Daily Development for Tuesday, August 18, 2009
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Husch Blackwell Sanders
Kansas City, Missouri

Here's a useful case provided by Larry Schnapf, our Environmental expert on DIRT

LENDER LIABILITY; ENVIRONMENTAL LAW: Mortgagee not liable when mortgagee fails to pass on to borrower environmental report that lender deems to be satisfactory in making loan, but may have provided clues that borrower could have pursued in identifying contamination.

Robert Hull and Point Pleasant Landco v. William Lewis (No.A-005403-07T3, App. Div.6/11/09)

First Fidelity had issued a loan commitment to the plaintiff in 1993 that required receipt of an acceptable phase 1. The property had been a coin-operated laundry. The bank obtained a phase 1 that concluded that there were no obvious signs of contamination and that due to relatively small amount of dry cleaning performed at site, it was unlikely that PCE was stored in sufficient quantities or USTs to be identified as a REC. The Phase 1 report contained express language that it was for the exclusive benefit of the bank and "was not intended to be, nor should be, for the benefit of any third party, including without limitation, any owner or lessee of the Property"

After reviewing the phase 1, the bank told borrower that phase 1 results were satisfactory to meet the loan commitment but did not provide the borrower with a copy of the report. The borrower then proceeded to purchase. In 2002, borrower tried to sell the land. A prospective purchaser performed a phase 2 and discovered extensive PCE and declined to proceed with the purchase.

 The borrower, now a plaintiff, filed a lawsuit against the prior owners and operators of the property was well as the bank and the consultant. The borrower/plaintiff alleged that it had relied on the bank's statement that the phase 1 was satisfactory to mean that the site was clean in proceeding to close on the property, and that the bank had a duty to advise the borrower of the specific findings of the phase 1 results and that failure was a breach of contract. Plaintiff sought reimbursement of its remediation costs.

In a ruling from the bench, the trial court granted summary judgment to the bank on grounds that there was no evidence that plaintiff had relied on the bank's satisfaction with the phase 1 report in deciding whether to purchase the property, and if it had such reliance would not have been reasonable. The court said that any "green light" by the bank might just as well been a waiver of its own requirements. The court also noted that the plaintiff's 30 day contingency period had expired two months prior to the issuance of the phase 1 report.

The appeals court affirmed, holding the issue is not whether the Bank subjectively intended the approval of the loan as an assurance that the property was free from environmental degradation, but whether the plaintiffs actually relied on this representation and whether such reliance was reasonable. The court agreed with the trial court that there was no evidence that the plaintiff had reasonably relied on the phase 1 report.

Reporter's Comment 1: This case illustrates the importance of a purchaser performing its own due diligence even if this means reviewing the phase 1 performed on behalf of the bank. A lender does not stand in the same shoes as a potential owner of property because of the secured creditor exemption. So long as a lender does not become involved in the operations of its borrower or take title through foreclosure, its liability for environmental conditions will be limited to the value of the loan. When banks held loans on their balance sheets, this potential loss was often enough to incentivize lenders to perform thorough phase 1 reports. In the era of securization, however, when the lenders would sell their loans almost immediately, lenders have been more concerned with keeping the assembly line of loan originations moving as fast as possible to maximize their fees.

The borrower, on the other hand, is going to be the owner of the property and will be first in line for any enforcement actions that may result if the land turns out to be contaminated. If the borrower is not named on the phase 1 report, it is quite likely that it will not be deemed to have engaged in an all appropriate inquiry or whatever level of due diligence may be required under a state innocent or prospective purchaser defense.

The preamble to the EPA AAI rule did state that "all appropriate inquiries investigations may be conducted by or for one person and used by another party.". But relying on a report prepared for another party may not be considered to be conducting an all appropriate inquiry under state law.

Reporter's Comment 2: Many states have statutes that require owners of property to disclose existence of contamination to prospective purchasers. Lender liability statutes in those states generally to not provide protection for common law claims or for failing to comply with the disclosure requirements. Lenders should carefully review the provisions of state lender liability laws and the scope of environmental disclosure laws as part of their loan due diligence. For example, in  2007. the Supreme Court of Missouri in Hess v. Chase Manhattan Bank (220 S.W.3d 758; 2007 Mo. LEXIS 65, 5/1/07) upheld a jury verdict finding a bank liable for common law fraud for failing to disclose the existence of an EPA investigation in a foreclosure sale. In so holding, the Court said that disclaimers in the contract did not preclude the fraud claim.
[The Bank had an obligation to disclose material information that was not discoverable through ordinary diligence and that the plaintiff could not have reasonably discovered the existence of EPA's investigation in the kind of diligence ordinarily done for real estate transactions of this kind. The bank also had failed to file the required property disclosure statement.]

Missouri had a statute compelling disclosure of any material information concerning property to be sold.  But even if a state does not have a statutory disclosure law, there may be an obligation under common law to disclose the existence of contamination or the results of prior investigations. Lenders have been held liable for improper disclosure in the past under common law theories of misrepresentation. For example, For example, in 2004 a Rhode Island Superior Court jury ruled that Fleet Bank was liable for $5.14 million in damages for failing to inform purchasers of a general store that the property drinking water was contaminated (Foote v. Fleet Financial Group) .

Another example was in 1999 when a Pennsylvania state court allowed a purchaser of contaminated land to maintain a claim for negligent misrepresentation against the bank when the bank failed to advise the plaintiff that real estate appraisal did not address environmental conditions (Seats v. Hoover, 1999 U.S. Dist. LEXIS 13379, August 18, 1999).

In 1991, the Montana Supreme Court reversed a summary judgment ruling in favor of a bank and allowed the borrower to proceed with negligent misrepresentation and constructive fraud claims against its former lender because there was a question of material fact whether the bank had created a false impression about the environmental conditions of the property (Mattingly v. First Bank of Lincoln,1997 WL 668215 (Sup. Ct. Montana, Oct. 28, 1997). 

In Boyle v. Boston Foundation, Inc. ,788 F. Supp. 627 (D. Mass. 1992) a bank that failed to disclose to purchasers of contaminated property the existence of notice from a state agency ordering a cleanup at the site was not held liable for misrepresentation because of a doctrine unique to the failed financial institutions taken over by the FDIC. The agency was acting as a receiver for the failed bank. The failure to disclose material information was held to constitute an "agreement" under the D'Oench doctrine and since this was an unwritten agreement, the plaintiffs could not prevail against the FDIC. It is likely that the plaintiff would have prevailed had the bank not been in receivership

It seems that at least once a year there is a case imposing liability on a bank for inadequately disclosing environmental conditions of foreclosed property that it has sold. It is not only prudent to err on the side of full disclosure in transactions, but in emerging areas such as vapor intrusion, to look back at prior disclosures to see if they could form the basis of a claim for non-disclosure. Given the volume of foreclosures we are now seeing, I would not be surprised to see more of these cases during the next year or so.

The Reporter for the case was Larry Schnapf of the New York and New Jersey Bars.

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