Whenever buyers and sellers negotiate environmental cleanup obligations under a real estate purchase agreement, they must consider what will happen if the party bearing the cleanup obligations files for bankruptcy. This article examines the practical implications for such buyers and sellers following a recent federal district court decision that held that a debtor’s bankruptcy ended its contractual obligation to clean up environmental contamination, the buyer’s past response costs could be treated as a general unsecured claim (meaning being paid pennies on the dollar with other unsecured creditors), and future cleanup costs were contingent claims disallowed under bankruptcy law. Route 21 Associates of Belleville, Inc. v. MHC, Inc., 2012 WL 6625280 (S.D.N.Y. Dec. 19, 2012).
1. The Background Facts.
In 2009, the debtor, MHC, who is the successor in interest to Kidde Industries, Incorporated, and an affiliate of Lyondell Chemical Company, filed a voluntary Chapter 11 bankruptcy petition. Twenty-six years earlier, in March 1983, Route 21 purchased property in Belleville, New Jersey from the debtor. Route 21 discovered contamination at the site, which the debtor cleaned up and later warranted that the site was free from contamination. In 1991, however, Route 21 discovered additional contamination from a leaking underground storage tank at the site. Route 21 sued the debtor under the New Jersey Spill Compensation and Control Act. In 1996, the parties settled. Under the settlement, the debtor was required to remediate the site under the direction of the New Jersey Department of Environmental Protection (“NJDEP”) to obtain a no further action letter, and to indemnify Route 21 for any environmental cleanup liability resulting from the debtor’s violations.
The remediation work had still not been fully performed as of 2004. Hoping to sell the property, Route 21 applied to the NJDEP for an agreement under New Jersey’s Brownfield and Contaminated Site Remediation Act. (The Act is intended to provide remediation and redevelopment of underutilized or abandoned commercial sites to make them marketable to commercial purchasers.) Under the Brownfield Agreement, Route 21 agreed to take over the remediation work (then estimated to cost approximately $3.1 million), and NJDEP agreed to reimburse Route 21 for 75% of the remediation costs.
In 2007, Route 21 and the debtor added an addendum to their 1996 settlement agreement to take into account the Brownfield Agreement. Under the addendum, the debtor continued to be responsible to maintain all monitoring wells, recovery wells, vapor recovery systems or other treatment facilities; to remove the systems upon completion; to sign certifications for offsite disposal of wastes; to reimburse Route 21 for the remaining 25% of necessary and proper response and remediation costs; and in the event of a sale of the site, to assume responsibility for completing the remedial work plan for groundwater contamination and to obtain the no further action letter.
Route 21’s proposed sale never closed, and it still owns the property. In response to the debtor’s bankruptcy, Route 21 filed a proof of claim seeking to recover in excess of $1 million for soil and groundwater remediation work and offsite disposal costs, and to have the debtor pay its 25% share of future groundwater remediation costs ($1.65 million of a newly estimated $6.6 million in costs). Additionally, NJDEP filed a proof of claim seeking more than $19 million for past and future environmental cleanup costs at a number of the debtor’s sites, including the site at issue.
2. Executory Contracts May Be Discharged.
Route 21 appealed the bankruptcy court’s adverse rulings to the district court, which upheld the bankruptcy court’s determination that Route 21’s agreement with the debtor was an executory contract that could be, and had been, rejected in the bankruptcy case. Generally speaking, executory contracts are contracts in which performance remains due to some extent on both sides. Under the Bankruptcy Code, the debtor may, with court approval, reject any executory contract, subject to certain exceptions. 11 U.S.C. § 365(a). More importantly, when an executory contract is rejected under Section 365, it is treated as if the contract had been breached immediately before the date of the bankruptcy petition’s filing. This makes the claim arising upon rejection a pre-petition claim. Under bankruptcy law, a bankruptcy court’s confirmation of a plan of reorganization discharges the debtor from liability on such claims, leaving the creditor with only a distribution under the plan of the pro rata value of the claim. In contrast, when a debtor owes an obligation that is not a claim, the obligation is not discharged in bankruptcy, and the debtor remains obligated to pay the claim despite the bankruptcy filing.
Because Route 21 had previously argued that the agreement was an executory contract, the district court held that Route 21 had waived its right to argue otherwise. Nevertheless, in order to be thorough, the district court analyzed whether the contractual obligations constituted a “claim” that the debtor could properly discharge in bankruptcy.
3. Claims That Do Not Arise From Injunctions Under RCRA Or An Equivalent State Law May Be Discharged.
Route 21 also argued that its claims were not dischargeable in bankruptcy based on case law concerning clean up obligations imposed by statutory injunctions. The issue here is whether the obligation of the debtor to perform clean-up tasks is a “claim” for the purpose of bankruptcy law. If the obligation was determined to be a “claim”, then the debt arising for the failure to fulfill such obligation can be discharged in the debtor’s bankruptcy case. Conversely, if the failure to perform the obligation was not a “claim”, the obligation could not be discharged because only claims are dischargeable in bankruptcy. Route 21 asserted that the debtor’s obligations were not dischargeable citing cases in which courts have concluded that the obligation to remediate contaminated property was a “claim” and thus a non-dischargeable obligation.
Both the bankruptcy court, and the district court on appeal, rejected Route 21’s argument, finding that all the cases were distinguishable because none entailed a remedy that gave rise to a right to monetary payment. Rather, each involved a debtor subject to equitable obligations imposed by a statute, that did not allow the claimant to seek monetary reimbursement from the debtor. By contrast, the courts found that the debtor’s obligation arose from a private contract that contains no such limitation. Route 21, 2012 WL 6625280, *9.
The district court also looked to the Seventh Circuit’s decision in United States v. Apex Oil Co., in which U.S. EPA sued Apex under the Resource Conservation and Recovery Act of 1976 (“RCRA”) and obtained an injunction requiring the debtor to clean up the contaminated site. 579 F.3d 734, 735 (7th Cir. 2009). The Seventh Circuit noted that RCRA only entitled the plaintiff to require the defendant to clean up the contaminated site at defendant’s expense and did not entitle the plaintiff to clean up the site and then seek monetary reimbursement. Id. at 736-737. Apex’s obligation, imposed by an injunction obtained under RCRA, could not be characterized as giving rise to a right to payment and therefore was not a claim that could be discharged in bankruptcy. Id.
The district court determined that “the existence of a ‘right to payment’ is the decisive factor in this line of cases.” Route 21, 2012 WL 6625280 at *10. The district court also relied on In re Chateaugay Corporation, 944 F.2d 997 (2d. Cir. 1991), which held that because the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (“CERCLA”) gave U.S. EPA the option to clean up the contamination and sue for response costs, it had a right to payment, which was a claim capable of being discharged in bankruptcy. The district court additionally focused on the exception to this body of case law that holds that an injunction against bringing further toxic waste to the premise or against any conduct that will contribute to the pollution at the site is not dischargeable in bankruptcy. But the district court noted that nothing in the parties’ agreement resembled an order imposed by U.S. EPA, a state, or a court to enjoin continued pollution.
In the end, the district court observed:
“Apex Oil, Torwico1, and Chateaugay can therefore be synthesized, as one court in this district has noted, to establish that “the proper test for determining whether an enforcing agency has a ‘right to payment’ … for an environmental injunction is to consider whether the enforcing agency has a right to cleanup and recover expense costs under the statute pursuant to which the enforcing agency obtained its injunction.”
Route 21, 2012 WL 6625280, * 10.
The district court, therefore, rejected Route 21’s bid for specific performance because it never obtained an injunction under a statute that bars it from seeking reimbursement for cleanup costs, but was instead trying to enforce cleanup obligations based on a breached contract.
4. Practical Implications For Buyers And Sellers.
This decision serves as an important reminder that whenever you are considering whether to enter into a contract with a party to investigate and remediate environmental contamination, you should consider whether the party has the financial resources and longevity to fulfill its obligations. Any doubt should lead you to consider alternative methods to protect against failure of the other party to perform. Such alternatives can include: (1) adjusting the purchase price; (2) staging of purchase price payments based upon compliance; (3) obtaining other collateral to secure the obligation to perform; (4) requiring a guaranty or indemnification from the seller personally or from someone other than the seller; or (5) whether environmental insurance to pay for the cleanup can be purchased or is assignable by seller to the buyer.
1 In Re Torwico Elecs. Inc., 8 F.3d 146 (3rd. Cir. 1993).
*This article originally appeared in Law360.