What’s the lender liability risk for soil pollution in the People’s Republic of China? An evaluation of China’s new Soil Pollution and Control Law in the light of the USA and UK regimes

The ‘Superfund’ regime

CERCLA is colloquially known as the ‘Superfund’, ipso facto, because the regulation initially relied on a large trust fund to carry out remediation works. ⁷⁰ The trust fund was replenished annually by way of an industrial levy on the chemical and petroleum industries. ⁷¹ This raised total revenue of US$1.6 billion within a 5-year period, ⁷² and much more thereafter. ⁷³ The fund was to be used by the federal authority – the USA Environmental Protection Agency (USEPA) ⁷⁴ – where a site was left abandoned. ⁷⁵ Tromans and Turrall-Clarke, referencing the case of EPA v Sequa Corp (In the Matter of Bell Petroleum Servs., Inc), ⁷⁶ suggested that the purpose of setting the levy was deemed necessary to shift ‘the cost of cleaning up environmental harm from the taxpayers to the parties who benefited from the disposal of wastes that caused the harm’. ⁷⁷ But this may also have been because of the very considerable remediation expenses associated with CERCLA sites, which, at that time, was based at an average of US$25 million. ⁷⁸ On 30 September 1994, Congress chose not to re-authorise the tax provision that allowed revenues to be collected and funding has since been supplemented by the USA Congress’ annual appropriations. ⁷⁹

However interesting the above account is, it is necessary to clarify that this article’s central thesis is that CERCLA places the primary liability for remediation costs on those responsible for the contamination. Thus, it was not the Superfund levy which presented the risk to lenders but the manner in which liability was to be allocated, viz on the basis of strict liability where responsible parties were unidentifiable. With respect to CERLCA, Jarvis and Fordham believe that:

The US provides the furthest developed illustration of primary lender liability. American lenders have found themselves responsible for clean-up costs arising from the polluting activities of their borrowers. ⁸⁰

The secured creditor exemption ⁹³

Before looking at the secured creditor exemption in detail, it is important to note that foreclosure is not the only danger point for lenders. If a mortgage or other security interest is seen as an interest in the land, the lender can be seen as an ‘owner’ even without foreclosing. There are three types of situations in which lender liability could attach by:

simply holding an interest in the property to secure debt;

To limit liability under CERCLA, the secured creditor exemption was drafted into the law by Congress, ⁹⁴ but this has proved somewhat problematic. The exemption provided an exclusion for an ‘owner or operator’ where it was the case that: ⁹⁵

without participating in the management of a vessel or a facility, a person holds indicia of ownership primarily to protect his security interest in the vessel or facility. ⁹⁶

In the case of United States v Mirabile, ⁹⁸ the court was presented with the issue as to whether a lender that forecloses a facility should be seen as ‘participating in the management’ of that facility and liable. By foreclosing the property, the bank had become a ‘mortgagee in possession’. It submitted that it was merely following its normal procedure upon a borrower’s insolvency. ⁹⁹ Fortuitously for the lender, the court ruled that a bank that ‘merely foreclosed on the property after all operations had ceased and thereafter took prudent and routine steps to secure the property’ could not reasonably be held as a potentially responsible party. ¹⁰⁰

The secured creditor exemption was next interpreted in United States v Fleet Factors Corp (1988), known as ‘Fleet I’. ¹⁰¹ By way of a collateral clause contained in a factoring arrangement, Fleet Factors had acquired a secured interest in a borrower paint works. ¹⁰² The USEPA discovered 700 drums, each containing 55 gallons of toxic substances. ¹⁰³ Fleet was allocated with the remediation liability. In the court of first instance, Fleet was found liable; ¹⁰⁴ but the decision was reversed on appeal in United States v Fleet Factors Corp (1990) or ‘Fleet II’. ¹⁰⁵ There the court held that liability will attach to a secured creditor:

if its involvement with the management of the facility is sufficiently broad to support the inference that it could affect hazardous waste disposal decisions if it so chose. ¹⁰⁶

The above case law shows that the SPC provides a new risk for lenders around the globe. It demonstrates that the judicial interpretation of the law can enfranchise the authorities to indirectly allocate remediation liability with to private companies, including lenders and their clients.

The structure of Part IIA

The contaminated land regime is ‘tiered’, ¹²¹ being made up of Part IIA of the EPA 1990, ¹²² the regulations, ¹²³ Department of Environment, Food and Rural Affairs statutory guidance ¹²⁴ and scientific and technical advice. ¹²⁵ The regulatory framework delegates local authorities (‘enforcing authorities’) with the power to fulfil its objectives. ¹²⁶ Much can be gauged about the structure by the definition given to ‘contaminated land’:

any land which appears to the local authority in whose area it is situated to be in such condition, by reason of substances in, on or under the land, that:

This definition shows that the local authorities are responsible, notwithstanding ‘special sites’, ¹²⁸ for inspecting their areas ‘from time to time’ ¹²⁹ and for allocating liability to appropriate persons. The use of the local authorities is similar to the local people governments in the PRC. Also indicated are the types of ‘harm’ ¹³⁰ that may lead an enforcing authority to identify contaminated land. Lenders must have knowledge of this to protect their lending interests, and this is particularly so when taking security.

Unlike CERCLA, there is no Superfund upon which the authorities can draw upon in a case where liable parties (‘appropriate persons’) ¹³¹ cannot be identified. Worryingly, the enforcing authorities often lack the necessary financial provision and technical expertise to fulfil their statutory duties, which has led some to question Part IIA’s suitability. ¹³² Moreover, it is evident that the technical and financial gaps have widened during the austerity years. ¹³³ Tromans and Turrall-Clarke have spoken about the ‘resource implications’ plaguing the contaminated land regime: ¹³⁴

There can be few local authorities who will not be concerned about the potentially major costs of instigating and maintaining a programme of inspection of its area for contaminated land. ¹³⁵

Where a ‘contaminant linkage’ (contaminant–pathway–receptor) ¹⁴¹ is identified and the land is determined as contaminated land under Part IIA, local authorities have a statutory duty to serve a ‘remediation notice’ onto each person who is an appropriate person. ¹⁴² Liability is thereafter allocated under s 78F ¹⁴³ to the appropriate person(s). ¹⁴⁴ By s 78F(2) and (3), liability may be allocated to a person who ‘caused’ or ‘knowingly permitted’ the contamination: ¹⁴⁵

any person, or any of the persons, who caused or knowingly permitted the substances, or any of the substances, by reason of which the contaminated land in question is such land to be in, on or under that land is an appropriate person. ¹⁴⁶

Thus, it appears that Part IIA liability could attach to a lender that has too much control over a borrower’s business affairs. ¹⁵³ This was also seen in the above discussion with respect to the ‘participates in the management’ analysis under CERLCA. With the introduction of the SPC, lenders should use their experience and understanding of CERCLA and Part IIA to a positive advantage. Avoiding too much ‘control’ over borrowers with suspect land appears an essential requisite in reducing liability. The second type of Part IIA liability concerns owning or occupying land:

If no person has, after reasonable inquiry, been found who is by virtue of subsection (2) above an appropriate person to bear responsibility for the things which are to be done by way of remediation, the owner or occupier for the time being of the contaminated land in question is an appropriate person. ¹⁵⁴

Identifying the risks

In his exegesis of ‘lending and taking security in China’, Zhang pontificates that environmental liability is a risk for lenders operating in the PRC, namely:

If a lender becomes the owner of the land use right on enforcement of the mortgage, it becomes responsible for pollution of the land even if it is not the actual polluter. However, the lender can claim compensation from the previous owner of the land use right (the actual polluter). ¹⁵⁹

A holder of a secured interest has priority in a case where there is a default event. ¹⁶⁴ The rights of secured interests are detailed in the Property Law. In respect to liens, for example, Article 230 states:

If a debtor defaults in his debts, the creditor shall be entitled to retain the property under legal possession and to the priority of having the debt paid with the money converted from the property or proceeds from sale or auction of the property. ¹⁶⁵

It is also necessary to state that a broader array of risks exist under the SPC. Although this is less of concern when it comes to land pollution, there can be ‘market risks’ which describes the situation where an environmental event impacts the value of a lender’s security portfolio following, among other things, a client’s initial public offering (IPO). ¹⁶⁶ Additionally, remediation costs are capable of increasing the likelihood of a default event, resulting in credit risk. ¹⁶⁷ Further to this, the depreciation of land value by pollution may impact the lender’s security. ¹⁶⁸ There is also the potential reputational risk that may be incurred through being associated with polluted land. ¹⁶⁹ As with lender liability, the risks discussed in this paragraph can be reduced by the employment of environmental risk management. That being said, a detailed discussion of such due diligence techniques falls outside the purview of this article, which deals with lender liability.

Managing the risks

Lenders can reduce the risk of SPC liability by adopting effective environmental risk management strategies. Following the introduction of the USA and UK regimes, national and foreign lenders began to exercise environmental due diligence as part of their day-to-day commercial lending practices. ¹⁷⁰ While it is likely that some foreign lenders will be accustomed to dealing with environment-related risks, it is less certain the extent to which the PRC national banks are au fait with such initiatives. Although bordering on being trite advice, a lender that does not have an environmental risk management strategy in place for the SPC should implement one with immediate effect.

When dealing with environment-related risks in loan finance, it is now common for external environmental professionals to be commissioned by lenders to undertake ‘environmental audits’ into properties. ¹⁷¹ This can help a lender make an informed choice as to whether it should provide loan finance in the first instance or whether it should enforce its security interests in the property to repay outstanding debt. ¹⁷² The same should be adopted in consequence of the SPC, as it places greater pressure on lenders to engage with external professionals. ¹⁷³ As the lenders do not have the technical experience to conduct surveys, reliance will have to be placed on the expertise of environmental consultants. ¹⁷⁴

Another form of due diligence that should be used is the careful drafting of the loan documentation and any later workout agreements. To limit the likelihood of liability, clauses may be inserted into the documentation as a means of risk mitigation. ¹⁷⁵ For instance, an exemption clause may be included in the agreement to declare that the lender acknowledges that it is not the land use right holder and only has a security interest in the property. ¹⁷⁶ In so doing, the lender may be able to nullify the degree of control that is necessary to incur SPC liability. The USA and UK regimes have shown that reducing control over clients and polluted properties is crucial, and the same is true under the SPC. Particular attention must also be paid to the drafting of workout agreements following a pollution event. As with the loan documentation, careful drafting must be deployed in workout agreements to reduce control and thus bar the possible transference of liability.