Introduction: The Interaction of Environmental Law with Insolvency
An important measure of the value placed on environmental protection is how the law regulates environmental claims and liabilities in the context of financially troubled businesses. Are environmental claims given any particular status or priority in the wider settlement of claims? Do insolvency practitioners such as liquidators have to be concerned with environmental liability issues at all? Can environmental regulatory authorities be heard in winding-up proceedings? To the extent that the law envisages circumstances where liquidators or receivers can incur liability in the discharge of their duties, can this extend to liability for environmental damage?
These questions will increasingly arise in straitened economic times, when overall cost-cutting can affect the upkeep of environmental management systems. Companies that have, historically, exercised lax environmental standards may well find that this will become apparent, and hidden liabilities emerge, during the environmental exit audit that can follow a closure enforced by financial distress.
This Briefing looks at the provision that the environmental regulatory system makes for business failure and insolvency scenarios and at how it interacts with the procedures and mechanisms for rescuing or dissolving distressed businesses. It identifies the principal risk areas for those involved in one way or another with an insolvency, such as owners, operators, lenders and insolvency practitioners.
Financial provision for environmental risk
Ireland’s system of environmental regulation entails the requirement for the operators of the most environmentally risky activities to have in place at all times a fund or other financial provision sufficient to meet the cost of remediating environmental damage, especially on permanent cessation of operations.
The Environmental Protection Agency (EPA) is the main environmental regulatory authority in Ireland. It is responsible for environmental licensing (essentially pollution control licensing) of the largest power generation, industrial and waste installations. Businesses or companies applying for these licences must satisfy a “fit and proper person” test, including demonstrating to the EPA that the business/company has the financial wherewithal to meet financial commitments, including any environmental liabilities during the operation and on cessation.
These requirements are stipulated in the Environmental Protection Agency Acts 1992-2003, the core legislation dealing with the powers and functions of the EPA and with operating permits for the main industrial facilities. When an environmental licence is granted it is now standard for it to look ahead to decommissioning of the licensed activity. There will be a licence condition specifying that the operator must identify all potential environmental liabilities and damage that could arise from the operations and assess the cost of rectifying these, and put it in place adequate financial provision to meet these costs.
As to what kinds of financial underwriting and provision is recommended, the EPA has issued a Guidance on Environmental Liability Risk Assessment, Residuals Management Plans and Financial Provision (2006). In summary, depending on the nature and extent of environmental liabilities, and on whether they are known or unknown, there are a range of financial provisions recommended including specific bonds, upfront cash deposits, accumulating cash funds, escrow accounts, insurances and basic credit checks.
While there has been an increased emphasis in recent years on ensuring financial provision is in place for environmental risk and liabilities, this regime generally only applies to the very largest installations and this, together with the relative flexibility still afforded to installation operators in the choice of financial underwriting instrument (a feature relatively common to other countries) means that in Ireland that we are still quite a long way from a situation where all environmental risks and liabilities are separately funded and underwritten to the point where they never have to “mix it” in the scramble for claims’ settlement in insolvency scenarios. As against that this aspect of the environmental regime is receiving much greater attention in the past few years.
Other protections designed to ensure environmental liabilities will not be avoided, or go unmet, include the rule that the most important environmental licences can only be surrendered with the consent of the EPA; that the EPA must be given advance notice of, and approve, any transfer of a licence to a third party (the transferee must also be a “fit and proper person”); there is also a requirement that the transferee takes the licence with any historic liabilities.
Environmental Risk for Liquidators and Receivers etc.
It should not be assumed that liquidators, or the creditors in whose interests they are appointed and act, have little or no exposure to liability stemming from environmental damage. Potential “environmental claimants” such as regulatory authorities or affected neighbouring landowners may be prompted to “move” against a property or a business by the very fact of, or the potential for, insolvency. Such “environmental creditors” may view the formal appointment of the liquidator as representing the last chance to establish the company’s environmental obligations or to force the company to meet those obligations. Liquidation proceedings may be viewed as a ready-made forum in which to participate and ventilate environmental claims.
Two principal factors combine to ensure that there will always be a degree of residual risk for insolvency practitioners. Firstly, much environmental damage involves or arises from slow, ongoing release of contaminants to soil or groundwater which can continue into the final insolvency phase of a company’s existence. The possibility of “continuing offences” during the insolvency therefore arises. Secondly, there is the fact that the main environmental Irish regulatory powers and “trigger terms” are so widely drafted or defined as to cover, not just the original culpable party, but, also, whoever happens to be for the time being in control or whoever happens to be the “occupier”.
This issue of control is a critical one for insolvency practitioners and can, in certain circumstances, give rise at least to the possibility of aiding and abetting environmental breaches. What is a safe level of control for an insolvency practitioner? This is not straightforward. A degree of control will of course always be required to enable insolvency practitioners to effectively carry out their functions. A receiver’s exposure may increase where appointed over all or many of the assets of a business under a floating charge. Legislation covering receivers’ powers and functions, and documentation relating to receivers’ appointments, can envisage a wide range of management and control powers for receivers. The receiver therefore, where he does not already have an indemnity (or one covering liability for breach of environmental law), may, in certain circumstances, be well-advised to secure one from the lender/security holder appointing him where there is an environmentally sensitive or risky business involved. Even such indemnities may not always protect him against certain environmental breaches amounting to crimes or illegalities. This heightens the need for a proper prior understanding of the environmental risk and liability position of the business to which the receiver’s appointment relates. It may, in appropriate cases, be in order for the receiver to agree to act on the basis of excluding certain potentially risky assets or property.
Examiners will need to exercise similar care as receivers and liquidators, particularly where the examiner’s role extends beyond overseeing the restructuring and refinancing of debt into more active day-to-day involvement.
Ultimately the message is not that environmental regulatory authorities draw little distinction between the liability position of insolvency practitioners and that of the original parties responsible for initiating a pollution event. In practice, the EPA is quite focused on and sensitive to the issue of who is the culpable party (in the sense of who is most proximate in causation terms to the pollution or contamination). However the EPA’s remit ultimately is the protection of the environment and in that context cases can arise where the circumstances – such as the seriousness of an existing or anticipated pollution or contamination event and/or the risk/immediacy of that event – may cause the Agency to focus its regulatory efforts on whoever is, or appears to be, for the time being in occupation or control of a site.
There is Irish precedent for insolvency practitioners being targeted by environmental regulatory authorities. In 2004 when Irish Ispat Limited (the owner and operator of the former Irish Steel plant in Haulbowline, Co. Cork) went into liquidation, Court proceedings were brought under the Waste Management Acts against the Company (in liquidation) and against the Liquidator by the Minister for the Environment and by the Minister for Marine and Natural Resources. The proceedings sought orders directing that large quantities of hazardous waste on the site be managed and cleaned up. The estimated clean-up cost was very significant and were expected to significantly exceed whatever was left in the way of the assets. The case involved an outright clash between Environmental Law and Insolvency Law. The Departments stressed that for the purpose of the Waste Management Acts that the “holder” of waste was defined as “…the owner, person in charge, or any other person having, for the time being, possession or control, of the waste”. As against that, the Liquidator argued that his duty was purely to the creditors in line with the traditional role of liquidators. This point was generally endorsed by the High Court which also upheld another of the Liquidator’s arguments (supported by certain UK legal authority) which was to be allowed to disclaim, under Section 290 of the Companies Acts, the Integrated Pollution Control Licence that had been issued by the EPA to the Company and which Licence was the main source of environmental licensing and control of the facility. This Licence, and its attendant clean-up obligation, was therefore disclaimed as “onerous property” in the liquidation. While the Irish Ispat case shows that the power to disclaim can be an important tool in avoiding environmental liabilities, the Case may be of relatively limited precedent value in that in Irish Ispat the High Court clearly attached a lot of weight to the fact that the environmental licence had only been formally issued to the Company by the EPA at a point when it was clear the Company was in a very fragile financial position and was about to go into liquidation. The Court questioned whether the licence should ever have been granted in the circumstances of that particular case. To an appreciable extent therefore the case stands on its own particular facts and liquidators and other insolvency practitioners should be careful against taking too much comfort from the decision.
Is there Lender Liability for Environmental Damage?
In this Country merely providing finance is generally not sufficient to incur environmental liability and consequently lenders have not had to concern themselves with the environmental consequences of their loans.
So far, direct lender liability for pollution has arisen as a significant concern only in the U.S. In United States-v-Fleet Factors Corp. (1990) the Court found the lender liable for environmental damage, reasoning that the lender’s involvement in the financial management of the borrower gave it the “capacity to influence the corporation’s treatment of hazardous waste”. This was despite the fact the Bank was not involved in the actual operation of the firm. The Court’s ruling was based on a particular interpretation of the U.S. legislation – the Comprehensive Environmental Response, Compensation and Liability Act 1980 (also known as the “CERCLA” or “superfund” legislation). The Act established a clean-up fund for contaminated sites and a regime identifying persons primarily and secondarily liable for clean-up. Ultimately the legislation was changed in order to clarify the involvement that a lender may have in the U.S. without becoming liable as an owner of contaminated property but, before those changes were put in place, there were drastic alterations to lending practices in the U.S. to protect banks from CERCLA liability.
There appears to be no great prospect in the short term of direct lender liability for environmental damage in this jurisdiction, at least for lenders that refrain from direct operational control of the borrower. There are, though, increased calls for such a move internationally through certain movements and bodies advocating Corporate Social Responsibility and Socially Responsible Investment. These movements argue that assigning liability to financiers would modify their behaviour and promote more environmentally sustainable lending practices. They argue for liability especially where financiers have advance knowledge of environmentally risky developments being capitalised.
While direct lender liability as a general rule may not be of immediate concern here, lenders here should still be aware of other routes to incurring environmental-related risk and liability. The environmental compliance record of a borrower often bears a direct relation to his creditworthiness. While the value of an asset held as security is assessed as a matter of course before the loan, ongoing risk to the asset value through the borrower’s poor environmental performance tends not to be. In addition there are great disparities in the extent to which lenders anticipate this issue in their own lending documentation. The most prudent lenders will ensure that specified breaches of law constituting default events will cover serious environmental breaches (irrespective of whether security is affected). Bankers’ indemnities to receivers should factor in some assessment of any ultimate environmental risk to the lender based on the assets involved, the anticipated role of the receiver and the nature of the defaulting borrower’s business. Similarly banks’ awareness of the range of risks related to being considered shadow directors should also encompass environmental risk. A company that runs into difficulties will usually be in frequent, perhaps daily, contact with its banks and their advice or instructions will be difficult for directors to ignore and so banks should be conscious of even indirectly influencing poor environmental performance of the company in such a context.
Environmental Liability of Company Directors and Managers etc
The largest operations holding environmental licences will almost always be carried on under a corporate structure. While the general principle that the directors and other representatives of a company are not liable for the wrongs of that company extends also to environmental wrongs, there are a number of important qualifications.
It is a standard provision in all of the main Irish environmental statutes – the Environmental Protection Agency Acts, the Waste Management Acts and the Water Pollution Acts – that where an offence under those Acts has been committed by a body corporate, and is proved to have been committed with “…the consent or connivance of, or to be attributable to any neglect on the part of… a Director, Manager, Secretary or other similar officer…that person as well as the body corporate shall be guilty an offence and liable to be proceeded against…”. This particular formula (in italics above) is common to a range of environmental statutes of a regulatory nature. However directors and officers who knowingly allow environmental failings under their watch can also risk conviction for traditional criminal offences such as those relating to the aiding, abetting or procuring breaches of the law.
The Irish Courts also exercise a general and residual power to “lift the corporate veil” if corporate structures are found to be a sham or a vehicle for fraud and this can also expose directors/officers to personal liability for underlying breaches of law, including under Environmental Law.
The Irish Courts have even identified a specifically environmental law basis for lifting the corporate veil – based on the “Polluter Pays Principle”. In Wicklow County Council v Fenton and Others (2003), a case concerned with illegal dumping, the High Court ruled that if the clean-up costs were not met out of the Company’s resources it would make a fall-back order fixing the individual Directors with those costs. The Court stressed the primacy (over traditional corporate law principles such as the separate corporate personality rule) of core Environmental Law principles, and in that regard specifically mentioned the Polluter Pays Principle. The High Court relied on the original European Community definition of “polluter” (for the purpose of the Polluter Pays Principle) – as meaning anybody who “directly or indirectly creates the conditions leading to environmental pollution” and the Court, in Fenton, emphasised that that covered the individual directors in that particular Case based on their state of knowledge of the wrongdoing.
* Note: The decision in Fenton needs to be treated with a degree of caution as a result of a decision of Edwards J. in the High Court (3 March 2011) in which it was held that European Regulations aimed at making company directors personally liable for the cost of environmental clean-ups have not been correctly transposed into Irish Law. The full judgment is not available as of 9 March 201 but details of the judgment, and of its implications for directors’ liability in environmental clean-ups generally, will be posted as soon as the full decision is available.
Apart from directors and other officers, Irish Environmental Law even envisages shareholders being personally liable in a limited range of circumstances.
Purchasing a distressed Company’s assets
Just as banks, receivers and liquidators need to be careful of taking control of a distressed company’s contaminated land, so do potential purchasers of such property from an insolvent estate. Contamination of land is often latent and verifiable only by reference to detailed and intrusive surveys which are often impractical or unfeasible in the context of an insolvency. There are other risks for purchasers: vendor indemnities or warranties are often out of the question in an insolvency situation and there is often very limited time for due diligence. Any savings achieved in a knock-down price will quickly be overtaken by the cost of a clean-up order.
The insolvency appointee will normally, at some stage of his appointment, focus on what insurances are available to cover the various risks and liabilities. As regards environmental damage though, the reality is that many property and public liability insurances, insofar as they cover pollution impairment, tend only to cover sudden or catastrophic events or releases rather than the scenarios behind most contaminated land which is slow, gradual release of contaminants into the soil.
Conclusion
Many environmental claims will not be fully established or determined, much less secured, when an insolvency arises. They will, therefore often struggle for recognition or priority in the overall scramble for assets and claims’ settlement. However there is an important matrix of factors that mean such environmental claims cannot simply be ignored. These factors include:
- An insolvency, or an impending insolvency, may itself be the factor that prompts environmental regulatory authorities to move – the State will wish to avoid being saddled with an expensive clean-up
- Meeting even a modest environmental claim or liability can, in cost terms, be immense. Even if a particular environmental claim has limited prospect in the insolvency, its sheer scale will demand attention
- Environmental regulatory authorities are equipped with a range of emergency and other flexible remedies and reliefs that enable them to “win the race to court” and secure court orders quickly and thus transform the status and priority of such claims
- Many of the key environmental law definitions and trigger terms, such as “holder” of waste, are broad enough to capture insolvency practitioners in certain circumstances
- Much environmental damage, while historic in origin, can be ongoing and can continue into the insolvency phase thereby increasing the risk of a liquidator being fixed with related costs.
In summary, Environmental Law and Insolvency/Corporate Law are two bodies of law that have developed largely independently of each other, and without regard to each other, and the result is a considerable degree of legal uncertainty that, in turn, creates a considerable degree of legal risk for the various categories of persons concerned where insolvency occurs.
For further information on this topic please contact Conor Linehan, Partner, Environment & Planning Group
