UK: Brownfield Land In The UK: Lenders' Liability


In this fourth in our series of briefings on topics relevant to those involved in brownfield land, we look at the issue of lenders' liability in respect of risks arising from brownfield sites under environmental law in England and Wales.

Whilst it is, in general terms, rare for liability to fall on lenders, there is potential for lenders to become directly liable in respect of risks associated with brownfield land and more scope for them to be indirectly affected. Having an awareness of the potential risks and taking appropriate action from the outset allows lenders to plan for and avoid/reduce the extent of any potential impact/liability. It is also useful for borrowers to be appreciative of the risks that inform the approach taken by their lenders.

Overview of risks facing lenders

In general, the issues that lenders face can be broadly categorised as follows:

  • The borrower's ability to repay the loan if it faces onerous environmental liabilities
  • The adverse impact on the value of the property (as security for the loan) as a result of its environmental condition
  • Liability falling on the lender in respect of any "responsibility" for the condition of the property attributed to it by the law or under contract.

Direct liability

Whilst the risks are usually low, there are a number of ways that lenders who fund the acquisition of, or operations at, brownfield sites may face direct liability, including through clean-up orders, damages claims and/or reputational damage. Lenders may be liable for environmental matters to the extent that they fall within one or more of the categories of person upon whom liability is imposed by statute or common law in the relevant circumstances.

Generally speaking, liability will not arise merely by virtue of lending but instead arises only through exerting significant control over the operations which cause environmental problems or through ownership or occupation of the property at or from which they emanate. As such, lenders have to get the balance right between obtaining adequate information and maintaining or enforcing contractual protection of their interests and avoiding an extent of involvement which could result in unwanted liability or, to the extent this is unavoidable (for example when exercising step-in rights), limiting that liability.

Contaminated land regime

The principal pollution liability legislation in the UK is the contaminated land regime enshrined in Part IIA of the Environmental Protection Act 1990.

Under the contaminated land regime, a party who has "caused" or "knowingly permitted" potentially hazardous substances to be present in the soil or groundwater at a site or, in the absence of such, the current owner may be responsible for carrying out or paying for the costs of clean-up of that contamination. Similar allocation principles apply in the other areas of environmental law, such as laws relating to water pollution.

In the ordinary course of events, a mere lender will not incur pollution liability. The contaminated land regime makes clear that the mere act of lending will not result in liability, and that a mortgagee that is not in possession will not be considered an "owner" for these purposes.

The risks are conceptually quite different at different points in time, in particular as between the point when the decision to lend is made on the one hand, and the time when a later problem arises and any enforcement action is taken.

As to the former, whilst it is of course always ultimately a commercial decision there is certainly no reason for a lender to walk away from a deal just because the site has environmental issues: many UK sites have extensive legacy contamination issues and yet they remain perfectly suitable for use and good security.

The issue is rather whether the anticipated costs of any required clean-up, ongoing monitoring, potential third party environmental claims etc. are likely to leave enough security should the lender ever need to enforce, taking into account any higher ranking security. This risk is something that can be assessed at the outset with help from the lender's legal and technical advisers.

Different considerations apply if a new contamination problem arises during the term of the loan. A separate decision can and should always be made at the relevant time in the future (based on up to date environmental reports etc.), whether and to what extent to exercise any step in rights or otherwise exercise contractual rights, whether to become mortgagee in possession, appoint an insolvency practitioner and so on. It is at this stage (rather than the initial lending stage) that the risk of direct liability (as "causer", "knowing permitter" or "owner/occupier") becomes less theoretical.

  • Causing pollution: If the lender actively controls aspects of the borrower's activities and those activities cause pollution, the lender may end up being liable for any contamination caused. Acting as a "shadow director" would be an obvious but rare example of this, but so in theory might injudicious exercise of control through enforcement of contractual rights in the facility agreement. On the other hand, merely knowing that the borrower's operations are causing contamination, or withdrawing financial support when it could be used to undertake preventive work, is unlikely to amount to "causing" pollution unless the lender also controls the borrower's operations.
  • Knowingly permitting pollution: In outline, a "knowing permitter" is someone that has both the ability and a reasonable opportunity to take steps to address contamination but fails to do so. For so long as the lender is a mortgagee not in possession, mere failure to enforce a covenant (for example a covenant not to cause pollution) is on its own unlikely to be interpreted as "knowingly permitting" that which the covenant prohibits. However, if the lender actively controls the borrower's activities, that may make it more difficult to later argue that the lender is not liable for failure to deal with known contaminants.
  • Owner/occupier liability: A mere owner or occupier of brownfield land will not incur liability under the contaminated land regime provided one or more "causers"/"knowing permitters" of the pollution in question can be identified and are still in existence. However, taking possession of contaminated land to enforce security clearly raises the prospect that the defaulting borrower will in due course be wound-up, creating potential owner/occupier liability for the lender, and/or of "knowing permitter" liability arising if contamination problems are not addressed within a reasonable window of opportunity.

There are, in addition to the contaminated land regime, other areas of environmental law where liability for lenders can theoretically arise depending on the extent of involvement in the borrower's activities. These include other statutory clean-up regimes and tortious liability under the laws of nuisance and negligence.

Indirect impacts

Obviously a more common scenario is that lenders find themselves indirectly impacted as a result of the effects of environmental laws on the borrower itself. For example, the costs of required clean-up of a property or required plant upgrade (leading to business interruption) might, in the absence of adequate insurance or other provision, affect the borrower's creditworthiness and/or the value of the lender's security.

The inability of a borrower to service a loan may also be compromised where environmental issues affecting the property and/or business result in reputational damage to the borrower and/or its business/property.

Priority of rights

Another concern for lenders may be as to whether their security will take priority over any claim by a regulatory authority for the latter's expenses in conducting remedial work on the site after the date of the mortgage or legal charge.

In the event that a regulatory authority carries out work by way of remediation, it will be entitled to recover the costs incurred of doing so from the borrower. The regulatory authority has powers to serve a "charging notice" requiring the relevant persons (i.e. the borrower) to compensate the authority for the incurred expenses.

Under the present legislation, the costs specified in a charging notice (and the accrued interest) will be made a charge on the site if the costs are not paid within the time specified. Such charge will rank in priority over a lender's mortgage or legal charge even if the lender's security took effect before the regulatory authority's expenses were incurred.

Protection for lenders

The most robust form of protection for lenders at the time of initial lending is carrying out thorough legal and technical due diligence to assess environmental risks as accurately as possible.

In the event that a preliminary check indicates that there may be environmental risks associated with the site or the proposed activity of the borrower, the lender should obtain, or require that the borrower obtain, a suitably detailed report from an environmental consultant with adequate rights of legal reliance in favour of the lender.

In addition to assessing the risks thoroughly, lenders will wish to seek appropriate contractual protection in the loan documentation to protect their position. These may include some or all of the following, by way of example:

  • A warranty that the property is free from hazardous substances/disclosure of any known contamination
  • A warranty that the borrower is unaware of any circumstances which are likely to give rise to any environmental claim
  • A covenant to comply with environmental laws and to notify the lender of any environmental claims made against it
  • An undertaking to obtain adequate environmental risk insurance to the extent available/attainable
  • An indemnity in favour of the lender in respect of any liability incurred by the lender relating to the environmental condition of the property or any failure by the borrower to comply with applicable environmental law
  • A condition precedent that an environmental report is provided to the lender confirming that the operations on the property comply with environmental law, and there are no (material) liabilities relating to the condition of the property and/or that any required clean-up has been undertaken

Throughout the period of the loan, lenders should maintain, so far as is practicable, an arm's length detachment from the running of the borrower's business/property as well as any receivership or administration. In doing so, lenders may avoid/minimise the risk of being deemed to be acting as a shadow director or having the necessary control to "cause" or "knowingly permit" contamination. This applies equally to direction given by the lender in relation to an environmental breach or claim. In a default scenario, unless incapable of remedy, the lender should not take control of the remedial process unless and until it becomes clear that the only option is to enforce its security.

Prior to taking any steps to enforce security over the loan (e.g. by appointing a receiver), the lender should undertake further updating investigations to determine whether he is likely to incur environmental liabilities in doing so. Whilst any receiver appointed by the lender should be regarded at law as the agent of the borrower, the lender will generally be required to indemnify the receiver in any event.

Of course, the existence of risks will by no means automatically preclude the taking of enforcement action – it is always a balancing exercise – but a proper appraisal of the environmental costs (e.g. clean-up) that might be incurred in the process will enable a thorough cost/benefit analysis to be performed.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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