Understanding and Planning for How Bankruptcy Might Impact Responsibility for Environmental Liabilities
This article examines the sometimes uneasy intersection between laws addressing responsibility for environmental liabilities and the protections afforded to debtors under the United States Bankruptcy Code. Following a number of industrial related environmental incidents and mishaps, in 1976 Congress passed the Resource Conservation and Recovery Act of 1976 (“RCRA”), by which Congress intended to reduce generation of toxic and hazardous wastes and ensure the proper disposal, treatment, and storage of such wastes. Soon thereafter in 1980, Congress passed the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (“CERCLA”) to redress decades of unregulated contamination by imposing cleanup costs on contaminators.1 Liability for violations of these statutes effectively transforms an entity into an environmental debtor of federal or state governments, or both.
In the same time period Congress created the U.S. Bankruptcy Code (the “Code”), which codified a legal regime that previously only existed as common law.2 A fundamental goal of bankruptcy is to give a debtor a “financial fresh start.”3 A second goal of the Code ensures that similarly situated creditors will receive equal treatment in recovering claims from the debtor.4 To effectuate these two goals, the Code contains several provisions related to the timing, amount, and status of distributions from a debtor’s estate.5 As discussed in this article, the Code’s plain language and twin goals can pose unique challenges in the context of the somewhat conflicting statutory mandates of RCRA and CERCLA.6
I. The Conflicting Goals of Bankruptcy and Environmental Laws
The “fresh start” offered by the Bankruptcy Code is achieved through a defined process that assesses a debtor’s liabilities and minimizes the burden of such liabilities on the debtor outside of the bankruptcy process.7 In carrying out this goal the Code and bankruptcy courts attempt to:
identify and reduce to a dollar amount all of the debtor’s pre-bankruptcy debts; to divvy up the debtor’s assets fairly for a final distribution on account of such debts, and to enable the debtor to emerge from the process with a fighting chance at future profitability. The more debts that are resolved through the bankruptcy, the less burden the debtor will have thereafter.8
Several specific Code provisions are intended to achieve the “fresh start” goal.9 These provisions include establishing what a “claim” is and whether the claim is subject to the bankruptcy process, implementing an automatic stay on collection of debts, and establishing an administrative expense and priority scheme.10 Manifesting the purpose of the “fresh start” goal by invoking these various provisions, however, can conflict with the goals of RCRA and CERCLA, whose purposes are to identify potentially responsible parties (“PRPs”) and assess the cost of cleanup against those deemed responsible for harming the environment and jeopardizing human health.11
A. Environmental Injunctions and Clean Up Orders in Bankruptcy “Claims”
In keeping with the “fresh start” goal, the Code broadly defines those types of items classified as a “claim” to include as many debts as possible within the debtor’s bankruptcy discharge.12 A claim includes: (1) any right to payment, regardless of whether the right has been reduced to a judgment or is liquidated, contingent, legal, equitable, etc.; or (2) any right to an equitable remedy for breach of performance, if the breach would give rise to a right to payment.13 Despite the Code’s broad definition of a claim, only those items that would create a right to payment of money are a “claim” within the meaning of the Code.14
Because only “claims” are dischargeable in bankruptcy, only those liabilities of the debtor properly classified as a right to payment will be discharged.15 The liabilities that fail to come within the Code’s definition of a “claim” survive bankruptcy and a debtor is still liable for such claims after discharge.16 Courts thus have had to grapple with the question of whether injunctions and clean up orders under RCRA and CERCLA are “claims” for purposes of the Code.
Generally, courts have held that a debtor’s obligation to comply with a RCRA or CERCLA clean up order or injunction is not a right to payment.17 Because these obligations do not amount to a right to payment they are not a “claim” within the meaning of the Code and remain in place, unaffected by a debtor’s bankruptcy discharge.18 Less clear is the treatment of a RCRA or a CERCLA clean up order or injunction that in bankruptcy has the effect of a money judgment.
Two cases, Ohio v. Kovacs and a subsequent Second Circuit case, Chateaugay I, seem to create two propositions regarding clean up orders that have the effect of a money judgment.19 First, when an injunction or court order, even impliedly, converts equitable relief to a money judgment, such an order is then a “claim” within the meaning of the Code.20 Because the once equitable relief is now a claim, it is also subject to the discharge provisions of Chapter 7 and Chapter 11, permitting a debtor-PRP to reduce its environmental liabilities in bankruptcy.21 Second, because only those injunctions that can be reduced to a money judgment may be a “claim” and because the express statutory language of RCRA does not allow for a cause of action for a money judgment, injunctions or clean up orders under RCRA can never be a claim within the meaning of the Bankruptcy Code.22 Allowing a debtor-PRP to reduce its environmental liabilities, especially in cases like Kovacs and Chateaugay I, where the debtor knew its actions violated the law, while comporting with the meaning of the Code conflicts with the purpose of CERCLA to hold those responsible for contaminating the environment and endangering human health.
B. Automatic Stays
The automatic stay (“Stay”) afforded by Section 362 of the Code temporarily halts collection on any action against a debtor or its property by creditors the moment the debtor files its bankruptcy petition.23 This provides the debtor with financial “breathing room” and allows a debtor to identify the extent of its liabilities and create a plan to address these liabilities in its bankruptcy.24 Invoking the Stay plays a fundamental role in a debtor’s successful emergence from bankruptcy.25 Section 362, nevertheless, excepts certain types of actions from the Stay’s protection.26
One recognized exception to Section 362 is an action enforced by a governmental body pursuant to its police power.27 The Code, however, provides an exception to the governmental body police powers exception.28 While a governmental body enforcing actions pursuant to its police powers is excepted from the Stay provisions, actions by this power are not excepted if the governmental body seeks to enforce a money judgment, essentially an exception to the exception.29 But the Code fails to define what types of judgments qualify as “money judgments” within the meaning of either Section 362 or the larger Code itself.30 Accordingly, controversy arises when a governmental body takes an action, such as imposing a clean-up order or injunction that is not a money judgment on its face, but which does require a debtor-PRP to expend money to clean up a contaminated site or otherwise comply with an environmental statute.
Penn Terra, a Third Circuit case, is the leading authority analyzing the issue of whether an injunction or court order that requires a debtor to spend money is equivalent to a “money judgment” under the Bankruptcy Code.31 The Pennsylvania state Department of Environmental Protection (DEP) obtained a state court injunction requiring Penn Terra to comply with the backfill requirements to prevent toxic discharges from its coal mining operations.32 Shortly after the state court ordered the injunction, Penn Terra filed for Chapter 11 bankruptcy.33 When the DEP attempted to compel Penn Terra to comply with the injunction Penn Terra filed contempt charges against the DEP for violating the Stay.34
In defining a “money judgment” the court looked to two factors. First, the nature of the injuries the injunction sought to remedy, meaning did the injunction seek to remedy past harm—usually satisfied by money damages—or future harm, where mere payment of payment of money generally never satisfies harm done.35 Second, and ultimately, the court looked at whether the injuries are those traditionally rectified by a money judgment.36 Because the nature of the injunction prevented future harm and the “mere payment of money without more. . . could not satisfy” the backfill and topsoil injunction, the injunction remained in place unaffected by the Stay.37
In the years following the Penn Terra decision, the majority of bankruptcy courts have narrowly construed the term “money judgment” to determine when an injunction or court order may be affected by the Stay provisions by applying the two factor test delineated in Penn Terra.38
Such an interpretation balances those interests served by the Stay—preserving the value of a bankruptcy estate—with the policies behind compelling compliance with environmental regulations of protecting the public health and environment.39 The express language of Section 362(b)(4) recognizes that occasionally bankruptcy policy must yield to another authority by excepting certain actions from the Stay.40 Moreover, such an interpretation is congruent with 11 U.S.C. §959(b), which requires a debtor or trustee to manage and operate a bankruptcy estate in compliance with state law, including state environmental laws.41
C. Administrative Expense Priority
Generally, Section 507 of the Code—”Priorities”—proscribes the order by which creditors’ claims and expenses are paid out of the bankruptcy estate.42 Section 503—”Allowance of Administrative Expenses”—provides an exception to the general payment scheme in 507 for certain categories of expenses and establishes a different priority for certain types of claims in bankruptcy.43 Section 503 provides an expense priority for any goods or services rendered to the estate after the date of filing, or rather “post-petition,” that are “[ ] actual, necessary, costs and expenses for preserving the estate.”44 In order to obtain an administrative expense the goods or services rendered to the estate must (1) be actual, (2) be necessary, (3) preserve the estate, and (4) occur post-petition.45 Claims and expenses outside of these four criteria do not meet the special priority requirements and are subject to the priority payment established in Section 507. The Code’s Section 503 administrative expense priority criteria cause a handful of conflicts with the practical abilities to remediate environmental contamination.
Initially, the provision requires the expense to be “actually” incurred.46 In many instances, however, environmental claims are highly prospective or even completely unknown when the debtor-PRP files bankruptcy.47 As a result, there often are no post-petition expenses “actually” incurred that are directly traceable to the particular bankruptcy estate because either a link has yet to be established between the contamination and the estate or the contamination is still undiscovered. Further, actions causing environmental contamination often occur pre-petition, ceasing either before the debtor files its petition.48 Because this contamination ceases before the debtor files its petition, the liability does not meet the fourth criteria of occurring “post-petition” and therefore cannot receive a payment priority under Section 503.49 Lastly, an action causing contamination may have occurred entirely pre-petition, but response costs may have only been incurred post-petition. In these instances, courts have struggled with what priority to assign such claims.50
Courts have determined that monetary claims for response costs wholly incurred pre-petition or for future response costs arising out of wholly pre-petition actions causing contamination do meet the four criteria required under Section 503(b)(1)(A) to be an administrative expense.51 Accordingly, costs or expenses incurred as a result of these wholly pre-petition expenses or actions causing contamination are general unsecured claims paid according to the priority established by Section 507.52 Less evident is the priority assigned to environmental liabilities when the actions causing contamination occurred wholly pre-petition, but the costs to clean up the contamination occurred wholly post-petition.
Across the federal circuits a trend has developed in how to determine when post-petition clean-up costs for wholly pre-petition actions may be entitled to an administrative expense claim. Generally, clean-up costs, for example CERCLA response costs (in essence, costs of remediating environmental contamination), will receive an administrative expense claim if (1) the contamination poses an imminent threat to public health and the environment or (2) to bring a debtor-PRP’s site into compliance with applicable environmental laws.53 Granting an administrative expense for these releases, because they pose an imminent harm to public health, acknowledges the balance between the policies of the Code and those of the environmental statutes as discussed by the Third Circuit in Penn Terra, albeit in a context involving different sections of the Code.54
Likewise, courts grant an administrative expense priority for the cost to bring a site into compliance with environmental laws because compliance with these laws is a “benefit” to the estate, i.e., one that in effect has “preserved” the estate by conferring such a beneficial interest upon it.55 Allowing this priority makes it less likely that the public will end up footing a huge bill for response costs because they are given a priority, as opposed to being a general unsecured claim, which regularly do not get paid in bankruptcy because of shortfalls in the estate.
II. The Next Big Issues in Bankruptcies Involving Environmental Liabilities
The next battlegrounds for environmental liabilities in bankruptcy will likely stem from bankruptcies involving wind farms and oil and gas operators that have employed hydraulic fracturing, or “fracking.” Both of these industries have experienced massive growth in the last decade but share characteristics that commonly lead to bankruptcy.56 Wind power as a source for electricity on a large scale, at least in the United States, is in many ways still a developing technology. Profitably harnessing wind has largely depended on the federal Production Tax Credit (“PTC”).57 The PTC provides an income credit on a wind developer’s bottom line, on a per kilowatt hour (“kwh”) basis.58 Once passed by Congress the PTC runs for a period of 10 years.59 For projects beginning construction on or before December 31, 2013, the PTC was $.023 per kwh.60 While seemingly small, this amount is often the difference between a developer’s breaking even or losing money in the first 10 years of the project.61 In fact, even with this credit in place it takes the majority of wind farms 10 years to break even at current electricity prices.62 Additionally, wind developers tend to be highly leveraged, generally putting down less than 10 percent of the total cost of a farm.63
Currently, the per turbine “installed cost” of the average turbine in the U.S., meaning a turbine with a 2.0-2.5 kilowatt (“kw”) rating, costs $1 million dollars.64 Depending on the physical location of the turbine, offshore or onshore for example, turbines are 200-500 feet in height, utilize 60 acres per installed kwh, and contain a vast array of moving metal parts and lubricating liquids for proper operation of the turbine65 As a result, proper, yet costly, maintenance of these turbines is critical to ensuring protection of human and environmental health. Given the nature of the industry as one whose profitability is largely intertwined with the political climate, highly leveraged, capital intensive, and subject to the volatile commodities market, wind farm developers are potential candidates for bankruptcy because even a small downward move in the price of electricity could significantly impact a developer’s bottom line.
Oil and gas production in shale or expired fields via the fracking process involving directional drilling on a large scale is a relatively recent phenomenon, even though fracking itself has been employed for several decades. Although not directly reliant on any single targeted tax credit to break even, like wind, fracking is an expensive technology.66 The cost to frack a single oil well can be as high as $6.4-$13 million dollars.67 Accordingly, to break even in fracking, it is generally believed that oil must remain above the $100 per barrel mark.68 Moreover, producers in the fracking business tend to be highly leveraged, and access to this credit is the result of the sustained high price of oil.69
In terms of the actual process, fracking utilizes “frack fluid”—a mixture of water, chemicals and propants injected at high pressure to prop open subterranean rock spaces so that oil may flow out after the frack fluid is withdrawn.70 Fracking is generally understood to at least create a potential for environmental contamination if there is inadequate “casing” of the wells to protect water bearing formations passed through to get to the deeper zones being fracked. Fracking is likewise capital intensive, highly leveraged, and risky. Because in many instances the bankruptcy courts do not uniformly recognize the underlying policy interests of environmental statutes and because the nature of these industries makes them vulnerable to market changes, it is wise to consider protection outside of the Code to guard against potential environmental contamination.
III. Means of Avoiding Environmental Liability Issues in Bankruptcy
One way to manage environmental liabilities outside of the Code’s protections is for parties to employ removal or restoration bonds in their contractual dealings. Removal or restoration bonds may be provided for in a wind or oil and gas lease and require the lessee to post a bond to ensure that when operations cease, the surface of the land is restored to its pre-existing state and all subterranean matter used in operations is also removed from the land.71 When the lessee must post the bond is also important. While the lessee need not post the bond before or even immediately after the commencement of operations, it is important that a lessee post the bond sooner, rather than later.72 The exact timeframe depends on the term of years of the particular lease and the break-even point for the industry.73
Next, it is important to specify the credit rating of the bonding company in the lease. A removal or restoration bond is no good if the bonding company itself is also experiencing a cash shortfall.74 Last, the lease must require the bonding company to be a third party non-affiliate of the lessee. In the event of a bankruptcy the affiliated bond would likely collapse into the property of the estate under Section 541 of the Code.75 Once collapsed into the estate the bond would be available as payment to secured and other creditors in compliance with Sections 507 and 503 and any environmental liabilities would very likely receive general unsecured claims status against the estate, making payment unlikely.76
In lieu of a removal or restoration bond, a lessee could also obtain a security interest in a certificate of deposit (“CD”) for an agreed upon amount to ensure surface restoration and protect against any environmental damage that may occur from operations on the lessee’s property.77 A developer, however, is less likely to commit to a CD because it ties up large amounts of capital. In the past, escrow accounts have been used to combat restoration and environmental concerns. Escrow accounts, like a bond from an affiliated company, would collapse into the bankruptcy estate and once collapsed would be available to secured creditors, rather than general unsecured creditors, the likely status of a lessee-environmental creditor in bankruptcy.78
Planning for bankruptcy during the negotiation process involving a wind or oil and gas lease while the lessee is still solvent provides the parties with the best chance of ensuring protections against environmental liabilities and the inadvertent loss of those protections due to the desirable, but sometimes conflicting, goals of the Code and the laws ensuring environmental protection and responsibility.
- 1. Sandra Franco and Melissa Murray, Treatment of Environmental Liabilities in Bankruptcy, (1999), http://www.bingham.com/Publications/Files/2011/04/Treatment-of-Environmental-Liabilities-in-Bankruptcy.
- 2. United States Courts, Bankruptcy Basics,
http://www.uscourts.gov/FederalCourts/Bankruptcy/BankruptcyBasics/Process.aspx (last visited March 30, 2014).
- 3. Id.
- 4. Lisa E. Waisbren, Abandonment of Toxic Wastes Under Section 554 of the Bankruptcy Code, 71 Marq. L. Rev., 353 (1986).
- 5. See Waisbren, supra note 4 at 354.
- 6. A detailed discussion of the RCRA and CERCLA legal regimes, which are used here as examples of environmental laws, and exactly how environmental laws give rise to liabilities that may or may not become the subject of bankruptcy proceedings under the Code, are generally beyond the scope of this article.
- 7. See Franco, supra note 1 at 343.
- 8. Id.
- 9. Id.
- 10. See id. at 344-47.
- 11. Id. at 341.
- 12. See 11 U.S.C. §105(A)-(B) (2013).
- 13. Id.
- 14. Id.
- 15. 11 U.S.C. §727(b); 11 U.S.C. §523(a)(3); 11 U.S.C. §1141.
- 16. See 11 U.S.C. §727(b); 11 U.S.C. §1141.
- 17. AM Int’l v. Datacard Corp., DBS, Inc., 106 F.3d 1342 (7th Cir. 1997); In re Chateaugay I, 944 F.2d 997 (2d Cir. 1991); In re Torwico Elec., Inc., 8 F.3d 146 (3d Cir. 1993).
- 18. AM Int’l, 106 F.3d at 1342; Chateaugay I, 944 F.2d at 997; Torwico, 8 F.3d 146.
- 19. Ohio v. Kovacs, 469 U.S. 274, 279 (1985); Chateaugay I, 944 F.2d at 997.
- 20. Chateaugay I, 944 F.2d at 999.
- 21. 11 U.S.C. §727(b) (2013); 11 U.S.C. §523(a)(3)(2013).
- 22. 42 U.S.C. § 6972(a); see Kovacs, 469 U.S. at 278; see Chateaugay I, 944 F.2d at 997.
- 23. 11 U.S.C. §362(a)(1)-(8) (2013).
- 24. See 11 U.S.C. §362(a)(1)-(3) (2013).
- 25. Penn Terra Ltd. v. Dep’t of Envt’l Resources, 733 F.2d 267, 271 (3d Cir. 1984).
- 26. 11 U.S.C. §362(b) (2013).
- 27. 11 U.S.C. §362(b)(4) (2013).
- 28. Id.
- 29. Id.
- 30. See 11 U.S.C. §101; see 11 U.S.C. §362 (containing no definition for “money judgment”).
- 31. Penn Terra Ltd., 733 F.2d at 267; City of New York v. Exxon Corp., 932 F.2d 1020 (2d. Cir. 1991) is another leading circuit case addressing whether compelling the debtor-PRP to comply with an injunction is the equivalent of a money judgment stayed by section 362. The Second Circuit paralleled Penn Terra’s reasoning to determine expenditure of money alone does not convert an injunction to a money judgment stayed by section 362. Id.
- 32. Penn Terra Ltd., 733 F.2d at 267.
- 33. Id. at 270.
- 34. Id.
- 35. Id. at 278.
- 36. Id.
- 37. Id.
- 38. New York v. N. Storonske Cooperage Co., 174 B.R. 366 (N.D.N.Y. 1994); Chateaugay I, 944 F.2d at 997.
- 39. Penn Terra Ltd., 733 F.2d at 278.
- 40. Id.
- 41. 28 U.S.C. §959(b)(2013).
- 42. 11 U.S.C. §503 (2013).
- 43. Id.
- 44. 11 U.S.C. §503(b)(1)(A) (2013) (emphasis added).
- 45. Id.
- 46. Id.
- 47. See Franco, supra note 1 at 351.
- 48. See id.
- 49. See id.
- 50. See id.
- 51. In re Nat’l Gypsum, 139 B.R. 397 (N.D. Tex. 1992); In re Mahoney-Troast Construc. Co., 189 B.R. 57 (Bankr. D.N.J. 1995).
- 52. In re Nat’l Gypsum, 139 B.R. at 397; In re Mahoney-Troast Construc. Co., 189 B.R. at 57.
- 53. Chateaugay I, 944 F.2d at 1010-11; In re Conroy, 24 F.3d 568 (3d Cir. 1994); In re Wall Tube & Metal Prod. Co., 831 F.2d 118, 123-124 (6th Cir. 1987).
- 54. Penn Terra Ltd., 733 F.2d at 278.
- 55. Wall Tube & Metal Prod. Co., 831 F.2d at 123-124.
- 56. Asjylyn Loder, Dreams of U.S. Oil Independence Slams Against Shale Costs, http://www.bloomberg.com/news/2014-02-27/dream-of-u-s-oil-independence-slams-against-shale-costs.html (last visited March 30, 2014); Database for State Renewables & Efficiency,
http://dsireusa.org/incentives/incentive.cfm?Incentive_Code=US13F (last visited March 30, 2014).
- 57. George Humphrey, Partner, Andrews Kurth, LLP, Guest Lecturer at Texas Tech School of Law: Wind Financing and Lease Agreements, (Mar. 11 & Apr. 17, 2014)
- 58. Id.
- 59. See Loder, supra note 56; see Database for State Renewables & Efficiency, supra note 56.
- 60. Id.
- 61. Humphrey, supra note 57.
- 62. Id.
- 63. Id.
- 64. Id.
- 65. Id.
- 66. Loder, supra note 56.
- 67. Id.
- 68. Id.
- 69. Id.
- 70. FracFocus, Hydraulic Fracturing and How it Works, http://fracfocus.org/hydraulic-fracturing-process (last visited March 30, 2014).
- 71. Humphrey, supra note 57.
- 72. Id.
- 73. Id.
- 74. Id.
- 75. 11 U.S.C. §541 (2013).
- 76. Nat’l Gypsum, 139 B.R. at 397; Mahoney-Troast Construc. Co., 189 B.R. at 57.
- 77. UCC §9-203 (2013).
- 78. 11 U.S.C. §541 (2013).
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