A Bankruptcy Case Littered with Environmental Issues

Co-authored by Edward Wu
There is a natural tension between the environmental laws, which seek to hold a polluter responsible for remediation, and the general principles of a fresh start and equality of treatment of similarly situated creditors that are the foundation of the Bankruptcy Code.  A recent decision by the District Court for the Southern District of New York, Route 21 Assocs. of Belleville, Inc. v. MHC, Inc., addresses several issues at the intersection of the environmental laws and the bankruptcy laws and is a useful primer on many of the key issues.
Before the debtor in MHC filed for chapter 11, it sold a property in Belleville, New Jersey to Route 21.  Route 21 subsequently discovered contamination on the property and sued the debtor under the New Jersey Spill Compensation and Control Act.  The parties entered into a settlement agreement in which the debtor agreed to remediate the site to the extent necessary to obtain a “no further action letter” from the New Jersey Department of Environmental Protection and also agreed to indemnify Route 21 for any environmental clean-up liability.  Several years later, after making arrangements to overtake the remediation to expedite a potential sale of the property, Route 21 entered into another agreement with the debtor under which the debtor agreed to reimburse Route 21 for 25% of the remediation costs (NJDEP was to reimburse Route 21 for the other 75%) and to perform certain tasks in the remediation of the site.
The sale of the property by Route 21 did not materialize and Route 21 continued to own the property at the time the debtor subsequently filed for chapter 11.  As part of the bankruptcy court’s resolution of Route 21’s claim, the court (i) denied Route 21’s cross motion for specific performance under the agreements; (ii) ruled that no portion of Route 21’s claim was entitled to administrative priority; and (iii) disallowed, pursuant to section 502(e)(1)(B) of the Bankruptcy Code, the portion of Route 21’s claim relating to future remediation costs.  On appeal, the district court affirmed each of the bankruptcy court’s rulings.
Entitlement to Specific Performance
In affirming the ruling that Route 21 was not entitled to specific performance under the agreements, the district court began its analysis by explaining that the confirmation of a plan of reorganization discharges a debtor from all liabilities that can be characterized as “claims” and typically leaves creditors with only a pro rata slice of the assets available for distribution under the plan.  If the obligation owed by the debtor does not constitute a “claim,” it is not subject to discharge and the reorganized debtor retains that obligation for a creditor to later enforce.  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 to payment.”  The debtor’s obligation to Route 21 to perform the cleanup would be treated as a “claim” if it “gives rise to a right to payment.”
In finding that the debtor’s contractual cleanup obligations did give rise to “a right to payment,” the district court relied on Ohio v. Kovacs, the Supreme Court’s seminal decision on the treatment of environmental obligations in bankruptcy.  In Kovacs, the state of Ohio obtained an injunction ordering Kovacs to clean up a hazardous site.  When Kovacs failed to do so, a receiver was appointed to take possession of the property.  In Kovacs’ ensuing bankruptcy case, Ohio sought a declaration that Kovacs’ duty to remediate the site was not a dischargeable claim because it did not give rise to a right to payment.  Rejecting this argument, the Supreme Court held that, because Ohio had already dispossessed Kovacs’ of the property, the state  was merely seeking to defray its own costs to pay for the clean-up.  Accordingly, the Supreme Court held that Kovac’s obligation could be satisfied through the payment of money and the cleanup obligation therefore was a dischargeable “claim” in bankruptcy.
The district court in MHC distinguished several recent cases that seemed to establish a trend in case law limiting the circumstances where cleanup obligations imposed by statutory injunction would be treated as a claim.  One case is United States v. Apex Oil Co., a decision by the Seventh Circuit where a debtor’s clean-up obligations under the Resource Conservation and Recovery Act (“RCRA”) were held not to be dischargeable.  The Seventh Circuit’s holding was based on the reasoning that RCRA requires a defendant to perform remediation at his own expense and does not allow a plaintiff to perform remediation itself and seek monetary reimbursement.  The debtor’s clean-up obligations did not constitute a dischargeable claim because there was no right under the statute to seek reimbursement of costs; the only remedy available was an order requiring performance of the cleanup.
In contrast to Apex, the creditor in MHC did not obtain an injunction under a statute that bars if from seeking reimbursement for clean-up costs.  Instead, Route 21 was seeking specific performance on a private contract that did not at all bar it from seeking monetary reimbursement.  This situation, according to the district court, was more comparable to In re Chateaugay Corp., where the Second Circuit held that the EPA’s claim under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) was dischargeable because the statute gave the EPA the option of either (i) ordering the responsible party to remediate, or (ii) obtaining reimbursement after remediating the site itself.
Accordingly, the district court affirmed the ruling that Route 21 was not entitled to specific performance.
Entitlement to Administrative Priority
The district court also affirmed the bankruptcy court’s ruling that no portion of Route 21’s claim was entitled to administrative priority, not even the portion relating to cleanup costs that Route 21 expended after the petition date.
Administrative priority is addressed under section 503 of the Bankruptcy Code and includes “the actual, necessary costs and expenses of preserving the estate . . .”  Citing a Second Circuit decision, the district court stated that administrative priority is only available (1) where a claim “arises out of a transaction between the creditor and the bankrupt’s trustee or debtor in possession,” and (2) “to the extent that consideration supporting the claimant’s right to payment was both supplied to and beneficial to the debtor-in-possession in the operation of the business.”
Critical to the determination of whether Route 21 was entitled to administrative priority was the fact that Route 21, rather than the debtor, owned the property after the bankruptcy filing.  The Second Circuit stated in Chateaugay that remediation costs may be entitled to administrative priority as such costs “are necessary to preserve the estate in the sense that they enable the estate to maintain itself in compliance with applicable environmental laws.”  According to the district court in MHC, costs spent to remediate property that the debtor did not own at any point after the bankruptcy filing are not costs necessary to preserve the estate.  The district court’s reasoning in MHC is consistent with the view that administrative priority treatment for cleanup costs may otherwise be appropriate when the debtor owns the property postpetition, due to the requirement that a debtor must operate its property in accordance with applicable law even after its bankruptcy filing.  Accordingly, the district court held that Route 21’s expenses were not beneficial to the debtor’s estate and therefore were not entitled to administrative priority.
Disallowance of Future Remediation Costs
While the bankruptcy court found that Route 21 had an allowed general unsecured claim for remediation costs already incurred, it disallowed the portion of the claim relating to future remediation costs under section 502(e)(1)(B) of the Bankruptcy Code.  The district court also affirmed this ruling.
Section 502(e)(1)(B) provides that “the court shall disallow any claim for reimbursement or contribution of any entity that is liable with the debtor on . . . the claim of a creditor, to the extent that . . . such claim for reimbursement or contribution is contingent as of the time of allowance or disallowance of such claim.”  As the district court noted, the section was enacted primarily to prevent duplicative recoveries to both an underlying creditor and a guarantor for the limited assets of the estate.
In order for a claim to be disallowed under the statute, three elements must be established: (i) the claim must be for reimbursement or contribution; (ii) the party asserting the claim to be disallowed must be liable with the debtor to an underlying claimant; and (iii) the claim to be disallowed must be contingent as of the time of its disallowance. 
As to the first element, the district court held that Route 21’s claim was for reimbursement or contribution despite the assertion by Route 21 that its claim was in the nature of restitution or indemnity.  Citing to Black’s Law Dictionary, the district court stated that the definition of reimbursement includes indemnification, and similarly, the definition of indemnity includes the concept of contribution.
As to the second element, that Route 21 is co-liable with the debtor to an underlying claimant for the cleanup, the district court rejected assertions by Route 21 that it was an “innocent purchaser” that could not be liable with the debtor.  In the first instance, Route 21 had taken a contradictory position at certain points in the case when it represented that it faced untold liability for the remediation.  Second, Route 21 had entered into a stipulation during the bankruptcy case with NJDEP and the debtor providing that any claims allowed as to the site would be treated as one claim to be apportioned between NJDEP and Route 21 per whatever arrangement they would later agree on.  According to the district court, the stipulation served the purpose of preventing duplicative recoveries to Route 21 and NJDEP from the estate on account of the site, which presupposes that Route 21 is co-liable with the debtor on account of the site.
Finally, the district court held that Route 21’s claim was contingent for the purposes of section 502(e)(1)(B).  While Route 21 argued that its claim was not contingent because the contamination had already occurred, numerous cases, including several from the Southern District of New York, have held that a claim is contingent under section 502(e)(1)(B) until a creditor such as Route 21 actually pays the liability owed to the underlying claimant for which it is seeking contribution or reimbursement.  Accordingly, the district court affirmed the disallowance of Route 21’s future remediation costs.
While the MHC case did not break new ground in explaining the intersection of bankruptcy and environmental law, the case reinforces the recent trends in this complicated area and provides a neat summary of the interaction in several contexts between two legal frameworks that do not always mesh well together.