Archive for the ‘Disclosure of Environmental Liabilities’ Category

Remedial Program Reform Proposals for EPA Administrator Pruitt

Tuesday, February 28th, 2017

Regulatory reform is at the centerpiece of the Trump Administration’s plan to stimulate economic growth. During the presidential campaign, candidate Trump vowed to rollback a variety of Obama Administration Climate Change Initiatives but said little about EPA remedial programs such as the federal Comprehensive Environmental Response, Compensation and Liability Act (CERCLA or superfund). Based on his testimony and follow-up written response to Congress, it appears that EPA Administrator Scott Pruitt recognizes the value of brownfield programs and the need to remediate contaminated sites. There also seems to be strong bipartisan support for the brownfield program in the House committee responsible for the EPA budget.

As a result, I have shared the following recommendations to Administrator Pruitt for reforming EPA’s remedial programs. These suggestions could improve the efficiency of the remedial programs without weakening environmental protections. Some of the changes could be achieved through legislative amendments but could be administratively implemented if Congress does not have the time to address environmental issues during the current term. The proposals are not in any order of importance

  1. CERCLA Continuing Obligations Guidance– The 2002 amendments to CERCLA added the Bona Fide Prospective Purchaser (BFPP) and Contiguous Property Owner defenses. These defenses (in particular the BFPP defense) were enacted to help incentivize purchasers to acquire and remediate contaminated properties so they can be put back into productive use. While EPA promulgated an all appropriate inquiries (AAI) rule to help define the pre-acquisition obligations necessary to be able to assert these defenses, there is little guidance from EPA on how property owners or operators may satisfy their “appropriate care” or “continuing obligations” so they can maintain their liability protection after taking title or possession of property. The 2003 “Common Elements Guidance” is inadequate. The lack of guidance and recent caselaw have created uncertainty for developers and undermined the value of these defenses. EPA should issue detailed guidance on what constitutes appropriate care. Developers and property owners should not have to rely on ASTM to provide guidance on how to comply with their legal obligations.

2. Revise “Enforcement Discretion Guidance Regarding the Affiliation Language of CERCLA’s Bona Fide Prospective Purchaser and Contiguous Property Owner Liability Protections” – This memo did not sufficiently address concerns raised by the Ashley decision that purchasers of contaminated property could lose their eligibility for the BFPP by agreeing to indemnify sellers. 

3. More Robust Use of PPAs and CPO “Assurance Letters”- With the passage of the 2002 CERCLA amendments, EPA announced in guidance that it would issue PPAs or CPO assurance letters only in rare instances because the landowner liability protections were self-implementing. However, these agreements can be incredibly valuable. EPA should urge its regional offices to issue such documents where they can facilitate redevelopment such as in urban superfund sites (e.g., GowanusCanal, Newtown Creek) and where municipal governments are willing to foreclose on contaminated properties and then convey title to redevelopers. 

4. Clarify Scope of Municipal Liability Protections Under CERCLA to Encourage Taking Title of Vacant Properties and Facilitate Reuse- There is considerable uncertainty among local government community if municipalities can invoke the protections of 42 U.S.C. 9601(20)(D) and (9601(35)(A)(ii) where they take title in lieu of formal tax foreclosure proceeding since this may not be “involuntary”. Local governments might be more willing to take title and assemble vacant properties so they would become more attractive to redevelopment if they could obtain clarity on the scope of this protection. Presumably, a purchaser from a municipality would then be able to assert the BFPP or third party defense. A related problem is that the BFPP defense would not apply to local governments who took title prior to January 11, 2002.

5. Reform EPA Remedial Programs Into a Single Unified Cleanup Program- Our nation’s remedial programs were created as we became aware of new concerns. This has resulted in different cleanup standards and procedures. We have separate staffs for CERCLA, RCRA, TSCA (PCBs), USTs, etc. We now have three decades of experience remediating sites. I think we should strongly consider combining these discrete offices into one streamlined remedial office that will provide consistent regulatory approach and reduce unnecessary staff. 

6. Clarify Lender Obligations Following Foreclosure- The original EPA lender liability rule contained a “bright-line” test for lenders to follow so they can be deemed to have taken commercially reasonable steps to sell property following foreclosure, thereby staying within the safe harbor created by the secured creditor exemption. Unfortunately, when the rule was vacated and the 1996 lender liability amendments were added to CERCLA, the “bright line” test was omitted. So lenders have no guidance on how to proceed during what is the worst economic downturn since the Great Depression. Can they reject an offer that is equal to artificially depressed price? How long can they hold onto property without losing protection? Some states allow for two years while others allow up to five years to sell the property. Greater clarity will help lenders move these properties.If control of Congress changes, this can be legislative proposal.  

7. Encourage States to Adopt Licensed Professional Programs– States are facing severe staffing constraints which are creating backlogs in site remediation.  EPA could use its authority under section 128 of CERCLA (approval of state response programs) as well as its RCRA delegation authority to have states adopt licensed site professional programs like MA, NJ and CT so that states could devote their limited resources to the sites that pose the greatest risk to human health and the environment. EPA could establish a national licensing program for consultants that sets forth minimum professional requirements and states could adopt these programs as part of their remedial programs. One way to accomplish this could be by amending the All Appropriate Inquiries (AAI) Rule to revise the definition of Environmental Professional. This could avoid having to promulgate a new regulation.  

8. Revise NCP- revising the NCP. It was last revised in 1990. Since then we’ve learned a lot about cleanup and have lots of informal guidance to help streamline the process and make it more cost-effective. Doesn’t make sense to continue to follow the RI/FS lockstep process. Why review five alternatives? The NY brownfield program requires applicants tp propose remedy and an unrestricted cleanup alternative, and this approach has been able to generate robust cleanups. The NCP could be revised to incorporate streamlined provisions for brownfield sites that will produce faster and more cost-effective cleanups while preserving right of contribution. Right now, firms are incentivized to follow the lock-step approach to preserve their ability to pursue cost recovery. 

9. Revise CERCLA Disclosure Requirements With Amnesty Program To Incentivize Accelerated Cleanups- Property owners are not currently required to disclose historic contamination. As a result, many sites remain unremediated until the owner is ready to sell the property. To help accelerate cleanups, I think EPA could announce it was going to change its disclosure rules from reportable quantity approach to contaminant concentrations and at the same time provide current property owners a one year amnesty period to voluntarily disclose contamination. Much like the EPA audit policy, owners who disclose the existence of contamination that they are not responsible for would be afforded BFPP status. They would have to exercise “appropriate care” but not full cleanup. The SARA Title III program resulted in substantial reductions in pollution. It seems worth the try to experiment with an amnesty period for contaminated sites. 

10. Seek Cost Recovery from Responsible Parties When Brownfield Grants Are Awarded – According to a 2004 EPA study, there may be 300,000 contaminated sites in the nation that may cost over $200 billion (not adjusted for inflation) to remediate.  Many brownfield sites were created when corporations closed plants and either relocated elsewhere in the country or exported the jobs overseas yet remains financially viable. EPA has been granting brownfield grants to local governments without considering if there is a responsible party.  Before EPA gives away public money, it should make a determination that there are no responsible parties. If responsible parties are available, RPA should give the responsible party an opportunity to conduct an investigation and remediation of the contaminated property is has left behind. If the responsible party declines to participate int he cleanup, EPA could then award the Brownfield grant and seek cost recovery. In this way, the brownfield funding program would not have to rely entirely on Congressional appropriations.

11. Move Away from Brownfield Grants/Loans and To Tax Credits- The brownfield financial incentives are becoming like public works projects. The funding often takes too long for private development. Rather than giving funds to local government to investigate and reuse planning, EPA could incentivize the private market to do this work by expanding and extending brownfield tax credits. The New York Brownfield tax credit program has resulted in an estimated $7.5B in investment in the state at a cost of $750MM. Tax credits put the upfront risk on the developer instead of the taxpayers. 

12.Adopt National Environmental “WARN” Obligations Under RCRA- to prevent future brownfields, companies closing operations should be required to notify relevant permitting authority at least 90 days in advance of closing to ensure that appropriate closure occurs so that public money does not have to be used to address cleanup or local government seeks brownfield funds.

13. Require States To Use Parceling To Encourage RCRA Brownfields- EPA RCRA Brownfield Reforms urged states to allow owners or operators of TSDF to sell off clean parcels of their facilities (e.g., portions never used for any waste management) while the HWMUs or SWMUs were undergoing corrective action. EPA should more forcefully use its delegation authority to allow this much needed reform.  

14. Clarify RCRA liability for Generator-only sites- There is much confusion if closure obligations for a generator site run with the land. In other words, a site may have been owner or operated by a defunct generator. A prospective purchaser is interested in redevelopment but is concerned it will become subject to closure obligations for the areas where wastes were managed. Presumably, generator sites could be treated as any brownfield site without the need to undergo formal RCRA closure.  

15. Add Landowner Liability Protections to TSCA for PCB Cleanups- Purchasers often take steps to qualify for CERCLA BFPP only to learn after taking title that the property has been impacted with PCBs and they are subject to TSCA cleanup. This might require Congressional action but I do not see any reason why TSCA should not have a BFPP defense. Congress added AAI and BFPP to OPA in 2004 with little controversy.

16. TSCA PCB Reform- The PCB cleanup and disposal rules are a bit RCRA-like, a bit CERCLA-like and not well integrated. The cleanup should also not depend on the original spill concentration but on current concentrations and media. I’d like to see the entire Subpart D to 40 CFR 761 repealed, and disposal of PCB-containing material handled entirely within RCRA via the listed-waste and LDR route. 

17. Adopt Restatement (Third) of Torts Approach to Joint Liability– When CERCLA was enacted, Congress said that liability should be premised on evolving concepts of common law. At the time of its enactment, the Second Restatement was in effect which favored use of joint liability for indivisible harm. However, this was before states began adopting comparative negligence statutes. The Third Restatement states that the law has shifted dramatically from the use of joint liability and that courts should try to find a basis for apportioning liability where there is a reasonable basis. Despite the publication of the Third Restatement in 2000, federal courts continue to cling to the doctrine espoused by the Second Restatement. Recently  an appeals court declined to adopt the suggestion of an amicus brief submitted by The American Tort Reform Association to use the Third Restatement to apportion liability for the Fox River cleanup. My post on this case is at: . The Administration might want to have Congress clarify that CERCLA liability should be based on the Third Restatement or  EPA could issue interpretative guidance that it now considers the Third Restatement to be the governing law for CERCLA liability. This  would reflect the Congressional intent to follow the evolving common law and confirm the direction where the law has moved.

Lender that Sold Contaminated Property Agrees to $1.4MM Settlement

Wednesday, May 6th, 2015

We have previously reported on instances where banks have incurred cleanup costs in connection with properties they have sold.  For some examples, click here, here, here, here and here

The latest installment of this saga involves Bank of America (BOA) which agreed to pay $1.4MM as part of a settlement involving a dry cleaner property that a BOA predecessor owned decades ago. A federal district court approved the settlement in Whitehurst v. Heinl, 2015 U.S. Dist. LEXIS 49147 (N.D.Ca. 4/14/15).

In this case, Charlotte A. Heinl (“Heinl”) operated a Norge Cleaners in Oakland, California from approximately 1965 to 1987. Bank of America, National Trust & Savings Association (“NTSA”) owned the property from approximately 1969 to 1987 and had leased it to Heinl. Bank of America became the successor to NT&SA when BankAmerica Corp. merged with NationsBank in 1998. As part of that merger, Bank of America, NTSA, was renamed Bank of America, NA (BOA).

NTSA sold the property to Richard and Lorraine Whitehurst (“Plaintiffs”) in 1987 for $265,000 pursuant to an “as is” agreement. The Plaintiffs had also been provided with a opportunity to investigate the property prior to the closing and had obtained a 120-day extension. The Property had been part of a larger parcel of real property that NTSA subdivided shortly before it sold the property to the Plaintiffs. The remainder of the parcel is still owned by Bank of America, NA and is potentially impacted by the former dry cleaner.

Sampling conducted September 2007 revealed elevated levels of PCE and its breakdown products in the groundwater. After the California Regional Water Quality Control Board, San Francisco Bay Region (“RWQCB”) sent an information request to the Plaintiffs, they filed a complaint against the Heinl and BOA asserting the defendants were liable under RCRA 7002,  CERCLA and various state common laws claims. The plaintiffs sought an order compelling the defendants to remediate the contamination and sought damages because they had been unable to lease or sell the property due to the presence of the contamination. The bank subsequently filed claims against both Whitehurst and Heinl alleging they were responsible for the contamination.

After several court-sponsored mediations failed to achieve a settlement, the parties reached an agreement on the eve of trial. Under the settlement, the parties agreed to establish a $2MM remediation fund. BOA agreed to contribute $1.4K with $200,000 of that amount representing a contribution from the Plaintiffs Whitehurst in the form of an interest free loan. The plaintiffs will be required to repay the loan within 6 months of receipt of a NFA letter from the RWQCB.  The Fireman’s Fund agreed to tender $600K on behalf of Heinl who passed away during the course of the litigation.

The plaintiffs and BOA entered into Fixed Price Remediation Agreement  with a consultant to implement remedial actions required by the RWQCB. BOA is required under the agreement to designate a Project Manager to supervise the cleanup and handle various administrative tasks associated with the cleanup.

A copy of the order approving the settlement is available from Google Scholar here 


NYC Enacts New Disclosure Law for School Sites

Monday, March 16th, 2015

On February 5th, New York City Mayor Bill de Blasio signed into law Int. No. 126-A (Local Law 12) requiring the Department of Education (DOE) promptly notify parents and other community groups of sampling results identifying elevated levels of in any public school or any proposed public school owned or leased by the DOE. The law takes effect in 90 days.

The law was passed in the wake of discovery of contamination at  PS 51 in the Bronx. PS 51 was located in a building that previously been occupied by in lamp factory. It was not until the lease was up for renewal and DOE had changed its policy to conduct indoor air sampling for lease renewals that sampling was performed. The investigation found levels of VOCs in the indoor air that exceeded the state Department of Health Vapor Intrusion Guidelines for TCE. DOE learned of the contamination in January 2011 but did not communicate the sampling results to the school community until August. The school was subsequently relocatedand the school site was enrolled in the NYSDEC brownfield cleanup program. 

This was only the latest incident where buildings contaminated from prior uses had been converted to schools without adequately investigation or abating the risks posed by the contamination. The problem frequently occurred for leased school sites since School Construction Authority (SCA) was not required to perform environmental reviews under the State Environmental Quality Review Act (SEQRA). The SCA has subsequently amended its policy to require environmental due diligence for new leases and lease renewals.  It was this pursuant to this new policy that the contamination was discovered at PS 51. Due diligence results for leased school sites are now available from the SCA website 

The law applies to contaminants, pollutants and the hazardous substances appearing at 40 CFR 302.4 that exceed “maximum levels” set forth in applicable federal or state regulatory guidelines. If no applicable regulatory guidelines have been established for a particular substance, DOE or SCA are to establish acceptable levels based on current industry standards and relevant published scientific data and guidance.

The disclosure obligation does not apply to tests for asbestos, lead-based paint or polychlorinated biphenyls since the DOE is believed to have adequate sampling and notification protocols for these substances. Notification is also not required where DOE or SCA reasonably expect exceedances of the maximum levels to return to or below the maximum levels through ventilation or cleaning within twenty-four hours, provided that the results that exceed maximum levels have returned to at or below maximum levels within such twenty-hour period and have not occurred in substantially the same space within the previous year

Within ten days of receipt of an environmental report showing exceedances of the maximum levels, DOE must notify parents of current students and the current employees of any public school. If the results are received during a scheduled school vacation period exceeding five days, the notification shall within ten days after the end of such period. The DOE is also obligated to make reasonable efforts to notify the parents of former students and former employees of any school for which notification is required.

DOE is also required to notify the directors of all afterschool programs operating under its jurisdiction, local elected officials, community education councils and local community boards. DOE is also required to “conspicuously post” a link to any environmental report that triggers notification on its website within ten days of receipt of the sampling results. The reports shall be searchable by school, community school district, council district and borough.

Copy of the bill available here 

Bankruptcy Courts Rules Bank May Not Seek Cost Recovery for Contaminated Site Purchased in Auction Sale

Thursday, November 27th, 2014

Pete Seeger’s popular song from the 1960s “Where have all the Flowers Gone?” has the haunting recurring lyrics “When will they ever learn”. This song came to mind when we came across another case of a bank taking title to contaminated property without doing any environmental due diligence.

In this case, Suburban Bank and Trust SBT-BB, LLC (SBT”) extended a $4MM loan Boston Blackies Properties IV, LLC (“Boston Blackies”) in October 2006 that was secured by a mortgage on the property located on East Grand Avenue in the Streeterville section of Chicago. Unfortunately, the gourmet hamburger chain embarked on an aggressive expansion plan that was derailed by the Great Recession and had to file for bankruptcy in 2009. (The owners of the chain apparently also had some ethical issues.

SBT foreclosed on the Property in March 2011. SBT did not perform a new phase 1 before taking title and included the October 2006 phase 1 in the Bidder’s Information Package when the property was put up for auction in April 2011. Standard Bank (Standard), the successful bidder also did not conduct a phase 1 report before submitting its bid.

Standard planned to demolish the existing building and construct a new branch office. However, when Standard applied for a building permit, it learned that the property was within the Lindsay Light Streeterville Thorium Monitoring Area (a/k/a as the Moratorium Area) because of the presence of radioactive fill material associated with the former Lindsay Light Chemical Company (“Lindsay Light). Applicants planning to excavate or disturb soils for properties within the Moratorium Area are required to perform soil testing, conduct certain radioactive monitoring and comply with other work practices. Applications for permits which involve work in the Moratorium Area will be held in the City Permit System until the applicant meets with the Department of Public Health (CDPH) and agrees to implement the health and safety work plan that has been established for the Moratorium Area.   Standard performed the required screening and learned the site was contaminated with thorium contamination.

During the early 1900s, Lindsay Light manufactured gas mantles containing radioactive thorium at three locations in an area in downtown Chicago including a location across the street from the restaurant location that Standard purchased. The process of gas mantle manufacturing involves dipping gauze mantle bags into solutions containing thorium nitrate and small amounts of cerium, beryllium and magnesium nitrates. The mesh bags were then placed inside the glass globe of a light fixture.  When heated by the gas flame, the fabric would burn off and the metal mesh would glow.

The thorium processing refining process produced a sand-like waste known as thorium mill tailings, which were used for fill for development projects in the low-lying areas including in utility installations in City-owned street and sidewalk rights-of-way throughout the  Streeterville AreaIn the 1990’s, EPA excavated approximately 40,000 tons of radioactive thorium-contaminated soils that were discovered during property development and utilities installation and maintenance. In 2000, EPA created the Moratorium Area as a form of institutional control in and around Streeterville to impose restrictions and conditions on excavation to limit exposure to the thorium problems created by Lindsay Light plants. 

Six months after learning of the thorium-contaminated soil, Standard retained a law firm to preparing a claim against Tronox, the successor to Lindsay Light. Tronox had itself filed for bankruptcy and a plan for reorganization had that was confirmed in February 2011. The confirmation order established the Tronox Incorporated Tort Claims Trust Agreement (the “Tort Claims Trust”) that assumed the liabilities for all tort claims of Tronox and was to pay holders of allowed tort claims. Because the bar date for filing proofs of claim in the Tronox bankruptcy had been August 12, 2009, Standard filed a motion for leave to file a late claim of approximately $1.5MM. Standard hoped it could be reimbursed by the Tort Claims Trust.

Standard Bank asserted that its failure to file a timely claim was the result of “excusable neglect” because it had no notice from Tronox and acted within a reasonable time. However, in In re: Tronox Incorporated, 2014 Bankr. LEXIS 4678 (Bankr. S.D.N.Y. 11/7/14), the bankruptcy court found that Standard Bank has not introduced admissible evidence as to the notice provided to Boston Blackies or, equally important, that Boston Blackies was aware of the contamination or Tronox’s chapter 11 case. Moreover, the court said there was nothing in the record that suggested that Tronox knew or should have known that Boston Blackies was a potential creditor based on Tronox’s own records.

In denying the motion to file a late claim, the court said that allowing a purchaser of property after the Bar Date would make finality impossible in any bankruptcy case. Instead, the court said a subsequent purchaser of property can protect itself by obtaining representations and warranties from its predecessor and “may also, of course, obtain an environmental report.”

Standard has also filed a complaint against the firm that prepared the October 2006 phase 1 alleging malpractice and breach of contract. Standard Bank and Trust v The English Company, 2014-L-005825 (Cook Cty Circuit Ct. 6/2/14) . This lawsuit appears to be dead on arrival.

First, the phase 1 contained the following passage discussing the review of the CERCLIS database:

“The Lindsay Light Company, 161 E. Grand Avenue, south adjacent property. This building was one of the former gas mantle manufacturing locations for the Lindsay Light Chemical Company, which refined thorium containing ores and made incandescent gas mantels for home and street lighting. This site is listed as a removal only site with no site assessment work needed, but no further information on the status of this site is provided. Based on the close proximity of this site to the subject property, there is the potential that soils have been impacted.”

Had Standard retain an environmental consultant to perform a phase 1, a transaction screen or even review the October 2006 report prior to submitting its bid, Standard would have learned that the property was likely in the Moratorium Area and that its construction plans might be complicated by the presence of thorium-contaminated soil.

In addition, the report was issued to SBT. By the express terms of the phase 1 report, Standard was not entitled to rely on the report. The complaint does not allege that the consultant knew its report would be included in the Bidder’s Information Package or that the consultant consented to allow bidders rely on its five-year old report. 

EB-5 Program Can Provide Alternative Source of Funding for Brownfield Projects

Saturday, September 27th, 2014

In a prior post, we discussed how the EB-5 visa immigrant investor program was becoming an important source of construction funding. Since then, the EB-5 immigrant investor program has continued to undergo explosive growth. The popularity of EB-5 is partially because traditional forms of project financing remains difficult to obtain. However, the EB-5 program is also attractive to developers because it can serve as an alternative source of relatively inexpensive capital or lending with typical interest rates for EB-5 financing is in the low single digits with some projects offering only 1%. Developers are able to offer such low rates of return because the EB-5 investors are primarily more concerned with obtaining green cards. The cheaper equity also allows developers to pursue more projects.

EB-5 capital has been used to fund a wide variety of projects including hotels, mixed use real estate development, nursing and assisted living facilities, hospitals, medical research facilities, manufacturing facilities, large infrastructure and construction projects and even solar energy projects. Some developers use EB-5 funding to acquire development sites those the purchase price cannot be used towards the job creation count. As a result, some developers have entered into purchase agreements with an EB-5 contingency.

Savvy developers are using EB 5 funding in combination with other sources of non-traditional or public-private financing, such as historical tax credits, New Markets Tax Credits (NMTC), and Tax Increment Financing. A number of our clients have used EB-5 funding on complex brownfield projects.

Following is a brief description of the EB-5 program. We then suggest how environmental professionals may play a role in this expanding and important program. Readers interested in learning more detailed information about EB-5 can visit the U.S. Citizenship and Immigration Services (“USCIS”)  website or review the websites of an EB-5 regional center in your geographic areas.  

What is the EB-5 Program?

EB-5 is an employment-based visa program designed to attract foreign capital investments. Foreign nationals that invest in an approved EB-5 qualified project will receive a conditional two-year visa from the USCIS.   If the investment project fulfills the job creation criteria after two years, the investor can apply for permanent resident status, and then seek U.S. citizenship in five years. Thus, the EB-5 program a very attractive means for obtaining green cards.

To qualify for an EB-5 Visa, an investor must invest at least $1MM (or $500K for a project in a “targeted employment area”) in an enterprise that will create at least 10 new full-time jobs for U.S. citizens and legal residents. If the project is an existing business, the 10 new jobs have to be in addition to the existing jobs in the business.

How Does EB-5 Program Work?

EB-5 is usually structured using limited partnerships or limited liability corporation that either extend loans or purchase equity stake in a special purpose entity established for the qualifying real estate or other capital development (i.e., job creating) project that is controlled by the developer. Limited liability partnerships (LLPs) are the preferred investment vehicle because EB-5 regulations require the EB-5 investor to control the business, unless the investor is a limited partner in the business. Each limited partnership generally invests in a single project. Foreign nationals qualify for the conditional visa by purchasing limited partnership interests of the LLP that invests in the qualified project either as a lender or equity participant.

When used as debt, EB-5 funding can be secured by a first lien, second lien, mezzanine pledge, or other collateral, and it may be in the form of recourse or non-recourse debt. The typical term of an EB-5 loan to a developer is five years. After the EB-5 investors obtain their green cards, project sponsors will typical “take out” the EB-5 investors by refinancing or selling the project.  

EB-5 investments may be pooled to raise the funds necessary to finance a project with the total financing dependent on the number of new jobs that are created. Because new jobs have to be created, EB-5 financing is generally used for construction projects such as building new hotels, medical facilities or multi-family projects but have also been used to fund major renovations of old buildings.

EB-5 investments can be made directly to a business or project, or through an approved regional center. In the direct EB-5 investment approach, a business owner raises capital for its business project directly from foreign nationals who will take an equity position directly in a business. Only full-time jobs (i.e., W-2- employees) directly generated by the business or project may be counted for EB-5 funding eligibility. The direct EB-5 model is usually more appropriate for foreign nationals who are interested in buying or starting a business, or want to control their investment and maximize their profits.

In contrast, projects that are sponsored by an approved regional center can include both direct and indirect jobs created within the designated geographic area of the project.  For example, if a shopping center is built with a direct investment of EB-5 financing, only the direct employees of the entity constructing the center may be counted towards calculating the amount of eligible EB-5 funding. However, if the same project received EB-5 financing through a regional center, all of the employees of the tenants in the shopping center could be counted, along with any other employees who provide goods and services to the shopping center. Regional centers usually use economic models to predict the total number of direct and indirect full-time jobs.

Since most EB-5 financings are done through limited partnerships or limited liability companies, EB-5 financings involve the sale of securities that will be subject to Securities and Exchange Commission. The offerings may be exempt from registration under Regulation D (for private offerings of securities) and Regulation S (for offshore offerings of securities outside the U.S.). Counsel for the business owner/developer will prepare the private placement memorandum, limited partnership or limited liability agreement, and subscription agreement for the EB-5 offering. Each EB-5 investor will generally sign a subscription agreement, place the full amount of their investment in escrow, and commence the immigration process by filing an I-526 visa application through a U.S. immigration attorney. Although not required, it is typical that the investor funds will remain in escrow until the investor obtains approval for the I-526 visa application.

For projects with $500K investors, a developer seeking to construct a $20MM hotel would have to generate 400 full-time employees. However, for projects sponsored by an approved regional center, the new jobs count can include direct jobs (hotel employees), indirect jobs (such as jobs at suppliers of goods and services to the hotel) and induced jobs (such as jobs created by other new businesses surrounding the hotel). For every 10 more jobs that can be counted, the developer can raise an additional $500,000 more in EB-5 financing. So, for example, a hotel that will create at least 300 new direct, indirect and induced jobs, could raise $15 million in EB-5 financing.

Not surprisingly, approximately 90% to 95% of all EB-5 visa investments are made through regional centers.  As of June 2014, there were 532 approved regional centers around the country although, many of these regional centers have not yet closed on any EB-5 financings. A number of large developers have established their own regional centers to take advantage of the demand from both investors looking for certified EB-5 projects. Business owners or developers may establish its own regional centers.

With the popularity of the EB5 program, the USCIS processing time for approving visas and regional centers has increase. While the foreign national I-526 petition is pending, the investor’s money is usually held in escrow is approved. Moreover, EB-5 funds cannot be used solely to pay down debt or redeem equity. However, the USCIS allows developers to use bridge financing or interim funding to maintain project feasibility and momentum prior to receipt of EB-5 capital. The bridge loan may be used to fund project costs or early-stage construction costs including demolition, renovation, remodeling can be used. If the project commences based on the bridge financing prior to the receipt of the EB-5 funding and then subsequently takes out the interim facility with EB-5 capital, the project may be able to count the jobs created during the interim financing period towards the required EB-5 job creation. When the EB-5 funding is approved, the EB-5 funds can be used to replace or “take out” the bridge financing. Terms vary widely with interest rates usually ranging from 10% to 14%. EB-5 bridge lenders tend to prefer hotel and senior facility projects in primary markets.  EB-5 funding can also be used for mezzanine financing to bridge the gap between developer equity and the loan-to-cost requirements of many commercial lenders.

Every EB-5 investor will be required to file an I-829 visa application for removal of the conditions within two years of the date that the investor obtained its conditional visa. At that time, the investor will be required to prove that the conditions under which the project was approved as an EB-5 investment have been met. If the business plan was not materially completed for any reason, the investors will lose their conditional visa.

Since obtaining US permanent resident status is generally the principal motivation behind an EB-5 investor, project success (i.e., project completion so permanent jobs are created) is critical to obtaining a permanent resident visa, due diligence has become critical for EB-5 projects. Obvious risks to investors include that the project may not qualify, there be insufficient investors in the project, the investment entity goes bankrupt, and the investor may lose its principal or suffer a delay in return of investment. The developer’s risk can include that investor’s source of funds is not lawful or the investor cannot document the source or path of its funds.

Use for Brownfields and Contaminated Sites

Regional centers and private developers begun turning to the EB-5 program for financing brownfield redevelopment in many US cities. For example, the Empire State EB-5 Regional Center recently closed and funded the first phase of a $220MM multi-use project on a brownfield site in upstate New York.  The America Now–Philadelphia Metro Regional Center, LLC is focused on redeveloping former industrial and brownfield sites. In Pittsburg, the state Department of Community and Economic Development (DCED) helped facilitate EB-5 funding for the Bakery Square project that transformed the former Nabisco property in Pittsburgh’s East Side into a mixed-use complex encompassing retail, office, hotel, dining and entertainment spaces. The Cleveland International Fund has also help fund construction projects on brownfield sites in Cuyahoga and Summit counties. In California, the American Development Center, LLC has provided early stage EB-5 financing for redeveloping former military bases and industrial properties. 

Projects with environmental issues can be a concern to EB-5 investors since the foreign nationals have to make “at-risk” investments. In other words, if the project does not produce the required number of jobs within the two year period, the foreign national’s path to path to permanent residency could be derailed. EB5 investors will need to understand the risks that environmental investigation/remediation process may impact project viability. Environmental issues can increase costs that could make a project infeasible or delay project completion so that the requisite jobs may not be created or may be delayed. Thus, developers seeking EB-5 financing for contaminated property should discuss complications posed by environmental issues in the offering memorandum if the environmental conditions could pose material risks to timely project completion. Foreign nationals will want to retain advisors to help understand the environmental issues as part of their overall project and financial due diligence. Likewise, regional centers promoting redevelopment projects on contaminated sites will need to understand the environmental risks to these projects.  

Rep and Warranty Insurance Becoming More Common in M&A Deals

Wednesday, August 13th, 2014

The use of reps and warranties insurance (RWI) is becoming an increasingly popular risk allocation tool in corporate transactions. According to trade press reports, the volume of RWI doubled from 2011 to 2012, with the value of the insurance bound last year exceeding $4 billion.

RWI covers losses related to breaches or inaccuracies in reps and warranties, and can be purchased by either buyers or sellers. An RWI policy can add flexibility to a deal and help parties resolve key transactional issues such as the scope of the reps and warranties, the size of indemnification deductibles and caps, reduce or eliminate the need for escrow as well as extend the survival period. A buyer can use RWI to distinguish its bid in an auction process since the buyer could propose lower or no escrows or indemnification caps. In an odd twist, buyers willing to rely on RWI may actually be able to negotiate longer survival periods and higher indemnification caps since the risk for breaches or inaccuracies would be shifted from the seller to the insurer. RWI is also useful when the buyer has concerns about the seller’s credit such as in distressed asset sales since the RWI can backstop or collateralize the seller’s indemnity

RWI policies are attractive to sellers because they can used as to substitute or supplement a seller indemnity. In this way, an RWI policy can provide certainty to a seller that its exposure will be capped at the amount of a negotiated escrow. The coverage can also help sellers remove contingent liabilities from their balance sheets or avoid establishing new accruals or reserves. The policies can also facilitate a “clean exit” for private equity and “end-of-life” funds to maximize distributions, reduce risk of paybacks and enhance performance metrics. 

The form of the policy and the claims handling procedures will vary, depending if the insured is the buyer or the seller. When purchased by a buyer, the RWI policy is written as first-party coverage. When the buyer learns of a breach or inaccurate rep or warranty, the buyer can simply file a claim directly with the insurer using of proof of loss form and does not have to deal with the seller.   

When purchased by a seller, RWI operates as a “third-party” liability policy. After the seller receives a notice alleging of a breach or inaccuracy in the reps and warranties, the seller will tender the claim to the insurer. Often times the seller will remain obligated under the RWI policy to defend the claim but a seller policies is often able to obtain advancement of defense costs.   

One key difference between a buyer or seller RWI policy is coverage for fraudulent misrepresentations. Seller policies will include an exclusion for fraudulent statements in the reps and warranties while RWI policies issued to a buyer typically would not exclude claims based on seller fraud. Thus, the buyer policy provides broader coverage.

The RWI policies can be structured to cover specific representations and warranties or provide “blanket” coverage for all representations and warranties contained within an agreement that are not otherwise excluded by the insurer. RWI policies generally do not cover known issues, such as issues discovered during due diligence, known to members of the deal teal or described in disclosure schedules. The policies also usually do not cover breaches for covenants or indemnification for specific contingent liabilities. However, a buyer could agree to look to the RWI for breaches of reps and warranties but continue to hold the seller responsible for other indemnification obligations, possibly allowing the parties to reduce any escrow or lower an indemnification cap.  Other standard exclusions may include consequential or damages, fines and penalties and claims for injunctive or other equitable (non-monetary) relief.

Parties should be aware that the RWI underwriters will carefully review the transaction documents and discuss the transaction structure with the deal team. Insurers will particularly focus on the thoroughness of the seller’s disclosure process and the risk management policies of the target company. Underwriters may exclude provisions that they believe are easily breached or perhaps too buyer-friendly.

The pricing for RWI coverage depends on a number of factors including the nature of the risk, the extent of the due diligence performed by the parties and the relative size of the deductible. Coverage limits can be as high as $50MM though higher limits are available by aggregating policies. Premiums have been dropping and now commonly range from 2%-3.5% of the coverage limits. Even at those levels, sellers often prefer the cost of the insurance premium rather than having portions of the sales proceeds tied up in escrow or having to reflect indemnities on their balance sheets.  Self-insured retention (deductible) also varies from deal to deal but often ranges from 1% to 3% of the transaction value.

It is important to know that not all RWI policies will cover environmental reps and warranties—especially if the environmental liabilities are potentially significant.  In such cases, the parties would be better suited obtaining an environmental insurance policy. However, even where a buyer insists on an escrow or indemnity for environmental liability, an RWI policy can still be useful. By covering claims for breaches of other reps and warranties, an RWI policy could enhance the chances that the escrow would not be exhausted by non-environmental claims.

Bankruptcy Court Finds Kerr-McGee Engaged in Fraudulent Transfer in Tronox Spinoff

Friday, December 20th, 2013

[Updated to reflect April 3, 2014 settlement]

In what may be one of the most significant cases involving the application of fraudulent conveyance laws and environmental liability, the bankruptcy court for the Southern District of New York held that Kerr-McGee had engaged in a fraudulent transfer when it spun off various assets in 2005 into a new firm, Tronox Incorporated (Tronox). The court found that Tronox was laden with overwhelming environmental and tort legacy liability that rendered it insolvent and undercapitalized on the date of formation. As a result, the court ruled that Kerr-McGee could be liable for damages ranging from $5 billion to $14 billon. The precise amount will be determined in later proceeding. In re Tronox Inc., 2013 Bankr. LEXIS 5232 (Bankr. S.D.N.Y12/12/13).

The dense 166-page opinion is packed with highly technical financial and legal analysis that can be mind-numbing to the non-business lawyer. However, it does contain some fascinating peeks into the world of corporate due diligence as well as some interesting statements about the application of the ASTM E2137 guide for estimating environmental liabilities and the relevance of financial disclosure statements to environmental liabilities in corporate transactions.

We discussed in a prior post a settlement of a class action lawsuit filed by shareholders alleging that the Registration Statement  issued in connection with the Tronox Initial Public Offering (IPO) contained false and misleading statements.  In contrast to the class action lawsuit, the accuracy of the financial statements were not relevant in the decision issued by the bankruptcy court because the lawsuit centered on the size of the legacy liabilities that Kerr-McGee imposed on Tronox and impact of those liabilities on the solvency of Tronox. Indeed, in an interesting aside, the court said that financial statements are of little use in a solvency analysis since generally accepted accounting principles (GAAP) require reserves only for claims that are “probable and reasonably estimable. More on disclosure later.

The Tronox litigation is an outgrowth of the 2009 chapter 11 bankruptcy petition filed by Tronox and 14 of its affiliates. Environmental and tort creditors filed proofs of claim for unliquidated amounts but where quantified totaled more than $6.9 billion. Tronox  and subsidiaries Tronox Worldwide LLC, the successor to Kerr-McGee Corporation (“Old Kerr McGee”) and Tronox LLC (f/k/a Kerr-McGee Chemical LLC) filed an adversary complaint against Anadarko Petroleum Corporation (“Anadarko”) and several of Anadarko’s subsidiaries, including Kerr McGee Corporation alleging that through a multi-stage transaction completed in 2005, the defendants segregated valuable oil and gas exploration and production assets from billions of dollars of environmental, tort, and other liabilities. The Complaint asserted that the subsequent spinoff of the “cleansed” oil and gas assets acquired by Anadarko constituted an intentional or constructive fraudulent conveyance that left Tronox insolvent and undercapitalized because of the massive environmental and tort legacy liabilities.

As part of the plan of reorganization which was confirmed in November 2010, the claims of the three debtors were assigned to litigation trust (the “Trust”) that would pursue the lawsuit. The key to the reorganization plan was the Environmental Settlement Agreement (“ESA”) that created an environmental remediation trust funded in part by an equity offering of shares in the reorganized Tronox and in part by the Trust. The creditors that held environmental claims against Tronox, including the federal government, 11 states and the Navajo nation along with individual tort creditors agreed to relinquish their claims in exchange for the right to the proceeds recovered by the Trust. The environmental and tort claimants were named as beneficiaries of the Trust.  The Trust subsequently sought $25 billion in damages relating to 2,000 sites across the United States. Meanwhile, the balance of the general unsecured creditors received stock in the reorganized Tronox that was now cleansed of the environmental legacy liabilities. According to the disclosure statement, the General Unsecured Creditors received a recovery of 58-78% on their claims.

Factual Background

Following is a detailed discussion of the transactions that are the heart of the $25B Litigation Trust lawsuit. The findings of facts are those recited by the court in its opinion.  Old Kerr-McGee was founded in 1929 as an oil and gas exploration company.  In the 1940s and 1950s, Old Kerr-McGee acquired refining, pipeline and marketing operation including more than 800 retail oil and gas outlets in 16 states. The company later acquired a mining and milling uranium operation, a wood treatment business, a manufacturer of ammonium perchlorate, a processor of radioactive thorium and a titanium dioxide pigment business.

As a result of these operations, Kerr-McGee had accumulated massive environmental liabilities associated with various lines of businesses including petroleum terminals, offshore drilling operations, gasoline stations, wood-treatment sites and agrochemical operations (“Legacy Liabilities”). The firm was a responsible party for more than 2,700 contaminated sites in 47 states. By 2000, the firm was spending an average of more than $160 million annually on remediation and employed more than 40 professionals in its Safety and Environmental Affairs (“S&EA”) Group just to manage the active environmental sites. During the six-year period ending in 2005, Old Kerr-McGee had settled approximately 15,000 claims of creosote tort liability for $72 million plus $26 million in defense costs and faced an additional 9,450 pending claims.

Starting in 1990, oil and gas exploration and production (E&P) industry was undergoing significant consolidation with almost 80% of the independent North American oil and gas firms being acquired or merged into larger companies. While Old Kerr-McGee had attracted potential suitors during this time, they had all been scared away by the firm’s mammoth Legacy Liabilities.

The bankruptcy court concluded that was clear that the management of Old Kerr-McGee  intended from the outset to free the valuable E&P assets from the Legacy liabilities, especially as this burden precluded Kerr-McGee from being an attractive merger. The court said the written record was also absolutely clear that freedom from Old Kerr-McGee’s legacy liabilities was a central consideration in the decision to split the two businesses and in the structure that was devised.  The court observed that Lehman Brothers had advised Old Kerr McGee that that if the E&P business was spun-off, “potential exists to isolate E&P operations from historical [Old Kerr-McGee] environmental liabilities.” Indeed, the court pointed out that Anadarko had rejected an acquisition of Kerr-McGee in 2002 after concluding that the costs of remediating the firm’s 500 active contaminated sites and more than 1,000 inactive contaminated consumed most of its free cash flow.  The court pointed out that Anadarko determined that, Kerr-McGee’s future environmental liability was “$BILLIONS” and there was “no end in sight for at least 30 more years.”

As a result, Kerr-McGee embarked on a two-step strategy in 2001 coined “Operation Focus” to make itself more attractive for acquisition by segregating the Legacy Obligations from the oil and gas business. In a series of 11 transactions, the firm formed a new “clean” parent company (“New Kerr-McGee”) along with a new “clean” subsidiary, Kerr-McGee Oil and Gas Corporation (“Oil and Gas Business”). A new holding company owned by New Kerr-McGee was formed, called Kerr-McGee Worldwide Corporation. Old Kerr-McGee, which was now a subsidiary of New Kerr-McGee, began to transfer billions of dollars of oil and gas assets to the Oil and Gas Business. Old Kerr-McGee then formed a new wholly-owned subsidiary, Kerr-McGee Chemical Worldwide LLC, and merged into it. Kerr-McGee Chemical Worldwide that became Tronox Worldwide LLC retained all of the legacy liabilities of Old Kerr-McGee. The court noted that the CEO of Kerr-McGee testified that the result of Project Focus was that “all of the businesses that were owned by the original Kerr-McGee were transferred out except for the chemical business.

One group of creditors was contractually protected against the transfer out of Old Kerr-McGee of the oil and gas assets — holders of approximately $2 billion in bonds that Old Kerr-McGee had issued approximately $2 billion in bonds. To obtain the consent of the bondholders to the transactions, Old Kerr-McGee covenanted that it would not divest itself of substantial assets unless the transfer involved “substantially all” of its assets and the recipient of those assets assumed its obligations under the bonds. Kerr-McGee represented that Old Kerr-McGee had “distributed substantially all of its assets to its parent” through Project Focus.

As a result of this restructuring, the Legacy Liabilities were only partially segregated since New Kerr-McGee still exercised control (and hence responsibility) over the legacy liabilities sitting in Old Kerr-McGee. The court said that most of the legacy liabilities derived from discontinued businesses and that when a discontinued business could not pay for expenditure, New Kerr-McGee recorded the net payable as an equity contribution or advance from the parent. In other words, New Kerr-McGee continued to pay all the environmental expenses and claims out of its centralized cash management system until the 2005 IPO.

After the E&P subsidiaries were transferred out of Old Kerr-McGee, the next step was to sever the Chemical Business and the Legacy Liabilities from New Kerr-McGee through either a sale or a spin-off. Kerr-McGee’s management requested Lehman Brothers update its analysis. In September 2004, Lehman advised management that there was a “window of opportunity” to separate the companies because of a hot market for chemical companies and high demand for TiO2. Lehman suggested a spinoff would be a better vehicle for a “clean separation” from the legacy liabilities because the environmental liabilities would have to be negotiated in a sale or leveraged buyout

In 2005, the New Kerr-McGee board authorized the company to divest the Chemical Business through sale or spinoff. Lehman identified 60 potential bidders, contacted 16 and 13 signed confidentiality agreements. The field was narrowed to four final bidders, who were given access to a virtual data room to perform due diligence. The data room established for the due diligence contained over 27,000 individual documents pertaining to over 300 contaminated sites. One of the finalists chose not to make a final bid in part because of the cost to diligence the legacy liabilities. Another firm made a final bid that assumed environmental liabilities only for currently operating sites. A third bidder proposed an asset purchase only for assets that are used in the operation of the chemical business. A fourth firm submitted a bid for the Chemical Business in the amount of $1.6B plus the assumption of certain environmental liabilities on the balance sheet (valued at $225MM) but excluded liabilities related to Wood Treatment facilities and the Manville site.  Kerr-McGee rejected this proposal because it wanted a “cleaner” separation from the legacy liabilities. Later, another potential bidder was willing to bid $1.2 billion without the legacy liabilities but only $300MM if they were to be assumed. [Disclosure: We worked with a firm that provided a preliminary evaluation for one of the parties that had signed a confidentiality agreement but declined to submit a bid because of the legacy liabilities. This post discusses only the public information disclosed in the litigation and discussed by the court in its opinion.]

According to the court, New Kerr-McGee proceeded with the spin-off because it could dictate the terms of the deal, avoid any third-party due diligence and eliminate any standard representations and warranties regarding its environmental liabilities. To effectuate the spinoff, New Kerr McGee incorporated Tronox as the holding company for the Chemical Business and the Legacy Liabilities. While New Kerr-McGee retained an attorney to represent the interests of the Chemical Business, New Kerr-McGee limited the attorney’s participation, disregarding his substantive comments and excluding him from meetings after he raised concerns on behalf of his client.

Tronox and New Kerr-McGee entered into a series of agreements that culminated in a Master Separation Agreement (“MSA”). The court held it was undisputed that the terms of the MSA were dictated by Kerr-McGee, noting that the MSA stated that “Parent will, in its sole and absolute discretion, determine all terms of the Separation. Tronox shall cooperate with Parent in all respects to accomplish the Separation and shall, at Parent’s direction, promptly take any and all actions necessary or desirable to effect the Separation.”  The court said that Kerr-McGee CFO was chairman of Tronox’s Board and it was undisputed that New Kerr-McGee exercised control over Tronox’s decisions to enter into significant transactions and the ability to prevent any transactions it did not believe were in New Kerr-McGee’s best interests.

Kerr-McGee arranged for Tronox’s financing that resulted in Tronox becoming indebted for an advance of $200MM and a revolving line of credit of $250MM that was provided by a group of lenders on a secured basis. Tronox also issued unsecured notes of $350MM at an interest rate of 9.5 % (increased from 7% initially contemplated). The net cash proceeds were $537.1MM after expenses. New Kerr-McGee also received approximately $26MM in cash, which represented all of Tronox’s cash in excess of $40 million. The court said New Kerr-McGee had deemed $40MM as adequate cash for the new company but found the record was not clear on how that amount was reached.

In addition, the parties negotiated an Assignment, Assumption & Indemnity Agreement (Indemnity Agreement) that provided that the Tronox would be solely responsible for all of the legacy liabilities except for those liabilities directly associated with the “currently conducted” E&P operations. While the Indemnity agreement was being finalized, EPA demanded that New Kerr-McGee reimburse the agency for approximately $179MM in response costs incurred at the Manville Superfund site. New Kerr-McGee denied liability and amended the Indemnity Agreement to provide that Tronox was obligated to indemnify New Kerr-McGee for any Legacy Liabilities Tronox had been required to assume and that were imposed on New Kerr-McGee. The court found that Tronox did not receive any consideration in exchange for assuming these liabilities or agreeing to indemnify New Kerr-McGee. Indeed, the court observed, to eliminate the risk that Tronox (i.e., the Chemical Business) could potentially seek contribution from New Kerr-McGee for the Legacy Liabilities following a sale or spin-off, New Kerr-McGee backdated the Indemnity Agreement so that it was purportedly effective as of December 31, 2002.

New Kerr-McGee did agree to provide Tronox with a limited indemnity expiring in 2012 of up to $100 million, covering 50% of certain environmental costs actually paid above the amounts reserved for specified sites for a seven-year period. The bankruptcy found that the indemnity was illusory since New Kerr-McGee knew that the Tronox would not have sufficient cash flow to spend the reserved amounts and thus trigger the indemnification. The court explained that to access the indemnity, Tronox had to spend $200K more than the existing environmental reserve for each individual site. However, the Tronox started its separate existence with a mere $40 million and never had enough cash to trigger the reimbursement obligation. Indeed, when the bankruptcy petition was filed, Tronox had received less than $5 million from Kerr-McGee under the MSA.

Upon execution of the master separation agreement, New Kerr-McGee received 100% of the Tronox stock. In November 2005, New Kerr-McGee sold 17.5 million shares of Tronox Class A shares in an IPO which generated $225MM in proceeds. The results were disappointing to Kerr-McGee because Tronox had been marketed as a specialty chemical company but because the market considered it a commodity business, the stock traded at a lower multiple. After the IPO, New Kerr-McGee continued to hold 56.7% of Tronox’s outstanding common stock. The Class A Tronox stock issued to the public had only 11.3% of the combined voting power of all outstanding issues.

Less than three months after the completion of the Tronox spin-off, Anadarko offered to acquire New Kerr-McGee for $16.4 billion in cash and the assumption of $1.6 billion of New Kerr-McGee’s debt. The purchase price was a 40% premium above New Kerr-McGee’s current stock price. New Kerr-McGee shareholders approved the offer in August 2006, and New Kerr-McGee Corporation became a wholly owned subsidiary of Anadarko.

Tronox began to struggle almost immediately after the March 2006 spinoff.  Tronox had anticipated that its financial position would be substantially bolstered by the sale of land in Henderson, Nevada. However, the property was extensively contaminated from ammonium perchlorate waste in ponds that potentially endangered the Las Vegas water supply. Because of cash flow issues, Tronox was unable to fund the Legacy Liabilities at the previous levels. Even with the reduced expenditures, the Legacy Liabilities amounted to 56% of Tronox’s 2006 EBITDA and 95% of its 2007 EBITDA.

Following a series of motions that reduced the scope of the claims, 34-day trial was held that involved 28 expert witnesses, over 6,100 exhibits and thousands of pages of deposition testimony of 40 witnesses. The court began its analysis by stating that litigation appeared to raise a novel of first impression-namely under what circumstances can an enterprise rid itself of its legacy environmental and tort liabilities by spinning off substantially all of its assets and leaving behind property incapable of supporting the liabilities. The court went on to say that the question was important because of the limited circumstances under which the owner or operator of property can avoid remediation obligations imposed by Federal and State environmental laws.

We limit our discussion on the court’s holdings to the claims for actual and constructive fraudulent conveyance claims.

Actual Fraudulent Conveyance Claim

Plaintiffs alleged that the transactions that culminated in the spinoff were made “with actual intent to hinder, delay, or defraud” creditors within the meaning of the federal Bankruptcy Code and the Oklahoma Uniform Fraudulent Conveyance Act. The court said that although there was no disclosure of the scheme in December 2002 and the disclosure in March 2003 was minimal and ineffective, the defendants made it clear in the S-1 Registration Statement that Tronox was being left with all of the Legacy Liabilities. Indeed, the court explained, this was also clear to the potential purchasers of Tronox who declined to submit bids because of their concerns about Legacy Liabilities. Moreover, the court said that the plan to impose the legacy liabilities on Tronox was what triggered the EPA demand letter in 2005.

What the defendants did not disclose, the court said, was that Tronox would not be able to support the legacy liabilities that were to be imposed on it by the restructuring plan. However, the court said that disclosure of a scheme is no defense and that liability may be imposed for an intentional fraudulent conveyance where the fact and purpose of a conveyance may have been known to creditors but the transferor intended to hinder or delay them.

The court rejected the defendant’s contention that plaintiffs had to prove that the defendants intended to damage a creditor by preventing them from collecting a debt. Instead, the court said the defendant’s interpretation of the phrase “actual intent to hinder, delay, or defraud” was too narrow. Relying on the definition of “intent” set forth in the Restatement (Second) of Torts and prior caselaw, the court explained that  a transfer may be made with fraudulent intent even though the debtor did not intend to harm creditors but knew   that by entering the transaction, creditors would inevitably be hindered, delayed or defrauded.

The court found that it was undisputed that New Kerr-McGee acted to free substantially all its assets from 85 years of environmental and tort liabilities. Without recourse to these assets and given the “minimal asset base” of Tronox, the court said the obvious consequence of this restructuring was to hinder and delay the legacy creditors. The court held that such a result was substantially certain to occur as a result of the restructuring.

The defendants argued in their brief that the every witness that testified on their behalf agreed that the Legacy Liabilities were not a driver behind the separation. However, the court said the record supported the finding that a principal goal of the separation of the E&P assets from the chemical business was to cleanse the E&P assets of every legacy liability resulting from the 85-year history of the company and to make the cleansed company more attractive as a target of an acquisition. Some of the evidence that the court relied on to support this conclusion was:

  • Lehman’s files make clear the centrality of the liability issues to the transactions undertaken and that the effect on creditors was well understood;
  • Lehman recognized that the environmental liabilities being left with Tronox were unique;
  • Lehman’s principal witness testified that  “other chemical companies didn’t have legacy liabilities of other businesses attached to an ongoing operation;
  • A Lehman email stated that the deal to sell to Apollo appeared to have “cratered” because Kerr-McGee would not represent that it was not aware of any other material liabilities outside of the 27,000 documents in the data room;
  • The testimony of CEO and CFO that the effect on creditors was never considered was contradicted by the record and by defendants’ efforts to cleanse the record.  The court noted that senior management had instructed Lehman to delete slides form its presentation that discussed the complications of the Legacy Obligations;
  • The credibility of the denials by the principal witnesses for the Defendants was further undermined by the destruction of documents in violation of an agreement with the Justice Department. For example, the court observed that the senior management directed their secretaries to destroy all files relating to the spinoff when they retired later in 2006, a few months after the tolling agreement was signed.

Badges of Fraud For Inferring Fraudulent Intent

Because of the difficulty of proving actual fraudulent intent, plaintiffs may rely on so-called “badges of fraud” which involve circumstances that are so commonly associated with fraudulent transfers that their presence gives rise to an inference of intent.  The UFTA identifies eleven specific “badges of fraud”. Any one of these factors can create a presumption that the transaction was fraudulent which the defendant must then rebut. The court said that the presence of several badges of fraud constitute strong and clear evidence of fraudulent intent. The court found the following five factors supported the conclusion that the defendants acted with actual intent to hinder or delay creditors:

  • The transfer or obligation was to an insider (i.e., substantially all of  Kerr-McGee’s assets were transferred to a corporate affiliate in the 2002 transactions, and then transferred additional consideration to an affiliate in the IPO);
  • Old Kerr-McGee retained possession and control of the assets after the 2002 transfers as well as after the November 2005 IPO;
  • The transfer or obligation was disclosed or concealed-(The court previously concluded that the disclosure for the 2002 transfers was ineffective and insubstantial) ;
  • Before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit-(Kerr-McGee of course had been in litigation for years regarding its environmental and tort liabilities); and
  • The transfer was of substantially all of the debtor’s assets-(the assets transferred represented more than 80% of the assets of the consolidated enterprise)

To overcome the presumption of fraud, the defendants had to show a legitimate supervening purpose for the conveyances.  The defendants advanced three “legitimate supervening purposes” as defenses to Plaintiffs’ contention that they acted with “actual intent to hinder or delay creditors” that is actionable under the UFTA.

First Legitimate Supervening Purpose

First, they contended that the record showed that Kerr-McGee intended and believed at all times that Tronox was and would be solvent and able to pay its debts and a successful independent company. The court disagreed, noting that Tronox started life with a capital structure that included $550 million in debt, a mere $40 million in cash and environmental liabilities that had cost Kerr-McGee more than $1 billion in the years prior to the IPO. The court also noted that Tronox’s projected cash flow was inadequate to service its debt without significant land sales that were not assured, and its prospects were clouded by a down-turn in the business cycle of its one product. In any event, the court said that the question was not if Tronox was “doomed to fail,” nor if defendants wanted Tronox to be a “big success.” Instead, the court said the real question was if Defendants had a good faith belief that Tronox would be able to support the Legacy Liabilities that had been imposed on it. The court said one of the most compelling facts in the enormous record of the case was the absence of any contemporaneous analysis of Tronox’s ability to support the legacy liabilities being imposed on it.

The defendants argued they and their advisors spent substantial time and took multiple steps to ensure that Tronox would be a viable standalone and that creditors would not be adversely impacted by its separation. Defendants claimed the controller worked with the external accounting firm analyzing cash-flow models prepared by Tronox’s management in connection with Tronox’s S-1 Registration Statement that projected Tronox’s cash flow through 2011. However, the court said that the cash flow was not thorough, observing that even though the “Provision for Environmental Remediation” was broken out on a pro forma basis for Tronox prior to 2005, it was apparently included in “Other” expenses for 2010 and 2011 with an entry of zero. The court said there was no support in the record for the proposition that Tronox’s environmental expenses would diminish to zero in 2010. The court noted the cover memo from the external audit stated that he was informed that “Kerr-McGee management believe … Tronox should experience a much diminished level of environmental charges going forward, reducing the historical operating losses related to the discontinued operations as well as the related cash flow requirements.” The court found estimate was “anecdotal and not rooted in reality,” stating in a footnote that “it would have been more reasonable for Kerr-McGee to anticipate paying more for environmental expenditures in the future.” The court noted that from 2002 to 2005, Kerr-McGee added more to its environmental reserves than the amount spent in each of those years. The amount reserved for expected future expenses increased over 47% from 2001 to 2005. The auditor’s memo stated that “Kerr-McGee has agreed to support Tronox, related to these and other environmental matters with the 50% cost reimbursement provided over the next seven years.” As previously discussed, the court said this reimbursement support was largely illusory.

The second piece of evidence that Defendants relied for the proposition that they took numerous steps to ensure that Tronox would be viable and creditors would not be adversely affected was a solvency opinion that concluded after four pages of caveats and conditions that “the fair value and present fair saleable value of the Company’s assets would exceed the Company’s stated liabilities and identified contingent liabilities.” The court said the critical issue in this case was the amount of Tronox’s contingent liabilities but the solvency opinion simply used the reserve in Tronox’s financial statements as Tronox’s anticipated contingent liabilities. The court then went on to say that a reserve for contingent liabilities in a financial statement has no probative value in determining liabilities or solvency for fraudulent conveyance purposes. Furthermore, the court said there was no evidence that the author of solvency opinion was even aware of the importance of the legacy liabilities to Tronox’s solvency. The court noted that the firm that prepared the solvency opinion testified that its concern from a fraudulent conveyance perspective was that Tronox had incurred of debt in the IPO and was not going to retain the proceeds from the debt issuance but instead dividend the proceeds up to its parent, Old Kerr-McGee. The court went on to say that while the dividending of proceeds to a parent was the usual concern in a leveraged buy-out (“LBO”), the real issue in this case was the amount and effect of the legacy liabilities.

Defendants’ final reason for their asserted belief in Tronox’s future was that the cash flow projections of the parties’ respective experts agreed that Tronox experience positive cash-flow for all projected years, except for 2006 when Tronox would be less than $1 million cash flow negative.” However, the court said that the problem with the expert reports were that they were performed after the transaction to support the litigation positions. Such post-transaction reports, the court said, could not serve as substitute for the absence of any internal contemporaneous analysis of the effect of the transfers on Kerr-McGee’s legacy creditors. Based on the record, the court concluded that neither the Board nor management ever reviewed a contemporaneous analysis of the effect of the transactions on the legacy liability creditors, and there is no evidence that one was ever prepared.

Second Legitimate Supervening Purpose-

The defendant’s second defense to badge of fraud inference was that the purpose of the restructuring was to unlock the inherent value of each of Kerr-McGee’s businesses by creating two successful standalone companies, and thereby maximize shareholder value. However, the court said that the defendants were not being sued because they made a business decision to spin off the chemical business from the E&P but because they to spin off “substantially all the assets” of the enterprise (the E&P assets) and imposed 85 years of the legacy liabilities on a fraction of the assets.  The court said the defendant’s burden was not to prove if there were some legitimate business reasons for the challenged transactions but to prove a legitimate supervening purpose for the “manner in which the transfer was structured.”  In concluding that the defendants failed to meet this burden, court noted the following facts:

  • Defendant’s investment banker testified that every chemical business has some environmental liabilities but “not like this they don’t.”
  • The liabilities imposed on Tronox included those associated with every discontinued business that Kerr-McGee had owned or operated;
  • Senior management rejected an April  2001 presentation Lehman to allocate the legacy liabilities in a manner proportionate to the asset values of the two lines of business;
  • Defendants never articulated a legitimate business reason for imposing all of the legacy liabilities on Tronox;
  • Before the spinoff, Old Kerr-McGee was an unattractive merger candidate as evidenced by the fact that Anadarko had rejected a merger in 2004 because of future environmental liability for which there was “no end in sight for at least 30 more years.”After the divestiture, Anadarko acquired the E&P business at a 40% premium.

Third Legitimate Supervening Purpose

Defendant’s final argument to rebut the badge of fraud inference was that they merely attempted to limit the overall environmental liability of the group. The court said defendants were trying to equate the conveyances as simply a risk management strategy but that this was not a situation where a company’s management used lawful ways to reduce the adverse impact of contingent liabilities. Instead, the court said the restructuring placed substantially all of the assets of Kerr-McGee out of the reach of the legacy liability creditors. In addition the court found that the defendants:

  • did not pay consideration for the December 2002 transfer of the stock of the E&P subsidiaries and did not pay fair consideration or reasonably equivalent value in connection with the spinoff;
  • were acutely aware of the legacy liabilities, and if they did not have a precise amount, the reason is they assiduously avoided performing the analysis necessary to obtain one;
  • Did not rely on fairness opinions. Indeed Lehman’s managing director believed that the legacy liabilities would choke the flower that was Tronox’s TiO2 business; and
  • carefully preserved the attorney-client privilege as to the legal advice they received and therefore cannot rely on an advice-of-counsel defense

The court said that if defendants’ conduct were simply management of legacy liabilities, then all enterprises with substantial existing environmental liability would be encouraged to do exactly what Defendants did — manage the liabilities so as to leave them attached to a fraction of the assets unable to bear them. Thus, the court found that plaintiffs have proved by clear and convincing evidence that defendants acted with actual intent to hinder or delay creditors, and Defendants wholly failed to rebut the evidence

Constructive Fraudulent Conveyance

To prevail on constructive fraudulent conveyance claim, plaintiff had to prove that (i) there was a conveyance of an interest in property or the incurrence of an obligation; (ii) receipt of less than reasonably equivalent value; and (iii) that the transferor was or was rendered by the conveyance insolvent, inadequately capitalized, or unable to pay its debts as they came due

There was limited dispute on the first point and the court easily found that Plaintiffs satisfied their burden of proof that Tronox as a consolidated entity received less than reasonably equivalent value (REV) since at the conclusion of the IPO, $17 billion in assets had been spun off and only $2.6 billion had been transferred in.

The more hotly contested question was if Plaintiffs satisfied their burden of showing that Tronox was insolvent because of the transactions. The defendants relied on a “market” defense, asserting that Tronox was not insolvent at the time of the IPO because it was able to issue $450MM in senior secured debt and sell $350MM in bonds to “market participants” who performed independent due diligence that extended well beyond publicly available information.

The court said the $450 million in debt did not deserve any weight in the solvency analysis. The court explained that these “market participants” were not representative of “the market” because the debt was secured by all of the assets of all of the Tronox companies, and the sophisticated lenders who bought this debt well knew they would come first in any bankruptcy or liquidation of the enterprise. Moreover, the court said these “market participants” received millions of dollars in fees from Kerr-McGee or anticipated significant fees from financing the purchase of the assets. Further, the court noted, none of these entities independently valued Tronox’s environmental or tort liabilities. The court went on to say that the defendants never explained how the diligence performed by these “market participants” and the information they obtained gave them any independent insight into the legacy liabilities. Instead, the court found ample evidence in the record that Morgan, CSFB and Lehman all took account of the obvious fact that if Tronox failed regardless of the reason, their debt would be protected.

While the court agreed that Tronox’s ability to issue unsecured bond debt and stock was Defendants’ strongest indication of solvency, the court found that plaintiff’s expert testimony convincingly demonstrated that the projections on which the IPO was based were inflated, sell-side projections, and that key numbers were imposed at the direction of Kerr-McGee’s chief financial officer. The court said the record was also clear that the financial statements omitted certain critical contingencies and potential liabilities. As an example, the court pointed out that EPA sent Kerr-McGee a formal demand for reimbursement of $350MM in past response costs and interest for the Manville superfund site but Kerr-McGee included no disclosure of the potential liability for that site. The defendants justified this omission on the existence of auditors’ letters and comments from the partner in charge at Covington that Kerr-McGee had “substantial defenses” to liability but the court pointed to four legal memoranda from Kerr-McGee’s counsel concluding that it was likely that Kerr-McGee had liability as the successor to American Creosoting Corp.

Similarly, the court noted that Kerr-McGee omitted any disclosure in the IPO Registration Statement of contingencies related to the contract for the sale of land in Henderson, Nevada. At the time of the IPO, Centex Homes and the Landwell Company had an ostensible contract to purchase the Henderson site for a total of $515 million, $154 million of which would be payable to Tronox on account of its 30% interest in the property. The Henderson proceeds were included in Tronox’s projections and were essential elements of its future cash flow. However, there was no disclosure of the risks relating to the land sale contract. It was not disclosed that the land had previously been contaminated and that “no action letters” had to be obtained from the Nevada Division of Environmental Protection (NDEP) for each of the four parcels being sold. The court noted an August 2005 Lehman email warning that a leadership change within the NDEP would “definitely delay” and “possibly could kill” the deal. It was not disclosed that, by the time of the IPO, the first three of four closing dates for the contract had passed and been extended. Most important, it was not disclosed that the contract was merely the economic equivalent of an option, in that it gave the purchasers the right to walk away for $2 million in liquidated damages (less than 1% of the purchase price).

The defendants also argued that supplementing this general market evidence was two critical “bookends” that established Tronox’s solvency. The first so-called bookend relied upon by the defendants was an offer to purchase the Chemical Business by Apollo that was based on six months and millions of dollars in diligence. The other “bookend” that defendants propound as evidence of Tronox’s solvency was the confidence of its officers and directors in its future as well in the form of the contemporaneous statements and actions of Tronox’s own officers and managers, including, including statements subject to the securities laws.

The defendants argued that Apollo’s bid was unassailable evidence of Tronox’s solvency because the Apollo submitted its bid after performing exhaustive due diligence. The defendants contended that Apollo and its advisors accessed the virtual data room more than 24,000 times and were intimately familiar with the issues facing the Company, including the so-called “secret’ sites,” the Henderson Property contract, Tronox’s financial performance and projections, and the TiO2 industry’s anticipated future performance.” However, the court said defendants overstated the nature and significance of the Apollo bid, explaining that Apollo did not make a “final and binding” offer for Tronox of $1.3 billion. For support, the court cited the opinion expressed by JP Morgan, Kerr-McGee’s investment banker on the deal, that the Apollo bid contained open items and that critical parts of the contract remained to be negotiated such as additional disclosures that could trigger Apollo’s rights of termination. Significantly, Apollo’s bid contained indemnities or environmental and tort liability totaling $504 million. The court noted that Kerr-McGee had previously rejected all indemnities and other guarantees relating to the legacy liabilities since this would not result in the “clean break” that Kerr-McGee demanded.

Moreover, the court said the trial record was inadequate to give Apollo’s analysis of Tronox’s environmental and tort liabilities the weight that Defendants demand. The court said there was no dispute that Apollo performed “‘significant diligence assessing the nature of the environmental liabilities, including retaining environmental consultant and environmental counsel. However, the court pointed to a memo prepared by Apollo that suggested the firm did not perform a true risk analysis but simply determined it could manage the liabilities over the period of time it would own Tronox. For purpose of a UFTA, the court said this did not constitute the basis for a solvency analysis.  As a result, the court concluded that the unaccepted Apollo bid did not provide “unassailable” or even probative evidence of Tronox’s solvency at the time of the IPO.

The other “bookend” that the defendant argued was evidence of Tronox’s solvency was the confidence of its officers and directors in its future. Defendants said all of the witnesses who were employed by Tronox testified that at the time of the spinoff they believed Tronox was “solvent” and not doomed to fail. The court said, however, that the optimism of some of Tronox’s management was not evidence of solvency under the UFTA and certainly no more proof of Tronox’s solvency than those who believed the Legacy Liabilities would be fatal.

More relevant to the court was that within six weeks of the spinoff, Tronox management was forced to adopt what were termed “draconian” cost-cutting measures by its CEO. While the court acknowledged that the Tronox’s need to cut costs was not proof of balance sheet insolvency,  it was evidence that  management’s good faith efforts to keep the enterprise going and their belief that this was possible do not constitute a “bookend” that proves or disproves Tronox’s solvency. The court said there was no question that Tronox’s cash-starved position made it increasingly difficult to pay any expenses relating to the Legacy Liabilities as well as prevented Tronox from accessing the indemnification provided by Kerr-McGee. In the end, the court conclude, there was no substitute for performing an analysis of the fair value of Tronox’s assets as at the date of the IPO and measuring them against the fair value of its liabilities.

Solvency Analysis

The court then proceeded with a solvency analysis. Plaintiff’s expert submitted reports totaling over 2,600 pages to attempt to value the environmental liabilities. Defendants called two expert witnesses and adduced over 8,000 pages of reports to dispute Plaintiffs’ expert. Separate experts and reports were relied on in connection with the tort liabilities. The defendants calculated the Legacy Liabilities at $278.1MM on a net present value basis while plaintiffs’ present value of the liabilities as of the IPO date was between $1.0 and $1.2 billion.

The court found the plaintiff’s estimation of the Legacy Liabilities more persuasive, characterizing plaintiff’s analysis as the only comprehensive valuation in the vast record of this case of Tronox’s environmental liabilities. The court noted that plaintiff’s expert spent more than 40,000 hours preparing a comprehensive report that was designed to calculate the cost of remediation at the 2,746 sites where Kerr-McGee had potential liability. In his 2,042-page report and 580-page rebuttal report, plaintiff’s expert assigned costs to only 372 of the 2,746 sites. 214 of the sites he chose were being remediated in 2005 or the subject of existing Kerr-McGee reserves, and therefore included on Schedule 2.5(a) of the MSA. He included 157 additional sites that they were similar to the “listed” sites in terms of contaminants and that would likely require remediation. He reduced his net costs by reimbursement from third parties such as the United States and certain States, and also apportioned costs among other liable parties but did not reduce the costs estimates for insurance, the indemnity under the MSA. He also did not adjust the amounts for the net tax impact since the tax benefits were treated as a contingent asset in the solvency analysis.

In contrast, the court said, Kerr-McGee never performed a comprehensive analysis of the Legacy Liabilities but simply relied on the accounting reserves for the environmental liabilities which the court said were applicable in a UFTA solvency analysis. The court said defendant’s expert report as well as his testimony was simply prepared as a rebuttal to plaintiff’s report. In a scathing footnote, the court reviewed criticisms of the defendant’s expert in other cases, noting that one court characterized his opinions as “naked guesses” or “far too speculative” and having “no firm grounding in science. Another judge rejected his responses in answer to the Court’s questions as “rank speculation,” concluding, “[t]here is simply no evidence to support [his] view,” and rejected his “suppositions … as unfounded and lacking all credibility.

In rejecting defendants position that the net present value of the remediation costs of Tronox as of November 2005 was $278.1MM, the court noted that Old Kerr-McGee’s environmental expenditures during the five years prior to the IPO had averaged $160MM per year, that it had spent $580MM just at the West Chicago Thorium site, that it had received a demand from the EPA for $179MM for the Manville superfund site  and that Tronox had succeeded to virtually all of the Kerr-McGee sites.  In other words, the court said that defendant’s expert concluded that Tronox’s future environmental liabilities should have been valued at approximately the amount that Kerr-McGee had paid over the preceding two-year period. This opinion, the court said, did not pass the “common sense test”.

Defendant’s expert evaluated plaintiff’s net present value of the remediation costs using a “conceptual probability” matrix. He assigned a 10% probability to response actions that he deemed “unlikely but possible,” a 30% probability to response actions that were “possible,” a 50% probability to response actions  that were “equally likely,” a 70% probability to response actions that were “more likely than not”, and a 90% probability to response actions that were highly likely. The court said that while such a matrix provides an aura of scientific precision, the analysis was dependent on the judgment of those who use it– and found that defendant’s expert did not support his probability allocations fairly. To illustrate its point, the court noted that for the former Kerr-McGee wood-treating facility in Wilmington, North Carolina, defendant’s expert claimed his choice of a remedy, in situ solidification, was the most likely approach and assigned it a conceptual probability of 50%.  He claimed at trial that his decision was based on project documents, site-specific information, and site-specific technical analysis, but Plaintiffs established that at deposition he had conceded that in situ solidification had never been used at any other Kerr-McGee wood-treating site, and such assumption materially understated the reasonably anticipated remediation cost. Likewise, at the Riley Pass uranium site, the court observed that defendant’s expert concluded the remedy would consist only of institutional controls such as fencing at a cost of $340K even though regulators had already rejected this approach in 2005 and instead proposed a $12MM remedy.

Application of ASTM E2137 To Solvency Analysis

The court said the defendants argued that the “preferred methodology” for estimating future environmental costs was the “expected value” probabilistic described in the ASTM “Standard Guide for Disclosure of Environmental Liabilities”.  It appears the court intended to refer to ASTM E2137 “Standard Guide for Estimating Monetary Costs and Liabilities for Environmental Matters.” Nevertheless, the court cited to section 5.2.2 stating that a probabilistic approach may not always provide the ‘best estimate for a given set of circumstances” and referred to section 5.2.3 providing that the approach used should be based on the “number of events and quality of information available or obtainable.”  The court found that plaintiff’s expert adequately explained that he did not use an expected value approach because he concluded that sites were either sufficiently well-developed to conclude that one remedy was likely or information was insufficient to assign reliable probabilities to remedial outcomes.  Accordingly, the court ruled that the plaintiff’s expert properly exercised his judgment when he used the “most likely value” approach recognized by E2137.

Defendants also contended that the use of the “most likely value” approach was also flawed because it failed to address future uncertainty. Instead, defendant’s expert opined that plaintiff’s expert should have applied a “gating” analysis to determine the likelihood that Tronox would incur costs at a site.  However, the court said that the objective of a solvency analysis was to assign a “fair valuation” to all debts, which the court said was defined as a liability on a bankruptcy “claim.” The court explained that a solvency analysis is often used in bankruptcy filings where all debts are “accelerated” and debtors are obligated to send notices to every known potential environmental creditor. The court noted that defendant’s expert admitted that he had previously never used a probabilistic analysis to estimate environmental costs in a fraudulent transfer case and that his probabilistic analysis assumed that the environmental claims were mere contingent claims that should be subject to a discount for the probability they will never be pursued. In contrast, the environmental claims would have been accelerated by the bankruptcy filing because the creditors would have become aware that they would lose the claims if they did not file and pursue their claims. As a result, the court found that the decision by the plaintiff’s expert to assign remediation costs to only 372 of Tronox’s 2,746 sites amply accounted for the fact that some potential remediation would never be pursued notwithstanding the fact that an insolvency case would accelerate them.

Relevance of Financial statements

Plaintiffs attempted to overcome the evidence of Tronox’s issuance of unsecured debt and stock in connection with the IPO by demonstrating that the financial statements on which the market relied were false and misleading, and the court agreed there was much evidence in the record regarding the insufficiencies of the Tronox financial statements. However, the court said it was not necessary for Plaintiffs in this case to prove that the IPO financial statements were false and misleading because this case is about the Legacy Liabilities that Kerr-McGee imposed on Tronox and their impact on Tronox’s solvency. In this case, the court emphasized, there was no contention that Tronox’s financial statements issued in connection with the IPO would be useful in determining Tronox’s solvency. The court pointed out that no party or any expert in the case suggested that financial statements and the reserves taken for environmental and tort liabilities were useful in a determination of solvency under the UFTA

The court said the principal reason why financial statements are of little use in a solvency analysis is that generally accepted accounting principles (GAAP) require reserves only for claims that are  “probable” and “reasonably estimable.” Nevertheless, the court said the record was replete with evidence that Kerr-McGee misapplied even this lenient standard and thereby understated its liabilities for GAAP purposes. The court pointed to testimony that Kerr-McGee only established reserves for those costs that it knew it was going to incur or almost certain it would incur. The court mentioned in a footnote that the personnel in Kerr-McGee’s S&EA Department prepared internal Sarbanes-Oxley certifications that covered only “known and reasonably estimable liabilities” and that its law department’s control documentation similarly misstated the standard, providing that reserves should be established “where a judgment or loss [was] considered probable and measurable.” The court said that New Kerr-McGee was aware of numerous sites where it had potential environmental liability but did not disclose or reserve for these potential liabilities. These undisclosed sites were referred to internally as the “secret sites.

The practical effect of this misapplication of GAAP, the court said, was that Kerr-McGee did not assess a potential environmental contingency at a site prior to receiving a demand or complaint from a third party.  The court noted that Tronox’s new controller and chief accounting officer raised concerns about this practice carried over from Kerr-McGee of reserving for environmental liabilities only after a demand was received from a third party. However, as the court observed, the MSA required Tronox to continue to use Kerr-McGee’s reserve setting methodology after the spinoff. Indeed, after a review of the 2008 reserves for 11 sites, Tronox concluded that the 2008 reserves were understated by $68.5 million and the financials were withdrawn. In October 2011, Tronox issued revised financial statements for the years ended December 2008-2010, concluding that its $189MM environmental reserve was understated by $303.2MM.

The court also found that since Kerr-McGee’s public financial statements were reported on a consolidated basis, the restricting transactions were not meaningfully disclosed in the company’s public financials. There was no disclosure, the court explained, that the “reorganization” diverted substantially all of the assets of the parent to a new holding company that would eventually disclaim liability for the Legacy Liabilities. As a result, the court concluded, it was impossible to determine the effect of the distribution to “a newly formed intermediate holding company,” and there was no disclosure that Kerr-McGee had this “newly formed intermediate holding company” assume more than $2 billion in debt owed to the group’s largest creditors because those creditors had the protection of covenants in their loan agreements.

However, the court said that financial statement reserves for environmental liabilities had no probative value in a solvency analysis because generally accepted accounting principles (GAAP) require reserves only for claims that are “probable and reasonably estimable.”

The remaining issue for the court to determine is the measure of damages. The parties will brief the issue over the next 60 days. Regardless of the outcome, though, there is little doubt that this case will be appealed.

On April 3, 2014, EPA and the Department of Justice (DOJ) announced an agreement to resolve fraudulent conveyance claims against Kerr-McGee Anadarko . Under the settlement, Anadarko will pay $5.15 billion to the litigation trust so that the settlement proceeds can be distributed to the trust’s environmental and tort beneficiaries. Specifically, the trust’s environmental and tort beneficiaries will receive approximately $4.475 billion and $605 million, respectively. More information on the settlement is available from the EPA website by clicking  here

NYSDEC Adds New Categories of Sites To Database To Chagrin of Some Property Owners

Wednesday, November 6th, 2013

The New York State Department of Environmental Conservation (NYSDEC) recently announced that it had added approximately 1,950 sites to its Environmental Site Remediation Database Search database of sites that are subject to one of the agency’s remedial programs. The  NYSDEC said it was adding these additional sites to facilitate real estate transactions and address the rising number of requests from the public for information about possible environmental contamination.

Previously, the NYSDEC searchable database contained summary information on on approximately 2,500 sites that were subject to one of the NYSDEC remedial programs such as the Brownfield Cleanup Programs (BCP), the Voluntary Cleanup Program (VCP), Environmental Response Program (ERP) for municipal sites, the Oil Spill Response Program (Spill Program) as well as sites on the Registry of Inactive Hazardous Waste Disposal Sites” (commonly referred to as the list of State Superfund Sites). The newly added 1,950 sites include three site classification types: Class P, Class PR, and Class N.

The “P” classification is used for are properties that the NYSDEC is considering placing on the Registry  because preliminary information indicates that a site may have contaminated at levels that could warrant listing on the Registry.  Generally, to qualify for placement on the Registry, there must be evidence that hazardous waste was disposed on the site and that any resulting contamination presents a significant threat (or reasonably foreseeable threat) to public health or the environment. If a site is found to present a significant threat, the NYSDEC may place the site on the Registry as a “Class 2” site unless a party agrees to implement remedial actions pursuant to an oversight document. Class P sites require information and/or investigation to if the property  qualifies for listing of the site on the Registry.   This contrasts to Class 3 Registry sites where NYSDEC has determined that contamination does not presently and is not reasonably foreseeable to constitute a significant threat to public health or the environment. A Class 3 designation is not used for sites where insufficient data is available to make a definitive decision concerning significant threat.  Many Class P sites do not end up being listed on the Registry. Sites that do not qualify for Registry listing are typically then reclassified on the database as a “Class N” (No Further Action At This Time) site.  In making information available about Class P sites, the NYSDEC emphasized that the information provided for a Class P site is preliminary in nature and unverified and that NYSDEC has not yet completed its investigation. Due to the preliminary nature of this information, NYSDEC said that significant conclusions or decisions should not be based solely upon these summaries.

Class PR sites (Potential RCRA Corrective Action)  are sites that are, or have been, subject to the Resource Conservation and Recovery Act (RCRA) program because hazardous wastes are or have been actively managed. These sites may have been contaminated if hazardous wastes were improperly stored, treated, or disposed. Similar to a Class P site, Class PR sites are investigated and reviewed to determine if RCRA corrective action is necessary. If so, remediation is carried out under a RCRA permit, order, or other legal mechanism.

The last category of sites that have been added to the Remediation Site Database are Class N sites. Many Class N sites were investigated decades ago before NYSDEC had an online database to store site information. This category can former Class P site where NYSDEC determined that contamination did not warrant placing the site on the Registry or it is being addressed under a brownfield program. Other Class N sites may include BCP, ERP or VCP sites where an application to participate was submitted but was either withdrawn or did not proceed because it did not qualify for the program. Other Class N sites include those where work was began under the brownfield program or voluntary cleanup program but work was not completed for lack of funding or some other reason.

Prior to 2013, information about Class P, PR, and N sites was usually only available by filing a Freedom of Information Law. In now making the information, NYSDEC  cautions users that the information should be used with caution and should not be used to form conclusions about site contamination beyond what the definition of the classification provides.

Finally, another important category is the Class A (Active) site. This classification has been used for sites in the BCP where the work halted for economic reasons and the contamination qualifies for placement on the Registry. If a new party proposes to re-enroll the site in the BCP or other remedial program, the NYSDEC can reclassify the site to Class A (active) to indicate that work has recommenced as  a non-registry site. This classification has also been used for Manufactured Gas Plant sites or those being remediated under an EPA Cooperative Agreement.

The newly added sites will make it easier to perform environmental due diligence as well as help developers identify potential brownfield sites. However, owners of Class P sites may be concerned that there properties may become stigmatized by the incomplete information about the extent of the contamination at their sites.

The NYSDEC Environmental Remediation Site Database Search is available at: The Petroleum Spills database is available at:

NY Case Illustrates Dangers of Completing Environmental Questionnaires

Tuesday, May 7th, 2013

The decision in Revell v Guido, 956 N.Y.S.2d 343 (App. Div-3rd Dept. 2012) is another example of the limits of “as is” contracts when it comes to environmental issues. The doctrine of caveat emptor is still valid in commercial transactions but may not insulate sellers from liability when they make misstatements in environmental questionnaires or engage in activity that courts perceive amount to active concealment.

In this case, the plaintiff was a licensed real estate broker purchased commercial property that contained nine rental homes from the defendant Real Property Solutions, LLC (RPS) in 2005.  The property information sheet prepared by the seller’s real estate stated, “Septic system totally new leach field totally replaced — new 5000 gallon holding tank.” The information sheet also contained a general qualification that “all information deemed reliable but not guaranteed.” The purchase agreement provided that the buildings on the premises were sold “as is”. The agreement also contained a “Septic System Contingency” which stated that the agreement was contingent on a timely test of the septic system. The plaintiff elected not to test the septic system inspected, thus waiving the contingency.

As it turned out, the defendants were notified of code violations associated with the septic system and was advised that that the defective septic system had to be replaced. Defendants retained a certified by a licensed engineer to install a new septic system which essentially amounted to an upgrade of the existing system by adding two 2,000 gallon septic tanks. In June 2004, the defendants were advised that the upgraded system was not functioning properly and that there were pools of sewage on the ground surface.

The defendants then entered into a consent order with the NYSDEC where they paid a fine and were required to submit a design to NYSDEC for approval. The proposed modified system- designed by the same engineer- incorporated the two septic tanks installed in 2003 but added a raised bed leach field. NYSDEC also required the use of infiltrators instead of pipe and stone. While the system was installed, the engineer never certified the modified 2004 system.

In connection with the 2005 transaction, the plaintiff’s bank required the completion of an environmental questionnaire. Defendant Joseph Guido on behalf of RPS indicated he had no knowledge of any past violations of environmental laws, that there were no prior environmental site assessment that revealed contamination or the need for further assessment. While the contract was pending, the engineer who designed the septic system sent a letter to the Guido discussing concerns about the septic system but Guido did not respond to the engineer or inform the purchasers of any issues. Within a month of the closing, the septic system failed again, requiring plaintiff to remedy the problems at their own expense.

The plaintiff filed a lawsuit alleging that RPS and Guido had fraudulently misrepresented the condition of the property. The plaintiff asserted it had relied upon the statements in the bank questionnaire that the septic system was “totally new” in purchasing the property without a septic inspection. The trial court denied the defendants’ motion to dismiss the complaint and granted plaintiff’s motion on the fraudulent misrepresentation claim. The court also ruled that corporate veil of RPS could be pierced to impose personal liability on Guido.

On appeal, Guido claimed his misstatements on the questionnaire were mistakes because he believed the questions pertained only to the current condition of the property. Guido also argued the plaintiff could not have reasonably relied on those statements since the plaintiff failed to exercise its contractual right to inspect the septic system or to independently search public records to discover the environmental history of the septic system.

The appeals court said that while New York traditionally follows caveat emptor in commercial real estate transactions, a seller may be liable for failing to disclose information if the conduct constitutes active concealment. Since the defendant admitted the falsity of the statement made in the bank questionnaire and plaintiff asserted it had relied upon those statements, the appeals court said the trial court had properly denied the motion to dismiss the complaint.

The court found that the plaintiff’s failure to exercise its rights to inspect the septic system did not as a matter of law prevent the plaintiff from asserting that it justifiable relied to its detriment on the misstatements in the bank questionnaire. The court reasoned that the “totally new” statement in the property description was technically false and there was a material question of fact if Guido knowingly intended to deceive, given his assertion that the system had been replaced twice in recent years at great expense to him and thus — in his opinion — was “totally new.” Further, the court found that Guido’s explanation that he believed the questionnaire was only referring to the present state of the property was belied by the unequivocal references in the questions to both the past and current status and events.

However, the court held the trial court improperly concludes as a matter of law that plaintiff had established reasonable reliance on the alleged misrepresentation because there were material questions of fact that had to be determined by a jury. These material questions of fact included if the representation that the septic system was totally new was knowingly made to induce plaintiffs’ reliance, if plaintiffs actually relied upon Guido’s answers in the environmental questionnaire in deciding to purchase the property, if the reliance was reasonable based on plaintiffs’ real estate experience and if plaintiff could have ascertained the facts with reasonable diligence, particularly where the contract contained a septic system contingency clause that plaintiffs waived. Accordingly, the court reversed the summary judgment ruling in favor of the plaintiffs, denied the defendants’ motion for summary judgment and remanded the case back to the trial court.

Many states also have property disclosure laws that sellers are required to prepare. For the very reasons illustrated by this case, many New York real estate lawyers advise their seller clients not to prepare the disclosure statement since the statutory penalty for non-compliance is a $500 price reduction. The real estate lawyers feel it is better for their clients to pay the $500 penalty than run the risk of making a material misstatement that could result in significant liability for misrepresentation.

Likewise, environmental consultants routinely submit environmental questionnaires to property owners and their clients as part of the phase 1 process I routinely urge purchasers and lending clients not to complete the questionnaire. The questionnaire is just the starting point for the due diligence since the environmental consultant will perform its own site inspection and historical records review. It is a rare occasion when the purchaser or lender has material information about the property that the consultant will not be able to obtain or that will result in a data gap that will prevent the consultant from determining if there is a recognized environmental condition (REC) on the property. The absence of an uncompleted questionnaire will not be significant in the overwhelming number of transactions where the client is a purchaser or lender. If the consultant still feels obligated to identify failure to prepare the questionnaire as data gap in such a situation, the consultant should be required to indicate that the data gap is not significant and does not alter the conclusions of the report.

It should be noted that the EPA All Appropriate Inquires (AAI) rule (40 CFR 312) identified what elements of the investigation were the responsibility of the environmental professional and which criteria were the responsibility of the prospective purchaser or brownfield grantee. The information that is to be obtained by the prospective landowner or grantee are known as “additional inquiries” and set forth in 40 CFR 312.22. The “additional inquiries” include: specialized knowledge or experience of the prospective landowner (or grantee); the relationship of the purchase price to the fair market value of the property, if the property was not contaminated; and commonly known or reasonably ascertainable information.

In the preamble summarizing the changes from the proposed rule to the final rule, EPA stated at page 66076:

“The final rule does not require the prospective landowner (or grantee) to provide the information collected as part of the “additional inquiries” to the environmental professional. [emphasis added].  Although we continue to believe that the information collected or held by the prospective landowner (or grantee) should be provided to the environmental professional overseeing the other aspects of the all appropriate inquiries, we agree with commenters who asserted that prospective landowners and grantees should not be required to provide this information to the environmental professional. Commenters argued that property owners (and grantees) may want to hold some information (e.g., the purchase price of the property) confidential. CERCLA liability rests with the owner or operator of a property and not with an environmental professional hired by the prospective landowner and who is not involved with the ownership or operation of the property.

Since it ultimately is up to the owner or operator of a property to defend his or herself against any claims to liability, we agree with commenters that asserted that the regulations should not require that prospective landowners (or grantees) provide information collected to comply with the “additional inquiries” provisions to the environmental professional. Should the required information not be provided to the environmental professional, the environmental professional should assess the impact that the lack of such information may have on his or her ability to render an opinion with regard to conditions indicative of releases or threatened releases of hazardous substances on, at, in or to the property. If the lack of information does impact the ability of the environmental professional to render an opinion with regard to the environmental conditions of the property, the environmental professional should note the missing information as a data gap in the written report.”

Beginning on page 66082 of the preamble to the AAI rule in the discussion captioned ” H. Who Is Responsible for Conducting the All Appropriate Inquiries?” EPA said [note we have broken out large block paragraph into smaller paragraphs for ease of reading]:

“Several commenters asserted that the mandatory nature of the proposed provision requiring the prospective landowner to provide information regarding the four criteria listed above to the environmental professional is problematic. Particularly with regard to the requirement to provide “specialized knowledge or experience of the defendant,” commenters pointed out difficulties in a prospective landowner being able to document such knowledge and experience sufficiently. Also, with regard to the information related to the “relationship of the purchase price to the fair market value of the property, if the property was not contaminated,” many commenters pointed out that prospective landowners may not want to divulge information regarding the price paid for a property. Commenters pointed out that the requirement to consider “commonly known or reasonably ascertainable information” about a property is implicit to all aspects of the all appropriate inquiries requirements. In addition, commenters stated that CERCLA liability lies solely with the owners and operators of a vessel or property. A decision on the part of a prospective landowner to not furnish an environmental professional with certain information related to any of the statutory criteria can only affect the property owner’s ability to claim a liability protection provided under the statute. In addition, the statute does not mandate that information deemed to be the responsibility of the prospective landowner and not part of the “inquiry of the environment professional” be provided to the environmental professional or even be part of the inquiry of the environmental professional. Some of the statutory criteria are inherently the responsibility of the prospective landowner.

We agree with the commenters who asserted that the results and  information related to the criteria identified as being the responsibility of the prospective landowner should not, as a matter of law, have to be provided to the environmental professional. The statute does not mandate that a prospective landowner provide all information to an environmental professional. Given that the burden of potential CERCLA liability ultimately falls upon the property owner or operator, a prospective landowner’s decision not to provide the results of an inquiry or related information to an environmental professional he or she hired to undertake other aspects of the all appropriate inquiries investigation can only affect the liability of the property owner.

In addition, we believe that the environmental professional may be able to develop an opinion with regard to conditions indicative of releases or threatened releases on, at, in, or to a property based upon the results of the criteria identified to be part of the “inquiry of an environmental professional.” Any information not furnished to the environmental professional by the prospective landowner that may affect the environmental professional’s ability to render such an opinion may be identified by the environmental professional as a “data gap.” The provisions of the final rule (as did the proposed rule) then require that the environmental professional comment on the significance of the data gap or missing information on his or her ability to render such an opinion, in light of all other information collected and all other data sources consulted.

As a result of our consideration of the issues raised by commenters, today’s final rule modifies the requirements of Sec. 312.22 “additional inquiries” by stating (in paragraph (a)) that “persons * * * may provide the information associated with such inquiries [i.e., the information for which the prospective landowner or brownfields grantee is responsible] to the environmental professional * * *.” The proposed rule provided that such information “must be provided” to the environmental professional

Although we expect that most prospective landowners and grantees will furnish available information or knowledge about a property to an environmental professional he or she hired when such information could assist the environmental professional in ascertaining the environmental conditions at a property, we affirm that compliance with the statutory criteria does not require that such information be disclosed. Ultimately, CERCLA liability rests with the owner or operator of a facility or property owner and it is the information held by the property owner or operator that may be reviewed in a court of law when determining an owner or operator’s liability status, regardless of whether all information was disclosed to an environmental professional during the conduct of all appropriate inquiries.”

In sum, AAI is a performance-based regulation. Failure to provide the information in 40 CFR 312.22 does not cause a prospective purchaser or party seeking the landowner liability protection to automatically lose its liability protection. The user may lose its ability to claim the protections IF the absence of that information prevents the EP from reaching a conclusion about the presence or absence of RECs or a release.  At the end of the day, the EP has to decide if the failure to respond certain information is a significant data gap that prevents the EP from rendering a conclusion if there is a release (or REC).

Ct Rules Indiana Real Property Transfer Law May Be Triggered By Historic Uses

Tuesday, April 30th, 2013

What started out as a toxic tort lawsuit has evolved into a precedent-setting case involving the Indiana Real Property Transfer Law (RPTL) with a potentially fascinating Racketeer Influenced and Corrupt Practices Act (RICO) ruling waiting in the wings.

The legal trade press focused much of its attention on the RCRA 7002 rulings handed down by a federal district court for the northern district of Indiana in Browing v. Flexsteel Indus., 2013 U.S. Dist. LEXIS 41164, (N.D.Ind. 3/25/13). However, the more interesting aspect of the decision from an environmental transactional perspective was the court’s ruling that the disclosure obligations of the Indiana Responsible Property Transfer Law (“RPTL”) are not limited the current use of a property but can be triggered by historic uses of a property.

In this case, David Dygert (a defendant in the RICO count) and his wife purchased vacant farmland adjacent to the Meadow Farms Subdivision in Elkhart Indiana in 1983. They leased the property to Dygert’s business, Dygert Seating, Inc. (Dygert Seating) which manufactured foam seats and metal seat frames at an adjacent facility.

After filing for bankruptcy in 1997, Dygert Seating sold substantially all of its assets including the facility to Flexsteel Industries, Inc. (Flexsteel). The former Dygert Seating business was then operated as the Flexsteel Dygert Seating division and the corporate entity, Dygert Seating, was dissolved in 2000. Dygert along with co-defendants Greg Lucchese and Gerald Alexander continued to work for the Dygert Seating division at the site.

Over the next several years, Flexsteel, PBD Corporation, Lux Steel, Inc., and Dylux Technology, Inc. all engaged in manufacturing at the site at one point or other. These entities used a variety of industrial solvents TCE, methylene chloride and TCA to degrease metal frames as well as ingredients in adhesives, spot removers, and glue and silicone sprays. According to the complaint, the corporate defendants reportedly directed their employees to dump and pour used TCE and other solvents and glues directly onto the ground at the Site where the contaminants eventually seeped into the subsurface soil and ground water. The complaint also alleged that the defendants stored hazardous waste in cardboard boxes and 55-gallon drums and disposed virtually all of the waste with regular trash without making proper waste determination or reporting their waste generation activities to EPA.

In January 2005, Flexsteel sold the Cooper Drive property to plaintiff Fred Lands. The purchase agreement stated that Flexsteel was not required to provide a disclosure under the Indiana RPTL. Flexsteel did not inform Lands of the past disposal practices and widespread dumping of hazardous chemicals.

In August 2007, a homeowner in the adjacent subdivision tested her tap water after reading an article about groundwater contamination in the newspaper. The sampling  revealed TCE contamination at levels as high as 1,360 ug/L. Subsequent tests detected levels as high as 330 ug/L in various plaintiffs’ drinking water. The Elkhart County Health Department then advised the homeowners to immediately stop using their water for drinking cooking and bathing, and to use only cold water when necessary to avoid vapors. Working under a cooperative agreement with the USEPA, the Indiana Department of Environmental Management (“IDEM”) implemented an area-wide groundwater sampling program that found elevated levels of volatile organic compounds (VOCs) present in 13 of the water samples. IDEM provided residents with bottled water after the testing, and EPA then provided carbon water filters. Eventually, EPA funded the extension of the public water supply to 26 homes.

In March 2011, the homeowners filed a complaint in Elkhart Circuit Court seeking damages and injunctive relief under theories of trespass, nuisance, negligence, negligent infliction of emotional distress, punitive damages, and for relief under the Indiana Environmental Legal Action statute. In December 2011, the plaintiffs filed a RCRA 7002 action against Flexsteel and Dygert Seating. In May 2012, the plaintiffs filed an amended complaint that contained RICO claims.

The defendants filed motions to dismiss a various claims filed by the numerous plaintiffs. On the RCRA count filed under RCRA 7002(a)(1)(A) alleging that the presence of hazardous wastes that had been illegally disposed constituted a RCRA continuing violation. However, the court said the conduct that was alleged to have caused the violation had ceased long ago and that the plaintiffs were seeking a remedy to address the continuing effects of this wholly past conduct. Since it did not have jurisdiction to claims for wholly past violation, the court dismissed this RCRA count. However, the court found there was a material dispute if the contamination constituted an imminent and substantial endangerment and denied the defendants’ motion to dismiss the RCRA 7002(a)(1)(B) count.

The court then turned to the motion to dismiss Fred Land’s claim that the defendants’ failed to comply with the Indiana Responsible Property Transfer Law (RPTL), Ind. Code § 13-25-3-1 et seq, which requires the transferor of certain property to  provide a disclosure form to the transferee identifying past uses of the property and potential environmental defects. A plaintiff may recover consequential damages, reasonable costs, and attorneys’ fees when a defendant fails to provide the required disclosure document required by RPTL.

RPTL applies to a property that contains an underground storage tank, is listed on EPA’s Comprehensive Environmental Response, Compensation and Liability Information System (CERCLIS) list or if it contains one or more facilities that are subject to reporting under Section 312 of the federal Emergency Planning and Community Right-to-Know Act of 1986 (EPCRA).

Land alleged that the Cooper Drive Property was subject to the RPTL’s disclosure requirement because while manufacturing activities had ceased at the Cooper Drive Property as of the date of transfer, the property had been and remained subject to reporting under Section 312 of EPCRA.  Land also asserted that although the site was not listed on CERCLIS at the time of the transfer, it would have had the appropriate agencies been notified of the defendants’ disposal practices.

Flexsteel argued that it was not required to provide a RPTL disclosure document the property was not listed on CERCLIS. Regarding the EPCRA reporting requirements, Flexsteel said that RPTL’s definition of “property” uses the present tense and since the last time the property was subject to EPCRA reporting requirements was 1993, the site did not fall within the RPTL definition of property when it was sold in 2005.

The Court began its analysis by acknowledging that no Indiana court had ever interpreted the application of the RPTL to historic uses of a property. However, the court then went on to rule that the definition of “property” for RPTL purposes should not be construed to mean that a facility must be required to file an ECPRA inventory report for the current calendar year before disclosure is mandated. In so holding, the court reasoned that the purpose of RPTL was to provide a broad swath of environmental information, including regulatory information during the transferor’s ownership, site information under other ownership or operation as well as “environmental defects”. The phrase “environmental defects”, the court said was broadly worded and any “environmentally related commission, omission, activity, or condition” that would violate environmental laws, “require remedial activity,” present a “substantial endangerment” to public health, public welfare, or the environment, “have a material, adverse effect on the market value of the property,” or would interfere with another’s ability to obtain environmental permits or licenses. Because the purpose of the statute appeared to be to disclose as much information related to environmental conditions on the property as possible, the court said it made sense to read the statutory definition of “property” broadly as well.

The court said the three categories that meet the definition of “property” intended to cover those properties where there is an elevated risk of environmental defects. The court observed that underground storage tanks posed a risk even if the transferor did not install the tanks. Likewise, the court noted that CERCLIS list sites have already been identified by the EPA as actually or potentially contaminated. Finally, the court said that the “ECPRA reporting” category was clearly intended to cover facilities that have been handling large amounts of hazardous chemicals, raising the likelihood of an accidental (or intentional) release and environmental defect. Given the broad purposes of RPTL and the broad disclosures required by the IDEM form, the court said it made little sense to exclude from the class of “property” for which the disclosures are required a transferor that was formerly required to submit hazardous material inventory reports under EPCRA but has ceased (or reduced) operations prior to the current calendar year.

Further buttressing this conclusion, the court said, was that the IDEM appeared to share this broad view of RPTL’s purposes. The court pointed out that the RPTL disclosure document asked broad questions designed to solicit information on past regulatory compliance as well as specific information that would allow a transferee to investigate potential unknown environmental defects. For example, court went on, the form broadly asks whether the transferor has “ever conducted operations on the property which involved the generation, manufacture, processing, transportation, treatment, storage, or handling of a ‘hazardous substance,” or whether certain common hazardous waste storage and disposal units are “at the property that are used or were used by the Transferor.” The court said the form inquires if the transferor has been required to file an EPCRA hazardous chemical inventory or a toxic chemical release form, and whether the transferor or any facility on the property has been subject to certain state or federal government actions. Finally, the court wrote, the form asks for limited information on previous owners and operators.

The court said that if it adopted Flexsteel’s “cramped reading of the statutory definition of “property,” the RPTL disclosure requirements would be so limited so as to defeat the statutory purpose. The court reasoned that a transferor that had stored (and perhaps released) substantial amounts of hazardous waste over the course of decades could avoid disclosure requirements by ceasing operations and removing hazardous chemicals before the beginning of the calendar year in which it intends to transfer the property, thus eliminating any reporting requirement despite known or suspected environmental defects. Given the broad purpose of RPTL and the substantial consequences of noncompliance, the court said it simply made no sense that the legislature intended to limit its coverage so drastically.

While the court acknowledged that present tense language in a statute may indicate an intent to focus on current and ongoing activity, the court said that it was not bound to adopt a construction to advance the strict letter of the statute if such an interpretation would lead to manifest absurdity

Finally, the Court noted that the complaint did not admit that the property has not been subject to EPCRA reporting requirements since 1993 but included allegations that the defendants had previously submitted EPCRA reports in the 1990s and were storing hazardous waste on the property in late 2001. While the complaint stated that manufacturing activities had ceased as of the date of transfer, the court said the allegations did not rule out the possibility that activities within the past calendar year triggered an EPCRA reporting requirement at the time of transfer. The court said RPTL’s definition of “property” did require that a transferor must have been complying with EPCRA reporting requirements at the time of the transfer but merely that it be subject to those reporting requirements. Thus, even under the defendants reading of the RPTL property definition’s “subject to” language, the court said it was not implausible that the plaintiffs could prove a current reporting obligation.

Because historic contamination usually does not have to be reported under CERCLA and most state statutes, environmental transaction statutes are an important tool for remediating contaminated properties. It will be interesting to see if other state courts apply the reasoning of this case to their statutes.