Southern District of New York Says Environmental Injunctions are Not Claims Subject to Discharge in Bankruptcy

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Contributed by David B. Hird

District Judge Shira A. Scheindlin, of the Southern District of New York, has affirmed a decision of the bankruptcy court finding that the government’s right to an injunction compelling a chapter 11 debtor to conduct an environmental cleanup is not a claim subject to discharge under the Bankruptcy Code.  In re Mark IV Industries, Inc. (Mark IV Industries, Inc. v. New Mexico Environment Dept.), No. 11 CIV 648 (SAS) (S.D.N.Y. Sept. 28, 2011).  The decision continues a trend in the decisional law limiting the circumstances under which an environmental cleanup obligation will be treated as a bankruptcy claim.

The issue is whether an order by a government agency compelling the debtor to spend money for environmental investigation or remediation fits within the Bankruptcy Code’s definition of a “claim” and is therefore subject to discharge.  Section 101(5) defines a “claim” as a “right to payment” or “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).  When the government is exercising its injunctive power to compel a debtor to perform work at substantial cost, but is not actually asking to be paid directly by the debtor, is it seeking an equitable remedy that is a claim because it can “give rise to a right to payment” or asserting a right which is not a claim and is unaffected by the bankruptcy discharge?

As many companies (both in and out of chapter 11) have experienced, complying with a government order to  investigate and remediate environmental contamination from historic operations can be very expensive, often costing tens of millions of dollars. Although the economic impact of the costs of a cleanup obligation on a debtor in possession may be the same as the monetary liability on a contract or tort claim, courts have often treated cleanup obligations very differently.

Although there are several key precedents examining the treatment of environmental cleanup injunctions under the Bankruptcy Code, the Mark IV case presented Judge Scheindlin with a set of facts that had never been considered in the Second Circuit.  The two most significant precedents were Ohio v. Kovacs, 469 U.S. 274 (1985) and In re Chateaugay Corp., 944 F.2d 997 (2d Cir. 1991).  In Kovacs, the State of Ohio had divested the owner of a landfill of his property and had obtained the appointment of a receiver to manage it; the State was conducting the cleanup itself, but was seeking to compel the owner to pay money toward the cleanup.  The United States Supreme Court held that, because the State had divested the owner of control over the property and the owner did not have the power to perform the cleanup himself, the State’s right to an equitable remedy had been converted to a right to payment and was thus a claim that could be discharged in the owner’s bankruptcy.  In Chateaugay, however, a reorganizing corporate debtor, LTV Steel, was seeking to discharge its obligation to clean up properties that it continued to own, but which had been contaminated by historical operations.  The Second Circuit held that an injunction solely to remove accumulated wastes is a “claim” for bankruptcy purposes if the party seeking the injunction has an alternative right to perform the cleanup itself and recover its costs, but an injunction intended to  stop or ameliorate “ongoing pollution” is not a claim and is not subject to discharge in bankruptcy.

The Chateugay decision left open many questions.  What is meant by “on-going pollution” as opposed to the removal of accumulated wastes?  How does the decision apply in a situation in which the government is seeking to compel the debtor to clean up property it no longer owns and may not have owned for a long time?  What happens if the government chooses to sue under a statute that only provides for injunctive relief, and not under another statute which provides a cost recovery remedy?

The facts in the Mark IV case raised all of these issues.  The State of New Mexico sought to compel Mark IV to clean up a property that Mark IV had not owned or operated since 1979, arguing that waste which Mark IV had left at the site over four decades ago was creating “ongoing pollution.”  The State brought its injunction under the New Mexico Water Quality Act, a statute that only provided for injunctive relief, even though other statutes available to the State would have given it a right to cost recovery.  Mark IV brought an adversary proceeding to have the State’s injunctive right classified as a claim subject to discharge and the Bankruptcy Court granted summary judgment to the State, finding that the environmental clean up was a non-claim obligation in bankruptcy.  Mark IV appealed to the District Court and Judge Scheindlin affirmed.

In doing so, Judge Scheindlin attempted to resolve some of the many issues left open by Kovacs and Chateaugay.  First, the court rejected Mark IV’s argument that the injunction was a claim under Kovacs because the debtor did not own the property and could only contribute to the cleanup by paying money.  The court held that Mark IV’s situation was different from that in Kovacs because, rather than excluding Mark IV from the property, the State, as well as the current owner, were willing to provide Mark IV with access to perform work.  What Judge Scheindlin did not address was a contention that the only way that the debtor could have performed the work was to pay others to do so.  This distinction had been critical to the decision in United States v. Whizco, Inc., 841 F.2d 147 (6th Cir. 1988), where the Sixth Circuit held that a cleanup injunction which a debtor could not perform without paying money to others was treated as a bankruptcy claim, but the Mark IV decision is silent on the issue.  Instead, Judge Scheindlin appeared to construe Kovacs as focusing on whether the debtor had access to the property, rather than on whether compliance would cost money.

Next, the court considered whether New Mexico had an alternative right to payment that potentially could have transformed its injunction into a claim.  The court held that the state did not have an alternative right to payment because it had brought its action under a specific statute, the state Water Quality Act, which had no cost recovery authority.  The court dismissed Mark IV’s argument that the state had other statutory authorities available to it under which it could recover costs.  Instead, the court concluded that the question of whether the government had an alternate right to payment was limited to the particular statute under which the injunction was sought, and the fact that the government could have sued for money under another statute is irrelevant.  The court’s concern was that because the federal government and states generally have cost recovery authority under some statute, holding otherwise would make all cleanup injunctions claims subject to discharge.  As a result, the court’s decision functionally provides a roadmap for federal and state environmental regulators to bring actions which will escape bankruptcy discharge:  Seek injunctions under statutes that have no cost recovery alternative.  The federal government had already done this in United States v. Apex Oil Co., 579 F.3d 734 (7th Cir. 2009), in which the Seventh Circuit held that the federal government’s right to a cleanup injunction under Section 7003 of the Resource Conservation and Recovery Act (RCRA), 42 U.S.C. § 6973, was not a claim because RCRA provided no right of cost recovery, even though the government could have brought its action for an injunction under the Comprehensive Environmental Response Compensation and Liability Act (CERCLA), which did include a cost recovery alternative.

Having concluded that the State had no cost recovery alternative under the statute it invoked, the court concluded it did not have to reach the question of whether, as a factual matter, waste from 1979 and earlier was still creating ongoing pollution in 2011.  The court did, however, consider Mark IV’s contention that the analysis in Chateaugay only applied to property that the debtor continued to own and operate, and not to property that it had owned many years in the past.  Again, the court rejected Mark IV’s position, holding that the Chateaugay analysis was not limited to property owned by the debtor at the time of the bankruptcy.  In this respect, Judge Scheindlin is consistent with the Seventh Circuit’s decision in Apex and the Third Circuit’s decision in In re Torwico Electronics, Inc., 8 F.3d 146 (3d Cir. 1993).  Judge Scheindlin’s decision cuts against the view, widely held by practitioners, that the Second Circuit’s holding in Chateaugay that an injunction to ameliorate “ongoing pollution” was a non-claim obligation applied only in situations where the debtor continued to own or operate the property in question because of the Chateaugay court’s reliance on 28 U.S.C. § 959(b), which provides that a debtor-in-possession must operate property in its possession in accordance with applicable law.  For commentary on this point, see D. Berz, S. Spracker & A. Strochak, 3 Environmental Law in Real Estate and Business Transactions § 19.02[1][d] (Matthew Bender 2010).

Given the significance of the legal issues involved, it is likely that Mark IV will appeal the case to the Second Circuit.  If this decision stands, it would not be likely to have much consequence for a liquidating corporate debtor:  A debtor that has distributed all its assets to creditors is incapable of complying with a cleanup injunction.  Although the bankruptcy court could not grant a discharge to the debtor, the debtor that has distributed its assets to its creditors would not be able to perform the work.  If the government regulators were to demand that the debtor’s funds be used for cleanup before distribution to creditors, then it would be difficult for them to dispute that they had not converted their injunctive right into a right to payment under Kovacs.

For a chapter 11 debtor that is reorganizing, however, it could mean that cleanup obligations would pass through to the reorganized entity, even when the reorganized debtor has no current interest in the property affected.  Under the circumstances, two strategies would be available to the reorganizing debtor.  First, in planning for reorganization, a debtor can ensure that the newly emerging entity will have sufficient financial resources to meet its cleanup obligations.  Second, the debtor may 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 reorganized debtors may negotiate terms which resolve environmental liabilities that would otherwise not be subject to discharge.