Structuring Ownership and Control of Real Estate Holdings to Avoid Federal Environmental Liability.
It is common practice for real estate developers and investors to form and use subsidiary companies (which are often single purpose entities) to acquire and own their various real estate projects. While there may be several reasons to use this type of structure, the most obvious and important reason is to put a shield of liability between the acquisition subsidiary and the parent company. Despite such prudent planning and structuring of real estate projects, many real estate developers and investors have been held indirectly liable for environmental cleanup costs under CERCLA. This article is intended to provide a brief overview and discussion of CERCLA and the liability issues arising thereunder, which may affect real estate owners, developers and investors using acquisition subsidiaries to own their various projects, and to provide some basic tips to avoid federal environmental liability. With that said, the reader should be reminded that there are other federal and state environmental laws which may be applicable to your particular situation, and that this Article should not be considered to be exhaustive of all potential corporate and environmental issues and concerns.
I. CERCLA Overview / Background.
The Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) (42 U.S.C.A. §9607), as amended, also commonly referred to as “Superfund,” provides broad authority for the federal government to initiate “response actions” to address or remedy releases or threatened releases of hazardous substances into the environment. In enacting CERCLA, Congress intended the federal statute to cast a wide net of responsibility for the costs of environmental cleanup, which was not to be avoided or impeded by state corporation laws intended to provide “shields” of liability for corporate shareholders and investors in limited liability companies. As such, CERCLA gives the federal government broad authority to compel all “persons” responsible for releases of hazardous substances (whether directly or indirectly responsible) to take all appropriate action to remedy any danger posed to human health, welfare and the environment in connection with a release or threatened release of such hazardous substances, regardless of the cost, and without regard to “shields” of liability arising under state corporation law. The term “person” under CERCLA encompasses both individuals and entities including, but not limited to, corporations, limited partnerships and limited liability companies.
Under CERCLA, there are four (4) broad categories of “persons” that can be held “strictly liable” (i.e. liable without regard to negligence or fault) and “jointly and severally liable” for the entire cost of cleaning up a contaminated site. The four categories of “persons” that can be held liable under CERCLA, commonly referred to as “potentially responsible parties” or “PRPs,” are:
1. The current “owner or operator” of property on which hazardous substances have been released (or on which there is a substantial threat of release).
2. A previous “owner or operator” of a contaminated property, when such ownership or operation existed or occurred at the time the hazardous substances were disposed of, released or stored on the property.
3. The “person” who generates, owns or possesses the hazardous substances, or the person who arranged for the transport of such substances to a property where contamination occurred (commonly referred to as “generator” or “arranger” liability).
4. A person who accepted hazardous substances for transport to a disposal or treatment facility from which there has been a release or contamination (commonly referred to as “transporter” liability).
Any “person” fitting within one of the above-referenced categories will be deemed a responsible party under CERCLA and may be held liable for all costs of environmental cleanup at the contaminated facility, regardless of negligence or fault. Under CERCLA, the term “facility” means the contaminated property or site.
The first two categories of PRPs listed above are generally referred to as forms of “owner or operator” liability because such liability is based on the person’s status as an owner or operator of the contaminated property or facility. Most liability under CERCLA arises “directly” because the PRP is either a direct owner or operator of the contaminated facility, or because they are directly responsible for generating, arranging or transporting the hazardous substance that caused the contamination. With that said, liability under CERCLA can also arise “indirectly” by virtue of a person’s status as a parent company of the “person” which acquires, owns and/or operates the facility. A more thorough discussion of the two theories of liability follows.
NOTE: All discussions and examples in this article of “indirect liability” under CERCLA will be in the context of a multi-tiered ownership structure involving a parent company, which owns and/or controls a subsidiary entity, which acquires, owns, develops and/or operates the contaminated property or facility.
II. Parent Company Liability Under CERCLA.
In considering the issue of “parent company liability” under CERCLA, it is helpful to first analyze the imposition of direct CERCLA liability, as applied to the subsidiary entity. Because liability under CERCLA flows directly to the “owner or operator” of the “facility,” the subsidiary entity that takes ownership of and controls the daily management of the “facility” would be subject to direct “owner or operator” liability under CERCLA. The significant question, therefore, becomes whether liability can extend up to the parent entity, based on either the parent entity’s ability to exercise corporate control over the subsidiary, and/or the parent company’s involvement, if any, in the operations of the facility.
Prior to 1998, based on the aforementioned congressional intent of casting a wide net of responsibility, federal courts often went beyond the traditional limitations on parent corporation liability, and imposed retroactive, strict, joint and several liability on parent companies under an expanded interpretation of CERCLA, which largely ignored the common law analysis for whether the “corporate veil” can be pierced. Regardless of the fact that indirect parent company liability was supposed to have been predicated on the common law theories of “piercing the corporate veil,” most courts did not require the plaintiff in a CERCLA case to prove up all of the elements necessary to pierce the corporate veil (as they would in a typical civil case). Instead, such courts liberally allowed the “piercing of the veil” to sweep in “everyone who is potentially responsible for hazardous-waste contamination” and force them to contribute to the costs of cleanup. See Pennsylvania v. Union Gas Co., 491 U.S. 1 (1989); see also Richard C. Coffin, United States v. Bestfoods: The Supreme Court Tackles Parent Liability Under CERCLA (June 1998).
This expanded interpretation of CERCLA, which was universally followed prior to 1998, frequently gave rise to parent company liability, based simply on the fact that the parent company had the corporate authority and/or voting power to control the subsidiary which owned and/or operated the contaminated facility or site, and regardless of whether the parent company had any involvement with the operations which resulted in the contamination.
III. The Law After the Bestfoods Case.
The aforementioned trend of liberally allowing the piercing of the corporate veil in CERCLA cases was reigned in by the United States Supreme Court in United States v. Bestfoods, et al., 524 U.S. 51, 118 S.Ct. 1876 (1998). In Bestfoods, the Supreme Court reaffirmed the “bedrock principle” that absent a legitimate basis in common law to pierce the corporate veil, a parent corporation is not liable for the acts of its subsidiaries, unless the corporate parent actively participates in, and exercises control over, the operations of the facility which caused the contamination. See Id. (emphasis added).
After Bestfoods, the two general theories by which a parent company can be held liable under CERCLA (direct vs. indirect liability), are now generally interpreted as follows:
A. Indirect Liability: Under CERCLA, indirect liability should not extend beyond the assets of the subsidiary to the parent company absent a showing of fraud, undercapitalization, disregard of corporate formalities, or other traditional common law grounds for “piercing the corporate veil” of the subsidiary.
B. Direct Liability: Direct Liability of the parent may still attach under CERCLA, but the Bestfoods case provided some additional guidance as to when direct liability would attach, such as: (i) if the parent company is found to be directly liable as an “operator” by managing, directing or conducting operations specifically related to waste disposal, pollution control, day-to-day management of the facility at issue, operations related to maintaining, disposing and/or transporting hazardous waste, or other management decisions about compliance with environmental regulations; or (ii) if the parent company is found to be directly liable as an “arranger” or “transporter” by arranging for the storage, disposal or transportation of hazardous substances owned or controlled by the parent company or the subsidiary, and such activities result in contamination to the subject facility or site. See Pinal Creek Group v. Newmont Mining Corp., 352 F. Supp2d 1037 (D. Ariz. 2005); citing Transportation Leasing Co. v. California, 861 F. Supp. 931 (C.D. Cal. 1993).
Generally, the Bestfoods decision establishes the rule that a parent company may actively participate in and control the corporate operations of its subsidiary, and communicate broad company policies without necessarily subjecting the parent company to CERCLA liability, so long as the parent company: (a) does not commit fraud, (b) sufficiently capitalizes the subsidiary, (c) observes and/or maintains corporate formalities and holds the distinction of the two corporate entities in due regard, and (d) does not actively participate in the daily management of the facility, or make arrangements or decisions pertaining to environmental issues including, but not necessarily limited to, the storage, disposal or transportation of hazardous substances. (See Section V below.)
IV. Parent Company Liability – As Applicable to LLCs and/or Partnerships.
The bulk of the reported cases addressing the issue of “parent company liability” are based on factual circumstances involving parent corporations, their subsidiaries and shareholders. As of the date of this article, I am not aware of any reported cases in or around Arizona, which have discussed or distinguished the issue of “parent company liability,” as applied to a limited liability company (“LLC”) and its members and managers, or to a limited liability limited partnership (“LLLP”) and its general and limited partners. Notwithstanding same, there are some published articles by legal scholars analyzing the “parent company liability” issue as applied to limited liability companies.
1. Limited Liability Companies. The legal scholars who have discussed the “parent company liability” issue as applied to LLCs draw the conclusion that the same “veil piercing” (indirect liability) and “operator/arranger” (direct liability) analysis would be applied to an LLC and its members and managers, as would be applied to corporations and their corporate subsidiaries and shareholders. See, e.g., Peter S. Britell, The LLC Vehicle and CERCLA Liability, New York Law Journal (May 15, 2000).
For example, if a member-managed LLC is the owner or operator of the problem facility or contaminated site, the members (including parent entities) who actively participate in the management and/or day-to-day operations of the facility, or the environmental affairs of the LLC, are likely to be deemed directly liable under CERCLA as an “operator.” To the extent there are any members (including parent entities) of the LLC that do not actively participate in the day-to-day management of the facility, or the environmental affairs of the LLC, but instead limit their involvement to general corporate matters and functions of the LLC, then such members should be able to avoid direct “operator” liability under CERCLA.
In the case of a manager-managed LLC (as the subsidiary /acquisition-development entity which owns the contaminated site or facility), the manager of the LLC could very likely be subject to “direct liability” under CERCLA based on the “operator” theory because the manager of the LLC typically controls the day-to-day management of the company. This is even more likely if such manager handles the environmental affairs of the company. The members of the manager-managed LLC that are not managers and, therefore, do not participate in the day-to-day management of the company or the environmental operations of the company likely would be treated similarly to passive investors or shareholders in a corporation, in that they should not be deemed directly liable as an “operator” under CERCLA.
In essence, regardless of whether the parent entity is a corporation or an LLC, the same analysis is likely to be applied by a court in determining whether the parent entity of the subsidiary can be held liable under CERCLA.
2. Partnerships. The CERCLA analysis, as applied to general partnerships, limited partnerships, limited liability partnerships and limited liability limited partnerships, has similarities and distinctions from the analysis applied to corporations and LLCs, depending upon the nature and form of the partnership which owns the contaminated property or facility. To illustrate this point, a brief discussion on each of the forms of partnerships will be applied to the issue of “parent company liability.”
a. General Partnerships. Because (i) general partnerships do not have a “corporate veil” or “shield of liability” under state law for the liability protection of the constituent partners, (ii) general partners in a general partnership are liable for the debts of the partnership, and (iii) each general partner in a general partnership participates in the management of the partnership, each of the general partners will most likely be deemed directly liable under CERCLA if the partnership owns or controls the contaminated property or facility.
b. Limited Partnerships. In the event the problem facility or contaminated site is owned or operated by a limited partnership (“LP”), the nature of the LP most likely will expose the general partner of the LP to liability because (i) the general partner controls and/or acts as the manager of the LP, (ii) under state law the general partner does not have a “corporate veil” or “shield of liability”, and (iii) the general partner is liable for the debts of the partnership. Limited partners most likely will not be subject to “direct liability” under CERCLA because of their “passive investor” status, unless the limited partners participate in the day-to-day management of the facility or the environmental affairs of the partnership.
c. Limited Liability Partnerships. If the problem facility or contaminated site is owned or operated by a limited liability partnership (“LLP”), each of the partners exercising management or control of the partnership will, most likely, be deemed directly liable under CERCLA, regardless of any state law “shield of liability” because of the control and/or involvement each of the partners have in the day-to-day affairs of the partnership. With that said, to the extent there are any partners that do not exercise management or control of the day-to-day affairs of the partnership involving the contaminated property or facility (or the environmental affairs of the partnership) should not be held liable under CERCLA. See Bestfoods (supra).
d. Limited Liability Limited Partnerships. To the extent the laws of the forum state provide for and recognize limited liability limited partnerships (“LLLP”), and to the extent the LLLP owns and controls the problem facility or contaminated site, it would appear reasonable to argue that the “parent company liability” issue, as applied to the LLLP, should be analyzed like that of an LLC; however, I an not aware of any case law or other controlling authority directly on point. In this situation, assuming the general partners of the LLLP manage the day-to-day operations of the facility or the environmental affairs of the LLLP, the general partners most likely would be treated like that of a manager of a manager-managed LLC, or the managing member of a member-managed LLC, and be subject to direct CERCLA liability as an “operator.” If the general partners did not manage the day-to-day operations of the facility or the environmental affairs of the LLLP (e.g., as a result of formal and actual delegation), those general partners arguably should not be held liable under CERCLA. See Bestfoods. The limited partners of the LLLP arguably should not be exposed to direct liability under CERCLA because of their “passive investor” status, unless those limited partners participate in the day-to-day management of the facility or the environmental affairs of the partnership.
NOTE: A discussion of the available CERCLA defenses is beyond the scope of this Article, but it should be noted that defenses to CERCLA liability have evolved along with the CERCLA law, the most notable of which are the revised “Innocent Landowner Defense,” the “Bona Fide Prospective Purchaser Defense” and the “All Appropriate Inquiries” rule related thereto.
V. Structuring Transactions / Conclusions.
After the Bestfoods case, the following general guidance should be kept in mind when structuring future real estate development transactions to reduce the risk of CERCLA liability from passing up through the subsidiary/acquisition-development entity and reaching the parent entity.
1. To the extent possible, structure future land acquisitions as asset purchases, so as to limit the liabilities that will be acquired.
2. Properly form and sufficiently capitalize the acquisition subsidiary and ensure that corporate formalities are observed at all times.
3. Prior to closing on any acquisition, the purchasing entity should: (a) obtain the best information available through vigorous environmental due diligence, in compliance with the All Appropriate Inquiries Rule promulgated by the EPA, so as to qualify for any applicable CERCLA defenses including, without limitation, the Innocent Landowner Defense and the Bona Fide Prospective Purchaser Defense; (b) make sure that the purchase agreement includes thorough environmental representations and warranties from the seller (including a clear representation that seller has disclosed or provided all material environmental information to the buyer); and (c) to the extent possible, insist upon an indemnification provision in the purchase agreement to insulate the buyer from environmental liabilities.
4. Consider obtaining a pollution legal liability (PLL) insurance policy, especially if there are known hazards on the property.
5. Immediately following the acquisition, the buyer/acquisition subsidiary should make sure that all outstanding environmental issues identified during the due diligence process are addressed, and that environmental management systems and policies are properly instituted.
6. The parent entity should ensure that the formal and actual responsibility for environmental operations and compliance at all facilities owned and operated by an acquisition subsidiary are clearly delegated from the parent entity, and its officers, directors, shareholders, members, managers, general partners, etc., to qualified individuals or entities at the facility level.
7. The parent entity should also avoid directly implementing or participating in environmental policies and procedures, and avoid exercising any authority over pollution control or waste disposal decisions and operational activities at the facility level.
In the foregoing circumstances, the parent entity’s actual and documented delegation of authority, responsibilities and control of all facility-level operations (particularly, environmental operations) to designated qualified individuals and/or qualified third-party consultants at the facility level, would provide a strong argument that the parent company is not acting as an “operator” of the facility; and, therefore, should not be held directly liable under CERCLA. Moreover, the parent entity should not be indirectly liable under CERCLA unless there is a basis under common law to “pierce the veil.”
Any questions about the foregoing topic, including any specific questions or issues related to entity formation and real estate holdings should be directed to Titus Brueckner & Levine PLC at (480) 483-9600.