Environmental obligations prioritised in insolvency proceedings

It is generally accepted that the push towards a greener future requires robust legislation, and in the case of common law jurisdictions ,supportive legal precedent which will assist in framing the landscape for the enforcement of environmental remediation obligations.

This article considers the recent Canadian law decision handed down in the Court of King’s Bench of Alberta in Qualex-Landmark Towers Inc v 12-10 Capital Corp 2023 ABKB 109 (“QL Towers”). This case has widened the protection awarded to enforcers of environmental reclamation obligations and their associated costs in an insolvency scenario, and as a result has the potential to undermine lenders’ confidence in property and projects in Canada.

QL Towers summary  

Canadian development company Qualex-Landmark Towers Inc (the “Claimant”) purchased land adjacent to 12-10 Capital Corp (the “Respondent”). During the land purchase, ground investigations revealed that the Respondent’s land was contaminated. Several years later, the provincial environmental regulator, Alberta Environment and Parks (“AEP”), requested that the Respondent undertake an environmental site assessment and provide a contamination delineation and remediation plan in relation to its contaminated land. Despite initiating plans, the Respondent never executed its plans. The Claimant commenced proceedings having discovered that the contamination had spread to their land.

After issuing proceedings, the Claimant discovered that:

• the contaminated land was the Respondent’s only asset;
• the estimated value of the contaminated land equated to the value secured by various mortgages registered against the title of the land;
• the Respondent had attempted to sell parts of the land, although these sales fell through; and
• the Respondent was insolvent.

In anticipation of the risk that the Respondent might sell the land with the aim of distributing the sale proceeds to mortgagees, and consequently would dissipate all available funds to satisfy a judgment in the Claimant’s favour, the Claimant applied to the Court for an attachment order against the Respondent. The attachment order would be applied to any gross sale proceeds of the Respondent’s land and would be prioritised above the mortgages already registered on the land title.

The decision

The Alberta Court granted the Claimant the attachment order sought and ordered that CAD $2,006,500 from any subsequent sale of the Respondent’s land be held on trust by the Respondent, which was the estimated remediation cost.

In determining whether the Claimant had a “reasonable likelihood” of succeeding in obtaining a judgment that is paid in priority above all other creditors, the Court relied on the principles established in the Supreme Court of Canada’s Redwater decision, which provided that obligations concerning environmental remediation can displace secured lenders if the remediation obligations would otherwise not be met.

The Court rejected the Respondent’s argument that only AEP as the environmental regulator were entitled to obtain a first-priority charge for environmental remediation costs, as a bona fide neighbour should not find themselves in a worse position than a regulator when seeking civil law recourse for a polluter’s breach of environmental remediation obligations.

In reaching the decision, the Judge highlighted that due to the Respondent’s lack of assets and general insolvency status, any successful sale of the land would prevent the Claimant from enforcing any subsequent award against the Respondent in respect of the environmental remediation obligations.

Extending Redwater

In Canada’s landmark Supreme Court decision in Orphan Well Association, Alberta Energy Regulator v Grant Thornton Limited and ATB Financial, 2019 SCC 5 (“Redwater”) it was held that an attachment order in favour of a public environmental regulator to secure costs for remediating environmental contamination from the defendant’s land to the claimant’s land took priority over secured mortgages in the order of priority insolvency proceedings. The Supreme Court of Canada (SCC) found that a provincial regulator may not be a secured creditor for the purposes of Canada’s statutory insolvency regime (see Canada’s Bankruptcy and Insolvency Act, RSC 1985, c B-3), as an insolvent estate’s end-of-life environmental obligations may not be sufficiently certain in respect of monetary value. In this instance, it was held that the environmental obligations would fail the tests for a provable claim in bankruptcy under the Bankruptcy and Insolvency Act and therefore the obligations would not be subject to the priority scheme in the Act.

Redwater caused widespread concern for lenders who feared that this decision restricted their ability to recover from secured assets in the event of a company’s insolvency,  increasing lenders’ risk overnight.

The QL Towers case represents the first decision to extend the reasoning of Redwater to a dispute between two individual entities, as opposed to the enforcement of an environmental regulator against a debtor in insolvency proceedings. Unsurprisingly, the QL Towers decision has raised further concerns for secured lenders vis-a-vis the possibility that their security could be eroded by individuals alleging environmental claims against companies which can often be unquantifiable.

The UK approach

The Court of Appeal decision Official Receiver As Liquidator of Celtic Extraction Ltd and Bluestone Chemicals Ltd v Environmental Agency CA 14 Jul 1999 (“Celtic Extraction”) is the leading English case on questions that arise over who is liable for environmental concerns when the polluting business becomes insolvent. The Court of Appeal found that a waste management licence was property within the meaning of the Insolvency Act 1986 and could be disclaimed as “onerous property” by a liquidator under Section 178 of the Insolvency Act 1986. Despite the Environmental Agency’s (“EA”) argument that insolvency law should consider the “polluter pays” principle in such instances, Lord Justice Morrit concluded that no precedent existed to suggest that the principle be applied in an insolvency situation that would leave unsecured creditors disadvantaged as a result.

More recently, the Scottish Courts have faced similar questions to those raised in Celtic Extraction, however, different conclusions have been reached. In Joint Liquidators of Doonin Plant Limited [2018] CSOH 89, the Court held that the costs of removing unlawful waste deposits were to be paid to the Scottish Environment Protection Agency before any distribution to creditors. This decision was reached even though the significant remediation costs exceeded the funds available for distribution to creditors. Further, in Administrator of Dawson International PLC [2018] CSOH 52; 2018 SLT the Court sided with the EA, concluding that the EA had standing against the insolvent company on the basis that not doing so could allow a company to avoid liability for environmental obligations by initiating insolvency proceedings.

The previous approaches adopted by the English and Scottish courts differ considerably and although Scottish decisions are not binding in the English jurisdiction, the “polluter pays” principle has developed considerably since the English Courts were last asked to determine the order of priority of an insolvent company’s secured creditors and their environmental obligations. However, it is noted that these cases still did not extend priority over secured lenders to private companies or individuals alleging remediation costs, and these cases still hinged on orders being issued by the public environmental regulators.

Analysis

The potential impact of the Canadian QL Towers decision is uncertainty for secured lenders whilst the process for selling an insolvent company’s assets will undoubtedly be impacted with greater costs and further complexity. Given the impact of this decision, we anticipate that the Respondent or one of the lenders named as Third Party Defendants to the claim may try to challenge this at the Court of Appeal of Alberta. As environmental remediation costs are likely to be a significant issue for Alberta land deals in the foreseeable future, given the province’s long history as a major oil and gas extraction site, developments in relation to the QL Towers case will be watched closely by lender businesses in Alberta and the rest of Canada.

Similarly, the UK lawmakers and the courts could also consider how this situation progresses. The UK Government continues to call for increased responsibility over environmental liabilities. It is therefore possible that the English Courts may find themselves revisiting the decision on whether or not to prioritise the costs of complying with environmental obligations over secured lenders. Whilst it would not be surprising if the English Courts adopted the Scottish Courts’ approach of prioritising the costs incurred by a public regulator, prioritising the claims of individuals or other commercial entities  would seriously undermine lender confidence, as has been commented on in the Canadian legal and business press following both the Redwater and QL Towers decisions.

In any event, the concerns felt by lenders to construction and real estate markets are not unwarranted as it will be the lender that pays for the polluter’s actions, as opposed to the polluting entity itself, in the event of an insolvency situation. The ability to lend and secure funding for property and construction projects is a significant underlying base to the economy and therefore “Redwater” and similar cases will be looked at closely by Lenders and other commercial entities exposed to remediation costs and obligations caused by insolvent third parties.