An Environmental Primer for Lenders

Banking & Financial Institutions Environmental, Regulatory & Administrative Law

Given the current demand for downtown properties, borrowers are acquiring contaminated properties like never before.  Against this backdrop, lenders should become familiar with the basics of environmental laws imposing liability, how to safely buy or lease properties for their own use, how to avoid liability at properties serving as collateral, and how to safely dispose of properties taken in foreclosure or by deed in lieu.

The Basics of Federal Environmental Liability

The most important federal law imposing environmental liability is the Comprehensive Environmental Response, Compensation & Liability Act (“CERCLA” or “Superfund”), 42 U.S.C. §§ 9601 et seq.  CERCLA operates differently from most laws in that it imposes liability based solely on a party’s status or relationship, either with respect to the involved real estate or to the contaminants, as opposed to liability incurred in a more traditional sense based on a party’s actions or failure to act, like negligence.  Absent a defense, CERCLA imposes liability on: (i) a contaminated property’s current owners and operators (typically tenants), even if they did not cause the contamination in question, (ii) a contaminated property’s owners and operators at the time contaminants were disposed of, even if the owners and operators did not cause the contamination in question, (iii) those arranging for disposal of contaminants at a property, and (iv) those transporting contaminants to a property, if they selected the property as a disposal site.

Liability under CERCLA is strict, joint and several, such that any one party can be left to pay for the entire cleanup.  Liability is not limited to the value of the real estate, and it is not unusual even for “raw,” undeveloped land to be contaminated.  Further, given how claims accrue under CERCLA, there is essentially no time limit on claims; it is common for CERCLA cases to involve contamination dating from the 1930s, or earlier.  Accordingly, liability can arise from past uses of the property that are not obvious today.

Properties Intended for a Lender’s Own Use or Investment

Lenders do have broader defenses to CERCLA liability if they simply are holding a security interest in property or exercising remedies in connection with a default; however, if a lender is buying or leasing property for the lender’s own use, or as investment property, the lender must qualify for one of the two “usual” defenses to CERCLA liability, the same as any non-lender.  These two defenses are the “innocent landowner” defense and the more broad “bona fide prospective purchaser” defense.  To qualify for the innocent landowner defense, the lender must show that:

  • the property was acquired or leased after the disposal of the contaminants; and
  • despite conducting all appropriate inquiry regarding the property, including a Phase I Environmental Site Assessment in accordance with ASTM Standard Practice E1527-13, the lender did not have reason to know of the presence of the contamination.

42 U.S. §§ 9601 (35)(A)(I), 9607(b)(3).

For the bona fide prospective purchaser defense to apply, the lender must demonstrate that:

  • the contamination occurred before the lender’s acquisition or lease of the property;
  • the lender conducted all appropriate inquiry regarding the property, including a Phase I Environmental Site Assessment in accordance with ASTM Standard Practice E1527-13; and
  • the lender had no affiliation with the party causing the contamination.

After buying or leasing the property, the lender also must:

  • comply with any use restrictions on the property, such as restrictions on the use of the groundwater or disturbing contaminated soil;
  • take reasonable steps and exercise appropriate care at the property;
  • cooperate with agencies addressing the contamination;
  • comply with information requests from agencies addressing the contamination; and
  • provide any legally-required notices.

Phase I Environmental and Property Condition Assessments

As noted, a party must have had a Phase I Environmental Site Assessment conducted to qualify for either CERCLA defense.  While it is helpful to obtain copies of historical Phase I Assessments for due diligence purposes, previously conducted Phase I Assessments may not satisfy ASTM standards depending on their age. Certain portions of an old Phase I Assessment will need to be updated if they will be more than 180 days old as of the closing or lease signing.  Further, any Phase I Assessment that will be more than one year old at that point must completely be redone to satisfy ASTM standards.

A lender also should ensure that proper searches are conducted in connection with the Phase I Assessment to identify any environmental liens or “Activity and Use Limitations” recorded against a subject property – note that the consultant performing a Phase I Assessment does not provide this search unless it is specifically requested and included in the consultant’s contract for services.  Similarly, Phase I Assessments do not address “non-scope” issues, like asbestos or lead-based paint, unless these items are specifically included in the contracted scope of services.  Once the final Phase I Assessment report is in hand, Lenders should carefully review the entire report, not just the Executive Summary, as the Executive Summary may not list issues noted in the text, such as wetlands, endangered species, or possible permitting or equipment issues, any of which could significantly impact development costs and schedules.

For developed properties, lenders also should consider having a Property Condition Assessment (“PCA”) conducted, per ASTM Standard Practice E2018-15.  A PCA includes an engineer’s inspection of the building shell and each building system, resulting in a report identifying any issues in need of immediate or short-term repairs and estimating the maintenance and repair costs for the building, year-by-year, over the course of a 10 or 12 year study period.  While not legally required, a PCA can be performed in conjunction with a Phase I Assessment and can help identify unexpected issues in time to address such issues through negotiations prior to closing.

Properties Securing Debt; Foreclosures and Deeds In Lieu

As alluded to above, broader protections are available when lenders are either taking a security interest in real property, addressing a default, or foreclosing or taking a deed in lieu.  First and foremost, CERCLA provides that a lender is not subject to “owner or operator” liability based simply on holding a security interest in property, as long as the lender does not “participate in the management” of the property.  The Lender Liability Act (Senate Bill 394, 1995) clarifies that, while a borrower is still in possession, the lender “participates in management” only if the lender (i) exercises decision-making control over the borrower to the extent that the lender has taken over responsibility for environmental compliance, or (ii) exercises control at a level comparable to that of a manager, such that the lender has effectively taken over responsibility for the day-to-day operation of the property.

With regard to exercising remedies in connection with defaults, the Lender Liability Act makes clear that a lender is not considered to be an “owner or operator,” liable under CERCLA, even if the lender takes a broad variety of actions to protect property and prepare it for other disposition, as long as the lender does those things at the “earliest practicable time” and on “commercially reasonable terms.”  While the determination as to whether a lender’s actions were “commercially reasonable” can be highly fact-specific, the Lender Liability Act provides further guidance by creating an extensive “safe harbor” list of lender activities that a lender can undertake without incurring liability, including inspecting property, providing financial or other advice, restructuring the loan, taking action to prevent potential environmental problems, and working with agencies conducting clean-ups.


There are important caveats to keep in mind with respect to the lender liability exemption for environmental contamination.  First, the exemption does not extend beyond “owner and operator” liability under CERCLA.  Lenders still can be liable under CERCLA for:

  • transporting contaminants;
  • arranging for the disposal of contaminants; and
  • violating the requirements of permitting programs.

Further, while the federal Resource Conservation and Recovery Act (“RCRA”) incorporates CERCLA’s lender liability exemption, RCRA can still leave lenders subject to liability for leaking tanks and subject to citizen class action lawsuits for “imminent and substantial” threats to health or the environment.  Also while this article has focused largely on CERCLA, other federal laws can result in liability.  Lenders should be aware of lender exemptions to state-level environmental liability and their particular technical requirements.  Nevertheless, states often require lenders to pay for emergency response costs and may still recognize common law claims for environmental contamination, such as claims based in negligence, nuisance, or trespass.  These issues all should be discussed with qualified legal counsel.

This article originally appeared in the Fall 2021 edition of Carolina Banker magazine.