Lender Liability Under Environmental Laws in Real Estate Transactions

February 10, 2017 (5 min read)

By: Annemargaret Connolly and Matthew D. Morton, Weil, Gotshal & Manges LLP.

Why should real estate lenders and other secured creditors concern themselves with known and potential environmental liabilities and requirements associated with their loan portfolios? After all, environmental liabilities and requirements generally are imposed on borrowers who own and operate the real estate collateral securing the loan, and several liability protections exist in federal and state laws that are designed to specifically protect secured parties from incurring environmental liabilities simply because they took actions to protect their assets.

THOSE PROTECTIONS NOTWITHSTANDING, THERE ARE, in fact, several reasons why lenders need to remain vigilant regarding environmental risks. First, a borrower’s potential environmental costs and liabilities, particularly those associated with remediating contaminated sites and achieving and maintaining compliance with environmental laws, can be significant and can impact cash flow and, therefore, adversely impact a borrower’s ability to repay its loan. In addition, environmental laws can impose liability risk on mortgage lenders and other secured creditors who foreclose on and repossess property used to secure loans and run afoul of the statutory safe harbors available under such laws. Finally, lenders may not want to foreclose on contaminated property that cannot later be sold, or even be associated with contaminated property that may be stigmatized or pose a risk to the local community. This article discusses the risks that real estate lenders and other secured creditors face under various environmental laws and offers practical advice for mitigating such risks.

Lender Liability Risks Under Environmental Laws

A lender holding a security interest in real estate collateral can face multiple environmental risks. A borrower’s potential environmental costs and liabilities, particularly the cost of complying with environmental laws and remediating contaminated sites, can be significant, which can impact the borrower’s ability to repay its debt. In addition, environmental conditions, most notably soil and groundwater contamination, can adversely impact the value of the collateral and must be assessed both before issuing a loan and in advance of any potential foreclosure. This is because, under certain circumstances, a lender that acquires contaminated property through foreclosure or similar means could incur liability for any required remediation.

As a general rule, the mere lending of money and the taking of a security interest in real estate should not result in lender liability for contamination associated with the real estate; however, lenders who overstep this role may find themselves incurring liabilities. Prior to foreclosure, lenders can be held liable under environmental laws, such as the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), when found to have acted more like an owner or operator by participating in the management of the property. In addition, lender environmental liability risks can intensify when foreclosure is necessary, as statutory protections can disappear if a lender fails to sell or divest itself of the facility at the earliest practicable, commercially reasonably time, on commercially reasonable terms, taking into account market conditions and legal and regulatory requirements. Furthermore, secured creditor protections generally do not extend to costs associated with continuing or prospective compliance obligations, such as air emissions or wastewater discharges from the foreclosed-upon site, and will not protect a lender from common law liability, such as claims for toxic torts, nuisance, or neighboring property damages. As such, environmental risks can increase the longer a property is held by the lender post-foreclosure.

To read the full practice note in Lexis Practice Advisor, follow this link.

Annemargaret Connolly is a partner and head of the Environmental practice at Weil, Gotshal & Manges LLP. She is the general editor of Environmental Law in Real Estate and Business Transactions (Matthew Bender), a 3-volume treatise which is updated annually by attorneys at her firm and focuses on environmental issues that arise during real property and business transactions. Matthew D. Morton is counsel at Weil, Gotshal & Manges LLP.