The imposition of a common-law duty of a lender to a borrower derives primarily from the lender’s exercise of control over the borrower. Lender liability includes a number of claims under tort, contract, equitable, and federal and state statutes.

The special assets manager should be familiar with the theories and statutes to avoid any potential lender liability.

Breach of Fiduciary Duty

One way that the borrower can claim excess control is by showing that the lender has become a fiduciary by means of its conduct and influence over the borrower. The existence of a lender-borrower relationship does not impose fiduciary obligations on the lender.

Notwithstanding, the lender could be found to have breached its fiduciary duty if it obtains control over a borrower or the collateral property

For example, a lender may be found to have become a fiduciary when the lender engages in the day-to-day management and operations. In effect the lender had the ability to compel the borrower to engage in “unusual transactions.” FAMM Steel v. Sovereign Bank, 571 F.3d 93 (1st Cir. 2009)

In addition to liability that may come to a lender because of excess control as discussed above, a lender may incur liability for “excess control” under both federal and state environmental law.

Comprehensive Environmental Response, Compensation, and Liability Act

Lender Exemption

Under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), lenders who do not participate in the management of a facility are exempt from liability

A lender qualifies for this exemption if it did not participate in the management of the facility prior to foreclosure, and after it forecloses on the facility, it limits its activities to usual efforts to protect an interest in collateral property (see below). It is important to note how CERCLA defines “participation in management.” It states that it means a lender that actually participates in the management or operational affairs of a facility; and does not include merely having the capacity to influence, or the unexercised right to control, facility operations.

Therefore, a lender shall be considered to participate in management only if, while the borrower is still in possession of the facility encumbered by the security interest, the lender:

• Exercises decision-making control regarding environmental compliance related to the facility, and that the person has undertaken responsibility for the hazardous substances handling or disposal practices related to the facility; or

• Exercises control at a level similar to that of a manager of the facility and, in doing so, assumes or manifest responsibility for the day-to-day decision-making with respect to environmental compliance; or overall or substantially all of the operational functions of the facility other than the function of environmental compliance.

42 U.S.C. § 9601(20)

However, what type of activities does not constitute “participating in the management of a facility?”

The term “participate in management” does not include:

• Merely having the capacity to influence or the unexercised right to control facility operations;

• performing an act or failing to act prior to the time at which a security interest is created in a facility;

• holding a security interest or abandoning or releasing a security interest;

• including in the terms of an extension of credit, or in a contract or security agreement relating to the extension, a covenant, warranty or other term or condition that relates to environmental compliance;

• Monitoring or enforcing the terms and conditions of the extension of credit or security interest;

• monitoring or inspecting the facility;

• requiring a response action in connection with a release or threatened release of a hazardous substance;

• providing financial or other advice to the borrower in an effort to mitigate, prevent or cure default or diminution in the value of the facility;

• restructuring the terms and conditions of the extension of credit or security interest, or exercising forbearance;

• exercising other remedies for the breach of the extension of credit or security agreement; or

• conducting a response action under CERCLA or under the National Contingency Plan, provided that these actions do not rise to the level of participation in management within the meaning of the statute.

42 U.S.C. § 9601(20)(F)(i), (iii) and (iv)

Furthermore, after foreclosure, a lender who did not “participate in management” prior to foreclosure may generally:

• maintain business activities;

• wind up operations;

• undertake a response action under CERCLA Section 107(d)(1) or under the direction of an on-scene coordinator;

• sell, re-lease or liquidate the facility; or

• take actions to preserve, protect or prepare the property for sale.

A lender may conduct these activities provided that the lender attempts to sell or re-lease the property held pursuant to a sale or lease financing transaction, or otherwise divest itself of the property at the earliest practicable, commercially reasonable time using commercially reasonable means

42 U.S.C. § 9601(20)(E)(ii)

Resource Conversation and Recovery Act

There is a similar lender exemption under the federal Conservation and Recovery Act (RCRA), which regulates the generation, storage, handling, transportation, and disposal of hazardous waste. An article by Connolly and Matthew (2017), in Lexis Practice Advisor Journal, entitled: Lender Liability Under Environmental Laws in Real Estate Transaction, states that absent evidence of participation of management, persons merely holding a security interest in property containing an underground storage tank (UST) will not be considered to be an owner or operator for purposes of the UST provisions of RCRA.

They further state that despite this exemption, lenders should remain aware that if lenders’ activities, particularly during foreclosure, violate other RCRA provisions, such as those found in Subtitles C or D pertaining to solid and hazardous waste permitting and management, RCRA liability may be incurred.

Clean Water Act

The Clean Water Act (CWA) regulates the discharge of pollutants into waters of United States. Connolly and Morton said that unlike CERCLA and RCRA, the CWA does not have a secured creditor exemption.

As such, lenders will be considered owners or operators of foreclosed upon properties and will be responsible for complying with regulations under the CWA

State Law

The aforementioned article, further points out that it is important for the lender to understand the state’s environmental requirements as CERCLA and RCRA do not preempt state laws governing the cleanup of hazardous substances.

Conclusion

The lender should have competent environmental legal counsel; albeit, the lender needs to educate itself concerning the many theories that can be asserted by the borrower as well as understand the potential liability that may be incurred statutorily. Litigation is costly and time consuming. A well informed special assets group can increase effective communication between lender and counsel and avoid unnecessary time and legal expenses.

This article was written by Conrad Andersen, Executive Managing Principal, The Syntax Group

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