In an opinion issued on March 24, 2020, the District Court for the District of Delaware held that pre-petition environmental fines accrued by Exide Technologies were dischargeable debts in Exide’s Chapter 11 bankruptcy case and that penalties that Exide accrued during the pendency of its bankruptcy case were not entitled to administrative priority. South Coast Air Quality Management District v. Exide Technologies, Civ. No. 19-891 (D. Del. March 24, 2020). The case suggests that environmental penalties assessed against a corporation, even if premised in part upon false reporting, may be dischargeable in a bankruptcy case and further, that additional penalties not based on cleanup costs during the bankruptcy will not receive special treatment by the courts.

From 2000 to 2015, Exide Technologies operated a lead battery recycling facility in Vernon, California, located in Los Angeles County. Exide’s facility allegedly violated numerous environmental statutes in its recycling process, including discharging lead in an unsafe manner and filing false or incomplete reports. As a result, the South Coast Air Quality Management District (the “District”), one of California’s regional environmental enforcement entities, issued several Notices of Violation and penalties against Exide between 2012 and 2013.

Exide filed a bankruptcy petition in June 2013, and in December 2013, on the bar date for governmental claims, the District filed a proof of claim alleging that over $38 million in liquidated penalties were owed. In January 2014, the District filed an enforcement action in state court in Los Angeles County which, after some procedural wrangling regarding the appropriate venue for the case, was allowed to go forward for the purpose of determining the amount of penalties only. During the pendency of the state court action, the District filed an Amended Complaint seeking a total of $80 million in penalties which included penalties for post-petition conduct.

The Bankruptcy Court confirmed Exide’s Chapter 11 plan of reorganization in March 2015. As part of this reorganization plan, all pre-petition claims against Exide were discharged, with general unsecured creditors receiving pennies on the dollar for their claims. Additionally, the discharge included a broad injunction against “commencing or continuing any action” related to any claims that were discharged.

After the discharge and Exide’s emergence from bankruptcy, the District amended its complaint in the Los Angeles County state case again, and also filed an administrative claim in the bankruptcy seeking to recover the post-petition penalties. In response to these actions, Exide filed a motion in the bankruptcy court to enforce the discharge and injunction in relation to the state court action and an objection to the administrative claim.

With respect to the pre-petition penalties, Exide claimed that, while government penalties against individuals were not dischargeable, they were for corporations. 11 U.S.C. § 523(a)(7). The District, however, argued that the claims it sought were instead within the exception to discharge for debts based on “false pretenses, a false representation, or actual fraud” under 11 U.S.C. § 523(a)(2)(A). That is, the District argued that the debts were based on Exide’s fraud or false representations and because this exception to discharge applies to corporations, these debts were not discharged at confirmation. In resolving the issue in favor of Exide, the Bankruptcy Court found and the District Court affirmed that the environmental penalties did not fall within the fraud exception because the District did not “sustain[] loss and damage as a proximate result of the misrepresentations having been made.” Rather, the Bankruptcy and District Court held that the limitation to discharge contained in Section 523(a)(2) requires proof that there was some “pecuniary loss” or compensable harm. The Court further found that because the environmental penalties were premised upon strict liability, the fraudulent behavior of Exide, to the extent any occurred, was irrelevant in justifying the penalties.

As to the administrative priority of penalties that accrued during the pendency of the bankruptcy case, the Court emphasized that such requests are “strictly scrutinized” and that claimants bear a “heavy burden” in order to fit their claims within the statute. Calpine Corp. v. O’Brien Envtl. Energy, Inc. (In re O’Brien Envtl., Energy, Inc.), 181 F.3d 527, 533 (3d Cir. 1999). Administrative priority claims are limited to those which are “the actual, necessary costs and expenses of preserving the estate.” 11 U.S.C. § 503(b)(1). Both Courts found that the penalties claimed by the District were not necessary expenses of preserving the estate, but despite being civil and not criminal in nature were instead intended to “punish and deter” under a strict liability statutory scheme. The District Court drew a sharp distinction between the compensatory expenses accrued by the state agency in Pennsylvania Department of Environmental Resources v. Conroy, 24 F.3d 568 (3d Cir. 1994), where the state undertook actual cleanup and was seeking reimbursement for those expenses, and the claims sought by the District in Exide’s bankruptcy. The District was not seeking compensation for any remedial activities it had undertaken during the pendency of the bankruptcy, nor were the penalties providing a “benefit” to Exide. Thus, these claims were not appropriate for administrative priority.