Court Affirms Application of Equitable Conversion Principles Under CERCLA BY MARTIN DOYLE AND DAVID FELDER As originally published as a Special to the Legal Intelligencer, PLW, October 20, 2008

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MARTIN DOYLE and DAVID FELDER are members of Saul Ewing‘s Real Department in the Firm‘s Philadelphia office. Both have worked on a number of major transactions and have been involved in all aspects of real estate development, sales, finance and leasing. Doyle received his J.D., cum laude, from the University of Pennsylvania School. Felder received his J.D., cum laude, from Harvard Law School.

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In a case which echoes the reasoning of a 2003 Eastern District of Pennsylvania decision, the 7th U.S. Circuit Court of Appeals ruled last month that state law equitable conversion principles have a place in determining whether a party may be held liable for cleanup costs under the Comprehensive Environmental Response, Compensation and Liability Act. The case, United States of America v. Capital Tax Corp. , decided Sept. 19, granted the appellant, Capital Tax Corp., the prospect of avoiding liability on the basis of its assertions that it had entered into a to sell the relevant before it took legal and that it was never an operator of the site. The case was remanded to district court for further proceedings in accordance with these conclusions.

CERCLA imposes liability upon parties who own or operate facilities where an environmental release occurs and for which the government or a private party has incurred cleanup costs. Once the prerequisites for liability are found, the statute applies a strict liability standard, and there is no question that CTC had title to the property in question during a period when releases, requiring cleanup, occurred. In the face of these facts, CTC's principal defense was that it was not an "owner" as that term should be read under CERCLA, relying on the state law principal of equitable conversion. The district court, which first heard the case, rejected this reasoning, but its ruling was overturned by the circuit court.

CTC is a company that purchases distressed real estate with a view toward reselling it quickly for a . The case at hand began in 2001, when CTC purchased from Cook County tax certificates relating to a derelict paint factory in Chicago. The tax certificates did not transfer legal title to CTC but entitled CTC to obtain tax to the property in the event that they were not paid off by the delinquent taxpayer within a given period of time. CTC representatives visited the property and, even though they could not gain entry, were aware that it was a former paint factory, according to the opinion.

CTC claims that, following its purchase of the tax certificates, but prior to accepting the tax deeds, it entered into a deal with Mervyn Dukatt, who agreed to purchase the property for $25,000. One of CTC's hurdles in this case is that CTC and Dukatt never signed a written agreement, thus raising questions under Illinois' statute of frauds provisions; however, the subsequent course of conduct allowed the court

to infer at least a colorable claim that such a contract existed (this being one of the issues on remand), and on that basis the court proceeded to address the legal issues which are the focus of this article.

On the basis of its agreement with Dukatt, CTC exercised its option to accept delivery of the tax deeds, and obtained an order evicting the prior owner. CTC turned over of the property directly to Dukatt, and received an initial payment of $15,000, according to the opinion. Dukatt took responsibility for the property from that point on and began operations therein, constructing improvements, selling some equipment for scrap and otherwise controlling the facility. CTC personnel never visited the property during this time but retained legal title as security for the payment of the balance of the purchase price. Dukatt never paid the outstanding $10,000 and eventually vacated the property without ever having obtained legal title.

During the period of Dukatt's operations, the Chicago Department of the Environment and the Environmental Protection Agency were notified of numerous complaints about toxic materials leaking from the buildings. After inspections revealed thousands of leaking containers, the EPA ordered CTC to clean up the property. CTC refused, and the EPA conducted the cleanup itself, incurring costs exceeding $2 million. The EPA then sued CTC for reimbursement under CERCLA.

Under CERCLA, the plaintiff must show that the site qualifies as a "facility," as defined; that the defendant is a covered person under the act; and that a release has occurred causing the plaintiff to incur response costs. Assuming all elements are shown, a responsible party bears strict liability. CTC conceded each of these elements other than that it was a responsible party.

Parties may be deemed responsible under CERCLA pursuant to several different sets of criteria. In CTC's case, the relevant category is the EPA's characterization of CTC as "the owner … of [the] facility."

As noted by the court, CERCLA itself is not helpful in determining whether a party is an owner, defining an owner as "any person owning" a facility. But in other cases, the court noted, such bare simplicity has been taken to imply that Congress intends that term to be interpreted in its common everyday way, and to rely on " analogies."

Further, the court noted that questions of property relations and have traditionally been governed by state law and concluded that it would be inappropriate, if not impossible, to craft a second federal definition of "owner." Consequently, in the absence of express guidance to the contrary, the court determined to rely on state law principles, here Illinois, to determine whether CTC was an "owner" under CERCLA.

While CERCLA doesn't define owner with any clarity ("a person owning"), it does contain a listing of interests which will not be considered to constitute under the statute. Under CERCLA, a party who, "without participating in the management of a … facility, holds indicia of ownership primarily to protect his security interest in the … facility" is not an "owner." A "security interest" is a right under a mortgage or similar instrument or other right to secure the repayment of money or performance of any other duty by an unaffiliated person. In general terms, this "security interest" exception is understood to

-2- protect secured lenders who may structure their transactions in a fashion that might otherwise unfairly subject them to liability under CERCLA.

CTC's argument before the district court was that, while it admittedly held title to the property during the period in question, it did so simply as security for its loan to Dukatt. The district court rejected this argument, reasoning that since CTC never loaned any money to Dukatt, its interest could not properly be considered a security interest.

Looking beyond CTC's constant reference to the "security interest exception to CERCLA," the court recharacterized CTC's argument as being that it was simply not the owner of the property during the period in question, based upon the concept of equitable conversion, and could not therefore be a responsible party under CERCLA.

Equitable conversion is the common law principle that holds that, once two parties have entered into an agreement for the sale of real property, the purchaser under the agreement is the owner-in- of the land, and the seller is deemed to hold legal title only as security for the payment of the purchase price. It is from this principle that arises the commonly stated precept that the buyer under an agreement of sale bears the risk of casualty or other loss, unless the parties agree otherwise.

The concept of equitable conversion is accepted in Pennsylvania, as it is in a majority of jurisdictions. In the 1969 Pennsylvania Supreme Court case of DiDonato v. Reliance Standard Life Insurance Co. , the court held: "It is well established … that when the Agreement of Sale is signed, the purchaser becomes the equitable or beneficial owner [and] the vendor retains merely a security interest for the payment of the unpaid purchase money." The same is true under installment sales agreements, as illustrated in the Common Pleas case of Gerhard v. Welker . Consequently, it is likely that a federal court applying Pennsylvania law would come to the same conclusions as that in Capital Tax .

In Capital Tax , the court noted that a number of district courts have applied the doctrine of equitable conversion in CERCLA matters, including the Eastern District of Pennsylvania in United States v. Union Corp . Further, two circuit courts had previously held that public or quasi-public companies which hold title to property to secure recoupment of development costs are not "owners" for purposes of CERCLA.

CTC's defense then (properly stated), would be that at the time it accepted the tax deeds, it had already entered into an agreement of sale and that, therefore, its ownership instantly transferred to Dukatt. It is important that CTC show that it did not ever engage in operations at the site, for if it did so, it would be liable under the "operator" prong of CERCLA's liability scheme.

As noted, CTC's case was hampered by its inability to produce a written agreement of sale, and the fact that CTC and Dukatt had numerous varying relationships, with the result that even the payments and Dukatt's activities on the site were subject to interpretation. Consequently, the 7th Circuit remanded the case for further review, for only if an agreement existed would CTC be able to rely on the equitable conversion defense.

-3- The concept of equitable conversion grew out of judicial determinations that it is generally fairer to allocate the risks and benefits of a property under agreement to the proposed buyer of that property. Over the course of time, real estate attorneys have, in common practice, abrogated certain aspects of this principle by way of contract. Consequently, the risk of a zoning change or a fire, or the benefits of finding out that the property is in the Marcellus Shale formation, are often expressly reallocated in agreements of sale. (Well, maybe not the Marcellus thing.)

It is interesting that CERCLA, which is intended to be a strict liability statute aimed at finding remediation dollars, finds itself subject to the traditional, unmodified common law rule. This, however, derives from the federal court's appropriate acknowledgement of the pre-eminence of state law in real property issues and, while clearly reducing the pool of potentially responsible parties, does serve to avoid creating results under federal law that run counter to expectations built around state .

CTC and similar cases raise the question of whether equitable conversion can be used in CERCLA matters as a sword, as well as a shield. Such a prospect would be substantially more troubling to real estate practitioners. In both Union Corp . and U.S. v. Wedzeb Inc. equitable conversion was in fact found to have shifted ownership for purposes of CERCLA to the buyer, but in both of those cases, there were other relationships between the "deemed-owners" and parties with truly dirty hands, so that fact may have influenced the courts in their findings.

Where, however, the purchaser is not obligated to close for reasons under its control, and does not do so, the court in K.C 1986 Partnership v. Reading Manufacturing held that the mere existence of an agreement between the parties will not result in CERCLA liability. The imposition of CERCLA liability on buyers generally, once an agreement is signed, would run counter to all reasonable expectations of real estate practitioners, and so it is to be hoped that courts will respect the contingent nature of most agreements of sale, and avoid making this leap, barring other compelling circumstances.

This article is reprinted with permission from the October 20, 2008 issue of The Legal Intelligencer. (c) 2008 ALM Inc. Further duplication without permission is prohibited. All rights reserved.

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