Restructuring

Contributed by Conray C. Tseng
For more than a quarter century the intersection of the policy goals of the bankruptcy laws (equality of treatment of creditors and the rehabilitation of financially-troubled businesses) and the environmental laws (parties responsible for environmental contamination should pay to clean it up) has generated conflict in chapter 11 cases.  An October 21 decision by Judge Bernstein of the United States Bankruptcy Court for the Southern District of New York in In re Mark IV Industries, Inc. is the latest guidance on this topic and continues a trend of recent decisions favoring environmental policies over bankruptcy ones. 

The crux of the court’s decision Mark IV is that an order requiring a debtor to perform environmental cleanup work is not a “claim” under section 101(5) of the Bankruptcy Code, and thus is not subject to discharge in bankruptcy, if the statute under which the environmental agency elects to proceed authorizes only injunctive relief and does not provide an alternate cost-recovery remedy.  The effect of the decision is that a reorganizing debtor has to comply with a governmental cleanup order, even one issued in connection with a property which the debtor no longer owns or operates. 
Although not binding on other courts, the opinion in Mark IV builds on the decision of the United States Court of Appeals for the Second Circuit in United States v. LTV Corp. (In re Chateaugay Corp.), 944 F.2d 997 (2d Cir. 1991), and moves the law in the direction of the decisions of the Third and Seventh Circuits in In re Torwico Elecs., Inc., 8 F.3d 146 (3d Cir. 1993),and In re Apex Oil Co., 579 F.3d 734 (7th Cir. 2009), both of which resolved conflicts between the policies of the bankruptcy and environmental laws in favor of the latter and found environmental cleanup orders to be non-“claim” obligations not subject to discharge.
In Mark IV, contamination occurred during the 1970s when Mark IV’s predecessor operated an electric circuit board fabrication facility in Albuquerque, New Mexico.  Those operations resulted contamination of groundwater with solvents that had migrated through the soil.  The debtor, which no longer owned or operated the property by the time of the bankruptcy, was required to perform groundwater treatment in accordance with an abatement plan to reduce residual concentrations of contaminants.  After filing for bankruptcy, Mark IV stopped performing the remediation work required by the abatement plan. 
The New Mexico Water Quality Act authorizes the New Mexico Water Quality Control Commission to set surface and groundwater standards for the state and to adopt regulations to prevent or abate water pollution in New Mexico.  The Commission adopted regulations that require polluters, upon the discovery of pollution in excess of state or federal standards, to implement a two-step abatement plan subject to the approval of the New Mexico Environmental Department (“NMED”).  The New Mexico Water Quality Act grants NMED certain enforcement powers to implement applicable environmental regulations and oversee abatement plans.  These powers include issuing compliance orders, assessing civil penalties, and commencing a civil action for injunctive or other appropriate relief.  The New Mexico Water Quality Act does not, however, authorize NMED to clean up a property itself and seek reimbursement of remediation costs from responsible parties.
NMED filed a proof of claim in the bankruptcy on account of Mark IV’s obligations to remediate the Albuquerque property, but reserve its right to assert that the obligation was not a “claim.”  After confirmation of its plan of reorganization, Mark IV commenced an adversary proceeding seeking a declaratory judgment that its environmental liabilities related to the Albuquerque site constituted a “claim” within the meaning of section 101(5) of the Bankruptcy Code and therefore were discharged by confirmation of the plan.
Judge Bernstein considered cross motions for summary judgment and ultimately granted NMED’s motion and denied Mark IV’s.  Beginning with the premise that section 101(5)(b) of the Bankruptcy Code defines a claim to include a “right to an equitable remedy for breach of performance if such breach gives rise to a right of payment” (emphasis added), the court reasoned that, if a creditor does not have an option to accept money in lieu of the equitable remedy, the equitable obligation is not a “claim.”  Judge Bernstein further concluded that, even though the debtor will have to spend money to perform a cleanup order, that does not convert the injunction into a “right of payment” and make it a “claim.”
After examining prior case law, Judge Bernstein focused on three operative questions:

1. Is the debtor capable of executing the equitable decree, or can it only comply by paying someone else to do it (e.g., has the environmental agency seized control of the site and, accordingly, control of the clean up)?  If a debtor cannot perform the equitable duty and must pay a third-party to complete the duty on its behalf, then the duty is a “claim” subject to discharge.
2. Is the pollution ongoing?  If pollution is ongoing, the debtor must stop or ameliorate the nuisance; it does not have the option to pay money and continue to pollute.
3. If the pollution is not ongoing or if the polluter has discrete obligations to clean up accumulated waste, does the statute imposing the equitable obligation permit the environmental agency to clean up the pollution on the debtor’s behalf and seek reimbursement from the debtor?  If the environmental agency cannot perform the remediation and later seek reimbursement, the equitable duty is not a claim.

Applying this three-factor test, Judge Bernstein found that Mark IV’s obligations were not a “claim” subject to discharge.  The first factor was not determinative because the debtor had access to the site and could perform the groundwater treatment.  As to the second factor, the court concluded that disputed facts precluded summary judgment as to whether the contamination was continuing to migrate.  The driver of the decision thus was the third factor. 
Although the New Mexico Water Quality Act does not authorize NMED to clean up the site and later seek reimbursement, the New Mexico Hazardous Waste Act and the federal Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) do provide alternative cost-recovery remedies that the NMED could have asserted.  Mark IV argued that, when evaluating the remedies available to NMED, the Court should not limit its examination to the remedies available under the statute the agency chose to assert as the basis for its rights, the New Mexico Water Quality Act, but should consider all available remedies.  Judge Bernstein disagreed and held that Court was limited to the statute under which NMED elected to exercise its remedies – the New Mexico Water Quality Act.  Because the statute did not permit NMED to clean up the site and later seek reimbursement, Mark IV’s obligations were not a “claim” and, accordingly, not dischargeable.  
The court reasoned that, taken to its logical conclusion, Mark IV’s position would render all environmental obligations dischargeable claims.  If a debtor cannot clean up a site, a state or federal agency may always intervene to protect public health and seek reimbursement under applicable environmental laws or in exercise of its general police powers.  In light of this remedy, all environmental obligations would become “claims” if the court adopted Mark IV’s argument.  Of course, the converse also is true: if an environmental regulator or private party effectively can opt out of a discharge by electing to proceed under one of many environmental statutes that provide only for injunctive relief and offer no cost-recovery remedy, then few environmental obligations ever will be subject to discharge.  This seems to defeat the well-settled principle that the term “claim” is to be broadly construed to effectuate the dual policies of providing debtors a fresh start free from pre-bankruptcy obligations and equality of treatment of creditors. 
Although Mark IV may provide more clarity on the issue whether an environmental obligation is dischargeable under the Bankruptcy Code, its focus on the particular statutory remedies that an agency elects will provide an incentive for environmental agencies and private parties to assert remedies under statutes that do permit cost recovery.  By doing so, environmental creditors effectively will be able to grant themselves priority over non-environmental creditors.  Judge Bernstein’s decision seems to tip the scale in favor of environmental policy goal of requiring those responsible for contamination to clean it up and away from the bankruptcy policies of affording debtors a broad discharge from prepetition liabilities and treating all similarly-situated creditors equally. 
But it is not at all clear that the decision actually will advance the policy goals of the environmental laws.  The real cost of the cleanup will be borne not by the party that caused the contamination – the debtor – but rather by the general creditor constituency.  In the typical case of an insolvent debtor, general creditor recoveries will be reduced because the reorganizing debtor will have to satisfy its prepetition environmental obligations in full. 
To illustrate the paradox, consider the following hypothetical.  A governmental agency seeking to enforce an order to remediate an historic release of contaminants will be satisfied in full under the rule established by the Mark IV decision, but a tort claimant who suffered direct injuries as a result of the release will receive only a pro rata distribution as an unsecured creditor.  The creditor who was actually injured by the contamination thus will bear a proportionate share of the cost of cleaning it up, while the public at large and the current owner of the property, who are the actual beneficiaries of any cleanup efforts, bear none of the cost.