Foreclosing on Contaminated Real Estate (Brownfields), Part I: Are Banks Protected?
Some Tips For Indiana Receivers

Foreclosing On Contaminated Real Estate (Brownfields), Part II: Are Purchasers Of Distressed Loans Protected?

This follows-up last week’s post that introduced foreclosure-related environmental issues and focused on liability exposure for conventional lenders.  This week’s post centers on environmental liability risks that purchasers of distressed loans may face.  In this situation, the traditional secured lender exemption discussed in my last post may not apply because of the investor’s intent to hold the property rather than to divest itself of the property as early as commercially reasonable.  Can liability still be avoided?

Successor lenders.  When an investor takes assignment of a distressed mortgage loan, thereby becoming the mortgagee (the lender), the investor’s objectives may be of critical importance in the context of potential environmental liability.  Some investors acquire a distressed loan with the goal of obtaining a payoff of the loan with interest.  They do not seek to own the underlying property through foreclosure, and if they do ultimately foreclose, they want to sell the property as soon as possible.  These types of investors are very similar to conventional lenders and, as such, the secured lender exemption discussed in last week’s post should apply.  Having said that, the law is not crystal clear on this point.

Investors/Developers.  Some investors acquire a distressed loan with the intention owning the mortgaged real estate.  In other words, they want the project – not the income from the loan.  Some call this a “loan-to-own” foreclosure.  Such purchasers of loans in default have developer-like aims, and it is these types of investors, and the transactions in which they engage, that are the real focus of today’s post.  The loan-to-own investors probably fall outside the CERCLA secured lender exemption because they are not seeking to divest themselves of the property “as early as commercially practicable.” 

The unsettled BFPP issue.  We believe that the investor still could avoid liability by going through the steps to become a BFPP (see last week).  The problem is that the BFPP rules require that the investor not have any “affiliation” with a PRP (here, the borrower/mortgagor/prior owner) through “any contractual … relationship ….”  Thus a question arises as to whether the loan documents create some kind of affiliation that defeats the BFPP exemption.  In one written opinion, the Court cited EPA guidance suggesting that “in deciding what ‘affiliations’ are prohibited by CERCLA, courts should be guided by ‘Congress’s intent of preventing transactions structured to avoid liability.’”  Ashley II of Charleston, LLC v. PCE Nitrogen, Inc., 746 F. Supp. 692, 753 (D.N.C. 2010).  Based on that rationale, we are of the view that the BFPP exemption should be available to investors.  Neither a mortgage loan nor a sheriff’s sale are transactions structured to avoid environmental liability.   

The policy argument.  Ultimately, if a court were to find a prohibited “affiliation” between a borrower and a mortgagee-turned developer, so as to defeat the BFPP exemption, such a finding would seem to be inconsistent with the purpose of the CERCLA’s BFPP and secured lender protections—namely, redevelopment of brownfields.  We think that it would be in keeping with CERCLA’s purpose of encouraging redevelopment to allow an investor to foreclose on its mortgage, transform itself into a BFPP and thus avoid liability.  But this is an unsettled area of law that could be highly fact dependent, and as experienced environmental litigators know, avoiding liability under CERCLA is an uphill battle.

Upshot?  Environmental liability related to the purchase and assignment of mortgage loans and subsequent development is clouded and complicated.  However, steps can be taken to ensure that your unique transaction most closely follows the statutory defenses to CERCLA and puts your entity in the best position should an environmental issue arise.  An investigation into environmental issues is advisable if you are interested in purchasing a distressed loan.  For more information on how the secured lender and Bona Fide Prospective Purchaser exemptions apply to your transaction, please contact Leah B. Silverthorn or me.  I’d like to thank Leah for taking the lead with these informative posts.