Recent case reminds lenders of the risks in managing a workout of an environmentally distressed property

November 1, 2010 By Frank J. Reed, Jr.

In the struggling economy and with more loans in work-out, banks and other secured lenders sometimes have to ask themselves, what liability, if any, might they incur if they proceed to foreclose on a property and/or sell the property at sheriff's sale, where the property has some environmental contamination. 

The short answer is that secured creditors are generally protected against liability for such conditions to the extent they comply with the federal lender liability protections under the Comprehensive Environmental Response Compensation Liability Act ("CERCLA"), codified at 42 USC Section 9601(20) and, if the property is in Ohio, the comparable secured creditor provisions at Ohio Revised Code Section 3746.26. The recent case of State ex rel. Richard Cordray v. Estate of James Roberts and Citizen National Bank of Norwalk, (May 7, 2010), 2010-Ohio-2003, illustrates that the bank, and bank personnel, should make a diligent effort to investigate and document the environmental conditions of a property before taking any action to foreclose on the property. In this case, a bank made a loan to a business, which manufactured artificial rocks and rock waterfalls, secured by an open-ended mortgage. The business failed, ceased operations, the bank accepted the key to the property, and several months later the bank instituted a foreclosure action. When Ohio EPA sued the owner for clean-up of the site, the bank argued that as merely the lender, the bank should not be held liable. The Court of Appeals did not agree, and held that because there was evidence that the bank sold "one or two" drums of chemicals and equipment used in the manufacturing process, as well one of the debtor's patents, the matter was remanded back to the trial court in order to determine whether the bank had "participated in the management" of the operations. The bank should take specific steps to document that neither the bank, nor its agents, "participate in the management" of the property or the environmental matters at the property, and fully comply with the above State and federal requirements.

Here is a short list of steps that banks should take and steps to avoid when confronted with environmentally distressed property.

1.  First, be familiar with and strictly follow the secured creditor protections afforded under State and federal law. 

2.  Document who has possession of the keys to the property.  Record the date, the time, and the name of the individual who received and who delivered the keys.

3.  Once the property is in default, take immediate steps to "assess" the condition of the property and any potential environmental threats. Through the creditor's attorneys or outside environmental counsel, and under the attorney-client privilege, hire qualified environmental professionals to conduct an assessment of what threats the conditions at the property present to human health and the environment. Pay particular attention to storage and handling of hazardous materials, potential sources of water pollution, air pollution, staining of soils, and possible exposure to persons (invitees, licensees, and trespassers, alike).

4.   Be careful about disposing of any personal or real property.  Ask questions and make a diligent inquiry among appropriate governmental entities before taking action. Carefully document the actions taken.

5.   Do not "participate in the management of the property," which is generally defined as management of the operational affairs or exercising control over the borrower's hazardous substance or petroleum handling or disposal practices. Therefore, do not inject yourself into decisions about disposal of hazardous materials. But, do insist on appropriate testing and documentation of unknown materials.

For more information on lender involvement in environmentally distressed properties, please contact Frank Reed, or any member of the Environmental Practice Group of Frost Brown Todd LLC. 

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