Restructuring

Retired U.S. Bankruptcy Judge Robert E. Gerber once observed that “issues as to the interplay between environmental law and bankruptcy are among the thorniest on the litigation map.”¹  Difficulties navigating this interplay largely stem from the inherent conflict between the goals of bankruptcy and environmental laws, with the former aimed at providing debtors with a fresh start, while the latter cast a broad net to hold parties (even some innocent parties) responsible for past harm to the environment.  The navigational task is made all the more difficult by the fact that the bankruptcy code speaks not a word as to the treatment of debts and obligations arising from environmental laws or stemming from the release of hazardous substances.  As a result, courts must balance the competing objectives of bankruptcy and environmental laws with little guidance from Congress. 

Despite the fact that modern environmental laws have been on the books for over 40 years, and that bankruptcy laws were first enacted in the earliest days of the Republic, relatively few courts have had occasion to opine on the treatment of a bankrupt debtor’s environmental liabilities.  As such, those stuck at the intersection of bankruptcy and environmental law often lack clarity as to how or whether a debtor’s environmental liabilities can be addressed through a restructuring. 

This is particularly true when the issues concern contaminated property owned by a debtor.  In the past, debtors owning contaminated real property generally had three options. One option, if the debtor was reorganizing, was to keep the property, but that would mean that any contamination liability would pass through the bankruptcy unaffected.  This is because, under the U.S. Comprehensive Environmental Response, Compensation, and Liability Act and similar state statutes, an owner or operator of real property is liable for any onsite contamination, regardless of fault.     

The second option was to sell the property, though finding a buyer willing to take full responsibility for liabilities arising from contaminated land often can be difficult, even under the best circumstances.  Finding a buyer willing to purchase contaminated land through a bankruptcy process involves many additional complications, including the need for court approval, heightened scrutiny of a buyer’s ability to perform any required remediation by environmental regulators, and the fact that debtors will rarely, if ever, provide a buyer of real estate with any contractual protections, such as indemnification.  Even if the property can be sold, the debtor may still face some liability for any contamination it caused. 

The third option was to attempt to negotiate a settlement with environmental regulators where the property would transfer to a trust, though the few past settlements of this type generally have required debtors to prepay into the trust the full amount of the expected cleanup costs, plus some contingency.  Given the inherent uncertainties in trying to negotiate a settlement with environmental agencies, combined with the fact that it typically makes more financial sense to fund environmental cleanup costs over the long periods of time that remediation often takes to complete rather than in one upfront lump-sum, this third option rarely has been a viable choice. 

A fourth option, often contemplated but almost never attempted, was to abandon the property under Section 554 of the bankruptcy code.  While the bankruptcy code provides debtors with a clear process for abandoning property that is burdensome to the estate, restrictions placed by the U.S. Supreme Court on the ability to abandon contaminated real property, coupled with questions about where title to the abandoned property would sit after abandonment, meant that abandonment was rarely seen as a viable means for addressing liabilities associated with contaminated land. 

Two recent bankruptcy cases, however, have opened some doors for debtors and their advisors to explore other options for addressing environmental liabilities.  As discussed in detail below, developments in the pending chapter 11 case of Exide Holdings Inc. (“Exide”) have both expanded the universe of cases where an environmental trust may provide an avenue for relief, as well as provided much needed clarity on when and under what circumstances a debtor may abandon contaminated real property under section 554 of the bankruptcy code.  In a separate case, involving defense contractor Wellman Dynamics Corporation (“Wellman”), the debtor and one of its secured creditors were able to negotiate a novel settlement with state and federal environmental regulators, which largely escaped press attention, that facilitated the sale of the debtor’s operations, including heavily contaminated land, under an arrangement where the buyer would fund remediation efforts based on an ability-to-pay formula tied to revenues generated from the acquired operations.  While dire circumstances in both cases no doubt contributed to the unique results, the outcomes suggest that there may be more options available for debtors seeking to address liabilities arising from contaminated real property than previously thought.         

In re Exide Holdings Inc.

Exide, once one of the world’s largest producers and recyclers of lead-acid batteries, sought protection under chapter 11 of the bankruptcy code in May 2020.  The company, which was founded in 1888 and developed the batteries for the U.S. Navy’s first modern submarine in 1898 and NASA’s first lunar landing module in 1969, was facing significant liquidity issues.  This was driven in part by over $200 million of environmental liabilities associated with 23 shuttered industrial sites and other ancillary non-performing properties, or “NPP” sites, which Exide continued to own at the time of the filing.  While Exide’s operating production facilities ultimately would be auctioned off during the pendency of the case, disposing of the NPP sites would prove to be perhaps the most significant barrier to confirming a plan of reorganization. 

Exide knew at the outset of the case that the NPP sites, spread across 11 U.S. states and one Canadian province, were likely to be a major headache.  For years, Exide had tried to find someone to buy the properties, but given that most of the NPPs had known environmental liabilities, it had been unable to do so.  The odds of finding buyers for all of the NPPs during a chapter 11 case that, given liquidity constraints, had to be completed within a few months were exceeding low.  Complicating matters further, Exide barely had enough cash available to keep the lights on at the NPP sites, even after receiving its debtor-in-possession financing, let alone enough to perform even a fraction of the required environmental remediation. 

It was clear before the case was filed that Exide had only two options for dealing with the NPP sites and the associated environmental liabilities: it could attempt to negotiate an orderly transfer of the properties to state regulators through some sort of consensual arrangement or it could move to abandon the properties pursuant to section 554 of the bankruptcy code.  Finding a consensual resolution was the preferred option, but it was far from clear whether Exide could negotiate a settlement with over a dozen different governmental agencies in only a few months’ time.  One major hurdle to a negotiated settlement was the fact that Exide had almost nothing it could offer state regulators to entice them to take the properties, and there was no legal mechanism available to compel them to do so.  While Exide had procured surety bonds totaling $62 million to backstop environmental obligations at certain of the NPP sites, the governmental agencies were entitled to those proceeds in the event of a default, regardless of whether they settled with Exide.  Moreover, the surety companies that provided the bonds were certain to fight any deal that shifted the financial responsibility squarely onto their shoulders.  Nevertheless, Exide realized that moving to abandon the 23 NPPs and their environmental liabilities was guaranteed to result in protracted litigation, which could delay the sales of the production assets, consume precious available cash and jeopardize the ability to confirm a plan.  

Implementing Settlement Procedures

With cash running out and the planned filing date approaching, Exide settled on a novel plan to compel the environmental agencies to negotiate with the debtors over the fate of the NPPs that would allow other aspects of the case to move forward.  As part of its first day motions, Exide moved for the bankruptcy court to establish procedures that would require regulatory agencies to enter into settlement negotiations with the debtors over the ultimate fate of the NPP sites and their associated environmental liabilities, and if those negotiations failed, the parties would be required to enter into mediation.  The entire process, as proposed, would play out over approximately two months, which would, if nothing else, delay any fight over abandonment and hopefully buy enough time to facilitate the sale of the production assets, saving thousands of jobs.  After a hearing to consider the request, the court approved Exide’s settlement procedures motion with minor modifications that were agreed to by all of the applicable regulators.       

Exide and representatives from 11 states, along with the U.S. Environmental Protection Agency (“EPA”) represented by the Department of Justice, promptly began discussions over the fate of the NPP sites.²  It soon became clear to all that the situation was dire: the debtors rapidly were running out of money and soon would lack the funds necessary to perform even the most basic activities at the NPP sites to protect human health and the environment.   While the agencies appreciated the gravity of the situation, the negotiations did not bear fruit, and the parties entered mediation as called for in the court-approved settlement procedures. 

A panel of five mediators conducted multiple mediation sessions over the course of a month with all interested parties, including not only the debtor and the environmental regulators, but also Exide’s secured and unsecured creditors and the surety providers. Following these sessions, the mediators made a proposal for the comprehensive resolution of all open issues among the stakeholders.  The proposal called for the NPP sites to be placed into trusts managed for the benefit of the environmental regulators, which would be funded with the proceeds from the surety bonds, along with a $10.1 million cash contribution from Exide’s secured creditors.  While the cash and surety proceeds combined would not cover the full cost of remediating the NPP sites, it was expected that proceeds from the sale by the trusts of sites it remediated could be used to fund most of the remediation at other locations.   After several days of deliberation, every one of the interested parties announced support for the mediators’ proposal.

All sides quickly went to work documenting the agreed arrangement, while representatives from the state agencies navigated their bureaucracies to obtain the necessary internal approvals to finalize the settlement.  After nearly six weeks of back-and-forth, the final proposed settlement agreement was filed with the court for approval.  Then, three days after the settlement agreement had been filed, representatives from California announced that the state’s governor had decided to withdraw from the deal. 

Abandoning Vernon

Exide and the other interested parties worked tirelessly over the following days and weeks to salvage the deal it had negotiated, all of whom ultimately agreed to move forward on substantially similar terms.  Importantly, the revised deal left open the option for California to re-enter the settlement and have the California property, along with $26.5 million in financial assurance that Exide was required to maintain for the benefit of California regulators, transferred to the trust overseeing remediation at other NPP sites.  California’s withdrawal from the original deal, however, meant that Exide would need to litigate whether it could abandon the one NPP site in the state, which was located in the City of Vernon, just south of downtown Los Angeles.  If Exide was not able to abandon the Vernon property, and California was unwilling to re-enter the settlement, Exide’s entire plan of reorganization was likely to fall apart. 

Exide viewed the Vernon property as the most complicated, and challenging, in its NPP portfolio.  The Vernon site had operated as a lead-acid battery recycling facility from 1922 until 2014, when Exide shut down the plant.  Lead battery recycling is a dirty business that generates significant amounts of lead dust.  We now know that lead is a toxic substance that can cause harm to humans, but for much of Vernon’s operating history, those dangers were not well understood.  As such, efforts to control lead dust present at the Vernon facility were not particularly robust for most of its operational history.  This resulted in significant lead contamination throughout the facility and, allegedly, at as many as 10,000 homes in surrounding communities.  Exide estimated the cost to clean up the facility alone was likely to approach $75 million. 

Environmental conditions at the Vernon site raised significant questions as to whether Exide could legally abandon the property.   Under Section 554 of the bankruptcy code, a debtor “may abandon any property of the estate that is burdensome to the estate or that is of inconsequential value and benefit of the estate.”³  There was no question that Vernon was burdensome to the estate.  Exide was in the process of demolishing the site, and the former lead smelter was encapsulated under a massive plastic tent designed to control releases of lead dust while demolition work took place.   Estate costs to maintain the tent (which was prone to crack and tear under the hot California sun), combined with the cost to rent the necessary scaffolding, along with the air emissions monitoring equipment it was required to deploy, and conduct the daily inspections it was required to perform, were running approximately $800,000 a month.  In fact, Vernon’s maintenance costs alone amounted to two-thirds of the budget to maintain the entire 23-site NPP portfolio.  It was the most burdensome property in the estate.      

The U.S. Supreme Court, however, has recognized an exception to a debtor’s abandonment authority.  In the case of Midlantic National Bank v. New Jersey Department of Environmental Protection (“Midlantic”), the Court ruled that:

The Bankruptcy Court does not have the power to authorize an abandonment without formulating conditions that will adequately protect the public’s health and safety. Accordingly…we hold that a trustee may not abandon property in contravention of a state statute or regulation that is reasonably designed to protect the public health or safety from identified hazards.⁴ 

The Court also noted in a footnote that “[t]his exception to the abandonment power vested in the trustee by § 554 is a narrow one…The abandonment power is not to be fettered by laws or regulations not reasonably calculated to protect the public health or safety from imminent and identifiable harm.”⁵ 

The Court’s conclusion in Midlantic arguably is a little unclear.  Was the Court saying that under no circumstances could a debtor or trustee abandon property in contravention of a state law that is reasonably calculated to protect the public health or safety from imminent and identifiable harm?  Or was the Court holding that this general prohibition could be overcome if the court formulated conditions to protect the public?  Subsequent lower court decisions interpreting Midlantic had focused primarily on whether conditions at the property to be abandoned present imminent and identifiable hazards to public health or safety.⁶  There was virtually no case law assessing what conditions a debtor or court might formulate to address such hazards to the point where abandonment would be permissible.

When the issue of Vernon’s abandonment came before the bankruptcy court, it was unsurprising then that California argued in favor of a bright-line test, asserting that abandonment could not be permitted under Midlantic because conditions at the site presented a threat to human health and safety, and that abandoning the property would violate numerous state statutes.   Exide essentially conceded that the site could present a risk to the public and that abandoning the property would violate state laws, but argued that the condition of the Vernon site at the time of the hearing did not present an imminent risk to human health and safety because of actions Exide had taken in the past, including the installation and maintenance of the massive tent over portions of the site.  And while it was true that, over time and without proper maintenance, the tent could deteriorate to the point where lead dust might be released, the debtor asserted that an orderly abandonment of the Vernon property to California environmental regulators (or a trust managed for their benefit) would provide the state with access to the $26.5 million in financial assurance that could be used to maintain the site in a safe condition for the foreseeable future.  In essence, Exide was arguing that its plan had formulated the conditions necessary to protect the public from any imminent harm that might arise from the abandonment of the Vernon property. 

Due to the delays caused by California’s withdrawal from the settlement, and the fact that the Vernon abandonment was the last major unresolved issue in the case, the bankruptcy court scheduled oral arguments over the Vernon abandonment for the plan confirmation hearing.  After two days of testimony and argument, Judge Christopher Sontchi sided with Exide, permitted the abandonment of the Vernon property, and confimed Exide’s plan of reorganization.  Judge Sontchi found that “[t]he issue is not whether the lead at Vernon is dangerous – it is.  The question is whether abandonment of the site presents an imminent danger – it does not.”⁷   The judge based his conclusion on evidence that demonstrated the lead contamination was contained and that contractors who had been working with Exide to keep the site safe were willing and able to continue performing their services for the State of California, which would have the financial assurance funds to pay them.  In addition, Judge Sontchi ordered that Exide would need to wait approximately two weeks before abandoning the site, which would give California time to make the necessary arrangements for an orderly transition.  California promptly appealed the bankruptcy court’s decision; though, before doing so, the state elected to take the option left open in the revised settlement to have the Vernon property and the financial assurance transferred into the trust created to manage the other NPP sites.    

On appeal before the United States District Court for the District of Delaware, California argued that the Bankruptcy Court had misapplied the Supreme Court’s Midlantic decision.  The state asserted that Midlantic requires a strict two-step analysis: first, do the property conditions present an imminent and identifiable harm to the public health and safety, and, second, would abandoning that property be in contravention of a state law reasonably designed to protect the public from identified hazards?  If the answer to both questions is “yes,” California argued, then abandonment cannot be permitted.     

Exide argued that California’s proposed test ignored language in the Midlantic decision suggesting that abandonment could be permitted where the court had formulated conditions that will adequately protect the public’s health and safety.  With respect to the Vernon site, Exide asserted that the bankruptcy court properly determined that the existence of the financial assurance combined with other factors that ensured an orderly transition of the site (which, by the time the appeal was heard, had already occurred), would adequately protect public health.  

In an unexpected development, the EPA filed a brief in the appeal siding with Exide, arguing that the debtor should be permitted to abandon the Vernon property because the bankruptcy court had formulated conditions that will adequately protect the public’s health and safety from imminent and identifiable threats.  EPA went on to note the tension between bankruptcy and environmental law and asserted that Exide’s plan “respect[ed] and harmonize[d] these two statutory regimes in accordance with Midlantic and maximize[d] the protections afforded to the public in light of a liquidating debtor with substantial environmental liabilities throughout the country.”⁸  While at first blush EPA’s position appears surprising, when viewed in the context of a case where California was seeking to overturn Exide’s plan of reorganization, along with the heavily negotiated settlement of environmental liabilities at 22 other NPP sites that had been substantially implemented by the time the appeal was heard, EPA’s advocacy in favor of abandonment is understandable.   

After considering the merits of the appeal based on the briefing, U.S. District Court Judge Richard Andrews issued his opinion finding that the conditions contained in Exide’s plan of reorganization satisfied the standard for abandonment under Midlantic.  Judge Andrews held that the evidence established that the Vernon site was highly contaminated and required appropriate safeguards to protect against imminent and identifiable threats to health and the environment, but that it also supported the conclusion that Exide’s plan meets Midlantic’s requirements by establishing conditions that would adequately protect the public’s health and safety, specifically noting the availability of the financial assurance funds to perform environmental remediation at the site.⁹            

Judge Sontchi’s and Judge Andrews’ decisions in the Exide case provided much-needed clarity on the circumstances under which a debtor or trustee can abandon contaminated property.  By siding with the more expansive reading of the Supreme Court’s Midlantic decision, the Delaware courts affirmed that contaminated real property can be abandoned under section 554 of the bankruptcy code, even where doing so would violate state laws aimed at protecting public health, so long as the debtors and the court address any imminent threats that would arise from the abandonment.  These rulings are likely to prove valuable for debtors and their advisors who are looking for creative solutions to address contaminated real property in the restructuring process. 

In re Wellman Dynamics Corporation

The Wellman chapter 11 case preceded the Exide bankruptcy by a few years, but a largely overlooked, yet unique, settlement resolving Wellman’s environmental liabilities merits further review.  Wellman is a specialized equipment manufacturer that casts precision-engineered products for the global aerospace, defense and industrial markets.  When it filed for chapter 11 bankruptcy protection in 2016, it was a relatively small business, operating one facility, located in Creston, Iowa, and generating approximately $60 million in annual revenues. Wellman, however, was a critical supplier to the U.S. military, producing specialized castings for every military helicopter in use.  Drawdowns in overseas military operations had impacted Wellman’s performance, ultimately resulting in its need for restructuring. 

Wellman’s Creston facility was heavily contaminated from decades of industrial operations and presented significant challenges to the company’s bankruptcy.  Wellman had been investigating environmental conditions at the site under U.S. EPA oversight since 2002, was in the process of closing an onsite foundry sand landfill under the oversight of the Iowa Department of Natural Resources, and had been in discussions with the Iowa Department of Public Health concerning the suspected presence of over 300 drums of radioactive waste buried beneath the facility.  Combined, the environmental regulators estimated that the cost to remediate the property could approach $30 million, which was about equal to the estimated value of Wellman as a going concern.  If there was any chance for Wellman to survive bankruptcy as an operating company, the onsite environmental liabilities would need to be addressed.   

Wellman ultimately determined that it was unable to reorganize and that the best path forward was to sell the business through an auction process governed by section 363 of the bankruptcy code.  Finding a buyer willing to purchase the Creston property, however, proved to be a daunting task for several reasons.  While Wellman had been investigating the site for over a decade, the extent of the environmental contamination, including the precise number and location of the buried drums of radioactive waste, was unknown at the time of the bankruptcy. As a result, the environmental agencies could not state with any certainty what remediation a buyer, who would become statutorily liable for any onsite contamination, would be required to perform.  This meant that potential buyers could not come up with accurate estimates of the potential liability they would be required to assume.  Without finding a way to give buyers some certainty as to the magnitude of the environmental obligations, it was likely that Wellman would liquidate, terminating the jobs of a sizable portion of Creston’s population and potentially disrupting Department of Defense supply chains. 

A First-of-its-kind Settlement

Wellman, working closely with their secured lender, came up with a novel solution: they would try to pre-negotiate a settlement agreement with federal and state environmental regulators, to which the ultimate buyer could become a party.  The settlement would need to provide potential buyers with some degree of certainty, but given the extent of the environmental contamination at the Creston property remained unknown, it was not clear whether the environmental regulators would be willing to entertain the idea. 

To overcome these hurdles, Wellman and its secured lender proposed a first-of-its kind settlement structure.  Rather than agreeing upon the scope and means of the remediation, or the total amount of the liability, the parties proposed a settlement that would require the buyer to pay for any future remediation based on the predetermined formula tied to a rolling average of annual sales.  If the business performed well after the sale, greater amounts would be contributed towards the remediation, and if the business struggled out of the gate, only minimal amounts would need to be spent.  The buyer would assume all environmental liabilities at the Creston site, both known and unknown, but it would have much greater visibility into the potential impact that those liabilities would have on future performance.  The idea seemed to solve the biggest problems holding up any sale of the debtor’s business, but it was far from clear whether the environmental agencies would be willing to accept such a drastic departure from the normal settlement structure. 

To the surprise of many, EPA and the Iowa environmental agencies agreed to consider the proposal in earnest.  As a first step, they undertook a detailed assessment of Wellman’s current financial condition and its revenue projections, along with the information known about the environmental contamination at the Creston site.  Then, after months of negotiating, which included the assistance of a court-appointed mediator, the parties agreed on a settlement structure generally consistent with the proposal devised by Wellman and its lender.  The buyer would need to agree to fund three trusts: one to address the ongoing site investigation and remediation, one to fund the landfill closure, and one to fund the radioactive material investigation and remediation.  For the first three years after the buyer acquired the property, it would need to contribute to the trusts a combined amount that ranged between 0.2% and 2.52% of annual net sales, depending on performance.  After the first three years, the high end of the sliding scale would extend to 5.0% of net sales.  All investigative and remedial action would be funded by the trusts, but only to the extent funds were available.  The parties also agreed on general remedial goals that the trusts would seek to achieve, which gave potential buyers some comfort that the environmental agencies would not later impose unreasonable cleanup standards.  Once the remedial goals had been met, the funding obligations would cease. 

The pre-negotiated settlement agreement was made available to potential buyers and achieved exactly what the debtors and its lender had hoped. After a robust auction, the Wellman assets including the Creston property were sold, the buyer entered into the pre-negotiated settlement agreement as drafted, and the Wellman business continues to operate today.  It also avoided a potentially calamitous liquidation that not only would have resulted in job loss and potential disruption to military supply chains, but also the de facto, if not de jure, abandonment of the Creston property.  No doubt, these considerations played a key role in the environmental regulators’ willingness to adopt this novel approach. 

Conclusion

Whether the techniques and unique settlement structures used to address environmental liabilities arising from contaminated land in the Exide and Wellman cases can be duplicated to solve similar issues in other cases remains to be seen; however, debtors, creditors and governmental agencies can look to these novel solutions as examples of what can be achieved when all are willing to think creatively and work collaboratively to navigate what remains one of the thorniest issues on the litigation map.