BROWNFIELDS: WHAT ARE LENDERS AFRAID OF? BY JOE DELANEY Foster & Pepper So you found some property you want to purchase and develop, but it is in an industrial area or known area of contamination. Or maybe you have such a property you would like to sell. Will you be able to obtain bank financing? Despite recent changes in laws protecting lenders, the answer is still uncertain. If the property is or has been significantly contaminated, you will need to satisfy a lender that the property has been cleaned up or that the contamination does not present a significant liability. Unfortunately, a lender's willingness to accept risks associated with contamination is generally less than a purchaser's or developer's. Therefore, you should determine how much information a lender will require to provide financing. Understanding a lender's concerns will help avoid pitfalls in the process. Why the concern? Contamination is a particularly difficult issue to resolve in the financing, purchase or development of property. Under federal and state environmental laws, the current owner of a property may be strictly, jointly and severally liable for all costs to clean up contaminated property. Investigating contaminated property is time consuming, expensive and inexact. In Washington, if you discover contamination on your property you have an affirmative duty to report that contamination to the Washington Department of Ecology. Aside from this duty to report, property owners are under no general affirmative duty to clean up their property. An owner must clean up a property only if ordered to do so by the state or federal environmental agencies. Properties are often cleaned up by owners without being ordered to do so by an environmental agency. In fact, the majority of cleanups taking place are "independent" cleanups, undertaken voluntarily by property owners without agency involvement. Most of these cleanups are conducted in order to make the property marketable. Many properties that are cleaned up probably never would have been targeted for cleanup by environmental agencies. Environmental agencies have extremely limited resources and target only those properties representing the most significant risks. Thus, many of the properties that are currently cleaned up in transactional settings are properties that, as a practical matter, would never receive cleanup orders from environmental agencies. If, however, a property owner were to ask an environmental agency to agree that a property did not need to be cleaned up, the agency would be unable to give assurances. In order to give such assurances, the agencies would have to gather significant information and require that the property be cleaned up. Although agencies have discretion not to exercise enforcement authority, they do not have discretion to agree to a settlement or release of a party unless they have thoroughly documented the condition of the property. Lenders generally require thorough investigation of a property before they are willing to provide financing. The level of certainty most lenders require may prove to be unfeasible on properties which are significantly contaminated or are part of an area-wide contamination problem. The federal and state Superfund laws provide that owners or operators of property are liable for costs to investigate and clean up hazardous substance contamination associated with a property. Both statutes contain "secured party" exemptions, excluding from owner liability "a person who, without participating in the management of a facility, holds indicia of ownership primarily to protect the person's security interest in the facility." Despite the exemption from liability, banks remain wary of lending on contaminated properties, expressing concern primarily in three areas. Legal liability for "participating in management." Banks are concerned that prudent lending practices may subject them to arguments that they are liable "for participating in the management" of a facility. This concern was heightened by court decisions under the federal Superfund law which indicated that a lender's unexercised ability to control the waste disposal activities of its borrower could subject it to Superfund liability. In response to this decision, the U.S. EPA attempted to issue a regulation clarifying that lenders would not be deemed to "participate in the management" of a facility by virtue of undertaking normal and prudent lending activities. However, the courts struck down EPA's attempt, finding that EPA's attempt at regulation was beyond the scope of its authority under Superfund. EPA has subsequently reissued the regulation as an EPA policy. Consequently, banks remain concerned that, under the federal Superfund law, they may be subject to arguments by private parties and others not bound by EPA policy that their normal lending activities subject them to legal liability for cleanups. Recent amendments to the state Superfund law have detailed the actions lenders can take without having "participated in the management" of a facility. These provisions give lenders some level of comfort that they will not be subject to liability under state Superfund law for undertaking ordinary and prudent lending activities. However, the uncertainty under federal Superfund law leaves banks concerned that they may be subject to claims for contamination when the bank's activities have been consistent with standard lending practice. Legal liability after foreclosure. Lenders are concerned that by foreclosing on a property they will become liable for contamination. Again, this concern was heightened by federal court decisions indicating that a lender loses its exemption once it forecloses on a property and thus becomes a "true owner." The EPA lender liability policy discussed above does not completely resolve this issue. The amendments to the state Superfund law provide that a lender does not become liable when it forecloses, provided that it undertakes certain activities and is able to dispose of the property within five years after foreclosure. In general, banks remain uncertain whether they can foreclose on a contaminated property without becoming liable for cleanup costs under the Superfund laws. Impaired collateral value. Banks are concerned about the impact contamination has upon a property's value. For example, a property which appraises at $5 million may be worth substantially less if contamination is discovered on the property. The process of determining the cost of cleanup or the impact contamination has on the property's value, is time consuming, difficult and uncertain. Even if lenders could be guaranteed legal protection from liability, they still could be left with properties of diminished value including some properties with negative values. Banks remain concerned about contamination and, other things being equal, would prefer to make loans on properties not impacted by contamination. In response to significant losses that banks have experienced on contaminated properties, most banks have instituted environmental risk programs with detailed requirements for the investigation and review of contamination. Complying with these requirements can be prohibitively expensive. Recent surveys have indicated that many bankers and other real estate professionals believe the level of concern over environmental contamination has peaked and is likely to decrease in the future. In the Puget Sound area, local governments are working together to attempt to provide a more certain regulatory atmosphere for property owners and lenders so that contaminated properties will become marketable and productive. The efforts are proceeding slowly. In today's climate, one should be prepared to spend a significant amount of time and money investigating and documenting the condition of a contaminated property in order to obtain financing. Some lenders may be unwilling to finance such properties, so long as there are "clean" opportunities which are more attractive. However, as more properties become redeveloped and the market becomes more comfortable with the idea that a contaminated property can become productive and marketable, we can expect lenders to become more flexible and willing to finance such properties. Joe Delaney, a senior associate at Foster Pepper & Shefelman, concentrates his practice in environmental law.