Addressing unknown future claims in a chapter 11 bankruptcy involves two competing concerns: (a) providing a debtor with a fresh start and (b) providing an unwitting claimant with due process. These competing concerns clash when a debtor seeks to confirm its plan of reorganization, which is intended to provide remedies to all the debtor’s creditors and provide the debtor with a discharge of all pre-confirmation liabilities.
The fundamental question becomes what constitutes a “claim” for purposes of balancing the competing concerns in a chapter 11 plan. In the context of an unknown claim, the question of how to adequately treat and discharge such claim can be exceedingly difficult to answer, especially when dealing with an environmental claim, which often carries latent injuries.
In West Salem Storage, LLC v. Exide Technologies (In re Exide Technologies), Adversary No. 17-51826-KJC (Bankr. D. Del. March 28, 2019), Judge Carey recently ruled that a chapter 11 plan discharged environmental liabilities to an unknown claimant who had received publication notice of the claims bar date. Balancing the competing concerns involved, the Court found that the debtor’s chapter 11 plan did adequately provide for treatment of the unknown claim, due to the claimant’s general knowledge of its potential claim and the debtor’s inability to ascertain the claimant’s identity through its books and records.
In November 2011, West Salem Storage (“West Salem”) purchased a property in Salem, Oregon that Exide Technologies (“Exide”) previously owned and used as a battery manufacturing plant (the “Property”).
Exide had acquired the Property sometime in 2001. In April 2002, Exide filed its first chapter 11 bankruptcy, after which it obtained court authority to sell the Property to Faries Salem Properties, LLC (“Faries”). The Property was subsequently conveyed a couple of more times before West Salem became the owner in 2011.
In the early 1990s, the Oregon Department of Environmental Quality (“DEQ”) became aware of lead contamination in the soils at the Property. In November 1999, the DEQ determined that no further action was required to remediate the soil, provided that the deed to the Property contain an easement and equitable servitude (“EES”) limiting the site usage to industrial operations.
Notwithstanding the soil contamination, the DEQ found it acceptable to lease the building on the Property for non-industrial commercial and recreational uses. As such, after purchasing the Property, West Salem continued to lease the building to various tenants for such purposes.
In June 2013, Exide filed its second chapter 11 case. In that case, Exide listed in its Bankruptcy Schedules the Property as a site for which it had received governmental notice that it might be liable under environmental law. But, Exide only listed Faries as an unsecured creditor related to the Property, and, as a result, it never sent West Salem actual notice of the bankruptcy case. Exide nonetheless published notice of the claims bar date in the Wall Street Journal, the New York Times, and 130 or so local and regional newspapers throughout the U.S. and Canada, including newspapers in Portland, Oregon, where the Property is located.
In March 2015, the Delaware Bankruptcy Court confirmed Exide’s chapter 11 plan, which contained discharge, claim holder release and injunction provisions.
In March 2017, after learning that the building on the Property contained high levels of lead, the DEQ ordered that the building be closed until cleaning and further assessment could be completed. Thereafter, West Salem vacated five commercial tenants from the building and delayed plans for a 6th tenant. West Salem ultimately incurred $1.2 million in expenses related to the investigation and remediation of lead in the building and $202,000 in compensation to tenants for their lost use of the building.
West Salem later filed an adversary proceeding against Exide, seeking a declaratory judgment that Exide’s two prior bankruptcy cases did not discharge West Salem’s environment claims against Exide.
Exide sought dismissal of the adversary proceeding, arguing that West Salem’s claims arose prior to the 2013 bankruptcy and therefore were released pursuant to its 2015 plan. Exide also argued that, given that West Salem was an unknown creditor at the time, it received enough notice of the claims bar date through news publications.
West Salem countered that its claims were not discharged because they arose after confirmation of the Exide’s 2015 plan, using the Ninth Circuit’s “fair contemplation” test, which focuses on whether there are sufficient indicia of potential claims against a debtor. Alternatively, West Salem argued that its claim did not arise pre-confirmation under the Third Circuit’s Grossman test, because it was not exposed to Exide’s product or conduct until 2017, when DEQ notified West Salem of contamination inside the building. Finally, West Salem argued that it did not receive constitutionally sufficient notice of the bankruptcy case or claims bar date for it to participate in Exide’s case.
The Bankruptcy Court analyzed both the Third and Ninth Circuit tests for determining when West Salem’s claim arose and whether it was properly discharged by Exide’s 2015 plan.
Under the Third Circuit’s Grossman test, “a claim arises when an individual is exposed pre-confirmation to a product or other conduct giving rise to an injury that underlies a ‘right to payment’ under the [Bankruptcy] Code.” Wright v. Owens Corning, 679 F.3d 101, 105 (3d Cir. 2012). Under this test, a claimant is required to recognize that “by being exposed to a debtor’s product or conduct, they might hold claims even if no damage is then evident.” Id. at 106.
Here, the Court found that under the Grossman test West Salem’s claims arose prepetition, because, when it purchased the Property in 2011, West Salem was sufficiently notified of restrictions on the Property’s use on account of environmental contamination caused by prior conduct on the Property. This notification occurred well-before the confirmation of Exide’s 2015 plan.
The Ninth Circuit’s fair contemplation test provides that “all future response and natural resource damages cost[s] based on prepetition conduct that can be fairly contemplated by the parties at the time of the [d]ebtors’ bankruptcy are claims under the [Bankruptcy] Code.” California Dept. of Health Servs. v. Jensen (In re Jensen), 995 F.2d 925, 930-31 (9th Cir. 1993) (quoting In re National Gypsum, 139 B.R. 397, 409 (N.D. Tex. 1992)). A party fairly contemplates potential liability when there are sufficient indicia of future costs based on prepetition conduct, e.g., knowledge that the debtor may be liable as a potentially responsible party under CERCLA or commencement of investigation or cleanup activities. See National Gypsum, 139 B.R. at 408.
West Salem argued that it could not have fairly contemplated the costs of investigating or remediating the building during Exide’s bankruptcy, because, while it had notice of prior remediation efforts with respect to the soil, the DEQ clarified that occupational uses of the building were acceptable if there was no contact with the soil. West Salem contended that its remediation claims arose two years after Exide’s 2015 plan was confirmed, when it first became aware of contamination in the building itself.
But, the Court found that the EES provided enough information about the prior use and contamination of the Property and restrictions on the future use of the Property. Thus, West Salem had received adequate information prior to the 2013 bankruptcy that should have allowed it to fairly contemplate incurring future remediation and restoration costs related to the Property.
Accordingly, the Court concluded that under either the Third or Ninth Circuit tests West Salem’s claims arose before Exide’s 2013 bankruptcy and thus were subject to the discharge provisions in the 2015 plan.
Once a potential environmental claimant has any type of notice that there might be a potential injury on the horizon due to activities of the prior owners of real property, it behooves them to do a little more investigation about the status of the prior owners, even if the claimant does not know the full extent of the injury. A failure to do so leaves the claimant subject to the same risks and results experienced by West Salem in Exide’s case. As they say, an ounce of prevention is worth a pound of cure.