NEW STORMWATER PERMIT CAN TRAP UNWARY LENDERS

Posted on February 22, 2011 by Richard Horder

Today, a drive through Georgia will present dozens of half-developed abandoned residential subdivisions, many having been graded and with various degrees of erosion control in place. However, the erosion control devices have not been maintained and are in disrepair. Such protection measures, if they even exist, fail to prevent Georgia red clay and other soils from rushing down the streets, causing damage to the proposed development as well as to neighboring down-gradient properties, and running off into nearby streams causing elevated turbidity and other problems.

Both federal and state environmental agencies are struggling to address this problem and have begun to develop regulations and guidelines to assign responsibility for reconstruction and continued maintenance of the soil and erosion control devices. Under a standard stormwater regime such as Georgia’s, prior to land disturbance activities, a developer must submit a Notice of Intent (NOI) to discharge stormwater under the state’s General Permit. Such permit is required for land disturbance of greater than one acre due to construction activities. Failure to obtain coverage under the General Permit or violation of the requirements of the Permit may result in daily fines. Typically, the developer is responsible for any violations or resulting fines. However, due to current economic conditions, many developers have abandoned their projects and are nowhere to be found, or have filed bankruptcy.

Thus, lenders are finding themselves left with loans secured by these properties and if they hope to recover on the collateral, they will have to confront the problems associated with them. The standard Phase I assessment does not consider stormwater compliance. Yet, many lenders foreclose on such properties without considering the consequences. The Clean Water Act under which the General Permit is issued does not have a secured creditor exemption and therefore, after foreclosure, lenders may be responsible as either an owner or operator. Lenders can then be liable for any permit violations and fines, which can range from hundreds to thousands of dollars. In addition, lenders may face the cost of maintaining continued compliance with soil and erosion control requirements and claims from down-stream property owners. Perhaps most importantly, savvy buyers will not relieve lenders of these problems, resulting in steep discounts at sale that may over-penalize relative to the real risk.
 

Georgia is in the lead among states in taking specific steps to impose stormwater liability upon lenders. In 2008, Georgia EPD issued new General Permits for Storm Water Discharges Associated with Construction Activity for Stand Alone Projects, Infrastructure Projects, and Common Developments. Under these new General Permits, a lender who acquires title to the construction site is directed to file a new NOI either seven days before beginning work at the construction site or thirty days from acquiring legal title to the property, whether the lender intends to carry out any land disturbance construction activities at the property or not. Under the permit and related regulations, EPD’s position is that a foreclosing lender essentially steps into the shoes of the former Permitee, assumes that Permitee’s obligations and must continue to comply with the General Permit. Obviously, this has serious implications for lenders, which are all too often discovered after it is too late.


However, it can be argued that these provisions of the new Permits stretch the boundaries of EPD’s authority. A defense to this broad assertion of liability for lenders lie in the fact that the lender (which may have to hold the property for years) does not intend to conduct any “land disturbance of one acre or more” on the property. It is that activity which would make the provisions of the General Permit applicable. Further, the General Permit does not specifically impose such obligation on a successor purchaser of the property who does not intend to carry out land disturbance activity. Why, then, should a foreclosing lender be treated differently than any other entity in Georgia solely because it has foreclosed on a property to protect its financial investment. The validity of this new provision has not been tested in court, but arguably would be subject to legal challenge.


Obviously, a lender who finds itself in this position would ideally undertake appropriate due diligence before foreclosing. The lender should determine what the actual status of the property is and whether foreclosing, and stepping into the shoes of the Permitee as EPD asserts, is worth the risk. For low value properties it may be better for the lender not to foreclose but instead to implement other strategies to realize on the collateral like note sales. On the other hand, if the lender does foreclose it certainly should take appropriate steps to protect itself from a number of risks, particularly claims from downstream property owners. Regardless of whether taking title makes sense, it may also be appropriate to take certain actions to stabilize the property, which could have the twin benefits of defusing regulatory scrutiny and removing a topic for negotiation with potential purchaser. In any event, following the General Permit provisions by filing an NOI and voluntarily stepping into the shoes of the previous Permitee may not be the wisest decision. A lender who does not take steps to preserve the ability to assert its defenses may be left holding a property for many years before it can be sold, and having to maintain soil and erosion control installations and continually monitor such devices for a significant period of time at a substantial cost. At a minimum, appropriate analysis needs to take place prior to foreclosure regarding which approach to use for recovery against the collateral in order for a lender to assess its risk and determine the best course of action.



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