Recent Developments in Bankruptcy and the Cleanup of Hazardous Waste

S. Scott Massin

S. Scott Massin is an Associate Professor of Business Administration at Emory University in Atlanta, Georgia. He holds a Juris Doctor from the University of Nebraska-Lincoln and a Bachelor of Journalism degree from the University of Missouri-Columbia. He also has completed post-graduate studies at the University of Oxford, Oxford, England.

[19 ELR 10427]

Thanks to recent legislation and court decisions, bankruptcy law and hazardous waste law now overlap substantially. Bankruptcy law creates a process to convert the bankrupt's estate into cash and distribute it among creditors. Bankruptcy trustees have a fiduciary duty to maximize assets available to satisfy creditors. At the same time, environmental law seeks to make funds available for hazardous waste cleanup that is frequently expensive.

This Article outlines the general structure of bankruptcy law, and then surveys recent court decisions on the interplay between bankruptcy and hazardous waste law.¹

Background on Bankruptcy

While bankruptcy can take many forms depending on the circumstances, bankruptcies with environmental impacts are usually voluntary liquidations under Chapter 7 of the Bankruptcy Code.² It is initiated by the debtor filing a petition, which operates as an "automatic stay" against a variety of acts taken against the debtor or with respect to property of the bankruptcy estate.³ A creditor can overcome the stay in some instances, but the stay's overall effect is to demand that all collection action be channeled through the oversight of the appropriate bankruptcy court. This restraint on creditors is a major attraction when firms are considering whether to file for bankruptcy.

The stay is not a complete shield, however. It does not cover some proceedings over environmental matters, including the entry of money judgments, the prevention of business operations, and the assessment of penalties. The stay does block the government from obtaining estate property and also blocks citizen suits to enforce environmental laws.

The Trustee in Bankruptcy

Under the provisions of Chapter 7, the bankruptcy estate is administered by a "trustee" in bankruptcy.⁴ This trustee, a distinterested party, serves as a fiduciary, but the Bankruptcy Code does not stipulate the precise nature of the fiduciary relationship. Essentially, though, the trustee acts on behalf of creditors, primarily to maximize the assets available to unsecured individuals with valid claims. The trustee has wide power to use, sell, or lease the estate's property, though in doing so must comply with state environmental laws on property transfer, such as New Jersey's Environmental Cleanup Responsibility Act.⁵

Priorities of Claims

After the trustee collects and sells the estate, the proceeds are applied to pay creditors' claims. Secured claims are paid first, then unsecured claims. If environmental cleanup costs are treated as normal unsecured claims, in practice there is generally little or no money available for cleanup.

Beside selling property, the trustee also has the right to abandon property that is worthless or a "burden" to the estate.⁶ Where hazardous waste cleanup costs are high, trustees will be tempted to want to abandon the property entirely, so as not to burden the estate with the costs. In dictum, the Supreme Court in 1985 pointedly hinted that it would find this permissible, and cleanup responsibility would shift to the property's prior owner.⁷

[19 ELR 10428]

Current Issues and Recent Developments

Trustee's Power to Abandon

After hinting that trustees can abandon contaminated property, the Supreme Court in 1986 was quickly faced with whether the trustee's abandonment powers under the Bankruptcy Code could be exercised in contravention of state laws. By a narrow 5-4 majority in Midlantic National Bank v. New Jersey Department of Environmental Protection,⁸ the Court found that such state laws remain binding if they are reasonably designed to protect public health and safety.

The facts of Midlantic revolve around the Quanta Corporation's waste oil processing business at two locations: Edgewater, New Jersey and Long Island City, New York. At the Edgewater plant, the New Jersey Department of Environmental Protection (NJDEP) found that Quanta had processed oil contaminated with carcinogens, thus violating its operating permit. After negotiations had begun with NJDEP for site cleanup, Quanta filed for reorganization under Chapter 11 of the Bankruptcy Code, and after NJDEP issued an order for cleanup, Quanta filed for liquidation under Chapter 7.

The bankruptcy trustee learned that the New York site was also contaminated and moved to abandon both sites as burdensome to the estate. The New Jersey and New York state governments objected.

In ruling that state laws remain binding on the trustee, the Court noted that this was the common law doctrine before Congress revised the Bankruptcy Code in 1978, and there is no clear evidence that Congress intended to change this when it revised the Bankruptcy Code. Moreover, other provisions in the Bankruptcy Code — concededly not pertaining to abandonment — show congressional deference to state law, and the growing body of federal law on hazardous waste is evidence of Congress' concern for the environment. The Court was careful to note, however, that it did not reach the issue of "whether certain state laws imposing conditions on abandonment may be so onerous as to interfere with the bankruptcy adjudication itself.⁹

Midlantic also leaves unresolved some other very troublesome issues. What precisely should a trustee do until a bankruptcy court authorizes abandonment, and exactly what state laws or regulations apply? Is a comprehensive cleanup of the contaminated site now a prerequisite to the abandonment? If the government goes forward and cleans up a contaminated site and then requests the estate to reimburse, is abandonment prohibited as a means to avoid liability? Can the estate's funds be used to finance mandated remedial actions?

A fundamental issue is how expenses for hazardous waste cleanup are prioritized among other claims on the estate's property. By definition, there will not be enough money to go around, and someone will be left with a meritorious claim that is nonetheless left unsatisfied.

A Federal Superlien … Or Is It?

The 1986 amendments to the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA)¹⁰ added new subsections providing for federal liens. CERCLA § 107(l) creates an added lien in favor of the United States for "all costs of removal or remedial action incurred by the United States" on all affected real property that belongs to the liable party. However, these liens are of rather dubious value since they are subject to the rights of any prior purchaser, holder of a security interest, or judgment lien creditor, as perfected under state law.

Priority for Cleanup Costs as "Administrative Expenses"

Administrative expenses are the first unsecured claims to be paid, and as a practical matter, if environmental cleanup costs fall lower than this, some or all of the costs are not paid.

In In re Dant & Russell, Inc.,¹¹ the Ninth Circuit held that the landlord of property contaminated by a bankrupt tenant is not entitled to administrative priority for cleanup costs, including both costs incurred before the bankruptcy petition and costs yet to be incurred.

The bankrupt tenant, Dant & Russell, Inc., leased land for a wood treatment and storage plant from Burlington Northern Railroad Company. The Oregon Department of Environmental Quality found that the land was massively contaminated with toxic waste. Cleanup costs were estimated at $ 10 to 30 million, but Dant & Russell, Inc. had unencumbered assets of only $ 3 million. Burlington Northern filed for administrative expense priority for the cleanup at the site.

In holding that Burlington Northern was not entitled to administrative expense priority, the Ninth Circuit observed that the conduct giving rise to cleanup costs occurred before the bankruptcy petition was filed.

The Sixth Circuit reached a different result in In re Wall Tube & Metal Products Co.¹² There, the Wall Tube company manufactured metal equipment at a site in Newport, Tennessee, before shutting down in 1983 and filing for bankruptcy in 1984. After the company filed for bankruptcy, the Tennessee Department of Health and Environment conducted an extensive inspection and chemical sampling program, and sought administrative expense priority for its costs. The Sixth Circuit granted this request, citing precedent for allowing other expenses for correcting damage arising after filing for bankruptcy.

Both the Ninth Circuit in In re Dant & Russell, Inc. and the Sixth Circuit in In re Wall Tube & Metal Products Co. recognized the significance of the date of filing for bankruptcy, but they recognized it as significant in different ways. The Ninth Circuit saw it as a date to measure the conduct causing the pollution: if the pollution was caused by conduct before bankruptcy, as is typically the case, then the cleanup costs are not entitled to priority. The Sixth Circuit, on the other hand, seems to look not at when the action causing the pollution took place, but rather when the cleanup actions take place. For the Sixth Circuit, when cleanup costs are incurred after bankruptcy, as frequently happens, they are entitled to priority.

[19 ELR 10429]

Environmental Obligations That Are Discharged in Bankruptcy

In United States v. Whizco, Inc.,¹³ the Sixth Circuit found that where a bankrupt mine operator does not have the physical capacity to reclaim an abandoned mine himself, he is discharged in bankruptcy from an obligation to reclaim the mine because doing so would require the expenditure of money.

Although Whizco involved administrative orders under the Surface Mining Control and Reclamation Act rather than one of the hazardous waste laws, its central issue was whether the discharge provisions of the Bankruptcy Code apply to mandatory injunctive relief, and the reasoning seems to apply to other environmental laws as well. The Whizco court was careful to note that its decision turned on whether the bankrupt could perform the work itself or would have to spend money to have the work done by others.

Moreover, the discharge of environmental obligations will probably not be undertaken lightly by courts. In In re Combustion Equipment Associates, Inc.,¹⁴ for example, the Second Circuit declined to issue a declaratory judgment that liability for hazardous waste cleanup costs was discharged in bankruptcy. In that case, the bankrupt firm, Combustion Equipment Associates, operated two landfill sites that were contaminated with hazardous water. The Environmental Protection Agency notified the firm that it was one of about 190 potentially responsible for cleanup of the site, and the firm sought declaratory judgment that its liability was discharged.

The Second Circuit's opinion shows much ambivalence on the issue, caught by the conflicting policies of environmental laws, the Bankruptcy Code, and the Declaratory Judgment Act. Even finding that it did not want to take a stand by issuing a declaratory judgment seemed painful for the court, and it closed its opinion by noting that "we express no opinion about the outcome of other cases" if they are "based on distinguishable facts."¹⁵

Compliance With State Environmental Laws During Bankruptcy Proceedings

While the Supreme Court's holding in Midlantic National Bank¹⁶ that bankruptcy trustees must comply with state environmental law still dominates, some lower courts have shown a willingness to nibble around the edges of strict implementation of that holding. In In re Oklahoma Refining Co.,¹⁷ for example, a bankruptcy court concluded that it only had to take state environmental laws "into consideration" in ruling on motions from bankruptcy trustees, and went on to authorize a trustee to abandon contaminated property without a closure plan required under state law and over the objections of state agencies. The problem, the bankruptcy court concluded, was lack of money to pay for the cleanup, and this would persist regardless of whether the trustee abandoned the property.

Similarly, in In re Franklin Signal Corp.,¹⁸ a bankruptcy court authorized a trustee to abandon drums of hazardous waste, despite objections from state officials that this would violate state law, reasoning that Midlantic required only that precautionary measures be adopted to ensure that there is no imminent danger to the public.

In cases such as these, courts have judged the merits of state environmental laws with a surprisingly stricter scrutiny than that usually accorded health and safety legislation. At the same time, however, courts seem uneasy enough that they reserve that judgment for themselves rather than ruling that trustees can make decisions on when to comply with state environmental laws.

Conclusion

Conflicts between bankruptcy law and environmental law seem inevitable. By definition, there is not enough money to satisfy everyone's legitimate claims, so the issue becomes which innocent claimants get stuck with the loss. Viewed in this light, creating special rights for government environmental agencies and special priorities and liens for environmental expenses is not necessarily the enlightened social policy. Doing so focuses the risk of loss, rather than spreading it out among innocent parties, even though in other legal fields, such as tort, the modern trend is to spread the risk of loss.

For now, perhaps the most that can be said is that courts seem to be feeling their way through the policy conflicts haltingly and hesitantly. The best advice for individual corporations is to try to avoid this issue in the first place. Lenders ought to inquire into environmental issues before making loans, for example, and certainly an environmental audit is appropriate before foreclosing on industrial property. Similarly, government can help to avoid the issue through vigorous environmental enforcement of ongoing, industrial operations, so as to minimize the problems left when some of them become bankrupt.

Even so, sorting through the environmental obligations of bankrupts is likely to occupy environmental and bankruptcy lawyers for years to come.

1. For an earlier summary of this topic, see Drabkin, Moorman, and Kirsch, Bankruptcy and the Cleanup of Hazardous Waste: Caveat Creditor, 15 ELR 10168 (1985). See also Openchowski, Bankruptcy is Not an Answer: A Rebuttal, 15 ELR 10314 (1985); Morris, State Enforcement of Environmental Laws Against Bankrupt Entities, 16 ELR 10143 (1986).

2. The Bankruptcy Code is codified at 11 U.S.C. §§ 101-1330. Chapter 7 is at 11 U.S.C. §§ 701-766.

3. 11 U.S.C. § 362.

4. 11 U.S.C. § 321. The trustees' duties are listed at 11 U.S.C. § 704.

5. 1983 N.J. Laws 330, codified at N.J. STAT. ANN. § 13-1K6 et seq. But see text accompanying notes 16-18, infra.

6. 11 U.S.C. § 554. Notice and hearing is required for abandonment.

7. Ohio v. Kovacs, 469 U.S. 274, 15 ELR 20121, 20123 n.12 (1985). In some circumstances, even abandoning the property may not relieve the bankruptcy estate from liability for cleanup costs. See Drabkin, Moorman, and Kirsch, Bankruptcy and the Cleanup of Hazardous Waste: Caveat Creditor, 15 ELR 10168, 10181 (1985).

8. 474 U.S. 494, 16 ELR 20278 (1986).

9. Id. at 507, 16 ELR at 20281.

10. 42 U.S.C. § 9601-9675, ELR STAT. CERCLA 001.

11. 853 F.2d 700, 18 ELR 21312 (9th Cir. 1988).

12. 831 F.2d 118, 18 ELR 20013 (1987).

13. 841 F.2d 147, 18 ELR 20571 (6th Cir. 1988).

14. 838 F.2d 35, 18 ELR 20494 (2d Cir. 1988).

15. Id. at 41, 18 ELR at 20497.

16. See supra text accompanying note 8.

17. 63 Bankr. 562, 16 ELR 20998 (1986).

18. 65 Bankr. 268, 17 ELR 20369 (1986).