Environmental Compliance, Permitting and Cleanup Obligations: To What Extent Should They Take Precedence Over Other Obligations During and After Bankruptcy?: B. Environmental Issues in a Bankruptcy or Reorganizational Proceeding: A Bankruptcy Lawyer's Pe

Environmental Compliance, Permitting and Cleanup Obligations: To What Extent Should They Take Precedence Over Other Obligations During and After Bankruptcy?: B. Environmental Issues in a Bankruptcy or Reorganizational Proceeding: A Bankruptcy Lawyer's Perspective

Richard P. Krasnow

Editors' Summary: Although NEPA requires the preparation of an EIS for every major federal action significantly affecting the environment, federal agencies often decide in particular cases that compliance with NEPA is satisfied by preparation of EAs. The decision not to prepare an EIS is usually based on a finding of no significant impact. When an agency's threshold NEPA decision is challenged in court, what is the appropriate standard of review? The federal courts of appeals answer this question in at least two different ways: some circuits use the "arbitrary and capricious" standard, while others inquire into the "reasonableness" of the agency's decision. Several courts have expressed doubt that there is any genuine distinction between the rival standards, and the Supreme Court has so far declined to settle the issue. The author of this Article surveys the federal case law on this question, exploring the approach of each circuit and taking issue with those who maintain that the difference between the standards is illusory. The vital difference, the author argues, is that courts using the reasonableness standard are more likely to substitute their own judgment for that of the agency, while courts adopting the arbitrary and capricious standard tend not to second-guess an agency's decision. Because he sees an important difference between these two approaches, the author urges theSupreme Court to grant certiorari to resolve the circuit split.

Richard P. Krasnow is a partner with Weil, Gotshal & Manges in New York, New York.

[18 ELR 10355]

In the sixteen years that have passed since the first Airlie House Conference, concern about preventing hazardous toxic exposures and cleaning up toxic waste sites has steadily increased. In turn, more and more federal and state legislation and regulations have appeared to redress these problems. The costs attendant to both preventive and cleanup costs, however, have become perhaps the most significant financial problem that many companies must face, often posing a threat to their continued viability.

During this same period, another growth industry has appeared on the scene: bankruptcy and reorganization. Larger companies with increasingly complex financial structures have been seeking protection under the federal bankruptcy laws. The trend became particularly apparent with the enactment in 1979 of the Bankruptcy Code,¹ which, among other changes, eliminated the requirement that a debtor be either insolvent or unable to pay its debts before it could file a petition — whether in Chapter 7² for liquidation or Chapter 11³ for reorganization. The problems now being presented to the bankruptcy court for resolution range from rejections of union contracts to products liability claims to [18 ELR 10356] multi-billion-dollar judgments. One side-effect has been the erosion of concern that filing for reorganization is an embarrassing, morally reprehensible thing to do. In its place has come the recognition that the Code affords the opportunity for a company to restructure. It is viewed as just one more management tool.

It should be unsurprising, then, that the burden of environmental compliance would also find its way into the bankruptcy courts. The result is the introduction of additional competing interests to an already complex process, be it liquidation or reorganization.

From the environmental standpoint, it would appear that the interest is to protect public health and safety. From the bankruptcy standpoint, the idea is to provide the debtor with a fresh start while affording creditors an opportunity to realize upon their claims, and to maximize that realization. The concept of reorganization, of rehabilitating a company rather than liquidating it, is somewhat unique. It is found in very few countries in the world, and has as its genesis the railroad reorganizations that occurred prior to the Great Depression. It is predicated upon a belief that the whole is worth more than its liquidated parts. It's worth more to its creditors, to employees, to shareholders, and to the public at large.

While it would appear at first blush that environmental and bankruptcy interests conflict, there is not a great difference in their respective approaches. As Douglas Baird noted, the real competing interests are economic in nature. Who will get the cash?

I would like to address environmental issues in bankruptcy, first within the context of Chapter 7 (liquidations), and then Chapter 11 (reorganizations). The results, like the cases themselves, are very different.

Chapter 7 begins when somebody files a petition, voluntary or involuntary. Unlike under the former Bankruptcy Act, a company need not be insolvent in order to enter a liquidation. While one might question why this change was allowed, in fact it makes no difference. It is doubtful that any company or individual would enter a Chapter 7 unnecessarily, particularly since, as a result, all of its assets are liquidated.

In Chapter 7, a trustee is appointed by a United States Trustee. After the U.S. Trustee appoints a trustee, the creditors may elect one themselves. In the typical Chapter 7 case, though, creditors are not particularly concerned about who the trustee may be. Therefore, typically the U.S. Trustee's choice is the one who oversees the liquidation.

The trustee's function is to take control of all of the debtor corporation's assets, and to marshal, liquidate and distribute them in a manner consistent with the Bankruptcy Code.

To the extent permitted, the trustee liquidates those assets that represent collateral of secured creditors, distributes to them the proceeds of that collateral, and then distributes the balance of the funds to unsecured creditors. With regard to the latter, Section 507 of the Bankruptcy Code affords priorities to certain claims. One such priority, found in Section 507(a)(1)(A),⁴ relates to administrative expenses, which have first priority. Others include employees, pension claims, and taxes. There is one type of claim, though, for which there is no specific priority: environmental cleanup.

In order to ensure the unimpeded marshaling and liquidation of the assets, Section 362 provides what is known as the automatic stay. Its purpose is to keep creditors at bay and prevent them from dismembering property of the estate. In this way, everything proceeds in an orderly fashion, and the trustee is not harassed by creditors' lawsuits.

There are certain exceptions to that automatic stay, including those provided in Section 362(b)(4)⁵ relating to the governmental exercise of police powers — important in the environmental area. This exception is somewhat modified by 362(b)(5)⁶, however, which provides that a governmental unit may not exercise its police powers in order to enforce money judgments.

In Chapter 7, the environmental issues are generally irrelevant, particularly with respect to corporations. Kovacs,⁷ a Chapter 7 case dealing with an individual, holds that environmental claims requiring debtors to clean up toxic waste sites are cognizable under — and thus can be addressed consistent with — the Bankruptcy Code. The concept is not new, and it should not trouble anyone.

In the case of a corporation, once all the assets have been liquidated, nothing is left but the shell. Thus, if the government's right to repayment for cleanup costs were not to be considered a claim, the government would be unable to participate in the distribution of assets, and it would end up with nothing. As a practical matter, while liquidation proceedings occasionally involve companies with as much as hundreds of millions of dollars in assets, such cases are rare.

Typically, liquidations occur where the assets are relatively de minimus. Thus, the question of whether the government's claim for recovery is dischargeable in Chapter 7 cases is somewhat academic.

The abandonment issue addressed by the Court in Quanta⁸ is of greater significance. One can envision situations where a trustee required to clean up hazardous waste sites, with meager assets available, would view such property as a substantial burden on the creditors. I submit that Quanta does not hold that a trustee who finds that property of the estate includes a hazardous waste site must clean it up. The court simply indicated that the trustee must take some minimal steps before abandoning the property. He must ascertain whether indeed there is a toxic waste problem. If there is, he must determine whether it represents a clear and imminent danger to the public safety; and if so, he must take some steps to lessen the danger.

In Quanta, the court was particularly disturbed by the fact that the trustee involved had abandoned the property before he even sought authority to do so. He failed to take even the minimal step of posting guards, ensuring that nobody would trespass upon the property or otherwise expose themselves to harm from the toxic wastes at the site. The court did not say that a trustee who took such minimal steps would be further precluded from abandonment. In my view, such a trustee can proceed to the typical considerations in deciding whether to abandon the property.

A trustee must consider the value of administering the property. If there is none, then the trustee should apply, and [18 ELR 10357] indeed the bankruptcy court should grant, an application to abandon.

If the property is abandoned, nonbankruptcy law applies. The property is no longer subject to the jurisdiction of, or the protections of, the bankruptcy court — including the automatic stay. If cleanup costs are considerable, the government presumably will spend whatever is necessary. The government is not without recourse, however, because it thus acquires a claim against the bankrupt estate. While the government may recover little, the claim's pre-petition status entitles the government to compete equally with other general unsecured creditors.

The trustee has yet another option. In the case where the sole asset is a toxic waste site which, to be of any value to creditors, would require a huge expenditure, the trustee need not abandon the property. Instead, he can suggest to the court that it abstain from exercising jurisdiction with respect to that bankruptcy case. The mere filing of a petition does not require that the case proceed. If nothing is to be gained from the prosecution of that petition, then it might be appropriate for the court to dismiss the case. If it is dismissed, the rights of the parties should be determined based on nonbankruptcy law.

In Chapter 11, the situation is somewhat different. The purpose of Chapter 11 is to afford the entity the opportunity to restructure its debt and to provide a breathing spell within which it can stabilize its affairs. The underlying premise is that a rehabilitated, reorganized company is more socially useful than a liquidated one.

Because Chapter 11 involves an ongoing entity, something rarely found in Chapter 7, many environmental issues are handled differently.

Let me first discuss the Kovacs issue of what qualifies as a claim. Is a government-imposed obligation to clean up a claim? While Chapter 7 allows exceptions to discharge, there are very few such exceptions in Chapter 11. The reorganized corporation indeed has a fresh start, and is relieved of substantially all obligations that arose not only prior to, but also during, the Chapter 11 proceeding.

At first blush, it might appear that the issue of whether or not a claim for cleanup costs is an administrative claim is somewhat academic. After all, if a debtor will be discharged of that liability under the Bankruptcy Code, regardless of whether the claim is pre-petition or administrative, what does it matter? Things, however, are not that simple. While the statute says that all liabilities of the reorganized entity arising prior to confirmation are discharged, Section 1129(a)(9)(A)⁹ requires that administrative-expense claims must be satisfied in full in order for a plan to be confirmed.

We must determine, then, whether there is a claim. In this light, what if the government waits until after the commencement of the Chapter 11 case to order a cleanup? This example returns us to the impact of Sections 362(b)(4) and (b)(5). If a debtor continues to operate, and in so doing, continues to pollute, and the government seeks a cease and desist order to prevent a violation of state or federal law, then under Section 362(b)(4) the government is free to do so. This policy is also reflected in 28 U.S.C. § 959, which requires a trustee and a debtor in possession that continues to operate to comply with those laws that would be applicable outside of Chapter 11.

What happens, however, if the government order is not merely to cease and desist but also to clean up the existing pollution? Do Sections 362(b)(4) and (b)(5) apply? There is disagreement on this point. Some cases suggest that if a debtor is required post-petition to clean up a hazardous waste site, that obligation represents a money judgment. By this logic, while the government can obtain an order directing the cleanup, it may be stayed from enforcing that judgment.

In Revere Copper,¹⁰ the court suggested that 28 U.S.C. § 959 is not immutable. Accordingly, while a debtor normally must comply with nonbankruptcy law if it continues to operate, a court may in the exercise of its discretion enter an injunction where compliance with that federal or state law would interfere with the reorganization process.

It could also be argued that, even where an order to a debtor to clean up a hazardous waste site occurs during the course of a proceeding, circumstances alone should not trigger an obligation to clean up, nor, for that matter, give rise to an administrative expense claim. It should be considered whether the claim truly arose post-petition. One must keep in mind that under the Bankruptcy Code a "claim" can be a fixed claim, a noncontingent claim that existed when the petition was filed, or a contingent, unliquidated claim. One case suggests that, to determine whether a contingent, unliquidated claim is to be viewed as a pre-petition claim, one looks to nonbankruptcy law to see whether the claimant had the pre-petition right to assert that claim.¹¹

Other cases, though, suggest that such a standard is improper. For them, the question is whether the underlying acts — the underlying basis — for that claim arose pre-petition or post-petition.¹² In environmental terms, if the underlying contamination arose pre-petition, while the direction to clean it up arose post-petition, it can surely be argued that it is a pre-petition claim and should be dealt with as such. There is, however, considerable uncertainty in this area.

In economic terms, if the government's claim for a cleanup is viewed as an administrative expense in a Chapter 11 case, the cost for the average toxic waste site may be $ 12 million. At some sites, the uncertainty as to cost may range from $ 5 million to $ 25 million. The imposition of such claims upon a debtor could significantly impair its ability to reorganize, since administrative-expense claims must be satisfied dollar for dollar.

In addition, such claims could also impair the debtor's ability to finance its Chapter 11 case. One of the most typical problems that a Chapter 11 debtor has is liquidity. Lenders will often lend money to Chapter 11 debtors in exchange for priorities and security provided by the court. If recognized, these administrative-expense claims could severely hinder the debtor's ability to finance.

Often, there is serious question whether cleanup costs should be viewed as an administrative expense. In order for a claim to be afforded administrative-expense status, it must arise from the provision of some benefit to the estate. If the cleanup costs relate to a particular operation of the debtor's [18 ELR 10358] that is otherwise unprofitable, there is serious question as to whether the government should be entitled to an administrative-expense claim.

In some cases, the government regulatory authorities have claimed that they should be entitled both to administrative-expense status and — to the extent that the property subject to the cleanup action is secured — to a priming. Under Section 506(c) of the Bankruptcy Code,¹³ trustee can assert an administrative-expense claim against collateral with regard to actions taken by the trustee to preserve that property and benefit the secured creditor. The agencies have argued that where cleanup costs incurred by the government enhance the value of property subject to liens, this expense is to the benefit of the secured creditor. By this logic, the government should be entitled to a priming of priority against that property — a priming, that is, of the secured creditor's lien. This view strikes me as improper, particularly since numerous cases hold that under bankruptcy law one cannot force a secured creditor to incur costs relating to its property without its consent.

The issues I have raised will ultimately be resolved in a typical Chapter 11 process. A Chapter 11 case is often quite dynamic. In such cases, the Bankruptcy Code frequently serves as a backdrop to the process, and the problems that arise are resolved through concensus.

Finally, I would like to discuss the issue raised by Mirabile.¹⁴ This case suggests that, where creditors play an extensive role in the operations of the debtor, they may be subject to the costs of environmental cleanup. In Chapter 11, creditors often assume more extensive control over the operations of the debtor than they would otherwise. Chapter 11 encourages such monitoring to ensure that the debtor's activities are consistent with the creditor's interests. I would ask whether the drafters of Chapter 11 ever intended to expose creditors to such significant liabilities.

In closing, the issues I have raised are unlikely to be resolved quickly. In addition, they are economic issues, and so they do not carry the urgency generally accorded to matters of public safety. I wish only to heighten public sensitivity to them.

1. 11 U.S.C. §§ 101 et seq.

2. 11 U.S.C. §§ 701-766.

3. 11 U.S.C. §§ 1101-1174.

4. 11 U.S.C. § 507(a)(1)(A).

5. 11 U.S.C. § 362(b)(4).

6. 11 U.S.C. § 362(b)(5).

7. Ohio v. Kovacs, 469 U.S. 274 (1985), 15 ELR 20121.

8. Midlantic National Bank v. New Jersey Department of Environmental Protection (In re Quanta Resources, Corp.), 474 U.S. 494 (1986).

9. 11 U.S.C. § 1129(a)(9)(A).

10. In re Revere Copper and Brass, Inc., 32 B.R. 725 (S.D.N.Y. 1983).

11. In re M. Frenville Co., 744 F.2d 332 (3d Cir. 1984).

12. See, e.g., In re A. H. Robbins Co., 63 B.R. 986 (E.D. Va. 1986); In re Baldwin-United Corp., 48 B.R. 901 (Bankr. S.D. Ohio 1985); In re Johns-Manville Corp., 57 B.R. 690 (Bankr. S.D.N.Y. 1986).

13. 11 U.S.C. § 506.

14. United States v. Mirabile, 15 Envtl. L. Rep. (Envtl. L. Inst.) 20994 (E.D.Pa. 1985).