Chapter 1:
Framework of Environmental and
Economic Development Concerns

The interplay between the economic and environmental arenas has dominated community development strategies in countless jurisdictions across the country. Acquiring, cleaning, and redeveloping older, and often abandoned, industrial sites can be very expensive and time consuming. In many situations, private developers and financiers are not able, or willing, to act on their own to ensure that the full economic potential of site reuse will be achieved. Rightly or wrongly, the ambiguity of statutes governing liability and cleanup has increased the uncertainties and perceived problems associated with brownfield activities. Heightened concern over environmental problems has brought a new dimension to the risks that lenders face and the hurdles that developers and local agencies must overcome. Cleveland Mayor Mike White has called contamination the number one issue facing development practitioners.

This chapter provides the backdrop against which these environmental and development concerns play out in specific community situations. Part 1 lays out the barriers to the cleanup and redevelopment of brownfields. It initially focuses on the economic context, describing why brownfield financing is problematic. To assist economic development practitioners unfamiliar with federal environmental laws, it pays particular attention to the two major statutes governing the cleanup of contaminated sites: the Comprehensive Environmental Response, Compensation, and Liability Act (commonly known as Superfund) and the Resource Conservation and Recovery Act. Part 2 discusses how lenders respond to the real and perceived fears of liability, and it reviews how these responses impact the local economic development process. Part 3 examines banking policies and regulations that affect brownfield cleanup and reuse.

Part 1: Barriers to Brownfields Redevelopment

Virtually every city in the nation's older industrial regions, no matter its size, grapples with the challenge of unused manufacturing facilities. These properties include the shuttered steel mills in western Pennsylvania and Chicago's southeast side; mining operations in Montana and Arizona; closed timber mills that dot many small towns in Washington and Oregon; and declining defense contractors, metal plating factories, machine shops, and chemical plants in communities from Michigan to Mississippi.

Local public officials, economic development practitioners, and plant owners who have sought to revitalize fallow industrial properties during the last few years face a daunting new challenge: contamination of the buildings, equipment, and surrounding land. Public concern about health effects from toxic pollution and stricter environmental laws have made it exceedingly difficult for communities to restore and reuse former manufacturing sites.

The precise magnitude of site contamination is unknown, but is no doubt pervasive and significant. Some experts have suggested that more than 500,000 sites nationwide show evidence of at least some contamination which could trigger Superfund rules and ultimately inhibit owners from selling the site, securing financing, or proceeding with reuse. In framing the brownfield issue, however, it is essential to distinguish between Superfund high priority sites — the worst of the bad with little prospect for economically viable reuse — and those sites characterized by low and medium levels of environmental contamination, typically industrial facilities in operation before CERCLA's 1980 enactment. To date, EPA has identified almost 1,300 high-priority sites that are the true environmental nightmares bearing significant health and safety risks and requiring considerable time and enormous resources to restore. The balance of affected sites — characterized as brownfields — generally are easier to clean and offer greater opportunities for reuse.

The convergence of economic development and environment issues comes at a critical time for local officials struggling to craft community revitalization strategies targeted to old industrial areas. Many brownfields are caught in a vicious cycle of decline, which only exacerbates the problems local officials face.

• A property owner, unable to sell a contaminated property, simply abandons it, undermining the local tax base.
• Vacant facilities deteriorate and invite abuse, including the unsupervised stripping of parts or material, vandalism or arson, and "midnight" dumping.
• Untended pollution may worsen and spread, further diminishing the property value, adding to the site's cleanup cost, and threatening the economic viability of adjoining properties.
• Brownfield sites often become unwanted legal, regulatory, and financial burdens on the community and its taxpayers.

Communities that allow brownfield sites to remain inactive lose the tax revenue and employment opportunities generated by thriving operations — for some cities, this can total hundreds of jobs, millions of tax dollars, and hundreds of thousands of dollars in wages that might circulate through the area, bringing still more economic benefits. Existing streets and roads, water lines, rail spurs, and other infrastructure systems go unused; in jurisdictions with numerous brownfield sites, this means that billions of dollars in prior public and private investment are essentially wasted. Given land-use patterns prevalent earlier in this century, many brownfield sites are well-located, often along waterfronts or adjacent to downtown centers; their festering presence can drag down efforts to revitalize nearby sites, stalling a community's revitalization efforts and undermining its tax base.

Yet rather than deal with old industrial sites, many developers prefer to build on previously undeveloped land outside the city. As one suburban-based developer put it, "The numbers just make sense that way." In addition to the environmental and social impacts of such sprawl to outlying "greenfields," this change has serious economic consequences for the cities left behind. For example, more roads are needed, and increasingly scarce federal and state infrastructure funding is funneled into suburban and exurban areas. Jobs moved away from the central city are less accessible to economically- disadvantaged persons, many of whom need public transportation to get to and from work.

No doubt cleanup adds to the costs of redevelopment projects, often significantly. Depending on the extent and type of contamination, these costs can reach into tens of thousands, sometimes millions of dollars. In most areas — but particularly in central cities — financing to carry out both cleanup and redevelopment activities is not available at affordable rates.

Contamination also triggers a web of technical and legal tangles. Cleanup requires time, delaying project completion by months and even years. For developers any delay is costly. These are sunk costs that eat into a project's profitability.

Valuable sites and structures, well-situated near other vibrant economic activity, where the expected financial returns exceed the redevelopment costs — including cleanup — will be reused. Economically marginal facilities, on the other hand, will lie dormant without some additional incentive or assistance. For example, the developer of an inner-city Cleveland parcel (who converted an industrial warehouse site into a small neighborhood shopping center) spent nearly $225,000 per acre for site testing, remediation, and preparation; he estimated that similar activities for a comparable project at a suburban greenfield site would have cost only $40,000 per acre. In this case, however, strong support from the city encouraged him to proceed.

When dealing with brownfield situations, it is not uncommon for the costs of site testing, remediation, and redevelopment to exceed the property's value — making reuse virtually impossible to justify without some type of compensating incentives. Consider several examples in St. Louis, outlined by Mayor Freeman Bosley in recent congressional testimony.

Retail site. St. Louis, like most older cities, has deteriorated commercial districts that impose a blighting effect on surrounding residential neighborhoods. The owners of these centers cannot command sufficient rent to properly maintain them. In one targeted area, the city paid $850,000 to assemble, clear, and clean a corner site deemed critical to the shopping district's viability. When these procedures were accomplished, a private company invested $1.5 million in what is now a thriving commercial business that employs 20 people, generates $2 million annually in sales, and helps to attract patrons to other retail and eating establishments in the area. However, it cost St. Louis $26.25 per square foot to reclaim this site — which has a real value of only $2.00 per square foot.

Industrial facility. The industrial center of St. Louis, like those of many older jurisdictions, is composed of city blocks occupying two to three acres. Since industrialists now tend to build out rather than up, cities need to assemble and prepare ready-to-build sites ranging from two to ten acres in size if they are going to compete for plants with greenfield locales. As Mayor Bosley emphasized, "No business is going to spend the time and money to (acquire and clean sites) even if they prefer the hub location of the city."

St. Louis spent $7.6 million to assemble a 50-acre industrial park; this translates into $6.00 per square foot for ground valued at $1.50 per square foot. The park has attracted considerable interest, but few ultimate users because of remaining environmental remediation needs.

Office building. St. Louis has many historically significant vacant office buildings; the local redevelopment authority has taken title to many. One, a 22-story, 300,000 square-foot art-deco structure, is in the city's cultural district adjoining St. Louis University. According to current estimates, it would cost $1.5 million to remove asbestos from the building, a step that's necessary to reuse it. The university would like to renovate the building, but cannot justify the cleanup costs. If investment is not attracted, the city will have to spend $1.5 million on basic remediation and another $1 million for demolition. The resulting cleared site would have a market value of $1.50 per square foot, but it would have cost $72.30 per square foot to reach this status.

Similar examples are found in cities and towns across the country. Even lease situations have been complicated by concerns over contamination. Landlords increasingly are afraid they will be responsible for costly cleanup resulting from hazardous materials that tenants use in production processes, and most building owners are putting tighter reins on tenant activities and requiring them to undergo much greater financial scrutiny. A Chicago real estate attorney noted that landlords are "adding all sorts of creative language to their leases." Many now require hefty security deposits, permission to inspect operations during tenancy, and environmental audits — in short, landlords are trying to shift as much of the environmental liability as possible to the tenant. Many of these lease stipulations deter new business start-ups, prove too burdensome for struggling small companies, and drive still other operations out of the cities and into greenfield sites.

Tables 1 and 2 compare the costs of a brownfield redevelopment project versus new greenfield construction. They were provided by J. Duncan Shorey, a real estate consultant active on brownfield issues in Cleveland. Table 1 is a hypothetical example, a composite based on several projects that Shorey advised. Table 2 on the next page is an actual project pro forma comparison, with references to specific companies and site locations removed.

Table 1
Hypothetical Project Comparison:
Brownfield vs. Greenfield
Assumptions for All Projects: 20 acres
Building Space: 261,360 sq. ft. (10% office)
Construction Costs: $25/sq. ft. for shell; $20/sq. ft. for office

Confronting these economic challenges requires a deliberate, multi-dimensional approach. A consistent lesson of the more detailed project profiles in Chapter 5 is that parties who often do not work together constructively — economic development practitioners, environmental advocates, real estate developers, financiers, and community leaders — must cooperate to bring about productive reuse of brownfields. The benefits can be considerable. In Cleveland, for instance, just a few sites restored as part of the city's brownfield pilot program have yielded more than 100 new jobs and $645,000 in annual property tax revenues in a year's time.

To help economic development practitioners understand the integration of environmental and economic concerns, which can be central to the quality of life in urban areas and small towns, this chapter reviews relevant environmental laws and their impact on lending and development processes.

Table 2
Development Project Comparison:
Brownfield vs. Greenfield

*Assumes Remediation: $2,000,000
Consulting: $300,000
Legal: $50,000

SOURCE: Kerry Chelm, President, Chelm Management Co., Cleveland, Ohio, July 1995.

Superfund

The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA or Superfund) is the most significant federal statute guiding public officials and private parties as they cope with site contamination. Unlike most environmental laws from the 1970s that regulate pollution coming from operating industries, Superfund deals with past dumpings of hazardous materials and the toxic legacy of sites that pose grave threats to public health and the environment. CERCLA is perhaps the most influential environmental law affecting whether and how contaminated sites are cleaned and redeveloped. The statute's liability, enforcement actions, and cleanup provisions have had, and will to continue to have, profound effects on communities and regulated industries. These aspects of the law should be of particular interest to local economic development practitioners.

Liability

Unlike earlier environmental laws, CERCLA uses liability — rather than public-sector regulation — to influence the handling of pollutants. Under Superfund, present and past owners or operators of a property are responsible for the costs of cleaning "any release or threat of release of hazardous substances." This provision can have a chilling effect on transactions involving brownfields, since the purchaser of such a site could be held responsible for contamination discovered. Prospective purchasers, therefore, often require extensive assessments and, if necessary, cleanup of any contamination at the property. Even then, many developers or property owners worry that state or federal officials may pursue them for additional cleanup costs.

The concept of liability — applied in CERCLA under its common law meaning of "strict" liability (i.e., not requiring any demonstration of wrong-doing on the part of the polluter) — was seen by lawmakers to offer several advantages to the government as it sought ways to control and reduce discharges of hazardous substances into the environment. First, the threat of liability was seen as a deterrent to mishandling such industrial materials. Indeed, CERCLA liability and the law's 1986 amendments, which require disclosure into a Toxic Release Inventory of certain chemicals released from operating facilities, have encouraged industry to handle hazardous materials more carefully, to reduce waste generation overall, and to pursue pollution prevention technologies at their facilities.

Second, Superfund's liability scheme effectively drafted bankers and insurers into the regulatory framework affecting industrial handling of hazardous waste materials. The long-term investments of these new stakeholders are protected when companies operate according to environmental laws and avoid enforcement and liability expenses.

Third, liability under CERCLA is applied "jointly" and "severally" among the parties responsible for a cleanup. This means that the government can pursue reimbursement or cleanup costs from one or all parties even remotely associated with the pollution. Horror stories abound of small "mom-and-pop" companies being sought for reimbursement of multi-million dollar cleanups because they may have contributed a few gallons of toxic chemicals to a site. In practice, however, companies in the best financial shape, those with "deep pockets," are the most sought after for payment and remediation of a hazardous waste site. Indeed, one mayor of a small town in Indiana recently referred to Superfund as a "smart bomb that lands on the deepest pocket." It is the "deep pocket" cases that lead to the most protracted litigation, effectively driving up the costs of cleanup.

Critics of CERCLA claim that liability is an inappropriate and unfair way to reduce or remediate discharges of hazardous materials to the environment, especially those that occurred prior to the bill's passage in 1980. Industry, they argue, may have released hazardous substances in a manner inconsistent with environmental stewardship, but such practices were not illegal at the time. On this basis, the law's critics are pushing for legislative reforms that would repeal retroactive liability before 1980 or, if the insurance companies prevail, before 1987, when they reformed their policies in response to the new obligations faced by their policyholders. So far, lawmakers, wary of burdening the public with cleanup expenses, have been unable to find the money needed to repeal retroactive liability. Meanwhile, state environmental agencies and the federal EPA have been working to establish appropriate limits on CERCLA liability, especially for lenders, fiduciary interests, innocent landowners, municipal governments, and prospective purchasers not associated with any pollution at a brownfield site.

Environmental law experts note that imposing strict, if not retroactive, liability has its roots in other environmental laws in place well before 1980, notably those laws to control oil spills and releases under the 1972 Clean Water Act (as well as the Clean Water Act Amendments of 1977 and 1978) and the 1976 Resource Conservation and Recovery Act, which amends the 1970 Solid Waste Disposal Act. The 1984 amendments to RCRA, which have had serious impacts on the costs and time lines associated with the cleanup of contaminated sites, are discussed in more detail later.

One exception to environmental liability, added to CERCLA in a 1986 amendment, is known as the "innocent landowners defense." It frees from liability, so long as certain conditions are met, those individuals or organizations that became property owners "and did not know and had no reason to know" of any contamination at the site. Congress spelled out what it meant by the phrase "had no reason to know," making it clear that the interpretation could vary in different situations. The 1986 amendment stated that the new owner must have undertaken, at the time of acquisition, "all appropriate inquiry" that is "consistent with good commercial and customary practice" into the previous ownership and uses of the property.

EPA and the courts have offered no clear guidance as to how much inquiry is enough, and what level is considered appropriate. Increasingly sophisticated pollution detection technologies further complicate this provision's interpretation. In addition, the lack of benchmarks has been both intimidating and frustrating to both site purchasers and project lenders. One witness, appearing before the House Small Banking Committee, likened the search for an innocent landowner to Diogenes in the daylight with his lantern. If contamination is discovered, then the innocent landowner defense does not apply; if it is not found, then the owner did not make all appropriate inquiry.

A second exception is a statutory exclusion that covers lending institutions having only limited involvement in the operation of a property, either as creditors or as owners following foreclosure. This is frequently referred to as the "secured creditor exception" (SCE) and is designed to accommodate financiers' conventional underwriting and lending practices. While lender liability is not the only issue involved in the complex relationship between environmental concerns and the economic development process, it is clearly a key one. During the last four years, lender liability has become a lightning rod, attracting diverse proposals for change and sparking considerable debate.

The critical issue for lenders arises from the CERCLA provision addressing security interests, namely, that a lender is not ensnared in liability so long as the lender holds only a security interest in the property and does not "participate in the management" of it. In other words, an institution that lends money is not liable under CERCLA for contamination at the borrower's facilities simply because it holds an ownership interest to secure the loan — as long as it does not participate in managing that facility.

But the statutory language defining the secured creditor exception is vague, and subsequent judicial interpretations only have clouded its applicability. In particular, the stipulation that a lender not "participate in the management" of a facility has spawned considerable legal anguish during the last few years. CERCLA does not define this phrase, and the judicial interpretation of "participate" has formed the core of the current lender liability debate. Successive court decisions have indicated that the lender must prove that it is entitled to claim the secured creditor exception. To date, judicial consideration has centered on two issues:

• whether mere ability to participate in managing a facility voids the SCE, even if the lender did not actually participate (i.e., distinguishing between a lender's influence and actual action).
• whether certain limited types of participation, such as offering financial advice to the borrower, leave SCE eligibility intact.

In the first situation, some courts have held that the lender does not forfeit a SCE simply because it has the power to participate in managing a borrower's facility. In its 1990 ruling on Bergsoe Metal Corp. v. East Asiatic Co., Ltd., the court noted that it was important what the defendant bond-issuing authority actually did by way of managing the project, not simply what rights or unexercised authority it had to influence the operation.

Another 1990 judicial decision, however, created considerable turmoil in the banking industry, and continues to influence the brownfield reuse issue. In United States v. Fleet Factors Corp., the court broke with existing precedent and held that a secured creditor could be liable under CERCLA if its involvement with a facility's management is "sufficiently broad to support the inference that it could affect hazardous waste disposal decisions if it so chose." The judge also stated that "it is not necessary for the secured creditor to actually involve itself in the day-to-day operations of the facility in order to be liable."

The American Bankers Association (ABA) has testified before Congress that the Fleet Factors ruling created a broad standard of lender liability that "is sending shock waves through the lending community." Lenders have taken issue with the fact that, despite CERCLA's explicit exclusion for lenders who hold a security interest in property, the court ruling infers that lenders serve as owners of property because of the nature of their financial relationship with their borrowers. Since lenders can be held liable for cleanup efforts, before making a loan on a contaminated property they must consider:

• whether the financial institution will become an "owner" if it later forecloses on the property; and
• whether the financial institution will become an "operator" if it later takes actions relating to hazardous substances on the property.

In predicting the impact of Fleet Factors on economic development finance, it is important to place the court's ruling in context. In this case, EPA alleged that Fleet Factors Corp., in the course of winding down operations of a defunct cloth printing facility and selling off equipment (used to secure its loan and on which it had foreclosed), had complete control of the property. During this period of control, Fleet handled barrels of hazardous waste and removed machinery in a way that released asbestos. In pressing suit, the federal government sought to recover $400,000 in costs paid by the Superfund to clean up the site during the time that Fleet held title to the property.

In explaining its ruling, the court cited the need to interpret vague statutory provisions broadly enough to achieve CERCLA's cleanup goals. Anticipating the financial industry's reaction, the court also indicated that its narrow interpretation of SCE eligibility still left a lender free to monitor any aspect of the borrower's business, or even become involved in "occasional and discrete" financial decisions pertinent to its fiduciary responsibility of protecting its security interest. In its opinion, the court emphasized that its interpretation of liability should not discourage lending to such enterprises; rather, it should encourage financial institutions to examine more vigorously the environmental practices of prospective borrowers. The court also suggested that this ruling would encourage bankers to consider CERCLA liability risks upfront, as part of the terms of the loan agreement.

The court's explanation notwithstanding, the Fleet Factors ruling declares that a secured creditor may be liable "if it participated in the financial management of a facility to a degree indicating a capacity to influence" disposal activities. Some lenders, as a result, decide that the best way to avoid liability is not to participate in any of their borrower's decisions, financial or operational. Such a course of action, though, deprives small businesses — which often need considerable technical assistance — of important financial advice. For some companies, this lack of involvement might mean that otherwise solvable financial problems lead to business failure.

Lender liability concerns cut across financial, economic development, and environmental interests. Banking organizations, as well as individual lenders, maintain that it is in the public interest to encourage lenders — rather than discourage them — to help their customers address the problems of pollution and clean up site contamination. This, they suggest, is the reason that the SCE must be interpreted in a way that protects lenders from liability, especially in loan workout situations.

From the financier's perspective, possible liability for multi-million-dollar damage awards has increased greatly the risk of doing business, and reduced the availability of capital, especially for small business clients. Lenders see themselves targeted as "deep pockets" to be tapped for cleanup costs, which may exceed the property's total value. Even in situations in which the lender is not held directly responsible, such liability creates risks by reducing the borrower's ability to repay the bank and by minimizing the value of the collateral.

Some lenders worry that advances in detection technology could find pollution at facilities they already have financed. According to a leading New Jersey environmental engineer, financial institutions want to know that the site or facility being financed is "clean, according to accepted scientific standards, now and for the life of the loan." In other words, they seek some assurance that no surprises will come bubbling up at a later time.

Even though only a handful of bankers have borne the cost of liability for such contamination, fears of liability have been exacerbated by the Fleet Factors decision. At best, many borrowers face greatly increased loan transaction fees and other costs as the lending community grapples with CERCLA's provisions. At worst, companies in sectors viewed as environmentally risky — manufacturing operations, as well as service businesses such as gas stations and dry cleaners — will not be able to secure financing when using their property as collateral.

Enforcement

CERCLA's enforcement provisions allow the federal government to take steps to respond quickly to releases of hazardous materials. "Release" is defined under the law as "any spilling, leaking, pumping, pouring, emitting, emptying, discharging, injecting, escaping, leaching, dumping, or disposing into the environment." Under the law, the federal government is authorized to:

• spend money from the Superfund Trust Fund to clean up National Priorities List sites;
• order responsible parties to clean the sites; and
• seek reimbursement from responsible parties for cleanup and related costs in the case of a federally-funded cleanup.

Cleanup Standards

"How clean is clean?" has become a key question for lawmakers, developers, public officials, and local residents, as communities undergo the time-consuming and expensive process of assessing the advantages of cleaning and reusing contaminated property. Successful redevelopment depends on their ability both to impose cost-effective standards and to protect public health and the environment. This balance links the science of cleanup standards with the policy of land use decisions, often putting local officials in the middle of contentious battles regarding the future of brownfield sites.

The Superfund program historically has relied upon a "risk range" in setting cleanup standards for the 100 most common chemicals at contaminated sites. The U.S. Environmental Protection Agency allows cancer-causing substances to remain on site only at concentrations resulting in the risk of excess cancer cases between 10-4 (one in 10,000 people) and 10-6 (one in one million people). This range accounts for the differences in site-specific risk assessments, which weigh the danger of the chemicals against the likelihood and duration of human exposure. State governments also have applied the concept of risk range to different land use classifications. Most states, for example, require that brownfields restored to residential use meet the cancer risk of 10-6. In such instances, state environmental agencies generally exercise little oversight of the cleanup, since the property developer essentially has agreed to remove all of the hazardous substances of concern.

Brownfields redeveloped for industrial or commercial use, on the other hand, increasingly are allowed to meet the cancer risk range of 10-4, which does not involve complete removal and restoration. The rationale is that funds used to remediate such sites completely would be better spent on residential properties, provided that resulting conditions at the industrial sites are safe for workers and others coming into contact with them. Although CERCLA calls for permanent treatment of hazardous waste, this preference is giving way to the economic and political expediencies of seeing these properties returned to some level of use. Therefore, engineering controls — such as caps, fences, or other physical means to contain pollution and prevent human contact with it — represent an increasing trend in the cleanup of both brownfield and NPL sites.

Institutional controls — such as permanent land use restrictions or constant monitoring for pollutant levels — represent another mechanism property owners can utilize to justify less-than-perfect cleanups. Environmental and community groups, however, tend to view these approaches as short- sighted, arguing that local governments lack the ability to track and enforce such restrictions, and that allowing lesser cleanups essentially locks in land use decisions indefinitely.

These issues are not easily resolved. Congressional Superfund reform proposals offer five balancing factors intended to help determine appropriate cleanup standards: (1) effectiveness of the remedy, including implementability, technical practicability, and the ability to reduce risks; (2) reliability of the remedy over both the short and long terms; (3) the remedy's risks to the affected community, remediation workers, and the environment; (4) community acceptance of the remedy; and (5) reasonableness of the cost, compared to other available remedies. Careful deliberation over future land use in their communities can position residents as players when cleanup standards are being proposed and developed for brownfields.

The States' Experience with Superfund

While EPA manages the nearly 1,300 sites on the National Priorities List (NPL), the states have identified about 70,000 hazardous waste sites that fall below the federal threshold. Approximately 22,000 of those sites have been targeted for cleanup, although none are eligible for federal Superfund cleanup dollars. This enormous number of sites, coupled with dwindling state resources, is in part driving the rapid adoption of state voluntary cleanup programs, with 17 of the 21 existing programs having been adopted since 1991.

The Environmental Law Institute (ELI) in 1993 examined the experiences of state-run superfund programs and discovered lessons that are worth mentioning in the context of brownfields cleanup and reuse. Of the state superfund program components — including goal setting methods, site discovery, site management, and methods to reduce litigation — the process of site discovery has most relevance to local government efforts to identify and prioritize sites for remediation and redevelopment.

One site discovery approach, referred to by ELI as "passive or property transfer programs," informs state and local officials of hazardous waste releases and contamination when property changes hands through sales, lease changes, or other transactions. New Jersey's Industrial Site Recovery Act and Illinois's Responsible Property Transfer Act are examples of such programs that provide a role for private property owners to help speed up discovery and cleanup at sites. Connecticut amended its Property Transfer Act in 1987 to increase the rate at which brownfield sites are identified and to include all dry cleaners, gas stations, furniture strippers, auto body repair shops, and painting shops operating after May 1, 1967, regardless of the amount of hazardous waste they generate.

Another approach, known as "targeted active site discovery," prioritizes cleanup in valuable or sensitive natural resources, such as the Indiana Sand Dunes or the Edwards Aquifer underlying Austin, Texas. In the case of brownfields site discovery, states and localities have modified this concept to base remediation activities upon a number of criteria in additional to environmental factors:

• site is located in distressed neighborhood, or empowerment or enterprise zone;
• site is located in area of historical significance;
• property features access to valuable infrastructure, especially transportation; or
• site is in an area or neighborhood already popular with developers.

As another means of targeting, local governments increasingly are using multi-focused data bases that can project employment growth or loss, population gains or losses, other demographic data, and environmental regulations.

The Resource Conservation and Recovery Act (RCRA) of 1976

The Resource Conservation and Recovery Act of 1976 (RCRA) is best known as the federal statute that governs the management of hazardous materials from "cradle to grave." Amending the 1970 Solid Waste Disposal Act, RCRA imposes a broad-reaching and stringent set of regulations on hazardous waste from its generation onward through its transportation, storage, and ultimate disposal. Where Superfund governs the cleanup and removal of hazardous wastes at abandoned dumpsites, RCRA focuses on hazardous and solid waste management to ensure that operating facilities do not become Superfund sites. Both laws have evolved with certain commonalities, often causing confusion among the regulated community and public officials regarding which law governs hazardous materials at a specific site. The 1984 Hazardous and Solid Waste Amendments to RCRA, particularly those provisions on corrective action and underground storage tank removal, added further confusion. Some 20 percent of sites on the National Priorities List are landfills, and RCRA provisions governing the operation of municipal solid waste landfills sometimes have clashed with Superfund regulations. Critics of the RCRA program charge that the law's permit requirements regarding hazardous waste removal are unduly burdensome, and that they should be waived in favor of allowing more flexible Superfund regulations.

As background, RCRA places requirements on all parties affiliated with hazardous waste movement — but especially transport, and storage and disposal facilities (known as TSDFs) — for strict record keeping and reporting standards for the use of proper containers, and proper labeling of those containers used for storage and transport. Known as the "manifest system," these requirements are intended to discourage illegal dumping and disposal at outdated facilities. Accordingly, §3004 of RCRA imposes on TSDFs strict facility operating criteria, standards for location, design and construction, contingency planning, financial responsibility in the case of an accident or need for corrective action, and permit requirements.

Finally, RCRA requires that these facilities operate sophisticated groundwater monitoring systems that can detect migration of wastes into the uppermost aquifer, sample for constituents of concern, and conduct corrective action to stop groundwater contamination in the event it is detected. As in Superfund, RCRA's groundwater protection standard specifies maximum contaminant levels for various pollutants. The goal of these regulations, embodied by Subtitle C of the statute, is to prevent uncontrolled releases of hazardous materials to the environment, especially groundwater, as well as to require and create incentives to reduce waste generation overall.

Through a series of EPA rulemakings required under RCRA, the law now governs the management of over 200 hazardous substances, including heavy metals, pesticides, organic chemicals, and other materials exhibiting the hazardous "characteristics" of corrosivity, toxicity, ignitability, or reactivity. The majority of the millions tons of hazardous waste generated annually in the United States exhibit the toxicity characteristic, or contain constituents otherwise "listed" by EPA.

Like CERCLA, RCRA is credited with spurring some degree of innovation and pollution prevention activities at industries that want to avoid the cumbersome and costly consequences of mishandling hazardous materials. Other points of commonality exist between the two laws: both establish remedial goals and acceptable risk levels, require site investigations, set cleanup standards, and select remedies.

As a result of congressional frustration over EPA's failure to make significant progress in implementing RCRA, the Hazardous and Solid Waste Amendments (HSWA) of 1984 brought about major changes to the law, the consequences of which many claim compare to Superfund's chilling effect on the cleanup and redevelopment of contaminated sites. HSWA imposed three provisions that critics charge are delaying cleanup, needlessly driving up costs, and presenting jurisdictional overlap with CERCLA requirements.

Corrective Action

The corrective action provision of RCRA signifies a departure from the law's original intent — to control new releases of hazardous constituents leaving industrial facilities and to ensure their proper disposal. The main goal of corrective action is to prevent or stop hazardous materials from deteriorating groundwater, defined either as the uppermost aquifer underlying the facility in question, or as the aquifer adjacent to a facility to which the waste may have migrated. EPA does not specify how corrective action is to be implemented; it states only the intended goal of groundwater protection. While EPA had required corrective action and groundwater monitoring under RCRA at regulated waste management units (e.g., surface impoundments, waste piles, land treatment units, or landfills receiving hazardous waste), the 1984 amendments imposed corrective action at all RCRA-permitted treatment, storage, or disposal facilities (TSDFs) for any hazardous materials at the site, regardless of when they were disposed of or even if they ever were classified as RCRA wastes.

Some estimates show that as many as 6,100 RCRA-regulated facilities probably will be subject to some corrective action, and perhaps at a cost far above that of Superfund's 1,300 NPL sites. According to EPA, initial investigations are underway at all these sites; "interim" measures are being carried out at more than 300 sites; another 1,000 sites are in the final investigation stage; and final remedies are underway at approximately 100 facilities. Some critics complain that the sites subject to corrective action regulations are becoming as complicated to clean as those under the Superfund program. They charge that EPA's rules are too costly, too inflexible, and not subject to enough public participation.

In response to this criticism, and in the context of reforming the Superfund program, EPA is working to revise the RCRA corrective action program. An Advanced Notice of Public Rulemaking is due from the agency in fall 1995, and revised regulations are expected within two years. These new rules would address:

• consistency in cleanup approaches and with CERCLA requirements;
• protective, yet common-sense cleanup expectations;
• shifting more responsibility for conducting corrective action requirements to the regulated community;
• streamlining permit requirements and reducing costs; and
• improving public involvement.

Land Disposal Restrictions

RCRA's Land Disposal Restrictions (LDRs), also referred to as the "land ban" rules, require EPA to establish treatment standards for hazardous waste (disposed on land, as well as in underground injection wells) in order to minimize the threat to human health and the environment. Between 1986 and 1990, EPA developed land disposal standards for a variety of wastes, including solvents, polychlorinated biphenyls (PCBs), liquid wastes containing cyanide or heavy metals, wastes with low pH, and wastes containing high concentrations of halogenated organic compounds.

Critics charge that the LDRs impede speedy and cost-effective redevelopment of brownfields and Superfund sites because they effectively prevent remediation wastes (e.g., contaminated sludge, soil, and hardware) from being "staged" on site for treatment. Given the time and expense associated with applying for a RCRA permit, these critics argue, many industries opt to let the waste remain in place, especially if it presents no immediate threat that could trigger enforcement action. In addition to seeking waivers under these circumstances, critics propose additional exclusions for pretreatment requirements; facility-wide corrective action requirements; and the minimum technology requirements stipulated for landfills, which require double liners and groundwater leachate collection and monitoring systems. EPA is developing rules to make RCRA's corrective action, land disposal restrictions, and minimum technology requirements comport more with the principles set forth in the administrative reforms developed under Superfund. (See Chapter 3.)

Underground Storage Tanks

The 1984 amendments added a new section to RCRA, Subtitle I, to address the newly discovered problem of leaking underground storage tanks (UST). Congress then estimated that as many as two million tanks (EPA later reduced the number to 1.4 million) — containing petroleum products, hazardous wastes, or hazardous industrial chemicals — posed the threat of leaking or bursting into surrounding soils and groundwater. Excavation at old industrial sites often uncovers underground storage tanks that may pose special regulatory problems.

At the time of the law's passage, 84 percent of the underground storage tanks were constructed of unprotected steel subject to corrosion and rust. Since underground storage tanks have been used predominantly to store petroleum products (47 percent) and retail motor fuel (49 percent), the impact of the law has been felt most acutely by gas station owners. In 1984, the costs either to install new tanks (between $60,000 and $80,000) or to pay for the insurance required by the new law (between $1 million to $6 million, depending upon the number of tanks) posed formidable financial obstacles, prompting many independent gas stations to go out of business.

The prevalence of underground storage tanks at former service station sites, therefore, poses special considerations to brownfields redevelopment efforts. Local officials must determine the extent of the contamination, the availability of state UST trust funds to remediate petroleum-related contamination, or the feasibility of using hazardous waste site remediation funds to clean up petroleum waste. EPA may allow Superfund site assessment and remediation funds to be used to determine the extent of contamination caused by an UST, as long as there is reason to suspect that CERCLA hazardous substances might be found in or around the tank.

Subtitle I requires underground storage tank owners to notify the appropriate state or local officials of the location, age, size, type, and use of its underground tanks (defined as any tank at least 10 percent below ground). Even owners of tanks not currently in use, but who had been operating them at some time after January 1, 1974, are required to report to the EPA, providing some paper trail of environmental conditions at now-abandoned sites. The goal of Subtitle I is to replace all leaking tanks by 1997, a move EPA feels is vital to protect the groundwater that provides drinking water for almost 100 million Americans. Using information provided by tank owners, EPA has developed regulations designed to detect, prevent, and clean up leaks from USTs. These regulations include leak detection system operating, monitoring, and reporting requirements; requirements for reporting tank releases and corrective actions undertaken to address them; a requirement to perform corrective action; closure and financial responsibility requirements; and design and construction standards for new USTs.

Part 2: Lenders and Their Perspective on Liability

Risk-averse by nature, lenders are changing the way they deal with projects that even remotely involve hazardous wastes. This, in turn, affects the reuse potential of specific sites, as well as the broader economic development climate in many areas. As explained in the following paragraphs, financial institutions grappling with concerns over environmental liability and contaminated project sites are:

• sharply curtailing their level of lending;
• cutting off financing for certain types of businesses, such as small enterprises or ones that routinely handle toxic substances (such as dry cleaners or auto-body shops);
• increasing transaction costs by requiring a thorough environmental assessment and necessary cleanup as conditions of loan approval; and
• imposing restrictions on or limiting their interaction with borrowers to reduce their exposure to liability.

Reduced Lending to Projects Perceived As Environmental Risks. From the lender's perspective, possible liability for significant damages has increased the risk of doing business. In a recent American Bankers Association (ABA) poll, 43 percent of small financial institutions with less than $250 million in assets indicated that they already had stopped making loans to companies associated with environmental contamination, and another 11 percent intended to curtail such lending.

In many areas, lenders have gone beyond cautious consideration of industrial reuse projects and moved to close the financial spigot. There is a growing unwillingness to provide any financing to some types of business unless the precise scope of a lender's liability is clarified, if not reduced. Throughout the country, but particularly in the old "rust belt" cities, bankers convey horror stories about industrial reuse projects gone awry for environmental reasons. In 1981, for example, a developer paid $3.5 million for a ten-story abandoned Alcoa factory in Edgewater, New Jersey. He planned to convert the facility, which was located across from Manhattan, into luxury apartments. But in 1985, an inspection revealed massive PCB contamination throughout the building and the project faltered.

Brownlining: Shunning Certain Project Types. Lenders and developers may simply avoid doing business altogether with certain types of companies or properties that carry environmental risks. Some development experts describe this lender reticence as "environmental redlining." Many bankers, in fact, have started to tally categories of undesirable borrowers, including tool and die shops, bottling and canning plants, high-technology metal fabricators, semiconductor facilities, and utilities. Ironically, local governments and economic development organizations have targeted many of these same industries for special attention and incentives, since they are seen as key to community economic growth and diver sification.

The size and financial resources of the current owner now influence a site's marketability and reuse potential. Prospective purchasers, for example, may buy old industrial property only from large, thriving corporations that can afford necessary site remediation. Thus, if EPA then sues for cleanup, the new owner has a chance to pursue successfully the seller to recover remediation costs (or EPA may go after the seller itself). Likewise, lenders wanting to avoid defaults associated with expensive cleanups, may limit their loan activity to large companies with considerable assets. Small enterprises — especially start-ups or expansion projects — usually use their land and buildings, being their chief assets, as loan collateral. Since the loan may not be made if the land or buildings are of questionable value, this scenario could stifle many budding enterprises.

The high failure rate among small businesses makes this type of lending especially risky, and puts even greater pressure on the collateral aspect of the loan agreement. Furthermore, there often is a need for the lender to work with and counsel the borrower, who — as an entrepreneur and not an accountant — has little expertise in the financial management area. Problems arise, particularly in the early stages of a new enterprise. Some bankers have significantly scaled back such relationships with their borrowers since the Fleet Factors decision clouded this practice with its liability implications.

The liability concern exacerbates other problems that many small business owners face in trying to secure credit. Without access to capital, these companies do not have the ability to maintain their competitiveness, expand to take advantage of new market opportunities, update their equipment and facilities, maintain necessary inventories, or have the capital needed to create new jobs. Moreover, they find it difficult to fund site clean up.

Increasing Transaction Costs. As previously noted, CERCLA gives prospective owners an incentive to evaluate sites before purchasing them — to determine their freedom from liability for past problems. Influenced by the Fleet Factors decision, lenders increasingly require extensive environmental testing and cleanup — not only to protect themselves from liability, but also to ensure the value of the collateral. Some states have adopted their own environmental assessment requirements. But these assessments are time-consuming and expensive, significantly boosting project transaction costs. Some test bores, for example, run $15,000 or more. An assessment of a long-time industrial site detailed enough to satisfy a prospective lender can cost $50,000 or more. In many cases, the tab for an environmental investigation and the delays involved in carrying out evaluations alter the balance sheet of the proposed deal, undermining its financial viability.

To this end, concerns over contamination have unleashed a flood of related paperwork. An official of a leading Chicago bank noted that the issue of environmental risk emerged about five years ago; now, loan officers must work through entire sections of loan documents devoted to nothing but environmental considerations. This paperwork increases the time and cost of assembling and processing the loan package — by as much as three-fold, according to some officials. Small businesses are particularly hard hit by these up-front investigative fees, which make small loans prohibitively expensive to obtain.

Testifying in April 1991 before the Senate Committee on Environment and Public Works, an ABA spokesperson discussed a still timely example of how liability may add to the cost of small business borrowing. The association described a typical borrower in a business viewed as risky — a dry cleaner. If the owner wanted to borrow $50,000 to improve or expand his facility, a typical amount for such a loan, the collateral almost certainly would be the existing dry cleaning establishment. The bank would require a basic environmental assessment, probably costing between $500 and $2,500. This constitutes a significant expense — 1 to 5 percent — for a loan of that size. Even if the assessment turned up no problems, the bank may remain nervous, since such assessments are not foolproof and offer no ironclad guarantees to the lender. If contamination surfaced later, the lender could find itself holding worthless collateral; if the bank foreclosed, if could face cleanup costs that exceeded the value of the collateral. As the ABA suggested, more and more lenders are unwilling to risk significant cleanup costs on small business loans on which they might make a profit of about $1,000 a year. In other cases, the bank will require a more detailed second assessment, that could cost significantly more than the initial examination. For many small companies, the cost is prohibitive, and the project is stalled.

If cleanup is needed, the transaction is further disrupted. Even a low-cost cleanup can take months to complete; complex efforts may take years. Old industrial sites can present special cleanup challenges since few records may be available on past uses. Moreover, contamination has had time to spread or is deeply buried. Numerous developers have recounted how such unwelcome surprises wreaked havoc with the financial projections of a project already underway.

In addressing contamination at a specific site, the developer must deal with local, state, and federal environmental agencies to ensure the adequacy of cleanup strategies. These agencies may disagree or may have different procedures and paperwork, unnecessarily complicating and delaying cleanup and redevelopment. Then, any contamination removed from the site must be taken to an appropriate treatment or disposal facility, often located hundreds of miles away. Some cities and states, in fact, are having difficulties locating a dump site that will accept the heavily contaminated debris from industrial reuse projects. Moreover, the party liable for the waste — be it developer, banker, or the local government that may have assumed title to a site — is still liable for the waste even after it has been taken to the dump.

Such procedures are fraught with delays and hassles. They are costly and may force otherwise viable projects to be abandoned. However, as some of this report's case studies suggest, a few developers have met with success by working closely with appropriate environmental agencies or by soliciting the help of the governor's office to expedite the cleanup process.

While environmental assessments undoubtedly increase the transaction costs for industrial facility projects — and can undermine the economic viability of some reuse efforts — such steps are precisely the desired result of the CERCLA liability provisions. By forcing responsibility for cleanup on owners and lenders, these provisions are achieving the goal of fostering privately-funded cleanups, thereby conserving public funds.

Restricting and Complicating Involvement with Borrowers. Real estate lenders manage their portfolios in a variety of ways. Some mainly originate and hold loans; others originate loans and then place them with investors in the secondary market. Some mortgage bankers do not even close loans in their own name, but instead match real estate projects to investors. Others act on behalf of insurance companies, pension funds, and other institutional buyers. Some lenders also take participatory interests in real estate, especially commercial projects, and are considered both an owner and a lender.

The possibility of site contamination — and potential CERCLA liability — is changing the way in which large real estate lenders do business. For example, real estate financiers are increasingly demanding indemnification from sellers for any pre-existing contamination. These agreements have been useful in allocating responsibilities and cleanup costs, and helpful in closing deals. According to legal experts, these agreements generally address issues such as:

• cleanup expenses and costs of fines, third party claims, and loss of profits;
• determining what costs are reasonable;
• defining how clean is "clean" for purposes of allocating costs;
• consequences to a party that fails to adhere to the agreement;
• length of time the indemnity will last, and what happens in the event of the sale or merger of one the participants;
• who has the burden of proof when determining at what point in time the contamination took place; and
• limits on potential liability and cleanup costs.

However, such agreements usually take a long time to negotiate and involve a number of technicians and lawyers, and are thus expensive to conclude. Because of this, indemnification agreements generally are not viable for small business operators. In addition, even the best-crafted agreements are ultimately worth little if a key participating company goes bankrupt. Moreover, no such agreements will ever be reached on many old industrial sites where the title is held by the corporate remnants of defunct manufacturing companies.

Alternatively, lenders may limit their oversight of borrowers to avoid the prospect of environmental liability. Unfortunately, this restraint occurs at a time when prudence would indicate the need for greater scrutiny from a credit-quality perspective. The high-stakes risk of CERCLA liability, combined with a lack of regulatory guidance and inconsistent judicial rulings, leaves lenders to search for the Holy Grail of certainty. Because the only effective protection is not to lend at all, financial institutions grow increasingly conservative in their practices. This, in turn, affects the economic development process, and has led some two dozen states to make their own attempts to sort out and routinize the cleanup process via state voluntary cleanup programs.

Part 3: Banking Policies and Regulations
Affecting Brownfield Cleanup and Reuse

Liability concerns, rightly or wrongly, have an important impact on the economic development process. When undertaking a project, developers, investors, and companies want to quantify their risk as quickly as possible. The fear of surprises has led to changes in financing practices. Given the uncertainty stemming from several recent judicial rulings, lenders and investors have grown wary of brownfield site reuse projects that may place them in a position of owning or operating a site. Many fear that even their activities in monitoring or salvaging their investments will put them in the "chain of title" and make them liable for cleanup costs.

The common perception that vacant or abandoned industrial sites are contaminated, extraordinarily expensive to develop, and laden with potential liability is a significant barrier to brownfield financing and reuse. The stigma of brownfields causes inexperienced or skittish lenders and developers to be conservative in their evaluation of a reuse proposal. Often, they do not have the technical expertise to address their uncertainty about environmental issues. And, unconvinced that they can guard against liability or sufficiently assess possible site cleanup and preparation costs, many lenders and investors avoid brownfield projects altogether.

The fear of liability not only impedes the approval of redevelopment loans, but also discourages lenders and investors from offering creative financial assistance that would prevent current industrial operations from becoming abandoned brownfield sites. Liability concerns also inhibit lenders from offering the types of technical assistance, financial advice, and creative loan restructuring alternatives that could help save a troubled firm. Economic development practitioners and private companies themselves need to recognize that lenders often view the following situations — which could work to everyone's benefit in terms of advancing brownfields reuse — as posing an unacceptable risk of liability.

Loan work-outs. A "work-out" is a situation in which the lender seeks to actively help a borrower grapple with a financial or management crisis, to keep the company from defaulting on its loan. In the case of brownfield projects, judicial rulings linking a lender's management activities to liability have inhibited the use of work-outs. Increasingly, lenders refuse to use a work-out altogether, resorting instead to an "early exit" — pulling the plug on the project to cut their losses. But more importantly from an economic development standpoint, the inability to engage in a work-out discourages lenders from making many loans in the first place. In their view, if they cannot implement a work-out scenario, some other exit strategy must be defined. In the case of a brownfield property, the potential for liability thwarts possible exit alternatives and often eliminates consideration of the site.

Foreclosure. Given concerns over liability, many lenders no longer view foreclosure as an option they can pursue. In addition to general concerns about assumption of ownership, lenders fear there might be an immediate need for a cleanup at the site, which they as the new owner would be required to carry out. As a result, a prospective business borrower faces tremendous pressure to identify acceptable alternative collateral to satisfy the lender's requirements — a requirement that owners or prospective reusers of most brownfield sites simply cannot achieve.

Button-up. Even if a lending institution chooses not to foreclose, it faces potential costs in a "button-up" situation. In such cases, a defaulting borrower may leave the bank with the considerable expenses necessary to close down an operating facility (i.e., to remove chemicals from storage tanks and process piping, to hire security for the facility, and similar activities). Clearly, the prospect of significant button-up costs deters lending on industrial projects or brownfield reuse activities. These expenses can be avoided if a lender successfully intervenes and structures a work-out that avoids a financial crisis for the company.

Collateral. Lenders typically are much more comfortable if a prospective industrial borrower can pledge non-real property as collateral — inventory or equipment, for example. In some cases, though, courts have interpreted the act of collecting on collateral — choosing inventory or equipment to acquire and liquidate — as involvement in management and operations. Such an interpretation raises the specter of liability, further shrinking the likelihood that sufficient collateral can be identified.

Trusts. Trusts can be sources of equity for brownfield redevelopment, but trustees, like any investor, can find themselves liable as owners. Therefore, a situation in which a lender or investor acts through a trust also is discouraged by the liability risk of managerial involvement.

The potential adverse effect of environmental contamination on a site or facility's collateral value and the potential for liability under CERCLA and other laws — no matter how remote — have become important factors for lenders as they assess real estate transactions and decide whether or not to make loans for project activities. Lenders also may feel constrained in doing brownfields lending because of concerns over how their regulators may view loans they made with potentially costly environmental situations. In fact, regulating agencies are concerned about the potential adverse impact of environmental contamination on the overall loan portfolio of the lending institutions they oversee. The Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), the Federal Reserve Bank system, and the Office of Thrift Supervision (OTS) all have issued guidelines for environmental risk and urged lenders to develop their own policies and procedures, within these guidelines, to address environmental concerns. In each case, the regulators suggest that environmental risks be evaluated as part of the cost of carrying out the banking business.

Economic development practitioners must therefore understand the guidance and direction that bank regulators have provided to the lenders they regulate. These policies affect lenders' actions as they consider the effects on their own financial situation of possible collateral devaluation or the inherited environmental responsibilities of nonperforming loans. Prospective borrowers will feel the impacts of these regulatory concerns when they pay higher transaction costs or endure exhaustive site assessments and testing. The following section assesses these regulatory agency guidelines.

Federal Deposit Insurance Corporation

On February 25, 1993, the FDIC outlined various procedures for banks to follow in establishing an environmental risk program to identify and evaluate potential concerns. The agency left no doubt as to its view of the importance of putting a responsible program in place, emphasizing that: Examiners will review an institution's environmental risk program as part of the examination of its lending and investment activities. . . . Failure to establish or comply with an appropriate environmental program will be criticized and corrective action required.

FDIC officials noted that the environmental risk program should be tailored to the practices of the financial institution. In other words, lenders with a higher concentration of loans to environmentally high-risk industries or brownfield locations with known contamination likely will require a more sophisticated and elaborate program than those whose lending practices focus more on commercial or residential projects in greenfield locations. Lenders need to address the following eight issues when crafting their risk program.

Staff training. FDIC-covered lenders must offer sufficient staff training to make sure that the environmental risk program is successfully implemented. Loan underwriters and other appropriate personnel must be provided with the training they need to make sure they can determine and evaluate potential environmental concerns that might affect the redemption of the loan and the lending institution itself. When environmental circumstances become too complex for the staff to adequately evaluate, they must consult with the outside experts they need to make reasonable decisions.

Policies. The institution's loan policies, manuals, and written guidance to staff should address environmental issues affecting specific lending activities. For example, the loan manual that staff follow might identify the types of environmental risks commonly associated with certain types of industries or former manufacturing sites typically found in the lender's normal service territory. Loan policies also could provide guidelines for underwriters to follow when conducting their analysis of potential environmental liability. The FDIC also suggests that similar procedures might be developed for credit monitoring, loan workout situations, and foreclosures.

Environmental risk analysis. Lenders must establish a procedure under which they carry out an initial environmental risk analysis during the loan application process. In the FDIC's view, this will help the institution minimize potential liability and avoid making loans that go sour due to contamination-related problems. Loan officers can gather much of the information needed for this analysis when discussing the business and prospective activities with the loan applicant; they also might visit the site to see if obvious contamination problems exist. In addition, loan applications can be modified to request pertinent environmental information, such as the present or past uses of the property and the company's prior cleanup activities or pollution prevention efforts.

Structured environmental risk assessment. The FDIC urges lenders to carry out a detailed investigation whenever the loan application, discussions with the borrower, or a site visit indicate a possible environmental problem. This so-called "structured assessment" might include:

• determining the identity of past owners and their uses of the property;
• inspecting the sites more closely, including contiguous parcels (which might contain contaminants that could spread);
• reviewing company records for past use or disposal of hazardous materials;
• contacting federal and state agencies to determine whether the borrower has been cited for violations of environmental laws or regulations; and
• reviewing state and federal lists (such as the CERCLIS list) that tally sites having significant environmental contamination.

Loan documentation. According to the FDIC, loan documents should include language to safeguard the lender against potential environmental losses and liabilities. Depending on the nature of the borrower and the loan, financial institutions can demand the borrower comply with all environmental laws, disclose information about the "environmental status" of the site, facility, or equipment being used as collateral, and give the lender the right to gather more information through inspections about the potential for contamination. The loan documents also could include provisions that give the lender the right to call the loan, not extend funds under a line of credit, or foreclose if the collateral is discovered to be contaminated. In light of this guidance, a growing number of lenders insist that they be indemnified by the borrower and any guarantors against liability associated with the collateral.

Monitoring. FDIC also states that borrowers should be monitored during the life of the loan, that ongoing environmental risk assessments are important to make sure the property used as collateral remains uncontaminated and retains its value. The lender, moreover, should be aware of changes in business activities carried out at the site that might increase the risk of environmental liability. The FDIC also suggests that if a situation arises where the potential for environmental contamination could undermine the property's value, the lender should consider exercising its rights under the loan agreement to require the borrower to resolve the problem and take whatever actions are necessary to protect the property's value.

Involvement in the borrower's operations. The lender must scrutinize its own actions as it monitors loans for potential environmental problems, and it must direct borrowers to take actions to resolve such concerns. The FDIC points out, however, that such actions a lender carries out or contemplates could constitute "participating in the management" of the business being financed, and thus trigger CERCLA liability.

Foreclosure. Exposure to liability can increase significantly if a lender takes title to the site or facility being held as collateral. The FDIC urges institutions to evaluate carefully the potential environmental costs and the liability potential associated with the property when deciding whether or not to take title by foreclosure or other means.

Federal Reserve Banks

The Federal Reserve's Division of Banking Supervision and Regulation issued a memorandum in late 1991 laying out its views on environmental liability. That document, which still serves as agency policy today, recommends policies and procedures for banks to follow, and suggests that they should:

• prepare environmental policy statements and provide training to ensure that staff are familiar with their provisions;
• establish guidelines and procedures for dealing with new borrowers who want to use real property as collateral;
• carry out appropriate analyses of potential environmental liabilities;
• review existing loans to determine those with potential environmental problems;
• develop a tracking system to document due diligence and efforts made at the time loans are made or property is acquired; and
• include warranties, representations, and indemnifications in loan agreements, as protection from losses due to environmental contamination.

The Federal Reserve emphasized that "safety and soundness" are its key concerns. Accordingly, its policy guidance notes that lenders must strive to limit their environmental liabilities by adopting protective policies — including vigorous analysis of their existing portfolios, based on the types of properties involved and their uses. As the Fed memo notes, banks must take the initiative to protect themselves because CERCLA provides little guidance in interpreting its secured creditor exemption, which would shield lenders from liability. In practice, this new scrutiny is often the reason that long- time industrial borrowers are suddenly denied credit when they seek the same type of working capital loan they have secured many times before.

Within the Federal Reserve system, guidance provided to bank examiners has two objectives: to determine if a bank's environmental risk safeguards and controls are adequate; and to identify any potential environmental problems with either a bank's loan portfolio or its non-lending activities. The Fed memo suggests that banks should minimize the potential environmental problems from non-lending activities, including trusts and mergers and acquisitions. Examiners are instructed to determine whether or not the bank has complied with Federal Reserve policies concerning environmental risk.

Examiners typically look for evidence that basic Phase I environmental audits have been carried out at all financed sites with a "higher than normal" risk — no matter what the loan size. As the Fed explains, the size of the loan "may bear very little resemblance to the size of potential environmental liabilities associated" with the property. Examiners also expect lenders to identify high-potential hazards in their loan portfolios, such as gas stations, plating facilities, feedlots, or trucking firms that may haul waste products.

Economic development practitioners and companies also need to be aware of the Federal Reserve's perspective on warranties and indemnifications. The Fed encourages banks to include them in their loan agreements, but notes that "at best, such provisions provide limited protection for lenders." Warranties and indemnifications are not binding against the government or third parties, and are only as good as the financial strength of the borrower. Banks, according to the Federal Reserve, should never view such covenants as a substitute for environmental reviews and assessments. Thus, prospective borrowers will not be able to avoid possibly expensive site testing with promises of future indemnification.

Finally, the Federal Reserve memo, with more detail than the FDIC guidelines, discusses lender activities that could be construed as participation in the management of a borrower's business. It recommends that bank staff avoid serving on a borrower's board of directors, participating in board decisions, or determining changes in company management. Given this, the Fed warns that banks should be careful to consider what it plans to do in the course of loan workouts or debt restructurings.

Office of Thrift Supervision (OTS)

The OTS policy bulletin on environmental risk and liability, issued in early 1989, was prescient for its time. It lays out in considerable detail the policy guidance that OTS still follows, including "basic categories of risk" to lenders that could emerge from transactions involving environmentally contaminated property. As lenders have recognized these categories in their own underwriting procedures, they have had a major impact on the availability of development finance for brownfield projects. These categories include:

• reduced value of collateral;
• inability of borrowers to repay loans if they also must cover site cleanup costs;
• preemption of a mortgage loan security by a cleanup lien imposed under so-called "super lien" laws in some states;
• potential for the bank to become liable for the cost of site cleanup in the event of a foreclosure, or to not foreclose in the face of significant cleanup costs; and
• possibility that the borrower would not maintain the facility financed in an environmentally sound manner.

Finally, OTS guidance stipulates that the loan officer should make sure that a Phase I environmental assessment is performed at the site, that the financial institution is the primary client for the report, and that the Phase I assessment is carried out by an auditor included on an approved roster maintained by the lender.

Office of the Comptroller of the Currency (OCC)

The OCC's two-page Banking Bulletin 92-38, issued in July 1992, essentially advises banks to follow the protective procedures laid out in EPA's June 1991 lender liability rule, which subsequently was invalidated by the courts for procedural reasons. EPA developed the rule to clarify the scope of existing liability exceptions and to make it easier for lenders to demonstrate that they are simply holding property as loan security and therefore are exempt from cleanup costs. The guidelines laid out a range of activities — including foreclosure — that lenders could undertake, without fear of liability, in order to manage and protect facilities that serve as collateral. EPA also attempted to clarify the circumstances in which a financial institution would be considered to be "participating in management" of contaminated property, a contentious issue clouded by court rulings. EPA proposed that lenders be able to offer financial and technical assistance or counseling to borrowers, and to insist that financed properties be maintained in an environmentally sound manner. Lenders, according to EPA, also could undertake refinancing or loan workout activities.

The OCC bulletin notes: "To avoid environmental liability [banks] should assure themselves that their policies, practices, and procedures are consistent with the definitions contained in the final rule."

Community Reinvestment Act

The Community Reinvestment Act (CRA), enacted in 1977, requires that banks make an effort to invest in and provide for the credit needs of their local communities. Addressing issues of geographic and racial discrimination in lending policies, CRA was intended to aid credit-starved neighborhoods, often located in economically declining urban areas or remote rural areas. It offers communities the opportunity to use CRA as an economic development tool by allowing them to monitor local bank performance in providing the credit necessary to maintain existing businesses and residential neighborhoods, and to attract new commercial enterprises. Some community development advocates estimate that CRA prompts more than $4 billion in lending each year.

CRA is overseen by the four agencies that monitor financial institutions, with the Office of the Comptroller serving as lead regulator. These agencies track lenders' activities to ascertain the credit needs of their service areas, as well as their participation and investment in local development or revitalization projects or programs. Regulators also may evaluate lenders' participation in government- insured, guaranteed, or subsidized loan programs for small businesses or housing.

Some community groups and development organizations have used CRA as leverage to obtain investment capital for local development projects. They also have used it to open serious negotiations with banks on specific projects that require private loans.

In the last few years, many local economic development advocates have suggested that brownfield projects increasingly are the target of environmental discrimination in lending policies and decisions — a "redlining of the brownfields." On May 4, 1995, the Comptroller of the Currency issued revised CRA guidelines that, for the first time, included a brownfields-related provision. The guidelines suggest that financial institutions can meet their CRA obligations through loans for the cleanup and revitalization of brownfields. In a brief footnote, the rules cite as an example "loans to finance environmental cleanup or redevelopment of an industrial site as part of an effort to revitalize the low- or moderate-income community in which the property is located." To qualify for CRA credit, bank-assisted projects must lead to redevelopment activities, as well as simply remove contamination. The CRA footnote also encourages banks to participate in EPA's brownfields initiative, designed to spur reuse of often abandoned, usually contaminated industrial sites.

This new impetus for lender participation in brownfields could be tempered, though, depending on the final form that CRA reauthorization takes. Legislation introduced in March 1995 would exempt most banks from CRA coverage. The Senate version, S. 650, introduced by Senators Richard Shelby (R- AL) and Connie Mack (R-FL), exempts banks with less than $250 million in assets; the House bill, H.R. 1362, introduced by Rep. Doug Bereuter (R-NE), sets the floor at $100 million. These volume provisions would relieve nearly 90 percent of all lenders from CRA obligations. In addition, both bills would prohibit regulators from collecting data on (among other things) geographic distribution of small business loans, and they would allow lenders to "self-certify" their compliance with CRA criteria.

Softening the Impacts of Financing Guidelines

From a practical standpoint, encouraging the finance of brownfield projects means helping lenders and investors better quantify financial risk. Improving information available to possible lenders and investors and providing guidelines for using legal and environmental information should help reduce uncertainty and encourage lending and redevelopment. This could soften the impact of the current rules, and encourage flexibility without disregarding necessary underwriting criteria. One way of reducing uncertainty is to devise and disseminate what financiers in Chicago have termed a "standardized brownfield development package and lending criteria."

A common format for evaluating brownfield loan packages would mean that lenders of all sizes and technical capability will be better able to recognize legitimate risks and to quantify costs, allowing the expedited development of more sites. Recognizing that rules and practices change, a standardized package is envisioned as general guidance for dealing with brownfield properties. Its goal is to pinpoint essentially groundless or irrelevant brownfield concerns that could needlessly scuttle projects. Obviously, lenders should not view these guidelines as routine or required for all properties, nor as a substitute for an appropriate environmental assessment. To help meet its objective, this type of loan package would include the following information.

Basic environmental information. In order to increase the lender's certainty with respect to site cleanup costs, the prospective borrower would provide detailed information on: scope of the potential cleanup; nature and extent of contamination; how a state voluntary cleanup program would be used; proposed cleanup plan for the site; and how the cleanup plan relates to the site's future use.

Representations, warranties, and covenants. Lenders would adapt standard loan documents for borrowers to demonstrate how those borrowers had performed appropriate environmental assessments, consulted all required parties, obtained all necessary approvals, and how they would take responsibility for unexpected costs. In addition, borrowers would certify via these documents that they would operate the property in compliance with environmental laws, and in ways that minimize the risk of new contamination. The standard package could provide loan underwriters with detailed explanations of these issues, as well as a basic factual checklist for initial review of the application.

Letters of certification. For states with voluntary cleanup programs, the standardized package should include information about that initiative, as well as an explanation of what successful program completion means in terms of releasing current and future site owners from liability.

Lender guidelines for underwriting environmental information. Lender guidelines, a key part of any standardized package, would show lenders how to quantify the information gathered. These guidelines might take the form of a worksheet that translates the loan application into some measure of underwriting for a project on a specific brownfield site. Already, lenders use standard policies, procedures, and benchmarks for underwriting a variety of risks associated with proposed loans. This concept could be extended, and brownfield guidelines could help financial institutions determine whether a site reuse project has been adequately evaluated, and whether its potential risks conform with the banker's approach to lending.

A standardized package of policies and guidelines also could help investors and lending institutions to better quantify financial risk. They could form the basis for developing model documents to help guide the practice of underwriting brownfield sites, as well as to educate lenders and developers about the nuances and realities of the risks involved in brownfield finance. For instance, they could provide information on the best-suited or most applicable warranties and representations, or explain the value of state voluntary cleanup programs.

Such measures hold significant potential for channeling private investment to brownfield sites, but they must be carefully crafted and clearly and honestly presented to the banking industry and other sectors of the community. Several prominent lenders active in brownfield activities have raised concerns about small lenders using a checklist to assure that they have met "all" environmental and liability concerns; since many such lenders have little familiarity with the complexity of environmental issues and procedures, they suggest that such a checklist may expose them to unfamiliar risks, especially in terms of determining true collateral value. Randy Muller, Vice-President for Environmental Services with Bank of America, captured the debate over a standard package well when he recently wrote: "Technically competent individuals will welcome simplification as a means to expedite what is currently perceived as a lengthy process. However, simplification in the hands of the uninformed may cause chaos."

Without question, such a standardized package should not be adopted until the key lender regulatory agencies review and provide some indication of their approval. Once this takes place, the package could have widespread usefulness and help expand the level of investment in brownfield sites. Economic development practitioners and technical assistance providers (such as SBDCs or EDA- supported planning districts) could use this information to further local business retention or expansion strategies. Insurance investors, community development corporations, pension funds, and other sources of capital for real estate development also could use the information obtained through the package to help determine the real risks of brownfield projects.

In short, banking policies and procedures have a tremendous impact on brownfield redevelopment. If public officials, development agency staff, and private companies are to encourage greater levels of brownfield lending and investment, they must recognize how lenders operate in this arena, what environmental situations raise red flags with them, and the views of the regulatory agencies. Lenders have a role to play as well. To deal with real fears, as well as to identify and cast aside perceived ones, they must develop and implement programs consistent with sound lending practices, good investment opportunities, and prudent environmental risk management — and to find ways that address each element without compromising the others.

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