For more than 30 years, the conflicting goals of US bankruptcy and environmental laws have
confounded investors and practitioners in their attempts to predict how a debtor’s
responsibility for historic contamination will be dealt with in chapter 11. Environmental
statutes are in significant part designed to ensure that entities responsible for contamination
pay the costs of cleanup, irrespective of fault or the passage of time. This statutory goal
directly collides with a principal purpose of chapter 11, namely the achievement of a fresh
start for the debtor, free from the overhang of legacy liabilities. The Supreme Court has
directed that when possible, the objectives of the environmental and bankruptcy laws should
be reconciled,1 but this is far easier said than done, and the result over the years has been a
potpourri of inconsistent case law. Some courts have bent logic to favor the environmental
goals,2 while others have done the same to favor chapter 11’s objectives.3 Two recent
decisions – Mark IV Industries, Inc.4 and Apex Oil Co., Inc.5 – establish a clear trend of
favoring environmental over bankruptcy goals.

What is a “Claim” in Bankruptcy?

Resolution of the conflict between bankruptcy and environmental laws turns on the question of
whether a particular cleanup obligation is a “claim” as defined by the Bankruptcy Code. If the
obligation is a claim, it is capable of being discharged; if it is not, the bankruptcy has no effect
on it, and the debtor cannot escape responsibility for the cleanup. Lest this seem
unimportant, bear in mind that environmental liabilities can be significant in many chapter 11

The Bankruptcy Code defines “claim” to include “a right to an equitable remedy for breach of
performance if such breach also gives rise to a right to payment.”6 Under environmental laws,
state and federal governments have broad power to pursue injunctive relief to compel a potentially responsible party (a “PRP”) to clean up historic contamination.7 However, no law
allows a PRP to make a payment in lieu of compliance with a cleanup injunction, although
certain environmental laws authorize the government to perform the cleanup itself and bill the
PRP for the cleanup costs.

Confusion in the Case Law

The only U.S. Supreme Court case to address whether a debtor’s cleanup obligation is a
“claim” is Ohio v. Kovacs.8 In Kovacs, the U.S. Supreme Court held that a state agency’s
injunction ordering a debtor to clean up hazardous waste became a right to payment when the
state obtained the appointment of a receiver for the site previously owned by the debtor, thus
dispossessing the debtor of the property and preventing him from performing the cleanup
work. The Supreme Court held that since the debtor would be forced to spend money to
comply with the state injunction, the injunction was therefore a dischargeable “claim” in

Because the Kovacs ruling turned on the appointment of a receiver, its application to
traditional chapter 11 cases is somewhat limited. As a result, lower courts that have been
confronted with the question of whether environmental claims are dischargeable in chapter 11
have reached varied conclusions. For instance, in United States v. Whizco, the Court of
Appeals for the Sixth Circuit took the “expenditure test” articulated in Kovacs to the next level
holding, even though the government sought to enforce an equitable remedy and did not seek
to recover monetary damages from the debtors, the government’s cleanup order was a “claim”
merely because it required the debtors to expend money.

At the opposite end of the spectrum from United States v. Whizco is Torwico Electronics, Inc.
v. State of New Jersey, where the Third Circuit Court of Appeals held that the debtor’s
obligations under a cleanup order relating to the debtor’s previously owned, but no longer
occupied property was not a “claim.” The Court reasoned that the order required the debtor to
act to reduce an ongoing hazard, rather than merely to pay money, and that the debtor could
gain access to the land and conduct the cleanup, for which it had an ongoing responsibility
under New Jersey law. Similarly, the Second Circuit Court of Appeals in United States v. LTV
Corp. (In re Chateaugay Corp.),9 held that the government’s cleanup order was not a claim,
regardless of whether it required the debtor to expend money, if it required the debtor to take
action that would end or ameliorate ongoing pollution.

Deliberate Trend or Added Confusion?

The Mark IV Industries and Apex Oil decisions provide the latest guidance on this topic. The
focus of these decisions is the statutory regime under which the government pursues its claim
and, in particular, whether the regime authorizes the government to perform the cleanup itself and to seek reimbursement from the debtor. In particular, these cases hold that where the
government brings an action for injunctive relief under a statute which does not authorize any
form of monetary relief – whether such action is commenced pre- or post-bankruptcy, and
whether the action could have been commenced under a different statute that does authorize
the government to perform the cleanup and to seek reimbursement – the debtor’s obligation
with respect to such injunctive relief is not a “claim,” and therefore is not dischargeable in
chapter 11.

In Mark IV Industries, the Bankruptcy Court for the Southern District of New York held that
because the New Mexico Water Quality Act authorizes only injunctive relief, and does not
provide an alternative cost-recovery remedy, the government’s cleanup order was not a
“claim,” and thus was not dischargeable. Significantly, the court held that, even if the
government could have sought monetary relief under other statutes, it is bound in its
determination by the statute under which the government elected to pursue its remedies.

In Apex Oil, the government proceeded under RCRA, which similarly does not provide an
alternative cost-recovery remedy, and obtained a cleanup injunction well after Apex had
emerged from chapter 11.10 The Court of Appeals for the Seventh Circuit similarly held that,
because RCRA does not authorize any form of monetary relief, the government’s cleanup
order under RCRA was not a “claim” and, therefore, was not dischargeable.11

These decisions arm government environmental creditors with enormous leverage in chapter
11 cases. With multiple statutory regimes at its disposal, there is little doubt that, after Mark
IV Industries and Apex Oil, wherever possible, the government will pursue troubled
companies, or even companies that have cleaned up their balance sheets and emerged from
chapter 11, under RCRA or a similar statute that authorizes only injunctive relief.


The Mark IV Industries and Apex Oil decisions highlight the need for distressed investors to
understand and properly account for the dischargeability (or not) of a company’s
environmental liabilities, and the resulting leverage (or lack thereof) of a government
environmental creditor in chapter 11.

From the debtor’s perspective, entities contemplating a chapter 11 filing should evaluate
carefully the potential business and reorganization implications of the possibility that
environmental obligations may survive chapter 11. In the light of Mark IV Industries and Apex
Oil, certain debtors with substantial environmental liabilities may find it exceedingly difficult, if
not impossible, to reorganize as a standalone entity. In that case, particularly where
successor liability is not an issue – whether as a result of a debtor’s corporate structure or
otherwise – restructuring by means of a “363 sale” in bankruptcy may prove a better solution.

Finally, an entity considering purchasing the stock or an asset or business of a company that
emerged from chapter 11 should appreciate that the debtor’s environmental obligations may
not have been discharged and, as the buyer, you may be held responsible for pre-bankruptcy
cleanup obligations associated with the acquired entity and/or assets.