Last October, the Fleming American Investment Trust (FAIT) agreed to pay $4 million to the US Environmental Protection Agency (EPA). This was in settlement of an action begun a year before, when the EPA had launched a $185 million action against the UK-listed investment trust for environmental damage.
There were several extraordinary aspects to this law suit. First, the alleged wrongdoing was almost 100 years old. The damage dated from the end of the last century when FAIT had an interest in a US railway company which involved in the construction of a bridge in Louisiana. One of the other parties involved had a creosote factory. It was the costs of cleaning up that site which had been traced back to FAIT. Secondly, FAIT was a passive investor: it was hardly an industrial concern involved in the manufacture of hazardous substances. Thirdly, FAIT settled the action without admitting liability. This is not unusual but FAIT genuinely believed it was not liable.
The news of the action had knocked off around six per cent of the trust's share price and £13 million off its market capitalization. The continued uncertainty had depressed the share price to less than 70% of net asset value, a much greater discount to NAV than is usual for an investment trust. It was cheaper to settle than to fight.
Finally, the trust's location in a different jurisdiction did not protect it from the long-arm reach of the EPA. This is worrying for lending banks, and not just because borrowers can go bust through environmental liability. Under US legislation (the Comprehensive Environmental Response Compensation and Liability Act, better known as Superfund because of the environmental clean-up fund it established) the EPA is empowered to recover pollution costs from "potentially responsible parties" including shareholders and lenders. Although the Superfund legislation provided a secured creditor exemption, US courts interpreted this in such a way that lenders forfeited their exemption simply by foreclosing.
In a bid to reassure the banking industry, the EPA issued a regulation clarifying the degree of management control a lender had to have in order to forego the exemptions protection. This was overruled by the courts which said it was for them to decide. Liability under Superfund is retroactive, strict (no fault liability) and joint and several (each party is liable for all of the damage regardless of the extent of its participation) which means it is draconian in the extreme.
Now banks fear the UK could be going the same way. The Environment Act 1995 inserted a new part IIA in the Environmental Protection Act 1990 imposing liability on "appropriate persons" which echoes Superfund. When brought into force it could increase the risk of borrowers becoming insolvent where land is contaminated and the borrower is served with a remediation notice. It can depress the value of property taken as security and can fix the lender with direct liability where he has taken possession of the security, which can occur simply by virtue of the borrower surrendering the keys or control of the business.
Recent examples include loans to an international instrument manufacturer and to an electro-plating company. In the first, the lender had advanced a £5 million facility against a freehold site valued at £7.29 million. The borrower went into liquidation. An irradiation plant on the site made the land unmarketable and the lender footed the decommissioning bill of £1 million. The post-decommissioning value was sterling £3.2 million. The property remains unsold. It is let on a short lease but the rental income does not meet the interest charges.
In the case of the electro-plating company, it returned the keys to the bank which then ensured the property was made safe, thereby becoming the owner. The site was valued at £40,000. An agent instructed to find a buyer found hazardous chemicals on the site and told the local environmental officer. The resulting clean-up and legal costs came to almost £20,000.
Lenders can be liable under other environmental regimes. For instance, the 1990 Act imposes liability in respect of waste. In 1995 Midland Bank accepted liability for cleaning up a site repossessed from a borrower. Liability can also arise for statutory nuisances where, if the person causing the nuisance cannot be found, the owner or occupier which may be a lender can be liable.
"Lenders are becoming more pragmatic and are adopting a more realistic view of the potential risks," says Jacqui O'Keeffe, the head of Denton Halls' environment team. Many have environmental criteria written into their standard lending conditions. Additional application stage safeguards include asking the prospective borrower about current and past compliance with environmental legislation and current and prior uses of the property, and then requiring a site survey or environmental audit as a pre-condition. Warranties and indemnities can be built into the agreement to ensure all consents are in place and complied with, existing problems are put right and there is continued compliance with all applicable legislation throughout the term as well as notification of regulatory notices or orders.
Lenders will treat borrowers which have environmental management systems such ISO 14001 or EMAS more favourably and could require it as a condition of the loan. Where an environmental audit is commissioned by the borrower, the lender may wish to determine the choice of consultant and be the recipient of any report so that the consultant owes it a duty of care. It may also wish to be satisfied about the extent of the consultant's professional indemnity cover and any exclusions.
Where the lender is concerned about a site over which it has taken possession, it may incur liability by "knowingly permitting" the land to be contaminated simply by virtue of its investigating and monitoring the site. Lenders should keep an eye on two sources of legislative development.
"In the UK, much of the recent legislation (which is not yet in force) dealing with contaminated land has been left to be fleshed out by the secretary of state's guidance," says O'Keeffe. This has been subject to extensive consultation. The closing date for comments was December 18 last year, but the final version is likely to be delayed until after the imminent general election. Secondly, the European Commission is considering whether to harmonize civil liability for environmental damage throughout member states. It could, if implemented, introduce strict liability for environmental damage, third party rights of action and no secured lender exemption.