There are unique and competing interests between the United States Bankruptcy Code1 and federal and state environmental laws. One of the primary purposes of the Bankruptcy Code is to allow a debtor to have a "fresh start." On the other hand, environmental laws are intended to require responsible parties to comply with environmental standards for the protection of human health and the environment. As a result of these competing interests, there has been extensive litigation related to the interplay between the bankruptcy and environmental regimes.

Although this is a complex area of law that requires close coordination between bankruptcy and environmental counsel, the purpose of this article is to briefly analyze two key questions related to environmental obligations in bankruptcy: 1) is there a test for determining whether an environmental obligation is a "claim," and therefore, dischargeable in bankruptcy; and 2) is it possible for a private party claim against a debtor to allow for the recovery of future environmental response costs?

Is there a test for determining whether an environmental obligation is a "claim," and therefore, dischargeable in bankruptcy?

One of the most significant issues relating to environmental liabilities is whether they can be discharged in bankruptcy. Dischargeability means a legal release or elimination of debt so that the debtor is no longer liable.2 As a general rule, only prepetition (for Chapter 7 cases) and pre-confirmation (for Chapter 11 cases) claims can be discharged in bankruptcy. Courts addressing the dischargeability of environmental obligations must first determine whether the environmental obligations constitute a "claim" under the Bankruptcy Code.

Under Section 101(5) of the Bankruptcy Code,3 a claim includes a "(a) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; or (b) [a] right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured." It is the second part of this definition that is typically at issue in determining whether an environmental obligation will constitute a claim. For example, when a debtor is subject to a cleanup order directing it to clean up pre-petition contamination on property owned by others, or on the debtor's own property.

The United States Supreme Court addressed this question in Ohio v. Kovacs,4 and held that the debtor's obligation to clean up environmental damage at a site the debtor did not own was a claim dischargeable in bankruptcy because the obligation had been effectively reduced to a money judgment. However, the facts in Kovacs were unique insofar as, prior to the debtor filing for bankruptcy, the state had obtained the appointment of a receiver who took possession of the site and the defendants' assets in order to implement the cleanup; thus, the only performance the state effectively wanted was the payment of money.5 Importantly, there are a number of issues that the Supreme Court did not specifically address.6 For example, the Court did not address what would have happened if the debtor's cleanup obligation was for the debtor's own site.

This and other issues have been addressed by courts subsequent to Kovacs, and an enumeration of fact-specific factors has developed over time.7 The clearest outline of a test was set forth by the United States Bankruptcy Court for the Southern District of New York in In re Mark IV Industries, Inc.8 The Mark IV court distilled the following three factors as a test for determining whether a cleanup obligation is dischargeable:

(1) Is the debtor capable of executing the equitable decree or can it only comply only by paying someone else to do it?

(2) Is the pollution ongoing?

(3) If not, does the environmental agency have the option under the statute giving rise to the equitable obligation to remove the waste and seek reimbursement from the debtor?

The first factor, which addresses the Supreme Court's holding in Kovacs, examines whether the debtor is in possession of or has access to the site such that it physically could undertake the remediation.9 The second factor is intended to make certain that the equitable obligation is not a "repackaging of a forfeited claim for damages," but is instead intended to address current, ongoing contamination that continues to impact the environment.10 The third factor examines whether the environmental agency has the "option" under the relevant statute to accept payment in lieu of performance.11 That answer may differ depending on the environmental law at issue.

While there has not been a universal adoption of this test, per se,12 the United States Bankruptcy Court for the Eastern District of North Carolina recently recognized the distillation of this test in 2017. 13

Is it possible for a private party claim against a debtor to allow for the recovery of future environmental response costs?

If a debtor's cleanup obligations are claims because they can be satisfied by the payment of money, a key issue becomes whether, and in what circumstances, other potentially responsible parties' (PRPs) claims may include at least some of the future cleanup costs debtors otherwise would have been responsible for under environmental remediation statutes, such as the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA). 14

This issue implicates Section 502(e)(1)(B) of the Bankruptcy Code, which provides for the disallowance of contingent claims for reimbursement or contribution where the claimant is co-liable with the bankrupt debtor. Specifically, Section 502(e)(1) provides:

(e)(1) Notwithstanding subsections (a), (b), and (c) of this section and paragraph (2) of this subsection, the court shall disallow any claim for reimbursement or contribution of an entity that is liable with the debtor on or has secured the claim of a creditor, to the extent that-- . . . (B) such claim for reimbursement or contribution is contingent as of the time of allowance or disallowance of such claim for reimbursement or contribution; . . . 15

Courts interpreting Section 502(e)(1)(B) have consistently applied a three-part test to determine whether a private party's claim is subject to disallowance. Each part of the test must be satisfied for a claim to be disallowed:

1) Contingency. The claim must be contingent at the time of allowance or disallowance.

2) Co-liability. The party asserting the claim must be liable with the debtor on the claim of a third party.

3) Reimbursement or contribution. The claim must be for reimbursement or contribution. 16

Two policies underlie the application of this section: 1) preventing double recovery on the same claim and furthering equitable distribution among creditors; and 2) enabling a bankruptcy case to proceed with distribution to unsecured creditors without awaiting resolution of contingency. 17

The answer to the question posed above - Is it possible for a private party claim against a debtor to allow for the recovery of future environmental response costs? - may depend on the Court of Appeals the bankruptcy case is brought in.

Decisions from the district and bankruptcy courts for the Southern District of New York, In re Lyondell Chem. Co., In re Chemtura Corp., and Route 21 Associates of Belleville, Inc. v. MHC, Inc. (affirmed by the Second Circuit),18 have adopted broad interpretations of each of the above elements and disallowed essentially all claims seeking recovery of future remediation costs.19 In these cases, all of the PRPs' claims for future costs were disallowed,20 as the courts found that: 1) claims remain contingent until liability has been established and amounts are actually paid; 2) the PRPs' claims were ultimately premised on co-liability to the government; and 3) the claims were for contribution or reimbursement.21 Thus, these decisions severely limit the types of claims a creditor PRP can assert against a debtor and preclude claims based on future costs and expenses.

Other courts, however, have arrived at more favorable conclusions.

In the Third Circuit, in In re Allegheny Int'l, Inc.,22 the court affirmed without opinion a Western District of Pennsylvania case that allowed a PRP's CERCLA Section 107 claim for future response costs after finding the co-liability element to be unsatisfied.23 The claimant sought to recover its own past and future response costs for a cleanup that lacked any governmental involvement. The Allegheny court concluded that "the distinction between a cleanup performed by [a claimant] and a cleanup performed by the [Environmental Protection Agency (EPA)] is crucial."24

Although a number of courts have criticized the reasoning in the Allegheny decision with regard to its reasoning on co-liability,25 the Bankruptcy Court for the District of Delaware issued a pair of decisions26 favorably citing Allegheny and holding that a PRP's CERCLA Section 107(a) claims for past and future costs were not subject to disallowance, both: 1) when the EPA had not been involved or asserted a claim against the debtor and the claim was direct,27 and 2) when the EPA had issued an administrative order, initiated litigation, and filed its own proof of claim, but the PRP claimant still had out-of-pocket costs to incur and recover and there was no possibility of multiple payment.28

Further, in 2004, the Bankruptcy Court for the District of New Jersey in In re G-I Holdings, Inc. followed Allegheny in allowing a direct claim for past and future cleanup costs asserted by a creditor PRP group against a debtor PRP group member.29 The EPA had issued a record of decision and an administrative order to the debtor and several other parties for site remediation, and the PRPs entered into a separate agreement allocating cleanup costs.30 After several years of remediation, the debtor filed for bankruptcy and stopped paying its share.31 While the G-I court rejected the PRP group's argument that its claim was entitled to administrative expense priority,32 the court did allow the claim because: 1) funds had been expended and the claim was, therefore, not contingent, and 2) the claimant sought to recover sums it had and would expend, and the debtor's liability was, therefore, direct. 33

Additionally, contractual liability for cleanup costs (e.g., indemnification agreements or site participation agreements) may avoid disallowance under Section 502(e)(1)(B). In In re RNI Wind Down Corp.,34 the Bankruptcy Court for the District of Delaware found that a claim for advancement (which the Court considered to be "reimbursement") of legal fees was not contingent and therefore not subject to disallowance under Section 502(e)(1)(B). Although the case was not in the environmental context, the reasoning is instructive. The court considered an objection to a claim brought by a former director of the debtors for defense costs pursuant to the debtor company's bylaws, including future defense costs not yet paid, incurred in defending a civil suit by the government on account of the debtors' accounting practices. The court found that the claim was not contingent because the advancement of defense costs was not dependent upon the director establishing that he met a certain standard of conduct or a determination of liability in the underlying suit.35 The Court concluded that the claim was a "direct" liability of the debtor, and fundamentally different from a contribution liability that does not arise unless and until the payment is made to a third party. Hence, pre-bankruptcy contractual obligations as to future cleanup costs arguably are immune from disallowance under Section 502(e)(1)(B) and the unliquidated claim amount could be established by the bankruptcy court through an estimation proceeding.

In addition to the Third Circuit, there is precedent in the First and Sixth Circuits that a coPRP's claim may not be disallowed under Section 502(e)(1)(B) where the government is barred from filing or has waived its right to file a claim. In In re Hemingway Transport, Inc.,36 the First Circuit vacated a bankruptcy court's order disallowing a PRP's claims, instructing the bankruptcy judge to either allow the bankruptcy trustee or the claimant to file a surrogate claim on EPA's behalf, or else allow and estimate the PRP's claim pursuant to normal claim allowance procedures.37 In In re Eagle-Picher Industries, Inc.,38 the claimant argued that it should not be considered co-liable with the debtor because the governmental agencies had not filed a claim before the bar date, which had passed several years earlier.39 The Sixth Circuit found that if the agencies were absolutely barred from filing a claim, there would no longer be co-liability between the claimant and debtor, and thus its claim should be allowed, though the case was remanded to the bankruptcy court multiple times to conduct an inquiry into whether EPA would still be able to assert a claim by demonstrating excusable neglect. 40

In sum, a PRP's ability to withstand a Section 502(e)(1)(B) challenge to its cost recovery claims for future costs appears to be better in the First, Third and Sixth Circuits than in the Second Circuit based on current precedent.

Conclusion

The above discussion demonstrates that issues involving environmental obligations in bankruptcy can be very fact specific and vary based on the jurisdiction of the bankruptcy filing. Thus, it is also important for bankruptcy and environmental counsel to coordinate early on in the bankruptcy proceeding to determine the viability of a claim and a successful strategy to pursue its recovery.