despite protections, sometimes a lender will prefer to incur the cleanup costs to avoid selling the foreclosed property at a loss.   

Liabilities under CERCLA may not be the only law that a lender needs to navigate.   Some states have enacted their own environmental laws which may differ from CERCLA.  For example, Massachusetts’ Oil and Hazardous Material Release Prevention and Response Act originally followed a “participation in management” liability standard.  However, the 1998 “Brownfields Act” replaced that measure of liability with a causation standard.  Now a secured lender is not considered an owner or operator of a site after acquiring ownership if it satisfies all of the outlined conditions, which include the requirement that for a lender who has commenced foreclosure proceedings (i.e., not yet in possession) to notify the Department of Environmental Protection and prospective bidders at the foreclosure auction of the release.    Massachusetts General Laws ch. 21E § 2 “Owner” or “Operator.”  The definition does not involve any provisions for a lender participating in management of a site.  Thus, it appears that a lender may need to worry more about disclosure in relation to a contaminated property in Massachusetts rather than its control over the property itself.      

Lending institutions would be wise to take as many precautions as economically sound to protect themselves from any liability arising from contamination of a foreclosed property.