The Discharge of Environmental Claims in Bankruptcy

what is a discharge in bankruptcy

Author: Michael H. Reed

This article appeared first in October 2002 in The Practical Lawyer. It is reprinted here with permission.

A LITTLE OVER 20 YEARS AGO, Congress enacted two important federal statutes, the Bankruptcy Code (1978, effective 1979) 11 U.S.C. 101 et seq. and the Comprehensive Environmental Response, Compensation and Liability Act (Superfund Act) 42 U.S.C. 9601 et seq. commonly known as "CERCLA." The central theme of the Bankruptcy Code is to give honest debtors a "fresh start" by releasing them from liability from unduly burdensome debts. CERCLA and related federal and state environmental statutes (the Environmental Laws) are aimed primarily at preventing and cleaning up pollution and making the polluters or other responsibleparties bear the cleanup costs.

The Bankruptcy Code puts a premium on quickly identifying and quantifying the assets and liabilities of the debtor, including claims held by and against the debtor. In contrast, the environmental laws put a premium on cleaning up pollution as rapidly as possible, allocating the cost of cleanup widely among "potentially responsible parties" and leaving final determinations of liability and allocations of cost among the responsible parties to the future.

Protecting our natural environment remains an important national policy. The importance of a national system of debtor relief has been evident since the founding fathers, under the U.S. Constitution, authorized Congress to promulgate "uniform laws on the subject of bankruptcies." Given their mutual importance and the competing statutory schemes, it was inevitable that the Bankruptcy Code and the environmental laws would collide.

THE COLLISION • The Bankruptcy Code and the environmental laws do, in fact, frequently point in different directions. Some of the "intersections" of conflict are:

• The bankruptcy "automatic stay" versus the enforcement of police and regulatory powers to prevent ongoing environmental hazards;

• Whether and when environmental cleanup costs incurred by the government or private parties to clean up contamination caused by the debtor should be afforded "administrative expense priority" under the Bankruptcy Code;

• Whether a bankruptcy trustee or debtor should be permitted or required to use the limited resources of a liquidating bankruptcy estate to clean up environmental contamination that presents no imminent threat of harm to the public;

• Whether the property of a bankruptcy estate may be sold "free and clear" of environmental cleanup liability;

• Whether and when environmentally contaminated property may be abandoned by a bankruptcy trustee;

• Whether disputes over the assessment of environmental cleanup costs should be decided by the bankruptcy court or an administrative agency;

• Whether and when environmental claims may be discharged in bankruptcy.

Bear in mind that when the environmental laws apply in a particular bankruptcy case, they are likely to impact the case in a number of ways. For example, an environmental protection agency’s claim for reimbursement of money it spent during a Chapter 11 case to abate ongoing pollution caused by the debtor usually will be allowed as an administrative expense of the debtor’s estate. Since administrative expense claims generally must be paid in full when the debtor’s Chapter 11 plan is confirmed, the agency probably won’t care that its reimbursement claim will also be "discharged" under the plan.

With the foregoing background in mind, we will focus in this article on the discharge of environmental claims in bankruptcy. Our discussion is divided into four general parts:

• What is the bankruptcy discharge?

• What is an "environmental claim"?

• When does an environmental claim arise for bankruptcy purposes?

• When is an environmental claim dischargeable in bankruptcy?

WHAT IS THE BANKRUPTCY DISCHARGE?

• The most important feature of the Bankruptcy Code is the comprehensive discharge of debts afforded to honest debtors. The discharge is intended to afford the debtor a "fresh start" in its post-bankruptcy business or financial affairs. In general, debtors who "reorganize" under the Bankruptcy Code, usually under Chapter 11 or Chapter 13, can obtain a more comprehensive bankruptcy discharge than debtors who "liquidate," usually in Chapter 7. Indeed, only a natural person can receive a Chapter 7 discharge. Corporations, partnerships, and other "artificial" persons cannot. See 11 U.S.C. §727(a)(1).

General Rule: The Discharge Applies to Environmental Claims

A bankruptcy discharge gives a debtor two essential things: a release from liability on all claims subject to the discharge; and an injunction preventing creditors from taking actions against the debtor to enforce the discharged claims against the debtor in the future. Although certain types of claims are excluded from the scope of the bankruptcy discharge, environmental claims, as such, are not, although most federal and state environmental protection agencies probably would have it otherwise.

It is well known that the scope of the Chapter 11 discharge is very broad. It binds all creditors whose claims arose before the date the Chapter 11 plan is "confirmed" by the bankruptcy court, whether or not a creditor filed a proof of claim with the court. 11 U.S.C. §1141. It applies not only to claims that are fixed in amount and presently due but also to unmatured, unliquidated and contingent claims, including certain types of "future claims."

WHAT IS AN ENVIRONMENTAL CLAIM? • Under the Bankruptcy Code, the concept of "claim" has a very expansive meaning. A "claim" is defined as a "right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured;" or a "right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured." 11 U.S.C. § 101(5). An environmental claim usually is a:

• Right to recover money from the debtor for environmental cleanup work performed or to be performed by the government or a private party;

• Right of the government to enjoin the debtor to stop polluting or cleanup pollution; or

• Fine or penalty imposed by the government or a court against the debtor for its violation of an environmental statute or maintenance of a public nuisance.

"Arisen:" Release or Threatened Release

An environmental claim often will be unmatured, unliquidated or contingent at the time of the bankruptcy discharge. A threshold requirement for an environmental claim to be deemed to have "arisen" for purposes of the bankruptcy discharge is that there have been a "release or threatened release of hazardous substances" caused by the debtor or for which the debtor is otherwise legally accountable, for example, because the debtor owned the contaminated property. In re Chateaugay Corp., 994 F.2d 997, 1005 (2d Cir. 1991); In re Chicago, M. & St.P. & Pac. R.R., 974 F.2d 775, 785-86 (7th Cir. 1992).

WHEN IS AN ENVIRONMENTAL CLAIM DISCHARGEABLE IN BANKRUPTCY? • Some general principles have emerged from the case law. These are discussed below.

1. Constitutional Requirements

Notice of the bankruptcy discharge must comport with fundamental principles of due process. See, Jones v. Chemetron Corp. 212 F.3d 199 (3d Cir. 2000); In re Trans World Airlines, Inc.. 96 F.3d 687 (3d Cir. 1996).

2. The Claimant Must Have Knowledge or Notice of the Environmental Hazard

Courts have held that for a contingent claim for the recovery of future environmental cleanup costs to be dischargeable in bankruptcy, the claimant must have had sufficient knowledge or notice of the release or threatened release to effectively assert its rights in the bankruptcy case in a timely manner. See, Matter of Chicago. supra, 974 F.2d at 787; In re National Gypsum Co., 139 B.R. 397, 407-09 (N.D. Tex. 1992).

3. The Claimant Must Have Knowledge or Notice of the Debtor’s Liability

Courts have also held that, for a contingent claim for the recovery of future environmental cleanup costs to be dischargeable in bankruptcy, the claimant must have had sufficient knowledge or notice that the debtor was a potentially responsible party with respect to the environmental hazard to effectively assert its rights in the bankruptcy case in a timely manner. See, Matter of Chicago. supra, 974 F.2d at 787; Ninth Ave. Remedial Group v. Allis-Chalmers Corp., 195 B.R. 716 (N.D. Ind. 1996); National Gypsum. supra, 139 B.R. at 409 (N.D. Tex. 1992); U.S. v. Union Scrap Iron & Metal. 123 B.R. 831, 839 (D. Minn. 1990).

4. Cleanup Costs Incurred Prior to Bankruptcy Are Dischargeable

In general, cleanup costs incurred and penalties assessed before bankruptcy will be treated as dischargeable general unsecured claims. See 11 U.S.C. §§101(5), 1141; In re Chateaugay Corp., 112 B.R. 513 (S.D.N.Y. 1990), later proceeding In re Chateaugay Corp.. 1991 U.S.Dist. LEXIS 5242 (S.D.N.Y. Apr. 17, 1991), and aff’d 944 F.2d 997 (2d Cir. 1991).

5. The Debtor’s Legal Successor Is Not Liable for Debtor’s Discharged Debts

A debtor’s successor by merger is not liable for environmental debts of the debtor that were discharged pursuant to the debtor’s Chapter 11 plan before the merger. See In re Chicago, Rock Island and Pac. R.R. Co., 1999 U.S. Dist. LEXIS 19455 (N.D. Ill. Dec. 2, 1999), rev’d sub. nom Maytag Corp. v. Navistar Int’l Transportation Corp. 219 F.3d 587 (7th Cir. 2000)

6. Bankruptcy Discharge Does Not Affect Debtor’s Liability Under a Subsequently Enacted Environmental Statute

Environmental claims based upon statutes enacted after a debtor receives a bankruptcy discharge generally will not be affected by the discharge. See In re Penn Cent. Transp. Co., 944 F.2d 164, 168 (3d Cir. 1991), cert. denied. 503 U.S. 906 (1992); cf. In re Duplan Corp. 212 F.3d 144, 151-3 (2d Cir. 2000). However, such claims may be barred where the type of liability imposed by the new statute is the same as liability imposed under another statute which was in effect in the jurisdiction at the time of the bankruptcy discharge. See Matter of Chicago, supra, 3 F. 3d at 208; Matter of Chicago, Milwaukee, St.Paul. & Pacific R.R. Co.. 1994 U.S. Dist. LEXIS 18570 at *6- *28 (N.D. Ill. Dec. 28, 1994), mot. denied, request denied, 1995 U.S. Dist. LEXIS 10060 (N.D. Ill. July 14, 1995).

7. Indemnification Agreements

A claim for contractual indemnification against environmental liability brought against a company after it receives a Chapter 11 bankruptcy discharge will be barred if the contract was entered into before the company’s bankruptcy filing, even though the claim is based upon an environmental statute enacted after the company received its bankruptcy discharge. See Olin Corp. v. Riverwood Int’l (In re Manville Forest Products Corp.) 209 F.3d 125 (2d Cir. 2000).

8. Debtor Will Remain Liable for Contaminated Property It Continues to Own or Operate After It Receives a Bankruptcy Discharge

A debtor’s pre-confirmation obligations under the environmental laws (which may be dischargeable claims) must be distinguished from the obligations which may arise anew under such laws if the debtor continues to own or possess the contaminated property after confirmation of the plan. See Ohio v. Kovacs. 469 U.S. 274 (1985); Matter of Chicago. supra, 974 F.2d at 783; In re Chateaugay, supra, 944 F.2d at 1008-09; In re CMC Heartland Partners. 966 F.2d 1143, 1146-47 (7th Cir. 1992); Industrial Salvage v. Illinois (In re Industrial Salvage). 196 B.R. 784, 789- 90 (Bankr. S.D. Ill. 1996).

9. Debtor Might Have to Continue To Comply with an Environmental Injunction After It Receives a Bankruptcy Discharge

The right of an enforcement agency to order a debtor to perform remedial work or to obtain a court injunction to compel the debtor to

do so is a claim that can be discharged in bankruptcy if the purpose of the order or injunction is solely to "remove…wastes that are not currently causing pollution," but if the purpose of the order or injunction is to "end or ameliorate current pollution" to any extent, then the order or injunction is not a "claim" under section 101(5) of the Code and, a fortiori, the order or injunction will not constitute a dischargeable claim under section 1141 of the Code. See In re Chateaugay. supra, 944 F.2d 997 at 1006-09; but see, U.S. v. Whizco, Inc., 841 F.2d 147, 150-1 (6th Cir. 1988).

10. Debtor Might Retain Responsibility for "Ongoing Pollution" After It Receives a Bankruptcy Discharge

A debtor’s duty to abate "ongoing pollution" it caused may not only survive the debtor’s Chapter 11 discharge but may "run with the wastes" even when the debtor no longer owns or operates the site in question. See In re Torwico Electronics. 8 F.3d 146, 151 (3d Cir. 1993), cert. denied. 511 U.S. 1046 (1994). But see. Kathryn R. Heidt, Undermining Bankruptcy Law and Policy: Torwico Electronics, Inc. v. New Jersey Department of Environmental Protection. 56 U. Pitt L. Rev. 627 (1995).

11. "Channeling Injunctions" and Nondebtor Releases Might Not Bind Enforcement Agencies

Two increasingly common features of reorganization plans are the so-called "channeling injunction" and nondebtor releases. These mechanisms are usually seen in plans under which the plan proponent seeks to insulate:

• Nondebtor entities that are making substantial financial contributions to the reorganization plan from future liability for debts shared with or related to the debtor; or

• (From liability for the debts of the debtor) a transferee of property under the reorganization plan that is supposed to operate free and clear of such debts in the future.

See, e.g. New National Gypsum Co. v. National Gypsum Co. Settlement Trust (In re National Gypsum Co.). 219 F.3d 478 (5th Cir. 2000), cert. denied, 532 U.S. 1075 (2001). The proponent of a plan involving a debtor with environmental liabilities might seek to utilize a channeling injunction and/or nondebtor releases to insulate nondebtor entities making substantial contributions to the reorganization from environmental liabilities to which the nondebtors might otherwise be subject by reason of their involvement with the debtor.

Although channeling injunctions and nondebtor releases may be effective to shield third parties from environmental claims held by private claimants, the authority of a bankruptcy court to insulate a nondebtor from liability to the government under a state or federal environmental statute as part of the plan confirmation process is doubtful. See, e.g. Southern Pacific Transportation Company v. Voluntary Purchasing Groups, Inc., 252 B.R. 373, 383-85 (E.D. Tex. 2000).

A HYPOTHETICAL • To illustrate how this works, let’s consider the Ajax Chemical Company (Ajax), an industrial manufacturer. Ajax files a Chapter 11 petition, and announces that a major objective of its bankruptcy filing is to deal with "the significant and burdensome" environmental liabilities it has incurred over the years that now are precluding it "from growing its business." About two years later Ajax emerges from bankruptcy pursuant to a confirmed Chapter 11 plan of reorganization.

Before the Bankruptcy

The following events occurred before the bankruptcy case:

• Ajax stored hazardous substances at a warehouse it leases, causing environmental contamination of the facility which remains after the lease terminates and Ajax vacates the premises. Ajax’s lease requires it to indemnify the landlord (the Landlord) against all environmental liabilities;

• Ajax discharged contaminated waste water from its manufacturing plant. The waste water migrated to adjoining land owned by farmers (the Farmers) contaminating the groundwater. The waste water also migrated to a nearby stream carrying the contaminants to a river that is the primary water supply of a nearby town (the Town); and

• Ajax abandoned storage tanks containing hazardous substances at a landfill that later was designated a federal "Superfund" site by the EPA. The EPA notified Ajax and 30 other companies that they are "potentially responsible parties" (the Co-PRPs) for environmental contamination found at the site. The EPAnegotiates a five-year $5 million remedial plan for the site with Ajax and the Co-PRPs. The plan allocates responsibility for a substantial portion of the cleanup costs to Ajax. Ajax also agrees to perform a portion of the remedial work with EPAoversight. (The Landlord, the Farmers, the EPAand the Co-PRPs all receive timely notice of Ajax’s bankruptcy filing.)

During the Bankruptcy Case

As the case progresses:

• Ajax, continues to operate the plant and discharge hazardous substances onto the adjoining land;

• Smokestacks at Ajax’s plant emit particles into the air in violation of state and federal air quality standards; and

• Ajax sells a vacant tract of land to a developer (the Buyer) pursuant to an order of the bankruptcy court approving the sale "free and clear of liens, claims and encumbrances." The Buyer plans to erect an assisted living facility there. Ajax fails to disclose to the Buyer the presence of several underground storage tanks from which hazardous substances are leaking.

After the Bankruptcy Case

Once the case has ended:

• The owners of land located adjacent to a site where Ajax formerly operated a manufacturing facility (the Landowners) detect for the first time groundwater contamination traceable to hazardous substances that Ajax had used at the facility when it was operating;

• Physicians examining school children (the Children) in the nearby town begin to notice an unusual "cluster" of a rare disease associated with a hazardous chemical that Ajax had used 38 The Practical Lawyer October 2002 Environmental Bankruptcy 39 at its present manufacturing plant but stopped using several years before the bankruptcy;

• The state environmental protection agency (the State Agency) discovers large quantities of a hazardous substance at a warehouse Ajax sold before its bankruptcy to a buyer who subsequently filed its own Chapter 7 bankruptcy case during which the trustee in bankruptcy abandoned the site. (Some of the Landowners and some of the parents and legal guardians of the Children were aware of Ajax’s bankruptcy while it was pending, while others were not.

The State Agency was aware of Ajax’s bankruptcy while it was pending but did not discover the contaminated warehouse or Ajax’s "tie" to it until after the bankruptcy case was over.)

Analysis

Each of the nine fact situations described above involves one or more potential environmental claims against Ajax arising under a statute, a contract or the common law that may affect, or be affected by, Ajax’s bankruptcy. A partial analysis of the hypothetical follows:

• The Landlord has a prepetition contract claim for indemnification which is dischargeable;

• The Farmers and the Town probably have prepetition claims and may have postpetition claims of various types. Any monetary claims for cleanup costs incurred are likely to be dischargeable. Factual issues may exist about whether the contamination was detectable and traceable to Ajax before it received its bankruptcy discharge. The Town or another governmental authority probably has claims for injunctive remedies. These may be nondischargeable;

• The EPAhas a prepetition statutory claim for cleanup costs as well as a prepetition right to compel Ajax to perform that portion of the remedial plan Ajax agreed to perform. The EPA may also seek to impose fines and penalties. The Co-PRPs may have prepetition claims for "contribution" against Ajax. The EPA’s monetary claim and the Co-PRPs’ contribution claims are prepetition unsecured claims that are dischargeable in bankruptcy. The EPA’s right to compel Ajax to perform the cleanup work Ajax agreed to perform is a prepetition unsecured claim that may or may not be dischargeable. Notwithstanding the dischargeability of the EPA’s claims, as a practical matter, a bankruptcy court may be unwilling to confirm a Chapter 11 plan that permits Ajax to emerge from bankruptcy as a going concern if the plan fails to fully fund Ajax’s share of the cleanup costs and the EPA objects to the plan for that reason. The EPA, however, may be content to force the Co-PRPs to fund Ajax’s share of the cleanup work, leaving it to the Co-PRPs to pursue Ajax’s bankruptcy estate;

• The responsible governmental authorities can seek to enjoin Ajax from continuing to pollute and request fines and penalties for Ajax’s failure to comply. Ajax’s duty to cease polluting is clearly nondischargeable and any fines or penalties assessed against Ajax for violating an injunction not to pollute during the bankruptcy case also are probably nondischargeable and allowable as administrative expenses of the bankruptcy estate;

• The Buyer has an administrative priority claim for breach of contract. While that claim is enforceable against Ajax’s bankruptcy estate, it is probably also dischargeable. The ability of the Buyer to collect its administrative claim will depend upon a number of factors, including whether the bankruptcy case is closed when the Buyer seeks to assert its claim;

• The Landowners’ claims may or may not have been discharged depending upon numerous factors, including (i) the detectability of the contamination prior to Ajax’s receipt of its bankruptcy discharge, (ii) the Landowners’ knowledge or notice of Ajax’s bankruptcy and (iii) the Landowners’ knowledge or notice of Ajax’s responsibility for the contamination;

• Any personal injury claims of the Children against Ajax probably were not discharged;

• The State Agency probably has claims for money and equitable relief. Such claims may or may not have been discharged depending upon several factors, including those discussed above.

CONCLUSION • Bankruptcy discharges are a source of confusion in easy cases. Environmental cases are never easy. Thus, it can be very difficult to determine when and whether an environmental claim is discharged—or exempted from the discharge. Adding to the confusion is the expansion of environmental law on the state level. But no matter how confusing it may look, there is usually an answer in the case law.

PRACTICE CHECKLIST FOR

The Discharge of Environmental Claims in Bankruptcy

One of the most difficult things to figure out in bankruptcy cases is whether environmental claims are dischargeable. For a claim to be dischargeable, the conditions below generally have to be met.

• To determine whether the claim is dischargeable, ascertain:

• That there was adequate notice of the bankruptcy discharge. It must comport with fundamental principles of due process;

• That the claimant has knowledge or notice of the environmental hazard;

• That the claimant has knowledge or notice of the debtor’s liability;

• Cleanup costs incurred before bankruptcy (they are dischargeable);

• The debtor’s discharged debts (the debtor’s legal successor is not liable for them);

• Any subsequently enacted environmental statutes. (Bankruptcy discharge does not affect debtor’s liability under a subsequently enacted environmental statute);

• Whether there are any indemnification arrangements. A claim for contractual indemnification against environmental liability brought against a company after it receives a Chapter 11 bankruptcy discharge will be barred if the contract was entered into before the company’s bankruptcy filing;

• What other property the debtor controls. (Debtor will remain liable for contaminated property it continues to own or operate after it receives a bankruptcy discharge); and

• Are there any environmental injunctions in effect? The debtor might have to continue to comply with an environmental injunction after it receives a bankruptcy discharge. Likewise, the debtor might retain responsibility for "ongoing pollution" after it receives a bankruptcy discharge.

Michael H. Reed

Mr. Reed thanks Philip J. Katauskas for his helpful comments.

Source: www.pepperlaw.com

Category: Bank

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