Several recent high-profile chapter 11 cases have involved environmental liabilities and highlight how significant these liabilities can be to the restructuring process. Though environmental liabilities often have some form of security associated with them (e.g., letters of credit, surety bonds, etc.) prior to a debtor filing its bankruptcy petition, because of their nature, environmental liabilities may still create the need for significant reserves in order to accommodate contingent claims. Further complicating matters, many environmental claims involve multiple parties with indemnity and contribution rights against each other.
When formulating a structure for a debtor’s reorganization plan, the mix and proportion of claims filed must be assessed in order to determine whether environmental claims are large enough to warrant significant focus in the plan process. Depending on the size of the environmental claims, it may be necessary for a debtor to create separate post-confirmation legal entities to deal with environmental claim matters.
Assuming that environmental claims represent a significant portion of a debtor’s overall claims pool, the next question is whether the plan contemplates restructuring for a going-concern or liquidation. With any plan contemplating reorganization as a going-concern, the key to success is striking a balance between allocating capital for business operations going forward and creating a source of recovery for claims made against the estate. For example, if unsecured nonpriority claims represent only 25 percent of total claim dollars and environmental claims are only 50 percent of the unsecured nonpriority claim class, then environmental claims would represent only 12.5 percent of total claim dollars. This would likely not be large enough to justify forming a plan around these claims. However, if the total claim pool was $1 billion, environmental claims made up 70 percent of this pool and only $250 million of capital was available to satisfy all claims, then environmental creditors may become an integral part of a debtor’s strategy. Knowledge of the substantive aspects of environmental law, advanced planning and engaging the relevant constituents in an attempt to develop a comprehensive, consensual plan is the key to obtaining confirmation of a debtor’s plan under these circumstances.
Many environmental claims asserted against chapter 11 debtors arise under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). [1] CERCLA is a complicated federal statute that imposes liability for environmental cleanup costs, natural resource damages and other categories of recovery on four types of potentially responsible parties (PRPs): (1) current owners or operators of contaminated property, (2) previous owners or operators of contaminated property, (3) persons who arranged for disposal of hazardous substances at a contaminated property and (4) transporters of hazardous substances to a contaminated property. [2] The Environmental Protection Agency (EPA) seeks cost reimbursement and injunctive relief for CERCLA violations while other state and federal agencies, such as the Department of the Interior, pursue natural resource damages. In addition to federal law, there are also state statutes similar to CERCLA that give rise to liability for environmental cleanup costs and related damages.
Because of the magnitude of the dollars typically involved, absence of a clear answer as to whether environmental claims have priority status in a chapter 11 case, variation in remediation cost estimates and the unique dynamics of negotiating with public vs. private entities, the negotiation and settlement of state and federal government environmental claims involves a significant amount of discussion and negotiation. These governmental entities are ultimately at risk of having to cover any shortfall necessary to remediate the environmental liabilities if the debtor has insufficient funds to do so.
In addition to the “primary” claims of federal and state governments, there are also “secondary” claims that may be asserted by parties that are co-liable with the debtor. CERCLA allows private parties (both PRPs and “innocent” parties) [3] to voluntarily clean up contaminated property and to then seek cost recovery or contribution from other PRPs. [4] Section 502(e)(1)(B) of the Bankruptcy Code can assist chapter 11 debtors in reducing these “secondary” type contribution and indemnity claims based on alleged co-liability with the other debtor PRPs under CERCLA or related state law. Section 502(e)(1)(B) provides:
[T]he court shall disallow any claim for reimbursement or contribution of an entity that is liable with the debtor on or has secured the claim of a creditor to the extent that—
(B) such claim for reimbursement or contribution is contingent as of the time of the allowance or disallowance of such claim for reimbursement or contribution. [5]
Courts have applied a three-part test to determine whether disallowance of claims under § 502(e)(1)(B) are permissible: (1) “the claim must be for reimbursement or contribution,” [6] (2) “the party asserting the claim must be ‘liable with the debtor’ on the claim” [7] and (3) “the claim must be contingent at the time of its allowance or disallowance.” [8] Indemnification claims for environmental response costs arising under contracts, including purchase agreements, have been held to constitute claims for reimbursement or contribution within the meaning of § 502(e)(1)(B). [9]
In addition to the role that environmental liabilities may play in the plan process, another consideration is how environmental claims and related creditors may impact the estate during the bankruptcy proceeding. Post-petition remediation costs can be characterized as administrative expenses since they are “actual and necessary to preserving the debtor’s estate.” [10] Absent creditor consent, these administrative claims must be paid in full at confirmation. [11]
Furthermore, even if a debtor is able to discharge environmental obligations that arose pre-confirmation, new environmental obligations may arise on the same property post-confirmation to the extent that the debtor continues to own that contaminated property. [12] In U.S. v. Apex Oil Company Inc., [13] the Seventh Circuit examined the issue of whether the government’s claim to an injunction obtained by the EPA, pursuant to the Resource Conservation and Recovery Act of 1976 (RCRA) was discharged in bankruptcy and could therefore not be renewed in a subsequent lawsuit. [14] In deciding that the government’s action did not constitute a “claim” for bankruptcy purposes, the court explained that the RCRA does not entitle a plaintiff to demand, in lieu of action by the defendant, payment of clean-up costs and does not authorize any form of monetary relief. [15] The court rejected Apex’s argument that the cost of complying with the equitable decree constituted a dischargeable “claim.” [16] In affirming the district court’s granting of the injunction, the court explained that discharge must be limited to cases in which the claim gives rise to a right to payment, rather than merely imposing a cost on the defendant. [17]
If asset dispositions are necessary to fund the operations of the business during a bankruptcy proceeding, then understanding where assets are located in relation to environmental claims against the estate is essential. For example, if a debtor requires $100 million from asset dispositions in order to successfully finance its operations through the plan-confirmation process and the estimated proceeds are composed of only two assets, one of which has significant environmental liabilities associated with it, then obtaining 50 percent of the funds needed to reach plan confirmation may require overcoming an objection from an environmental claimant. Failure to accomplish this could hold the business and plan process hostage, so it is necessary to carefully plan these transactions and engage the relevant constituents well in advance of the proposed transaction in order to allow adequate time to negotiate agreed-upon terms that will facilitate the estate’s receipt of the sale proceeds.
Environmental claims can have a significant impact on the restructuring process because of their unique legal, technical and economic issues. The complexity of these claims, along with the fact that these claims do not have a clear priority status, often results in long, negotiated settlements that, if not planned and managed properly, can adversely impact a debtor and its advisors’ restructuring efforts.
1. 42 U.S.C. §§ 9601, et seq. CERCLA provides the federal government with both monetary remedies (cleanup cost reimbursement and natural resource damages) and injunctive relief remedies. See 42 U.S.C. §§ 9606, 9607.
2. See CERCLA § 107(a), 42 U.S.C. § 9607(a).
3. When the EPA identifies PRPs with respect to a particular contaminated site, the PRPs often form groups to negotiate with the EPA and often file proofs of claim that seek cost recovery and contribution from the debtor under CERCLA for the same liabilities for which the EPA and state environmental agencies file claims.
4. Id. at §§ 9607(a), 9613(f). PRPs that fund response actions can seek contribution from other PRPs “during or following any civil action” that was instituted under §§ 106 or 107 of CERCLA, as well as from PRPs who settle their liability to the EPA or a state through a settlement approved by a court or administrative body. 42 U.S.C.
§§ 9613(f)(1), 9613(f)(3)(B).
5. 11 U.S.C. 502(e)(1)(B). Some courts state that § 502(e)(1)(B) is compatible with the congressional policies underlying CERCLA because the threat of disallowing contingent private claims for remediation costs provides an incentive for parties to conduct prompt cleanups. See Juniper Dev. Group v. Kahn (In re Hemingway Transport Inc.), 993 F.2d 915, 924-25 (1st Cir. 1993) (section 502(e)(1)(B) encourages “targeted PRPs to initiate cleanup efforts as expeditiously as practicable in the expectation that their contingent claims may become ‘fixed’ in time for allowance against the debtor estate”); see also Syntex Corp. v. Charter Co. (In re Charter Co.), 862 F.2d 1500, 1564 (11th Cir. 1989); In re Eagle-Picher Indus. Inc., 164 B.R. 265, 271 (S.D. Ohio 1994).
6. “Reimbursement or contribution” under § 502(e)(1)(B) is a broad term that includes any claim that would result in double payment by the bankruptcy estate if the claim is not disallowed. Norpak v. Eagle-Pitcher Indus. Inc. (In re Eagle-Picher Indus. Inc.), 131 F.3d 1185 (6th Cir. 1997). Courts have held that CERCLA claims for statutory cost reimbursement or contribution brought by PRPs meet the “reimbursement or contribution” element of § 502(e)(1)(B). See, e.g., Syntex Corp. v. Charter Co. et al. (In re Charter Co.), 862 F.2d 1500, 1503 (11th Cir. 1989) (claimants in ongoing civil actions); In re Eagle-Picher Indus. Inc., 164 B.R. 265, 271 (S.D. Ohio 1994) (claimants who entered into consent decree and administrative orders with EPA had CERCLA contribution claims that satisfied the reimbursement or contribution element of § 502(e)(1)(B)); In re Eagle-Picher Indus. Inc., 197 B.R. 260, 275 (Bankr. S.D. Ohio 1996) (claims for contingent costs that might have arisen in complying with consent decree were contribution claims and disallowed).
7. For the purposes of § 502(e)(1)(B), being “liable with the debtor” means that, by paying the primary creditor, the debtor would be eliminating a requirement that the secondary creditor make the same payment. See Fine Organics Corp. v. Hexcel Corp. (In re Hexcel Corp.), 174 B.R. 807, 811-12 (Bankr. N.D. Cal. 1994); see also Juniper Dev. Group v. Kahn (In re Hemingway Transport Inc.), 126 B.R. 656, 661-62 (D. Mass. 1991), aff’d in part, rev’d in part, Juniper Dev. Group v. Kahn (In re Hemingway Transport Inc.), 993 F.2d 915, 923 (1st Cir. 1993)); Norpak, 131 F.3d at 1190. It is not necessary that the debtor be a party to the administrative or civil-remediation order that is the basis for the claimant’s co-liability. See, e.g., Juniper Dev. Group, 993 F.2d at 925-28. Furthermore, co-liability can be based on two entirely separate grounds, so long as the underlying claim is the same. See Norpak 131 F.3d at 1190 (affirming bankruptcy court’s determination that claim was for reimbursement or contribution for purposes of § 502(e)(1)(B)).
8. A claim is contingent, for § 502(e)(1)(B) purposes, until liquidated costs are actually incurred. See, e.g., In re APCO Liquidating Trust, 370 B.R. 625, 636 (Bankr. D. Del. 2007) (disallowing future source-control costs not yet incurred). “The determination of whether the claim is contingent is made at the time of the allowance or disallowance of the claim, which courts have established is the date of the ruling.” In re Alper Holdings USA, 2008 WL 4186333, at *5 (quoting In re Drexel Burnham Lambert Group Inc., 148 B.R. 982, 985 (Bankr. S.D.N.Y. 1992)). In re Alper Holdings USA, No. 07-12148, 2008 WL 4186333, at *5 (Bankr. S.D.N.Y. Sept. 10, 2008).
9. See In re Alper Holdings USA, No. 07-12148, 2008 WL 4186333, at *5 (Bankr. S.D.N.Y. Sept. 10, 2008).
10. Government entities can require a debtor’s continued compliance with environmental laws during its bankruptcy case since environmental laws are a part of the government’s police and regulatory powers that are excepted from the automatic stay. See Safety-Kleen Inc. v. Wyche, 274 F.3d 846, 866 (4th Cir. 2001). 11 U.S.C. § 503(b)(1)(A); see also, e.g., In re H.L.S. Energy, 151 F.3d 434, 439 (5th Cir. 1998) (holding that expense incurred post-petition to remedy post-petition environmental liability is administrative expense under § 503(b)(1)(A)); In re American Coastal Energy Inc., 399 B.R. 805, 816-17 (Bankr. S.D. Tex. 2009) (post-petition expenditures for pre-petition environmental liabilities are § 503(b)(1)(A) administrative expenses).
11. 11 U.S.C. § 1129(a)(9).
12. See Ohio v. Kovacs, 469 U.S. 274, 285 (1985); Matter of Chicago, Milwaukee, St. Paul & Pacific Railway Co., 974 F.2d 775, 788-89 (7th Cir. 1992); U.S. v. The LTV Corp. (In re Chateaugay Corp.), 944 F.2d 997, 1008-9 (2d Cir. 1991); In re CMC Heartland Partners, 966 F.2d 1143, 1146-47 (7th Cir. 1992); Industrial Salvage Inc. v. Illinois (In re Industrial Salvage Inc.), 196 B.R. 784, 789- 90 (Bankr. S.D. Ill. 1996).
13. 579 F.3d 734 (7th Cir. 2009)
14. Apex Oil involved the determination of whether the injunction constituted a "right to an equitable remedy for breach of performance” under § 101(5)(B) of the Code.
15. Importantly, the court explained that in Apex Oil the government was not seeking payment of money since the injunction that the government obtained did not entitle it to such payment. But see Ohio v. Kovacs, 469 U.S. 274, 285 (1985) (allowing discharge in bankruptcy of equitable obligation to clean up contaminated site where receiver was seeking money rather than order requiring clean up of contaminated site). Id. at 736.
16. Id. at 737.
17. Id. at 738.