Bank Declines To Foreclose Because of Costs to Remedy Stormwater Violations

When builders were defaulting on construction loans during the height of the Great Recession, states began turning to banks to ensure that partially completed developments remained in compliance with environmental laws. The greatest number of enforcement actions were brought against banks in California,Georgia and North Carolina with unconfirmed reports in other states.

Under the federal Clean Water Act (CWA) and state versions of that law, developers and builders are required to obtain stormwater permits and implement Storm Water Pollution Prevention Plans, Best Management Plans and/or Erosion Control Measures. These requirements are the reason that construction projects have those ubiquitous black and orange silt fences.

Unlike CERCLA, the CWA does not have a secured creditor exemption.  As a result, banks foreclosing on partially constructed sites may not only become responsible for complying with the full panoply of environmental laws associated with the development such as maintaining erosion controls but could also become saddled with fines and penalties for unpermitted sediment runoff

The bank in Carolina First Bank v. Stambaugh, 2011 U.S. Dist. LEXIS 144518 (W.D.N.C. 12/14/11) was aware of this trend and opted to refrain from foreclosing on its collateral because of the costs to remedy erosion controls and potential penalties associated with stormwater violations.

In this case, the borrower/defendants executed a promissory note in 2007 the amount of $245K to finance a real estate development project in North Carolina. In January 2008, the defendants were unable to pay the principal due on the first note and entered into a second promissory note that increased the total loan principal to $350K. Between February and November 2009, the plaintiff bank allowed the defendants to use loan advances to make monthly principal-and-interest payments on the second note.

The defendants defaulted on their loan in December 2009 and foreclosure proceedings were commenced in March 2010 that the defendants did not contest. The trustee noticed the sale of the property for April 30, 2010 but postponed the sale after it performed an environmental assessment and learned that the site had severe soil erosion issues that would cost at least $60K to repair along with costs for stormwater violations.

When the bank commenced foreclosure proceedings, the defendants apparently anticipating that the bank would eventually take possession of the property and failed to take any steps to prevent soil erosion or otherwise stabilize the site.

The trustee then abandoned the foreclosure proceeding and elected to sue the defendants on the note. The defendants filed a counterclaim, contending that soil erosion was caused by the Bank’s unreasonable delay in pursuing its rights and that the bank should pay for the damage.

The court granted summary judgment to the bank, holding that it did not unreasonably delay pursuing its remedies. The court said that the bank filed suit within seven months of the default which was well within the statute of limitations period.  The erosion damage, the court said, resulted from the defendant’s unilateral decision to cease spending money on or maintaining the property. The court said the bank did nothing to prevent the defendants from taking any action they deemed necessary with respect to the property.