When Considering Bankruptcy, Don't Forget About Environmental Obligations

With economic downturn comes bankruptcy. It is often observed that the intersections between the U.S. Bankruptcy Code and environmental law can create conflict, because while many federal and state environmental statutes seek to hold parties responsible for contamination, in some cases, many years after a release has occurred, the Bankruptcy Code seeks to offer debtors a fresh start. There is little U.S. Supreme Court case law to guide courts in this area, and these matters are often highly fact-dependent, leading to variation in how different jurisdictions will treat similar issues. Depending on the concerns facing your organization, it may be important to bring environmental attorneys into the conversation early in the Chapter 11 process. This alert highlights a number of key topics, but by no means represents an exhaustive summary of the challenges that can arise in this complex area of the law.

One important consideration is whether an environmental claim or obligation will be subject to the automatic stay. Section 362(a) of the Bankruptcy Code mandates that pre-petition claims of creditors are automatically stayed, triggered by the filing of the bankruptcy petition.¹ There is an exception to the automatic stay for a governmental entity's commencement or continuation of an action within its police or regulatory power.² An action to collect a monetary judgment, however, will be stayed.³

A Chapter 11 debtor must comply with environmental laws prior to filing its plan of reorganization – and afterwards, if it remains in possession.⁴ Analysis of the police and regulatory power exception to the automatic stay is not only highly fact-dependent, but similar facts are sometimes analyzed differently by courts in counterintuitive ways, highlighting the importance of engaging counsel familiar with this area of the law in your jurisdiction.⁵

Generally, the automatic stay will not be effective against proceedings to fix penalty amounts, natural resource damage amounts or involving the share of costs to be allocated to a "Potentially Responsible Party" (PRP) under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA).⁶ In considering whether such claims fall within the police and regulatory power exception to the automatic stay, most courts will employ one or both of two tests – the pecuniary purpose test and public policy test.⁷ Under the pecuniary purpose test, reviewing courts focus on whether the proceeding relates primarily to the government's pecuniary interest or to matters of public safety, with matters of public safety falling within the exception to the automatic stay. Under the public policy test, courts except proceedings effectuating public policy from the stay, whereas those adjudicating private rights (for example, a government agency's suit to recover from a contractor who failed to deliver goods) will be stayed.⁸

The automatic stay will, however, be effective against the enforcement of monetary judgments, even if such enforcement is in furtherance of the government's regulatory powers, because otherwise, the government would receive unfair treatment compared with other creditors.⁹ For example, efforts to collect a PRP's share of CERCLA cleanup costs will be stayed.¹⁰

Chapter 11 allows debtors to discharge all claims arising before the bankruptcy petition.¹¹ The Bankruptcy Code defines a "claim" as a "right of payment" or "right to an equitable remedy for breach of performance if such breach gives rise to a right of payment."¹² The meaning of this definition in the context of environmental obligations has been the subject of considerable – and at times inconsistent – interpretation by courts.

After a Chapter 11 debtor has reorganized, the organization will still need to comply with environmental laws.¹³ Accordingly, orders addressing ongoing pollution will often not be dischargeable.¹⁴ There are cases where courts have refused to confirm a reorganization plan because the debtor did not satisfactorily demonstrate that it could comply with environmental laws if allowed to remain in possession after reorganization.¹⁵ Courts are sometimes skeptical, however, of attempts by government agencies to collect a monetary claim arising from a pre-petition act of the debtor by characterizing the claim as a regulatory action to address ongoing pollution.¹⁶ Monetary claims related to pre-petition releases, including natural resources damages, are generally dischargeable in bankruptcy.¹⁷ This includes claims brought by the government ¹⁸ and those brought by private parties.¹⁹

Fines or penalties payable to a government agency, however, may not be dischargeable in bankruptcy.²⁰ There is noteworthy variation in how different courts have treated fines and penalties. A recent Delaware case found that pre-petition penalties for air emission violations were dischargeable claims.²¹ In contrast, other courts have not only refused to allow penalties to be discharged, but have granted them first priority payment as administrative expenses that are "actual, necessary costs and expenses of preserving the estate."²² These courts have characterized fines and penalties,²³ or even administrative and legal costs incurred by a state agency in arranging remediation efforts,²⁴ as part of the "cost of doing business" for the debtor, and therefore benefiting the estate, while other courts have found that penalties that seek to "punish and deter" do not benefit the estate and therefore should not receive administrative expense priority.²⁵

Another common issue is whether an environmental injunction, consent order, or other such obligation related to pre-petition activities of the debtor constitutes a pre-petition claim dischargeable in bankruptcy. Factors courts examine include (1) whether the debtor is capable of performing the cleanup, (2) whether the pollution is ongoing, and (3) whether the environmental agency has an option under the applicable environmental statute and regulations to remedy the problem itself and seek reimbursement from the debtor.²⁶

In considering whether the debtor is capable of performing the cleanup, some courts focus on whether the debtor has access to the property, with the ability of the debtor to access the property weighing towards finding a non-dischargeable obligation rather than a dischargeable monetary claim.²⁷ Other courts consider whether the debtor can personally complete the actions required by the injunction, reasoning that any expenditure of money makes an injunction the equivalent of a monetary claim.²⁸ Most courts, however, recognize that almost all injunctions require some money to be spent,²⁹ and one court even found that a requirement to pay a performance bond did not constitute a monetary claim, because the purpose of the bond was to ensure the debtor's performance under the order, not to reimburse costs incurred by the state.³⁰

The issue of whether pollution is ongoing can sometimes be dispositive, as courts are reluctant to allow an ongoing threat to human health or the environment.³¹ For example, where a debtor's predecessor had improperly drained wetlands, and a state agency sought to require the debtor to build new replacement wetlands in another location, the court found that the agency was, in essence, seeking "compensation for past misconduct," not seeking an order ameliorating ongoing pollution.³² The court distinguished these facts from cases where hazardous waste is continuing to migrate into waterways unabated. ³³ In another case, an injunction requiring a debtor to remove asbestos from buildings was dischargeable, because the asbestos would create a hazard only if removed or disturbed, and therefore, its presence did not qualify as ongoing pollution.³⁴

Cases discussing whether the U.S. Environmental Protection Agency (EPA) or a state agency could opt to complete the desired action itself and seek reimbursement highlight the importance of understanding the underlying environmental statutes. For example, under CERCLA, EPA has the option to remediate a contaminated site and then sue PRPs for response costs, so an order to clean up a site, to the extent that it imposes obligations beyond any obligation to stop ongoing pollution, will be a dischargeable claim.³⁵ In contrast, under other statutes, such as the Clean Water Act or the Resource Conservation and Recovery Act (RCRA), where the government has no such option to seek payment, an injunction will not likely be found to be a dischargeable claim. ³⁶ Courts conduct a similar analysis of state statutes.³⁷

A further wrinkle is that the threshold question of whether a claim arose pre-petition, and is therefore even potentially dischargeable, can be complicated for environmental claims, especially for contingent claims, such as claims seeking future response costs and future natural resource damage costs. Different jurisdictions apply different tests to determine when a claim arose, with many endorsing the "fair contemplation" approach.³⁸ In In re Jensen, the U.S. Court of Appeals for the Ninth Circuit held that all future response and natural resource damage costs based on pre-petition conduct that can be "fairly...