Restructuring

Contributed by David B. Hird
Sometimes, a decision by the Supreme Court not to take a case can be almost as significant as a decision by the Court.  That is certainly the case with the Supreme Court’s decision on October 4, 2010 to deny the petition for certiorari by the losing defendant in United States v. Apex Oil Co., 579 F.3d 734 (7th Cir. 2009).  The consequence of the Court’s refusal to take the case is to reinforce a trend in the case law holding that the federal or State government’s right to compel a debtor to perform an environmental cleanup may not be dischargeable under the U.S. Bankruptcy Code, even if the only way that the debtor could comply is to spend substantial amounts of money.

The Apex Oil case addressed a critical issue at the intersection between environmental law and bankruptcy law which has reverberated through the courts for the last 25 years:  Is the government’s right to injunction ordering a debtor to perform an environmental cleanup (and to spend money doing so) a “claim” that can be discharged in bankruptcy?
From a debtor’s financial perspective, an order compelling it to spend money on environmental cleanup has the same effect as an order compelling it to pay damages on a contract or tort claim.  In each scenario, there is a monetary obligation based on an event that occurred prior to the bankruptcy petition.  But the significant difference is that in the case of a cleanup injunction, the debtor does not pay the money directly to the government, but rather pays a contractor to perform the cleanup activities that the government wants done.
The Bankruptcy Code provides for the discharge of “debts,” which are defined as a “liability on a claim.”  11 U.S.C. § 101(12).  A “claim” in turn is defined to include both a “right to payment” and a “right to an equitable remedy for breach of performance if such breach gives rise to a right to payment.”  11 U.S.C. § 101(5).  For 25 years, the courts have struggled with the question whether a government demand that a debtor spend its money to perform an environmental cleanup falls within the second prong of that definition.
The early cases appeared to support the concept that an obligation to spend money for environmental cleanup is a “claim” and may be discharged.  The first significant decision was by the Supreme Court itself in Ohio v. Kovacs, 469 U.S. 274 (1985), a case in which the State of Ohio had succeeded in having a lower court appoint a receiver to manage the cleanup of a toxic landfill.  The State also sought to compel Kovacs, the former owner-operator of the landfill, to provide funds for the receiver’s cleanup.  The Supreme Court itself held that the State’s demand was a “claim” in Kovacs’ chapter 7 case and was barred by his discharge.  A few years later, the Sixth Circuit in United States v. Whizco, Inc., 841 F.2d 147 (6th Cir. 1988), held that the federal government could not compel a former operator of a strip mine to spend money to restore the mine site because that too was a “claim” discharged in the mine operator’s bankruptcy case.
After Kovacs and Whizco, however, the decisions began to trend in the opposite direction.  In In re Chateaugay Corp., 944 F.2d 997 (2d Cir. 1991), the Second Circuit ruled that the presence of hazardous substances in the soil and groundwater under a debtor’s property represented continuing pollution, and therefore the debtor could be compelled to spend money to clean up the property and that obligation was not subject to discharge in the debtor’s bankruptcy case.  But Chateaugay only addressed cleanup obligations with respect to property that the debtor continues to own and operate, recognizing that, under 28 U.S.C. § 959(b), a debtor in possession had a statutory obligation to operate its property in accordance with applicable law.  Then, the Third Circuit in In re Torwico Electronics, Inc., 8 F.3d 146 (3d Cir. 1993), held that a debtor’s obligation to fund a cleanup was not a “claim” and was not dischargeable, even though the debtor did not own the property and its lease had expired four years earlier.  The Third Circuit held that the debtor had a continuing obligation to clean up waste that it had left behind.
The Seventh Circuit’s 2009 decision in Apex Oil continued the trend, finding that a reorganized debtor’s obligation to pay for an environmental cleanup of property that it did not own was not a claim and was not dischargeable, although the only way the debtor could comply was to pay $150 million to a contractor to perform the work.  Judge Posner, writing for the Seventh Circuit, held that because the government had brought its claim under section 7003(a) of the Resource Conservation and Recovery Act (“RCRA”), 42 U.S.C. § 6973(a), a statute that allows the government to sue for an injunction to compel a cleanup, but does not allow the government to sue for money, the government’s right to an injunction was not a “claim” under section 101(5) of the Bankruptcy Code.  In the Seventh Circuit’s view, the right to a RCRA injunction “was not a right to an equitable remedy,” the breach of which gave “rise to a right to payment,” but RCRA did not provide for a monetary recovery, and therefore was not a “claim” under section 101(5).  579 F.3d at 736.  Further, Judge Posner concluded that the fact that it would cost the defendant money to perform the work required under the injunction did not make it a “right to payment.”  Id. at 737.
An interesting facet of Apex is that the government brought the case under section 7003(a) of RCRA, rather than under the Comprehensive Environmental Response Compensation and Liability Act (“CERCLA”).  Section 7003(a) of RCRA was adopted in 1976, four years before the adoption of CERCLA in 1980.  Generally, the U.S. Environmental Protection Agency (“EPA”) prefers to bring cases under CERCLA, rather than section 7003(a) of RCRA, in part because CERCLA provides for both injunctive relief and the recovery of cleanup costs spent by the government.  42 U.S.C. §§ 9606(a), 9607(a).  But although the record in the Apex case indicated that EPA first began to address the contaminated site at issue under CERCLA, the government made a deliberate decision to bring its case against Apex only under RCRA.  The reason for this decision is apparent: If the government had sued under CERCLA, Apex could have argued that CERCLA creates an alternate right to monetary and therefore the government’s right is exactly the sort of equitable right which can give rise to a right to payment.  By suing under RCRA, the government hoped to forestall that argument, and its strategy worked.
In its petition for certiorari, Apex made exactly this point: The government had a “right to payment” under CERCLA, but was trying to avoid that characterization by bringing its claim under a RCRA provision it would otherwise not have used.  Apex also argued that the Seventh Circuit was inconsistent with both the Supreme Court’s decision in Kovacs and the Sixth Circuit’s decision in Whizco.  But these arguments did not persuade the Supreme Court to grant certiorari.
The consequence of the Supreme Court’s decision not to take the Apex case is to reinforce the trend of cases holding that cleanup injunctions are not dischargeable in bankruptcy, even if the only means of compliance is for the debtor to spend money.  While the question of whether an injunction under CERCLA is a dischargeable claim has not yet been decided, it may not matter because the federal and state governments will be careful in future cases to demand injunctions against debtors and reorganized debtors under RCRA and other statutory authorities that do not permit the recovery of money, rather than under CERCLA.
For a corporate debtor that is liquidating, this decision will have little consequence: Once the debtor is without assets, it is incapable of complying with a cleanup injunction.  But for a corporate debtor that is reorganizing, the Supreme Court’s refusal to consider the Apex case may be highly significant.  It means that the debtor’s discharge is not likely to protect it from injunctions to perform environmental cleanups in the future.
This leaves the reorganizing debtor with two alternative strategies.  First, in planning for reorganization, it can make sure that the newly emerging entity will have sufficient financial resources to meet its cleanup obligations.  Second, it can attempt to settle its environment cleanup obligations in the context of its bankruptcy case.  Often, the federal government (and sometimes the states) are more flexible in settling environmental obligations with reorganizing debtors than they would be with ordinary commercial entities, and terms may be negotiated which protect the reorganized debtors from environmental liabilities that are not subject to the discharge.  It is frequently in the debtor’s interest to reach an amicable resolution of these liabilities with the government in the course of its reorganization process, rather than emerging from the chapter 11 process to face unresolved government demands, as Apex did.