It May Be Safe to Lend on Contaminated Property

If your financial institution is presented with an opportunity to lend on potentially contaminated property, running the opposite direction may not be the wisest strategy.One of my partners and I recently helped a lender-client loan money to a borrower who was purchasing a gas station/convenience store, a type of property that typically has residual contamination. The property was in fact contaminated, but it was being cleaned up by a major oil company under Department of Ecology oversight. The oil company agreed to indemnify the borrower and lender for all claims arising from the oil company’s cleanup of the contamination. The borrower initially approached a regional bank, which turned down the loan. The bank’s counsel advised the bank not to lend on this property, based on the oil company’s limited indemnity, which did not cover all claims related to the contamination, but only the cleanup. My guess is that the attorney was being overly cautious because he saw the specter of lender liability under the Model Toxics Control Act (MTCA), Chapter 70.105D RCW.

In fact, that bank missed a good business opportunity because lenders are protected from MTCA liability if they follow the clear guidelines in the statute. A lender will usually have a security interest, such as a deed of trust, in the borrower’s contaminated property. Under MTCA, a lender may actively manage the property to preserve the value of the collateral or to mitigate any default by the borrower, within one year of foreclosure. If one of these two conditions are met, then the lender can hire and manage environmental consultants and engineers to investigate and, if necessary, clean up the contamination, if the borrower fails to do it.

If the property goes through foreclosure, then the lender must sell at the “earliest practicable, commercially reasonable time,” but no later than five years after the foreclosure. Further, the lender is exempt from having to comply with the Washington commercial real estate rule, codified at Chapter 64.06 RCW, which requires the seller to disclose all its knowledge of the environmental conditions at the property.

In most cases, five years is sufficient time to fully characterize and clean up the property. Lenders traditionally do not like to deal with heavily contaminated properties in their portfolio, however. Thus, there is no substitute for good environmental due diligence early in the loan process. In our gas station matter, I discovered that the ground water met applicable cleanup standards and had not migrated off the property. Ecology was very pleased with the consultant performing the cleanup for the oil company, and given these favorable environmental conditions, Ecology was expected to issue a No Further Action Letter for the property by the end of the year. In sum, good due diligence combined with a better understanding of the MTCA lender liability rule paid off for our client, who was able to comfortably enter into a beneficial financial transaction.

The regional bank’s caution was our lender client’s gain. Lesson to be learned: don’t let the specter of lender liability scare you away from a good business opportunity. Take the time, and get good counsel, to determine if that really is a reason to avoid the deal.