Overview Banking organizations are increasingly
becoming exposed to liability associated with the cleanup of hazardous-substance
contamination pursuant to the federal superfund statute.
1 The superfund statute is the primary federal law dealing with
hazardous-substance contamination. However, there are numerous other
federal statutes, as well as state statutes, that establish environmental
liability that could place banking organizations at risk.
While the superfund statute was
enacted a decade ago, it has been only since the mid-1980s that court
actions have resulted in some banking organizations being held liable
for the cleanup of hazardous-substance contamination. In this connection,
recent court decisions have had a wide array of interpretations as
to whether banking organizations are owners or operators of contaminated
facilities, and thereby liable under the superfund statute for cleanup
costs. This has led to uncertainty on the part of banking organizations
as to how to best protect themselves from environmental liability.
Banking organizations may encounter losses arising from
environmental liability in several ways. Of greatest concern are situations
where banking organizations may be held directly liable for cleaning
up hazardous-substance contamination. However, the more common situation
has been where banking organizations have elected to abandon their
rights to contaminated real-property collateral because cleanup costs
exceed balances owed by borrowers.
Risk of credit losses can also arise where the credit
quality of individual borrowers deteriorates markedly as a result
of being required to clean up hazardous-substance contamination. In
this case, significant cleanup costs borne by the borrower could threaten
the borrower’s solvency and jeopardize the banking organization’s
ultimate collection of outstanding loans to that borrower. Therefore,
even advances to borrowers to fund operations or to acquire manufacturing
or transportation equipment could be adversely impacted by environmental
liability, regardless of the fact that no real-property collateral
is involved.
Overview of Environmental
Hazards Hazardous-substance contamination
is most often associated with industrial or manufacturing processes
that involve chemicals or solvents in the manufacturing process or
as waste products. For years, these types of hazardous substances
were disposed of in land fills, or just dumped on industrial sites.
Hazardous substances are also found in many other lines of business.
The following examples demonstrate the diverse sources of potential
hazardous-substance contamination which should be of concern to banking
organizations:
- farmers and ranchers (use of fuel, fertilizers, herbicides,
insecticides, and feedlot runoff)
- dry cleaners (various cleaning solvents)
- service station and convenience store operators (underground
storage tanks)
- fertilizer and chemical dealers and applicators (storage and
transportation of chemicals)
- lawn care businesses (application of lawn chemicals)
- trucking firms (local and long-haul transporters of
hazardous substances such as fuel or chemicals)
Impact on Banking Organizations Clearly, the greatest risk to banking
organizations of the superfund statute and other environmental-liability
statutes is the possibility of being held solely liable for costly
environmental cleanups. If a banking organization is found to be a
responsible party under CERCLA the banking organization may find itself
responsible for cleaning up a contaminated site at a cost that far
exceeds any outstanding loan balance. This risk of loss results from
an interpretation of the superfund statute as providing for joint
and several liability. Any responsible party, including the banking
organization, could be forced to pay the full cost of any cleanup.
Of course, the banking organization may attempt to recover such costs
from the borrower, or the owner if different than the borrower, provided
that the borrower or owner continues in existence and is solvent.
Banking organizations may be held liable for the cleanup of hazardous-substance
contamination in situations where the banking organization—
- takes title to property pursuant to foreclosure;
- involves the banking organization’s personnel or contractors
engaged by the bank in day-to-day management of the facility;
- takes actions designed to make the contaminated property
salable, possibly resulting in further contamination;
- acts in a fiduciary capacity, including management
involvement in the day-to-day operations of industrial or commercial
concerns, and purchasing or selling contaminated property;
- owns existing, or acquires (by merger or acquisition),
subsidiaries involved in activities that might result in a finding
of environmental liability;
- owns existing, or acquires for future expansion,
premises that have been previously contaminated by hazardous substances.
For example, site contamination at a branch office where a service
station having underground storage tanks once operated. Also, premises
or other real estate owned could be contaminated by asbestos requiring
costly cleanup or abatement.
Banking Organizations’ Environmental
Policies and Procedures Banking organizations
should have in place adequate safeguards and controls to limit their
exposure to potential environmental liability.
Loan policies
and procedures should address methods for identifying potential environmental
problems relating to credit requests as well as existing loans. The
loan policy should describe an appropriate degree of due-diligence
investigation required for credit requests. Borrowers in high-risk
industries or localities should be held to a more stringent due-diligence
investigation than borrowers in low-risk industries or localities.
In addition to establishing procedures for granting credit, procedures
should be developed and applied to portfolio analysis, credit monitoring,
loan-workout situations, and—prior to taking title to real property—foreclosures.
2 At the same time, banking organizations must be careful that
the actions undertaken to make, administer, and collect loans—including
assessing and controlling environmental liability—cannot be construed
as taking an active role in participating in the management or day-to-day
operations of the borrower’s business, which could lead to potential
liability under CERCLA. Activities which could be considered active
participation in the management of the borrower’s business, and therefore
subject the bank to potential liability, include, but are not limited
to—
- having bank employees as members of the borrower’s
board of directors or actively participating in board decisions;
- assisting in day-to-day management and operating
decisions; and
- actively determining management changes.
Banking organizations should take steps to avoid or mitigate
potential environmental liability by—
1.
preparing an environmental policy statement and providing training
programs so lending personnel are aware of environmental-liability
issues and are able to identify borrowers with potential problems;
2.
establishing guidelines and procedures for dealing with new borrowers
and real property offered as collateral; and
3.
conducting
an appropriate analysis of potential environmental liability. Such
analysis should be more rigorous as the risk of hazardous-substance
contamination increases. The following are examples of types of analyses
and procedures that should be progressively considered as the risk
of environmental liability increases:
a.
Environmental review—screening of the borrower’s activities by lending
personnel or real estate appraisers for potential environmental problems
(using questionnaires, interviews, or observations).
Review
procedures might include a survey of past ownership and uses of the
property, a property inspection, a review of adjacent or contiguous
parcels of property, a review of company records for past use or disposal
of hazardous materials, and a review of any relevant Environmental
Protection Agency records.
b.
Environmental
assessment—structured analysis by a qualified individual that
identifies the borrower’s past practices, regulatory compliance, and
potential future problems. This analysis would include reviewing relevant
documents, visiting and inspecting the site, and, in some cases, performing
limited tests.
c.
Environmental
audit—a professional environmental engineer performs a similar structured
analysis as previously indicated for environmental assessments, however,
more comprehensive testing might involve collecting and analyzing
air samples, surface soil samples, subsurface soil samples, or drilling
wells to sample ground water.
4.
Reviewing
existing loans to identify credits having potential environmental
problems.
5.
Developing
recordkeeping procedures to document the due-diligence efforts taken
at the time of making loans or acquiring real property.
6.
Including warranties, representations, and indemnifications in loan
agreements designed to protect the banking organization from losses
stemming from hazardous- substance contamination. (Although such provisions
provide some protection for the lender, these agreements are not binding
against the government or third parties. Such contractual protections
are only as secure as the borrower’s financial strength.)
Conclusion Potential environmental liability can touch on a
great number of loans to borrowers in many industries or localities.
Moreover, nonlending activities as well as corporate affiliations
can lead to environmental liability, depending upon the nature of
these activities and the degree of participation that the parent exercises
in the operations of its subsidiaries. Such liability can result in
losses arising from hazardous-substance contamination because banking
organizations are held directly liable for costly court-ordered cleanups.
Additionally, the banking organization’s ability to collect the loans
it makes may be hampered by significant declines in collateral value,
or the inability of a borrower to meet debt payments after paying
for costly cleanups of hazardous-substance contamination.
Banking organizations must understand
the nature of environmental liability arising from hazardous-substance
contamination. Additionally, they should take prudential steps to
identify and minimize their potential environmental liability.
Indeed, the common thread to environmental liability is the existence
of hazardous substances, not types of borrowers, lines of business,
or real property. SR-91-20; Oct. 11, 1991.
