Bankruptcy and Reorganization Failed to Shield Shareholders From
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www.torys.com 2000-19N BANKRUPTCY AND REORGANIZATION FAILED TO SHIELD SHAREHOLDERS FROM ENVIRONMENTAL CLAIMS Date: July 17, 2000 A recent Second Circuit Court of Appeals decision underscores the need for careful environmental risk analysis before receiving shares in reorganized companies following a bankruptcy. Under circumstances that may well be surprising to financial institutions and other investors, shareholders of distressed companies may not be insulated from liability if potential environmental claims are not expressly discharged. In Duplan1, a textile company filed for protection under Chapter XI of the former Bankruptcy Act in 1976. The reorganization plan provided for the discharge of all of Duplan’s debts but, as is typical, stated that Duplan would be responsible for “administrative claims” arising during the bankruptcy. The reorganization plan and the court order confirming it were both silent with respect to environmental liabilities. Duplan’s creditors, including Goldman Sachs, received cash and shares in the reorganized company, which later changed its name to Panex. The reorganization ultimately failed. Under a plan of liquidation and dissolution, Panex dissolved and made cash distributions to its shareholders. In 1987, the Environmental Protection Agency found that property adjacent to a former Duplan facility in the Virgin Islands was contaminated with oil byproducts and chlorinated solvents, and that various oil companies were potentially responsible. The owners and lessees of the Virgin Islands site sued the oil companies, asserting claims under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA, also known as Superfund). The oil companies then moved to sue Goldman and the other shareholders of Panex, arguing that the Duplan facility had contributed to the contamination. Goldman made a number of assertions to oppose the oil companies’ motion. The central question was whether confirmation of the reorganization plan discharged the environmental claims against Duplan. The Second Circuit said it did not. Key to this finding was the fact that, as mentioned above, Duplan had expressly agreed to assume responsibility for all “administrative claims” of the reorganization. The Second Circuit determined that the CERCLA liabilities arose from ordinary business conduct before the reorganization was complete (CERCLA having been enacted between the petition date and the close of the bankruptcy case), and thus constituted an administrative claim that was not discharged. In some respects, the precise trap fallen into by creditors in Duplan is not likely to arise in current bankruptcy proceedings, because CERCLA has been on the books for 20 years. In other important respects, Duplan demonstrates the need for caution and vigilance. Shareholders cannot assume that potential environmental claims will automatically be discharged in a bankruptcy and subsequent reorganization. Creditors of companies that are reorganizing should carefully consider the potentially hidden environmental liabilities they may be acquiring if they receive shares in that company, and be certain that appropriate steps are taken to discharge those liabilities. Moreover, the acquisition of a 1 In re Duplan Corporation, et al. v. Esso Virgin Islands, Inc., et al. , No. 99-5105(L), 2000 WL 628705 (2d Cir. May 16, 2000), to be reported at 212 F.3d 144 (2d Cir. 2000). -2- company that filed for bankruptcy before CERCLA was enacted requires careful due diligence regarding potential environmental issues and close examination of prior bankruptcy court proceedings. If you would like to discuss this or any other matter regarding the complex interplay between bankruptcy and environmental law, please call us at 212.880.6000, extension 6114. If you are calling long distance, you may call us toll-free at 1.800.505.TORY (8679), extension 6214, from anywhere in the continental United States or Canada. Torys’ client memos are also available on our Web site, at www.torys.com. If you usually receive our client memos by regular mail and wish to receive them by email instead, please send an email to email@example.com. This memorandum is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues raised by this memorandum with you in the context of your particular circumstances.