De Facto Lender Liability: Secured Creditors and Environmental Liabilities in Chapter 11
By R. Todd Silliman
INTRODUCTION
When a potentially responsible party (PRP) enters bankruptcy, the complex issue of who should pay to clean up hazardous waste becomes even more complicated. In addition to the question of the debtor's environmental liability, another serious question arises: What priority should the debtor's liability have against the claims of other creditors?When a potentially responsible party (PRP) enters bankruptcy, the complex issue of who should pay to clean up hazardous waste becomes even more complicated. In addition to the question of the debtor's environmental liability, another serious question arises: What priority should the debtor's liability have against the claims of other creditors?A 1986 Supreme Court opinion effectively granted environmental claims priority over other pre-petition unsecured claims in a liquidation proceeding under Chapter 7 of the Bankruptcy Code. In Midlantic National Bank v. New Jersey Department of Environmental Protection, the Court recognized equitable limits to a trustee's power to abandon “worthless property” where abandonment would violate a law necessary to protect the public from “imminent and identifiable” harm. By forcing the debtor to remain in possession of polluted property, the Court offered the debtor little choice but to use his resources to eradicate the environmental danger, lest the estate maintain a public hazard in violation of the same law. After Midlantic, some environmental obligations that would otherwise have been unsecured pre-petition claims have attained administrative expense priority, a status normally reserved for the expenses of maintaining the estate.
State and federal agencies generally have more leverage to force the debtor to clean up contaminated property when the debtor continues to operate his business in a reorganization proceeding under Chapter 11 of the Bankruptcy Code than when the debtor liquidates under Chapter 7. For instance, state or federal law may require that all firms—bankrupt or not—comply, as a condition of doing business, with any injunctive order to clean up contaminated property that poses a threat to public health and safety. Where a threat exists and the debtor is maintaining a hazard illegally, requiring the debtor to remedy the environmental harm as an administrative expense in bankruptcy is justified; granting priority to the environmental claim in bankruptcy merely mimics the legal obligation that would be faced by a solvent business outside of bankruptcy. Some courts, though, have in effect required operating debtors to satisfy pre-petition environmental claims as if those claims were administrative expenses, even in cases where no violation of the law existed. Thus, these courts have forced bankruptcy businesses to use unencumbered assets to clean up as a condition precedent to operating in bankruptcy, even where state or federal law did not impose such a requirement on solvent firms.
Elevating environmental claims above unsecured claims in this manner violates bankruptcy priorities and property rights. Fundamentally, bankruptcy law provides a collective forum within which creditors may settle their rights to the debtor's assets. These rights are property rights created primarily under state law. Bankruptcy law should neither violate these property rights nor alter the nature of environmental liability as determined by state and federal environmental laws. Because neither Congress nor state legislatures grant environmental liabilities priority over traditionally higher-priority claims, neither should bankruptcy courts.
Granting priority to environmental claims during either a Chapter 7 liquidation or a Chapter 11 reorganization disrupts a debtor's attempt to distribute assets to creditors; in Chapter 11, it also deprives the estate of assets necessary for reorganization by forcing the debtor to pay costly environmental claims, in cash, on the effective date of the reorganization plan. This may prevent the estate from successfully reorganizing and creating the largest collective “pie” for distribution to creditors.
More importantly, granting priority to environmental claims in the absence of statutory instruction threatens property rights otherwise protected by Chapter 11. Reorganizations generally take time and tie up the debtor's encumbered assets, often with no benefit to secured creditors. For this reason, secured creditors are entitled to “adequate protection” of the value of their interests in the debtor's property. Reorganization also invites certain risks that accompany the estate's ongoing operation, such as liability for post-petition environmental violations or violations exacerbated by the estate's continued existence, risks from which unsecured creditors generally benefit and thus must bear the costs. In short, the secured and unsecured creditor dichotomy reflects bankruptcy policies as well as property rights. The “security” that secured creditors have traditionally enjoyed in Chapter 11 has been weakened in the face of debilitating environmental liabilities.
Recently, by making the claims of secured creditors vulnerable to costs of environmental cleanups during the operation of a debtor's business in Chapter 11, courts have eroded the “adequate protection” norm and threatened property rights. One court, for example, was willing to charge a secured lender for a cleanup that was an independent duty of the debtor and that only incidentally improved or maintained the collateral of the secured party. Another court, despite public outcry and subsequent political action to shield secured lenders from liability for environmental claims against their borrowers, authorized the estate's expenditure of encumbered funds for an environmental cleanup, regardless of whether any benefit would accrue to that secured lender. In their zeal to make debtor-PRPs no better off inside of bankruptcy than outside of it, these courts have threatened secured creditors with liability to which they are not exposed when dealing with non-bankrupt borrowers.
After a brief overview of bankruptcy law, this Note traces the manipulation of priorities in favor of environmental cleanups. It then examines the costs traditionally borne by secured creditors under Chapter 11 and concludes by discussing how recently imposed environmental clean-up liability threatens the property rights of secured creditors.A 1986 Supreme Court opinion effectively granted environmental claims priority over other pre-petition unsecured claims in a liquidation proceeding under Chapter 7 of the Bankruptcy Code. In Midlantic National Bank v. New Jersey Department of Environmental Protection, the Court recognized equitable limits to a trustee's power to abandon “worthless property" where abandonment would violate a law necessary to protect the public from “imminent and identifiable” harm. By forcing the debtor to remain in possession of polluted property, the Court offered the debtor little choice but to use his resources to eradicate the environmental danger, lest the estate maintain a public hazard in violation of the same law. After Midlantic, some environmental obligations that would otherwise have been unsecured pre-petition claims have attained administrative expense priority, a status normally reserved for the expenses of maintaining the estate.
State and federal agencies generally have more leverage to force the debtor to clean up contaminated property when the debtor continues to operate his business in a reorganization proceeding under Chapter 11 of the Bankruptcy Code than when the debtor liquidates under Chapter 7. For instance, state or federal law may require that all firms—bankrupt or not—comply, as a condition of doing business, with any injunctive order to clean up contaminated property that poses a threat to public health and safety. Where a threat exists and the debtor is maintaining a hazard illegally, requiring the debtor to remedy the environmental harm as an administrative expense in bankruptcy is justified; granting priority to the environmental claim in bankruptcy merely mimics the legal obligation that would be faced by a solvent business outside of bankruptcy. Some courts, though, have in effect required operating debtors to satisfy pre-petition environmental claims as if those claims were administrative expenses, even in cases where no violation of the law existed. Thus, these courts have forced bankruptcy businesses to use unencumbered assets to clean up as a condition precedent to operating in bankruptcy, even where state or federal law did not impose such a requirement on solvent firms.
Elevating environmental claims above unsecured claims in this manner violates bankruptcy priorities and property rights. Fundamentally, bankruptcy law provides a collective forum within which creditors may settle their rights to the debtor's assets. These rights are property rights created primarily under state law. Bankruptcy law should neither violate these property rights nor alter the nature of environmental liability as determined by state and federal environmental laws. Because neither Congress nor state legislatures grant environmental liabilities priority over traditionally higher-priority claims, neither should bankruptcy courts.
Granting priority to environmental claims during either a Chapter 7 liquidation or a Chapter 11 reorganization disrupts a debtor's attempt to distribute assets to creditors; in Chapter 11, it also deprives the estate of assets necessary for reorganization by forcing the debtor to pay costly environmental claims, in cash, on the effective date of the reorganization plan. This may prevent the estate from successfully reorganizing and creating the largest collective “pie” for distribution to creditors.
More importantly, granting priority to environmental claims in the absence of statutory instruction threatens property rights otherwise protected by Chapter 11. Reorganizations generally take time and tie up the debtor's encumbered assets, often with no benefit to secured creditors. For this reason, secured creditors are entitled to “adequate protection” of the value of their interests in the debtor's property. Reorganization also invites certain risks that accompany the estate's ongoing operation, such as liability for post-petition environmental violations or violations exacerbated by the estate's continued existence, risks from which unsecured creditors generally benefit and thus must bear the costs. In short, the secured and unsecured creditor dichotomy reflects bankruptcy policies as well as property rights. The “security” that secured creditors have traditionally enjoyed in Chapter 11 has been weakened in the face of debilitating environmental liabilities.
Recently, by making the claims of secured creditors vulnerable to costs of environmental cleanups during the operation of a debtor's business in Chapter 11, courts have eroded the “adequate protection” norm and threatened property rights. One court, for example, was willing to charge a secured lender for a cleanup that was an independent duty of the debtor and that only incidentally improved or maintained the collateral of the secured party. Another court, despite public outcry and subsequent political action to shield secured lenders from liability for environmental claims against their borrowers, authorized the estate's expenditure of encumbered funds for an environmental cleanup, regardless of whether any benefit would accrue to that secured lender. In their zeal to make debtor-PRPs no better off inside of bankruptcy than outside of it, these courts have threatened secured creditors with liability to which they are not exposed when dealing with non-bankrupt borrowers.
After a brief overview of bankruptcy law, this Note traces the manipulation of priorities in favor of environmental cleanups. It then examines the costs traditionally borne by secured creditors under Chapter 11 and concludes by discussing how recently imposed environmental clean-up liability threatens the property rights of secured creditors.
When a potentially responsible party (PRP) enters bankruptcy, the complex issue of who should pay to clean up hazardous waste becomes even more complicated. In addition to the question of the debtor's environmental liability, another serious question arises: What priority should the debtor's liability have against the claims of other creditors?When a potentially responsible party (PRP) enters bankruptcy, the complex issue of who should pay to clean up hazardous waste becomes even more complicated. In addition to the question of the debtor's environmental liability, another serious question arises: What priority should the debtor's liability have against the claims of other creditors?A 1986 Supreme Court opinion effectively granted environmental claims priority over other pre-petition unsecured claims in a liquidation proceeding under Chapter 7 of the Bankruptcy Code. In Midlantic National Bank v. New Jersey Department of Environmental Protection, the Court recognized equitable limits to a trustee's power to abandon “worthless property” where abandonment would violate a law necessary to protect the public from “imminent and identifiable” harm. By forcing the debtor to remain in possession of polluted property, the Court offered the debtor little choice but to use his resources to eradicate the environmental danger, lest the estate maintain a public hazard in violation of the same law. After Midlantic, some environmental obligations that would otherwise have been unsecured pre-petition claims have attained administrative expense priority, a status normally reserved for the expenses of maintaining the estate.
State and federal agencies generally have more leverage to force the debtor to clean up contaminated property when the debtor continues to operate his business in a reorganization proceeding under Chapter 11 of the Bankruptcy Code than when the debtor liquidates under Chapter 7. For instance, state or federal law may require that all firms—bankrupt or not—comply, as a condition of doing business, with any injunctive order to clean up contaminated property that poses a threat to public health and safety. Where a threat exists and the debtor is maintaining a hazard illegally, requiring the debtor to remedy the environmental harm as an administrative expense in bankruptcy is justified; granting priority to the environmental claim in bankruptcy merely mimics the legal obligation that would be faced by a solvent business outside of bankruptcy. Some courts, though, have in effect required operating debtors to satisfy pre-petition environmental claims as if those claims were administrative expenses, even in cases where no violation of the law existed. Thus, these courts have forced bankruptcy businesses to use unencumbered assets to clean up as a condition precedent to operating in bankruptcy, even where state or federal law did not impose such a requirement on solvent firms.
Elevating environmental claims above unsecured claims in this manner violates bankruptcy priorities and property rights. Fundamentally, bankruptcy law provides a collective forum within which creditors may settle their rights to the debtor's assets. These rights are property rights created primarily under state law. Bankruptcy law should neither violate these property rights nor alter the nature of environmental liability as determined by state and federal environmental laws. Because neither Congress nor state legislatures grant environmental liabilities priority over traditionally higher-priority claims, neither should bankruptcy courts.
Granting priority to environmental claims during either a Chapter 7 liquidation or a Chapter 11 reorganization disrupts a debtor's attempt to distribute assets to creditors; in Chapter 11, it also deprives the estate of assets necessary for reorganization by forcing the debtor to pay costly environmental claims, in cash, on the effective date of the reorganization plan. This may prevent the estate from successfully reorganizing and creating the largest collective “pie” for distribution to creditors.
More importantly, granting priority to environmental claims in the absence of statutory instruction threatens property rights otherwise protected by Chapter 11. Reorganizations generally take time and tie up the debtor's encumbered assets, often with no benefit to secured creditors. For this reason, secured creditors are entitled to “adequate protection” of the value of their interests in the debtor's property. Reorganization also invites certain risks that accompany the estate's ongoing operation, such as liability for post-petition environmental violations or violations exacerbated by the estate's continued existence, risks from which unsecured creditors generally benefit and thus must bear the costs. In short, the secured and unsecured creditor dichotomy reflects bankruptcy policies as well as property rights. The “security” that secured creditors have traditionally enjoyed in Chapter 11 has been weakened in the face of debilitating environmental liabilities.
Recently, by making the claims of secured creditors vulnerable to costs of environmental cleanups during the operation of a debtor's business in Chapter 11, courts have eroded the “adequate protection” norm and threatened property rights. One court, for example, was willing to charge a secured lender for a cleanup that was an independent duty of the debtor and that only incidentally improved or maintained the collateral of the secured party. Another court, despite public outcry and subsequent political action to shield secured lenders from liability for environmental claims against their borrowers, authorized the estate's expenditure of encumbered funds for an environmental cleanup, regardless of whether any benefit would accrue to that secured lender. In their zeal to make debtor-PRPs no better off inside of bankruptcy than outside of it, these courts have threatened secured creditors with liability to which they are not exposed when dealing with non-bankrupt borrowers.
After a brief overview of bankruptcy law, this Note traces the manipulation of priorities in favor of environmental cleanups. It then examines the costs traditionally borne by secured creditors under Chapter 11 and concludes by discussing how recently imposed environmental clean-up liability threatens the property rights of secured creditors.A 1986 Supreme Court opinion effectively granted environmental claims priority over other pre-petition unsecured claims in a liquidation proceeding under Chapter 7 of the Bankruptcy Code. In Midlantic National Bank v. New Jersey Department of Environmental Protection, the Court recognized equitable limits to a trustee's power to abandon “worthless property" where abandonment would violate a law necessary to protect the public from “imminent and identifiable” harm. By forcing the debtor to remain in possession of polluted property, the Court offered the debtor little choice but to use his resources to eradicate the environmental danger, lest the estate maintain a public hazard in violation of the same law. After Midlantic, some environmental obligations that would otherwise have been unsecured pre-petition claims have attained administrative expense priority, a status normally reserved for the expenses of maintaining the estate.
State and federal agencies generally have more leverage to force the debtor to clean up contaminated property when the debtor continues to operate his business in a reorganization proceeding under Chapter 11 of the Bankruptcy Code than when the debtor liquidates under Chapter 7. For instance, state or federal law may require that all firms—bankrupt or not—comply, as a condition of doing business, with any injunctive order to clean up contaminated property that poses a threat to public health and safety. Where a threat exists and the debtor is maintaining a hazard illegally, requiring the debtor to remedy the environmental harm as an administrative expense in bankruptcy is justified; granting priority to the environmental claim in bankruptcy merely mimics the legal obligation that would be faced by a solvent business outside of bankruptcy. Some courts, though, have in effect required operating debtors to satisfy pre-petition environmental claims as if those claims were administrative expenses, even in cases where no violation of the law existed. Thus, these courts have forced bankruptcy businesses to use unencumbered assets to clean up as a condition precedent to operating in bankruptcy, even where state or federal law did not impose such a requirement on solvent firms.
Elevating environmental claims above unsecured claims in this manner violates bankruptcy priorities and property rights. Fundamentally, bankruptcy law provides a collective forum within which creditors may settle their rights to the debtor's assets. These rights are property rights created primarily under state law. Bankruptcy law should neither violate these property rights nor alter the nature of environmental liability as determined by state and federal environmental laws. Because neither Congress nor state legislatures grant environmental liabilities priority over traditionally higher-priority claims, neither should bankruptcy courts.
Granting priority to environmental claims during either a Chapter 7 liquidation or a Chapter 11 reorganization disrupts a debtor's attempt to distribute assets to creditors; in Chapter 11, it also deprives the estate of assets necessary for reorganization by forcing the debtor to pay costly environmental claims, in cash, on the effective date of the reorganization plan. This may prevent the estate from successfully reorganizing and creating the largest collective “pie” for distribution to creditors.
More importantly, granting priority to environmental claims in the absence of statutory instruction threatens property rights otherwise protected by Chapter 11. Reorganizations generally take time and tie up the debtor's encumbered assets, often with no benefit to secured creditors. For this reason, secured creditors are entitled to “adequate protection” of the value of their interests in the debtor's property. Reorganization also invites certain risks that accompany the estate's ongoing operation, such as liability for post-petition environmental violations or violations exacerbated by the estate's continued existence, risks from which unsecured creditors generally benefit and thus must bear the costs. In short, the secured and unsecured creditor dichotomy reflects bankruptcy policies as well as property rights. The “security” that secured creditors have traditionally enjoyed in Chapter 11 has been weakened in the face of debilitating environmental liabilities.
Recently, by making the claims of secured creditors vulnerable to costs of environmental cleanups during the operation of a debtor's business in Chapter 11, courts have eroded the “adequate protection” norm and threatened property rights. One court, for example, was willing to charge a secured lender for a cleanup that was an independent duty of the debtor and that only incidentally improved or maintained the collateral of the secured party. Another court, despite public outcry and subsequent political action to shield secured lenders from liability for environmental claims against their borrowers, authorized the estate's expenditure of encumbered funds for an environmental cleanup, regardless of whether any benefit would accrue to that secured lender. In their zeal to make debtor-PRPs no better off inside of bankruptcy than outside of it, these courts have threatened secured creditors with liability to which they are not exposed when dealing with non-bankrupt borrowers.
After a brief overview of bankruptcy law, this Note traces the manipulation of priorities in favor of environmental cleanups. It then examines the costs traditionally borne by secured creditors under Chapter 11 and concludes by discussing how recently imposed environmental clean-up liability threatens the property rights of secured creditors.
