Foreclosing on Contaminated Real Estate (Brownfields), Part I: Are Banks Protected?

From time to time, banks may be forced to foreclose upon mortgaged real estate with an active environmental problem.  I touched upon this subject back in September of 2009 – Always Consider An Environmental Liability Analysis – but this and next week’s posts provide depth to the topic with the assistance of my colleague Leah Silverthorn, who specializes in environmental law at our Firm. 

Some history on environmental law.  The Comprehensive Environmental Response Compensation and Liability Act, also is known as “Superfund” (“CERCLA”), enacted in 1980, imposes joint, strict, and several liability for releases of hazardous substances upon four categories of parties:  “owners,” “operators,” “transporters,” and “arrangers” (collectively known as potentially responsible parties or “PRPs”).  The statute imposes liability simply by virtue of acquiring a contaminated property.  In 1986, Congress amended CERCLA through the Superfund Amendments and Reauthorization Act (“SARA”), which, among other things established the innocent landowner exemption, the now rarely-invoked precursor to the 2002 exemptions discussed below.   

The exemptions.  CERCLA’s goal is the cleanup of contaminated sites, and, as such, it originally contained virtually no legal defenses.  Because of this harsh liability scheme, both lenders and developers, as well as local municipalities, raised concerns over the disincentive this statute caused for re-development of “brownfields”—a term given to contaminated (or perceived to be contaminated) real estate.  As a result, in 2002, Congress enacted the Small Business Liability Relief and Brownfields Revitalization Act (the “Brownfields Amendment”), adding an exemption to liability for bona fide prospective purchasers (“BFPPs”) and for secured lenders.

    BFPP defense.  The BFPP defense requires a party (a) to conduct all appropriate inquiries (through a Phase I Assessment), (b) not be related to or associated with another PRP and (c) follow post-closing obligations, including notifications, stopping or preventing future releases or exposure, and cooperating with government requests for access, if necessary.  With the enactment of the BFPP exemption, a party can purchase a property with knowledge of environmental conditions and still avoid liability, so long as it takes these steps.  (Aside:  The BFPP defense does not prevent the United States, if it undertakes remediation itself directly, from placing a senior lien on the real estate.  The theory is that the landowner benefitted from such cleanup activities and should not receive a windfall for such benefit.  Care should be taken to ensure that the government does not see a need to undertake a cleanup.) 

    Lender’s exemption, specifically.  The Brownfields Amendment also created an exemption for secured lenders (mortgagees), resulting from financial industry worries that foreclosure would automatically transfer liability for all contamination to a foreclosing mortgagee.  This exemption comes into play when a mortgagee is forced to foreclose on the property and/or take control of the management of the property.  Per CERCLA, lenders typically are exempted from the “owner or operator” definition so long as they “hold indicia of ownership primarily to protect [a] security interest.”  The lender must not “participate in management” of environmental decision making and must “seek[] to sell, re-lease (in the case of a lease-finance transaction)” “at the earliest practicable, commercially reasonable time, on commercially reasonable terms, taking into account market conditions and legal and regulatory requirements.”  A Phase I is not a prerequisite to this exemption. 

Good to go, generally.  In instances where banks immediately intend to liquidate the mortgaged real estate following the sheriff’s sale, the law is relatively clear—banks generally will be exempt from liability.  Since selling the real estate as soon as possible is the modus operendi of virtually all banks and lending institutions, the law provides at least some comfort that conventional banks, in business to enforce their loans through foreclosure and prompt liquidation of their loan collateral, should not be exposed to environmental liability. 

Part II, next week, involves the sticky situation when the foreclosing mortgagee decides to retain ownership of the mortgaged real estate. 

Federal District Court Flushes Another Borrower’s Post-Foreclosure Case

My research turned up another Indiana federal court opinion regarding the Rooker-Feldman doctrine, which I have discussed on three prior occasions (most recently, Another Rooker-Feldman Knock-Out:  Federal Court Ends Post-Foreclosure Lawsuit).  Roberts v. Cendant, 2013 U.S. Dist. LEXIS 80210 (S.D. Ind. 2013) (.pdf) is a fourth recent opinion in which the Court granted a defendant mortgagee’s motion to dismiss a pro se plaintiff’s federal court action. 

The law.  With regard to the applicability of Rooker-Feldman, the Court stated “the fundamental question is whether the injury alleged by the federal plaintiff resulted from the state court judgment itself or is distinct from that judgment.”  The doctrine prevents federal courts from exercising subject-matter jurisdiction where federal claims were “tantamount to a request to vacate the state court’s judgment of foreclosure.”  In Roberts, the Court concluded that the success of the plaintiff’s statutory and constitutional claims required “evaluation of the state court’s judgment” in the underlying foreclosure action.  The plaintiff borrower’s core argument was that the lender never had standing, but “the underlying action necessarily concluded that the [foreclosing lender] had standing to foreclose.”

Foreclosure firm.  One thing that distinguished Roberts from the cases in my prior posts was that the borrower named in his federal court suit the law firm that handled the state court foreclosure case.  Judge Magnus-Stinson held that “the Rooker-Feldman arguments are equally effective at barring the claims against . . . [the foreclosure firm/lawyers], and the Court dismisses the claims against them as well.” 

Dismissed.  The Court ultimately held:

Accordingly, because the success of [borrower’s] statutory and constitutional claims require evaluation of the state court judgment in the foreclosure action, and those claims can only succeed if the Court were to conclude that the state court acted erroneously in finding that [lender] had standing to foreclose and granting judgment in favor of [lender], the Rooker-Feldman doctrine bars the Court from exercising subject-matter jurisdiction in this matter.

The Rooker-Feldman doctrine is a powerful and well-recognized defense – at least in Indiana – for lenders to obtain a quick and inexpensive exit to what, in the final analysis, really are frivolous claims brought by disgruntled pro se (unrepresented) borrowers. 

Indiana Deficiency Judgments: Separate Action Not Applicable

 

Last week, an out-of-state lawyer and reader of my blog asked a question I’ve received several times previously – whether Indiana has a separate process for post-sheriff’s sale deficiency suits.  In this instance, he was reading my 4/22/08 post, How Much Should A Lender/Senior Mortgagee Bid At An Indiana Sherriff’s Sale?, and had some follow-up questions. 

My definition.  The terminology “deficiency judgment” refers to the amount of the judgment remaining after deducting the price paid at the sheriff’s sale or, more generally, the difference between the debt amount and the value of the collateral securing the debt.

Indiana’s process.  It’s my understanding that some states require post-sale deficiency actions.  Not in Indiana.  Here, a judgment entered in a mortgage foreclosure action typically is comprised of two elements.  The first is a money judgment on the promissory note and/or guaranty, and the second is a decree of foreclosure based on the mortgage.  The deficiency is a product of the sheriff’s sale.  In Indiana, a deficiency judgment isn’t really a technical or statutory term.  More than anything, the words simply describe the net amount owed by a borrower or guarantor following a sheriff’s sale.

One judgment.  So, as to Indiana, unlike some other states, a personal judgment (against a borrower or a guarantor) for any post-sale deficiency actually occurs before the sheriff’s sale takes place.  There is no second procedural step or subsequent process to establish a deficiency judgment.  In fact, as noted in my 8/1/08 post Full Judgment Bid = Zero Deficiency, ultimately there may be no deficiency (residual money judgment) if the sheriff’s sale price meets or exceeds the amount of the judgment. 

Judgments Cannot Be Collected Directly From Separate, Albeit Related, Corporate Entities

Lenders and other parties often are frustrated trying to collect business debts owed by assetless corporate entities.  This is especially true when it’s known that there are related, healthy entities owned by the same person.  Indiana Regional Council of Carpenters v. First American Steel, 2013 U.S. Dist. Lexis 79562 (N.D. Ind. 2013) (.pdf) helps explain the fundamentals of corporate entity judgment collection and why separate and distinct entities are not liable for the debts of another. 

Pertinent parties.  Plaintiff obtained a judgment against defendants First American Steel, LLC (“Steel LLC”) and its owner Castellanos, who also owned a company named First American Construction, Inc. (“Construction, Inc.”).  Power and Sons Construction, named as a garnishee defendant in Plaintiff’s proceedings supplemental, owed money to Construction, Inc. but not to Steel, LLC or to Castellanos.

Collection theory.  The First American Steel opinion dealt with Plaintiff’s efforts to compel Power and Sons to turnover money it owed to Construction, Inc.  In other words, Plaintiff asked the trial court for an order directing Power and Sons to pay to Plaintiff the money Power and Sons owed to Construction, Inc.  Castellanos contested the motion on grounds that Power and Sons could not be ordered to turnover money due to a non-party to the underlying action.

Execution basics.  In Indiana, a judgment-creditor (plaintiff) carries the burden of demonstrating that the judgment-debtor (defendant) has property or income subject to execution (collection).  Rules of property govern whether the judgment-debtor holds an interest in the targeted property.  The core issue in First American Steel was whether the judgment-debtor, Castellanos, held an interest in the debt owed by Power and Sons.  If so, then Plaintiff could step into the shoes of Castellanos and collect the debt.  Thus the question was whether the money owed by Power and Sons to Construction, Inc. was the personal property of Castellanos. 

Separate and distinct.  The Court noted that a corporation is a legal entity created by the state that has its own legal identity.  People who own stock in a corporation do not own the capital of the corporation.  Instead, the capital belongs to the corporation as a legal person.  “Because a corporation is a separate legal entity, although Castellanos owns the corporation in its entirety, his ownership interest is distinct from the corporate assets.”  In other words, Castellanos’ personal property consisted “of his shares of the corporation, not the corporate assets themselves.”  (See also:  Does A Guarantor’s Bankruptcy Stop A Foreclosure Case Against the Borrower?)

Motion denied.  Because the money Plaintiff sought was an asset of Construction, Inc. (a separate and distinct legal entity) and not Castellanos, ordering Construction, Inc. to turn over the funds “essentially would hold it liable for the debts of another.”  No can do.  Plaintiff therefore failed to meet its burden to demonstrate that the property was subject to turnover.

Alternatives.  The Court noted that Plaintiff could have, if supported by the facts, extinguished the fictional separation between Castellanos and Construction, Inc. (his corporation) by piercing the corporate veil or by showing the company was being used as an alter ego.  The Court also stated that, if Construction, Inc. was dissolved or in the process of dissolving, then the assets of the corporation “would become the personal property of the owner (Castellanos), provided there were no creditors of that corporation to absorb the assets.”  Instead of pursuing Construction, Inc. directly, Plaintiff could have explored those theories to effectively terminate the separation between Castellanos, the owner, and his corporation.  The Court in First American Steel said that Plaintiff made no attempts to establish grounds for those remedies.