Can an Environmental Claim Survive Bankruptcy? - ABA YLD 101 Practice Series

By Erica M. Zilioli

In an economy where bankruptcies are declared on a seemingly regular basis, environmental lawyers increasingly face the challenges of pursuing environmental claims against a company that is contemplating or has actually filed for bankruptcy. Having a solid understanding of--and realistic perspective on--how environmental claims are likely to be treated could save your client time and money. This analysis will focus on Chapter 11 (reorganization) bankruptcies, so keep in mind that the outcome could be different in a Chapter 7 (liquidation) bankruptcy context.

Assume your client is one of several corporations that contributed to environmental contamination to a property. The site remains contaminated and your client suspects that the EPA might bring a cleanup action against one or more of the involved companies. The owner of the property, X Corp., has just filed for Chapter 11 bankruptcy, and your client, a potentially responsible party at the site, wants to know if it can bring a claim against X Corp.

The answer will vary depending on (1) the jurisdiction, as bankruptcy courts differ in their treatment of environmental claims, and (2) the specific facts of the case, particularly how events develop during bankruptcy proceedings. With those caveats, you will essentially face three obstacles resulting from protections the Bankruptcy Code, 11 U.S.C. § 101, et seq., affords debtors like X Corp.

Defining the Claim
The first hurdle you will face is proving that your client has a claim. One of the fundamental features of bankruptcy law is that only genuine claims against the debtor are preserved for resolution at the end of the proceedings. A "claim" is broadly defined and includes both:

  • Rights to payments; and
  • Equitable remedies for breach of performance by the debtor if such breach would give rise to a right of payment.

Because a proof of claim must be filed by a set date even if the value is not yet determined, a claim can be "contingent" at the time it is filed. In such cases, the bankruptcy court must estimate the value of the claim. Many environmental claims are contingent, particularly where cleanup costs of a property have not been allocated among several responsible parties. Unfortunately for private parties like your client, the Bankruptcy Code offers debtors two protections against such claims:

  • First, the court may "disallow" certain contingent claims for contribution at the request of the debtor if the creditor is also a joint tortfeasor.
  • Second, even if the claim is allowed, the Bankruptcy Code does not permit payment of contribution or indemnification claims that remain contingent at the end of bankruptcy proceedings. If such a claim becomes fixed (i.e., an actual value is attached) before the close of bankruptcy proceedings, however, then it might be included in the reorganization plan.

Your client may at some point have a contribution or indemnification claim against X Corp. for reimbursement of cleanup costs, depending on how events unfold. These claims are contingent, because they have not yet accrued and do not have a particular value. In order to preserve these potential claims, you should file a proof of claim with the bankruptcy court before the set deadline. However, the court might disallow the claims if your client and the debtor could be jointly liable to another creditor (e.g., the EPA) for the contamination. Also keep in mind that if the claim remains contingent at the end of proceedings, it will not be included in the reorganization plan.

The Automatic Stay
The second hurdle you will face is that your client cannot collect on its claim during bankruptcy proceedings. As another means of protecting debtors, the Bankruptcy Code automatically stays most creditors from collecting on monetary debts or trying to create or enforce new judgments against a debtor once the bankruptcy petition is filed.

Filing for bankruptcy does not, however, shield the debtor from governmental enforcement of ongoing or new violations of environmental laws under one of three exceptions to the automatic stay:

  • Exercise of police powers;
  • Exercise of regulatory powers; or
  • Perfection of an interest in property.

This authority is somewhat limited if the government seeks monetary damages, including cost recovery, because the automatic stay still prevents collection on such judgments during bankruptcy proceedings.

Your client might actually be able to take advantage of the governmental exceptions. Under the Bankruptcy Code, if a creditor does not timely file proof of its claim, an entity that is also liable to the creditor can bring a claim on the creditor's behalf. Thus, if your client and X Corp. are both potentially liable to the EPA, and the EPA fails to timely file a proof of claim, your client can file a claim on the EPA's behalf. The benefit to your client may be limited, however, because the automatic stay would likely still prevent collection of monetary damages during bankruptcy proceedings.

Resolution of Claims - The Discharge
The final hurdle your client and most other creditors must face is the discharge of all pre-petition claims at the end of bankruptcy proceedings--the ultimate protection for debtors.

The court-issued reorganization plan provides for the payment of claims to a series of classes that are defined, in part, based on statutory priorities. Generally, secured claims are paid first, and certain non-secured claims have priority over general non-secured claims. Most environmental claims are general, non-secured claims. Once the reorganization plan has been issued, most pre-petition claims are discharged, meaning any judgments obtained against the debtor relating to the claims addressed by the plan are void.

Thus, regardless of whether the reorganization plan fully compensates your client, if the claim is discharged, your client is precluded from pursuing the claim against X Corp.

It is important to note, however, that to the extent your client has a claim against X Corp. for ongoing liability (e.g., natural resources damages), your client could bring a "new" claim after bankruptcy, because the discharge only applies to claims that arise pre-petition.

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About the Author

Erica M. Zilioli is an attorney with Beveridge & Diamond, P.C., in Washington, DC. She practices in the areas of environmental law and litigation and can be reached at ezilioli@bdlaw.com.

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