Foreclosing Residential Lenders Ignore Environmental Issues at Their Own Risk

Several years ago, we assisted a lender who foreclosed on rural residential property and then discovered that vandals had removed metal pipes from the basement of the house. That was bad enough, but the removed piping had connected a home heating oil tank to the house’s main heating system. Without the pipes, heating oil from the tank had spilled onto the dirt basement floor and soaked into the soil, penetrating the groundwater under the house. What initially appeared to be an annoyance became a seven-figure problem.

There is a natural tendency to associate environmental risks with large, commercial and industrial properties that use, generate, or release significant quantities of hazardous chemicals. For lenders, accepting such properties as collateral almost automatically triggers the hiring of consultants and environmental lawyers as well as an often bewildering array of acronyms: RCRA, TSCA, CERCLA, and many others. However, when the property is a quaint two-story colonial in a quiet suburban neighborhood, foreclosing lenders sometimes forget the environmental liabilities that may exist below the surface or within the walls. Such oversight can result in potentially costly environmental and civil liability as well as adverse publicity.

Ten Areas of Potential Residential Property Environmental Liability

• Asbestos-containing materials
• Radon
• Lead-based paint
• Mold
• Household/hazardous waste
• Septic systems
• Underground/home heating oil tanks
• Issues associated with private wells
• Contamination from neighboring properties
• Methamphetamine production wastes

Five Specific Suggestions for Addressing and Evaluating Risk

1. Have a Policy: Ensure there is a standard, established step within the foreclosure process that involves a consideration of environmental issues. Performing a formal environmental due diligence on all foreclosure properties is almost certainly cost-prohibitive and impractical. However, processes should be established so that issues identified can be evaluated before the foreclosure proceeds. Given the minimal value of many residential properties, the existence of potential environmental issues may be enough for the lender to place the foreclosure process on hold until further information can be gathered.
2. Train Personnel to Recognize the Warning Signs: Without formal environmental reports on residential properties, it will be up to lender personnel, foreclosure firms, and property preservation companies to spot and escalate warning signs of environmental issues. As part of the policy and procedure adoption process, training and guidelines should be provided to all applicable personnel so they know what to do and who to escalate those issues to.
3. Timing Can Be Everything: Ordinarily, the foreclosure process proceeds at an established pace. In states such as Georgia, with relatively streamlined non-judicial foreclosure processes, environmental issues may have the effect of slowing down, if not halting, the otherwise efficient progress of the property towards foreclosure. While this is frustrating, it is also important because the potential scope and extent of a lender’s environmental liability may change based upon whether or not that lender actually holds title to the property. Put another way, once title has been vested in the foreclosing lender, unraveling that transaction can be extremely difficult.
4. Consult before Acting: It is often a lender’s natural inclination to immediately remediate identified environmental problems in the most direct, efficient, and cost-effective manner. However, the act of removing and disposing of potentially hazardous wastes—by way of example—may itself create additional environmental liability for the lender. A number of key questions should be answered before any action is taken: Does the contractor doing the work have the proper licenses and experience? Are any state/local notifications or permits necessary? Does the lender have a contract with the contractor? Are there any state clean-up funds available to help complete the remediation? Consultation with appropriate environmental consultants and counsel may be necessary and appropriate once an issue has been identified.
5. Be Aware of Environmental Disclosure Requirements: Once the foreclosure is complete, the lender will begin the process of actively marketing the property. Many state laws require sellers—including lenders—to disclose environmental issues to potential purchasers. Understanding these obligations before proceeding with foreclosure can be critical because it allows the lender to take necessary remedial measures in advance to ensure that the associated disclosures do not make the property difficult, if not impossible, to market.

As with many types of risk, there is no way to completely eliminate environmental risks associated with residential property foreclosures. However, by following the steps outlined above, lenders can begin to implement processes designed to at least limit those risks.