Methane Gas, an Apartment Complex and a Bankruptcy Filing

A federal bankruptcy court authorized the owner of the upscale Marble Cliffs Crossing Apartments complex in Columbus, Ohio to install a methane gas remediation plan over the objections of the purchaser of the mortgage note, holding that the plan was necessary to protect the safety of tenants and was critical for preserving the value of the property. The order allowed the owner/debtor-in-possession (DIP) to use cash collateral in the form of rent proceeds to pay for the installation and monitoring of the methane remediation system.  In re Marble Cliffs Crossing, LLC, 2012 Bankr. LEXIS 5099 (Bankr.S.D.Ohio 10/21/12)

In many ways, the events surrounding the Marble Cliff Commons Apartments are a microcosm of the national economy over the past decade. The project involved lack underwriting, overly-optimistic financial projections, inadequate environmental due diligence, a failed restructuring attempt, a loan default,  debt purchase at an auction sale and a pre-emptive bankruptcy filing by the property owner to facilitate debt restructuring.

The 30-acre complex consists of includes 276 rental units located in nine ranch style buildings and twenty-four two story buildings, a 3/4-acre pond, a community building and a mail center. A 7,000 square foot community center includes the leasing offices, three social rooms, a business center, a fitness center, a billiard parlor, a movie theater and an outdoor heated swimming pool, and a dog park. The complex was constructed in 2003 on the site of a former limestone quarry was used for the disposal of construction/demolition debris, yard waste, and other biodegradable materials between the 1970s until approximately 1985. Prior to construction, soil fill material was placed over the fill and a compacted clay “cap” was installed. Some of the buildings were constructed on the solid rock portion of the quarry and some of the buildings were constructed on the clay “cap” where the construction fill was located.

The development was originally financed with a $30MM loan originated by Armstrong Mortgage Company (Armstrong) in 2002 and guaranteed by the Department of Housing and Urban Development (“HUD”). Marble Cliffs Crossing, LLC (Marble or Debtor-in-possession) also granted a liens on all rents and profits generated by the complex.  Apparently, Armstrong was owned by the former owner of the property. The project encountered unanticipated delays in infrastructure construction and a market shift to home ownership that prevented the complex from reaching its projected occupancy rate. By 2005, the complex was encountering financial difficulties and had to restructure the HUD-guaranteed loan.

Also in 2005, tenants began complaining of odors. The Debtor retained a consultant to perform an indoor air quality investigation which detected elevated levels of organic compounds in certain areas. As a result, a passive methane system was installed in certain areas around the complex and odor complaints decreased significantly.

Financial conditions further deteriorated in late 2008 and the HUD-guaranteed loan went into default. In 2010, Armstrong assigned the mortgage to HUD who sold the loan at auction for $23.25MM to MTGLQ Investors, L.P. (MTGLQ). Marble subsequently entered into a forbearance agreement with MTGLQ to allow Marble to explore refinancing options. A prospective purchaser who was acceptable to both the note holder and the property owner performed additional environmental due diligence. The investigation revealed the presence of elevated levels methane and hydrogen sulfide gases in the subsurface below the complex at levels, and recommended additional investigation.

When the purchaser declined to proceed with the transaction, MTGLQ commenced foreclosure proceedings on November 1, 2011. Marble responded by filing a chapter 11 bankruptcy proceeding in November 2011 approximately two weeks later, staying the foreclosure action. Marble then obtained approval by the court to use cash collateral to retain an environmental consultant to further evaluate the environmental issues at the complex.

In early 2012, Marble’s environmental consultant conducted two rounds of indoor air monitoring in eleven apartments that revealed only minor concentrations of methane and no hydrogen sulfide. The consultant also performed a desktop review of historical reports and aerial photographs to better understand the location and type of fill material. Based on this information, the consultant drilled seven additional soil bores and installed twelve gas probes. The results of the additional subsurface gas testing were consistent with the earlier data. As a precautionary measure, Marble authorized the installation of methane detectors in the common areas of all buildings and in each of the ranch apartments.

The consultant also recommended installing a subsurface remediation system to control the lateral and vertical migration of methane gas. Marble obtained approval for the consultant to evaluate alternatives for the remediation system and prepare detailed engineering plans and technical specifications for the remediation system at a cost of approximately $71K.

Marble sought input from the Ohio Environmental Protection Agency (OEPA), Ohio Department of Health, the Columbus Public Health Department, the federal Environmental Protection Agency and the Agency for Toxic Substances and Disease Registry. The agencies requested that Marble perform supplemental sampling in additional locations, and then approved the design of a remedial system. Marble also worked with the agencies to prepare a letter to the tenants describing the environmental issues and the proposed remediation System.

Because of the additional work and interaction with the government agencies, Marble had to file a motion with the court to increase the authorized budget by approximately $42K. Initially, MTGLQ objected to the request for additional funds but the court ultimately approved the request.

Marble then sought court authority to implement the remedial system approved by the government agencies that was estimated to cost approximately $754K. The proposed remedial system consisted of a series of seventeen wells at the probable locations of fill materials that would collect the methane gas and direct it through underground pipes to a central area for safe ventilation. The remediation system would operate for several years until the methane gas concentrations dropped to acceptable level.

MTGLQ retained an expert to review the proposed remediation plan and filed an objection. At a hearing, MTGLO’s expert testified that the system might not be effective in removing methane gas because the radius of influence around each of the seventeen wells may be insufficient to extract methane gas, especially for the wells located directly under the buildings. MTGLQ’s expert said the remediation costs could increase significantly if the remedial system was improperly designed. Instead, he testified that additional testing should be conducted, which could cost as much as $50K to $100K. Marble objected to any delays because the approaching cold season could increase the costs of the existing proposed system.

The court found that both experts agree that the radius of influence would not be in perfect circles, and that Marble’s expert acknowledged described the radius of influence would be “amoeba-like” in shape, and that there was a possibility for some overlap and some gaps because the nature of the soil and the heterogeneity of the fill material. However, the court noted, Marble’s expert testified that further testing was not necessary because the system could be re-balanced after installation without having.

The court noted that MTGLQ’s expert had not visited the property to conduct testing, did not review OEPA documents or even talk to OEPA personnel. Moreover, the court observed that MTGLQ’s had never designed a gas extraction system and did not have any data indicating that the proposed remediation system would be ineffective. Furthermore, the court observed that OEPA would review the Debtor’s periodic reports to determine the efficacy of the post construction balancing. Finally, the court observed that OEPA has not requested any additional pre- construction testing.

As a result, the Court concluded that the Debtor had presented a reasonable plan and that it was imperative to implement the remediation as soon as possible to protect the interests of all creditors and the safety of the tenants. The court said the gas remediation plan was a capital and/or maintenance expense contemplated by the Agreed Order, and constituted an ordinary and necessary business expense as contemplated by Section 363(c)(1) of the United States Bankruptcy Code. Finally, the court found that MTGLQ had adequate protection because the property value exceeded the amount of the secured claim. Since the Creditor was over secured, there was no need for any type of adequate protection payment or additional liens to commence and complete the remediation program, as proposed by the Debtor.

In March, the Debtor filed a progress report and presented testimony confirming that the remediation plan had been installed and was properly operating. The bankruptcy proceeding was subsequently dismissed after the parties informed the court that they had settled their dispute.