No Administrative Claim For Hotel Damaged By Methane from Bankrupt Landfill Operator

It seems like there were a lot of cases in 2011 involving commercial properties impacted by methane gas from former landfills. A recent case involved a novel question if the owner of a hotel damaged by methane gas migrating from a landfill could seek administrative claim status in a chapter 7 bankruptcy case.

In the case of In Re Resource Technology Corp, 2011 U.S. App. LEXIS 22022 (7th Cir. 10/31/11), Congress Development Company (Congress) owned and operated a landfill in Hillside, Illinois. From 1992 to 1996, Congress used a flare system to control landfill gases. In 1996, Congress contracted with Resource Technology Corporation (RTC) to construct and operate a gas collection and control system (GCCS) that would replace the flare system. RTC, in turn, would convert the gas to electricity and then sell the electricity to power companies. In 1999, RTC filed a chapter 11 bankruptcy petition and continued to operate the GCCS as a debtor in possession (DIP) until 2003 when the bankruptcy court appointed a Chapter 11 trustee.

In October 2002, Markwell Hillside LLC (Markwell) purchased a Holiday Inn hotel located next to the landfill. As it turns out, Markwell’s purchase was ill-timed as conditions at the landfill significantly deteriorated in 2002. According to an expert in the bankruptcy case, RTC did not properly operate or maintain the GCCS during its time in bankruptcy. The problems included a history of high-pressure gas readings, broken fittings, broken valves, broken wellheads, and broken sampling ports.

In September 2005, the bankruptcy court converted the RTC case to a Chapter 7 liquidation proceeding. A chapter 7 trustee was appointed and given operational control over RTC’s was its business operations were wound down. Four days after the chapter 7 trustee assumed control, the GCCS failed. Landfill gases migrated into the hotel through electrical outlets and floor cracks. The odors sickened guests and employees, resulting in a disastrous fall off in the hotel’s business for a period. Markwell subsequently filed its own chapter 11 proceeding.

The Illinois Environmental Protection Agency (IEPA) issued notices of violation to Congress and RTC after receiving odor complaints. The Chapter 7 trustee responded that the estate lacked the financial resources to fix the GCCS and estimated even if it had the funds, it would take a year to bring the GCCS into compliance. In January 2006, the bankruptcy court lifted the automatic stay and allowed Congress to take control of the GCCS. Congress then terminated its contract with RTC and began to rebuild the GCCS.

Landfill gas continued to enter the hotel. Markwell discovered explosive levels of methane gas at the hotel in February and March of 2006. This was apparently the final nail for Maxwell reorganization hopes. In September 2006, Markwell’s trustee sold the Holiday Inn for 20% of the value had there not been a methane problem.

In May 2006, Markwell’s trustee filed an administrative claim against RTC’s Chapter 7 estate seeking compensation for damages. Markwell alleged that RTC’s negligent maintenance of the GCCS had created a nuisance that damaged Markwell’s property and caused economic loss. The Markwell estate assigned its claim to Samuel Roti, Markwell’s sole member. Roti then amended the Chapter 7 claim, requesting compensation for out-of-pocket costs, loss of hotel revenue, damage to the land, and diminution in the hotel’s market value.

Creditors in a chapter 11 bankruptcy may seek administrative claim status for post-petition environmental claims on the basis that the chapter 11 DIP or trustee has an obligation to comply with environmental laws under 28 U.S.C. 959. However, Markwell never filed a claim against the chapter 11 estate. Instead, Roti sought what it characterized as a post-petition administrative claim against the chapter 7 trustee on the basis that it “operated” the GCCS for nearly four months.

The United States District Court for the Northern District of Illinois rejected the request for administrative priority status and the Court of Appeals for the Seventh Circuit affirmed. The appeals court noted that the trustee had been operating RTC’s system for only four days when the failure occurred. The court said the failure resulted from years of RTC’s neglect, there was no evidence that the chapter 7 trustee was aware of that neglect, did not exacerbate the problem, could not have done anything to prevent the failure within the few days that it had nominal control of the system, and could not have done anything to mitigate the damage afterward. The court is was possible that the Chapter 11 trustee may have had some responsibility for the neglect of the GCCS but there was no longer a Chapter 11 estate from which Roti could seek relief.

The appeals court acknowledged that the nuisance matured into a claim when the Chapter 7 trustee had possession of the GCCS and therefore could be viewed as occurring post-petition. However, since the acts causing the nuisance occurred prior to the time the chapter 7 trustee assumed control, the court said the trustee was “no more personally responsible for it than the owner of an apartment house is responsible for the murder of one of his tenants by another tenant.”

After concluding that the Chapter 7 estate and not the trustee was the proper tortfeasor, the court examined if the claim should be afforded administrative expense priority. The court said that while the chapter 7 trustee was given operational control, it was not the kind of operational control seen in chapter 11 cases where a trustee is managing an ongoing business to preserve and enhance the value of the bankruptcy estate. Instead, the court said, the trustee had neither the mandate nor resources to do anything but liquidate the estate.

Roti argued that estate had generated from revenue from the sale of energy and was therefore continuing the operation of the business.  However, the appeals court said the trustee did not operate the GCCS in any meaningful way during the brief period it was in charge. While there was some revenue generated from energy sales, the court said the proceeds were less than 10% of its normal revenue and insufficient to cover the GCCS operating costs. The court concluded that the continued operation of the GCCS in its diminished state should be more properly viewed as simply the exercise of the estate’s obligation to prevent further contamination. Thus, while Roti as assignee of Markwell, was simply a general creditor.

Commentary: When companies encounter financial difficulties, spending on environmental compliance is often one of the first expense items to be slashed. Even during a chapter 11 bankruptcy when the estate has obligations to comply with environmental laws, debtors will often spend the absolute minimum on environmental compliance to preserve estate cash. As a result, parties considering purchasing corporate assets in a bankruptcy proceeding should carefully assess review environmental compliance prior to acquiring the assets. Lenders also need to scrutinize environmental compliance before exercising rights that could provide them with control over a defunct borrower’s facility. There have been many cases where lenders have become saddled with the costs of disposing of hazardous wastes. We have several archived posts that discuss the potential risks facing lenders during bankruptcy proceedings