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Pre-liquidation environmental clean-up liability held to be an expense of the liquidation

A statutory waste removal obligation incurred by a company before it entered liquidation was held to be dischargeable as an expense of the liquidation (Re Doonin Plant Limited [2018] ScotCS CSOH 89).

UK Insolvency Practitioners will need to consider the implications of this decision when advising on strategy in relation to waste management businesses.  Additional pre-appointment due diligence may be needed and the costs of a court application to confirm that the IP's remuneration can be paid in advance of the costs of any such liabilities should be factored in. 

Secured lenders operating in this sector should also be alert to the risk that the costs of complying with statutory waste removal obligations may now take priority over floating charge realisations.  In practice this could have a significant impact on recoveries.

Facts

The Company in this case operated a waste management business.  It was alleged that it had deposited waste on a site without a licence for a number of years.  For the purposes of the application all parties accepted that this was true and that the deposits were unlawful.  The Company went into liquidation.

The Scottish Environment Protection Agency (SEPA) issued two notices requiring the Company to remove the unlawfully deposited controlled waste from the site.  One notice was issued before the company entered liquidation, and one after.  The Joint Liquidators applied to the court for directions in relation to these notices.

The Environmental Protection Act 1990 (EPA)

It is an offence under the EPA to unlawfully deposit controlled waste, or knowingly cause or permit controlled waste to be deposited, unless a waste management licence authorising the deposit is in force and the deposit is in accordance with the licence.  If these provisions are breached, the relevant waste regulation or waste collection authority may serve a waste removal notice requiring the occupier to either:

  • Remove the waste within a specified period; or
  • Take specified steps with a view to eliminating or reducing the consequences of the deposit of the waste.

If the notice required the occupier to remove the waste, and the occupier failed to do so, then the relevant authority can remove it themselves and seek to recover any reasonably incurred expenses (referred to as a recovery liability) from the occupier. 

The EPA confirms that people acting in certain capacities, including insolvency practitioners and receivers, will not be personally liable for remediation works for which the insolvent entity would be liable unless the contamination arises as a result of an unreasonable act or omission of that person.

Priority of liabilities in administration and liquidation

Any liability payable as an expense of an administration or liquidation will be paid in priority to all provable debts other than those secured by a fixed charge.  It is possible for a statutory obligation to constitute an expense if Parliament intended that the obligation should be discharged by an officeholder in the event of a formal insolvency.  This will be a question of statutory interpretation in each case.

Insolvency law provides an order of priority of payment of expenses.  Expenses properly chargeable or incurred by the insolvency practitioner in carrying out their functions (including those arising under statute) have top priority in Scottish liquidations and Scottish, English and Welsh administrations.  This means such expenses are payable before the liquidator's or administrator's own costs and remuneration.  The position is different in English and Welsh liquidations (whether voluntary or compulsory), where these expenses are accorded the lowest priority and are payable after the liquidator's costs and remuneration.

Liquidators and administrators in each jurisdiction may apply to court to vary the order of priority of expenses.

The application

The Joint Liquidators applied for directions on three points:

  1. Whether the waste removal notice obligations and any recovery liabilities comprised, at the liquidation date, an ordinary, unsecured, contingent debt owed by the Company to SEPA;
  2. If not, whether the Liquidators would be obliged to carry out the remediation work specified in the waste removal notices and, to the extent that funds were available, to procure the Company to meet these obligations; and
  3. If so, whether the remediation costs should be categorised as an expense of the liquidation and, more specifically, whether they would be an expense properly chargeable or incurred by the Joint Liquidators in carrying out their functions.

In the event that the court ordered that the remediation costs would be an expense of the liquidation, the Joint Liquidators sought an order varying the order of priority so that their costs and remuneration would be payable in advance of the remediation costs.  This was particularly important as the remediation costs were estimated to be between £2.3 and £3.7 million, but only c. £635,000 had been realised by the Joint Liquidators as at the date of the application.

The decision

The court held that the Company's obligations under the notices continued notwithstanding the liquidation, and that the costs of remediation would be expenses of the liquidation properly chargeable or incurred by the Joint Liquidators in carrying out their functions.  The court reached this conclusion as a matter of statutory construction.  It considered the underlying aims and objectives of the EPA, including the principle that the "polluter pays". Lord Doherty noted that:

"For the UK to comply with its obligations under the directive there has to be an effective means of requiring that those who deposit waste unlawfully bear the responsibility for its removal and remediation. That is so even if the person becomes insolvent. Thus, in the event of liquidation a company should continue to be obliged to carry out removal and remediation of waste, and the expense involved should be a liquidation expense. Otherwise the polluter would generally escape liability."

The court reassured IPs that there would be "no real risk" that the court would refuse to order that a liquidator's remuneration be paid in priority to such an expense if that was necessary to ensure the liquidator would be remunerated.

The court held that obligations under a waste removal notice could not constitute an unsecured debt, as no debt was owed to the relevant authority.  It may be possible that an authority's recovery liabilities could be a contingent, unsecured debt.  However, the reality here was that SEPA would not exercise its powers to carry out the remediation works, as a matter of policy and because of budget constraints.  Accordingly, no debt would arise in this case.

The court dismissed the Joint Liquidators' concerns that the decision could mean that IPs may be unwilling to take appointments in these circumstances.  Lord Doherty acknowledged that the decision may make liquidators' tasks "more challenging" but not "unworkable".

This Scottish decision will be persuasive but not binding on English courts.  Unless and until an English decision is reached on the same point, secured lenders and IPs dealing with businesses in this sector throughout the UK will need to consider the potential impact of pre-insolvency environmental obligations and liabilities.

Key considerations for secured lenders in this sector

If an environmental liability is found to be dischargeable as an expense of the insolvency process, then it will take priority over all other provable debts (with the exception of those secured by a fixed charge). 

Where the level of debt exceeds the value of fixed charge assets, lenders will need to consider whether or not a floating charge provides them with adequate security in light of this risk and in the specific circumstances in each case.  There is a real risk that a pre-insolvency environmental obligation could impact upon recoveries in an insolvency situation.

Key considerations for IPs in this sector

Pre-appointment due diligence will be crucial to establish the potential extent of liabilities.  This should include conversations with the relevant authority to ascertain (i) whether any enforcement notices have been served and (ii) whether the company has provided the authority with any "financial provision" that may cover clean-up costs.  In practice it is unlikely that the authority will be willing to give any categorical assurances.  This due diligence will also not alleviate the risk of a notice being served post-appointment in relation to the company's pre-appointment actions.

In England and Wales the extent of any potential liability may inform the choice of insolvency process, as it may be possible for a liquidator to disclaim  waste or a waste management licence as onerous property.  Specific advice should be taken in each case.  Any disclaimer will need to be served on the relevant authority, and there is a risk that the authority may challenge a disclaimer in light of this decision. 

In all administrations and in Scottish liquidations a court application is likely to be needed at the outset of the appointment to provide IPs with the comfort that remediation costs will not be prioritised over their remuneration.

There are also practical issues to consider once appointed.  The court in this case was unconvinced that contractors would require personal guarantees from IPs before undertaking clean-up works, but it seems likely that contractors will want some form of reassurance that their costs will be met.  Where funds are limited, IPs will also need to determine which parts of the clean-up operation should be prioritised, and further specialist advice may be needed.

It remains to be seen how the English courts approach the same issue.  If you are advising on or appointed in connection with a waste management business and have any questions please contact a member of the Restructuring & Insolvency team.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at September 2018. Specific advice should be sought for specific cases. For more information see our terms & conditions.

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