The Second Circuit Limits Corporate Successor Liability Under Superfund

Sunday, February 1, 2004 - 00:00

Under the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA" or Superfund),1 any "person" who is the present or past owner or operator of a contaminated facility or a generator of hazardous substances that are polluting a facility, is liable for the costs of cleaning up that facility.2 CERCLA defines "person" to include corporations or other business entities.3 Since the enactment of CERCLA, companies making acquisitions have been increasingly exposed to the environmental liabilities of the acquired companies, even where they have purchased assets rather than stock. Expanded theories of "successor liability" were attached to CERCLA by several courts. Recently, however, in its December 17, 2003 decision in State of New York v. National Service Industries, Inc.,4 the United States Court of Appeals for the Second Circuit limited the circumstances under which a purchaser may be held liable for the acts of an acquired company under CERCLA.

In National Service, the Second Circuit reversed the decision of the United States District Court for the Eastern District of New York, which had held that National Service Industries, Inc. ("NSI"), as the purchaser of all of the assets of Serv-All Uniform Rental Corporation, Inc. ("Serv-All"), was responsible for all of Serv-All's CERCLA liability. Serv-All's CERCLA liability arose from its 1978 disposal of several drums of perchloroethylene at a landfill in Islip, New York, at which New York State had subsequently incurred cleanup costs. NSI purchased the assets of Serv-All in 1988.

CERCLA does not address the issue of when one corporation may be held liable for the acts of another related corporation. However, in a 1996 decision in a case entitled B.F. Goodrich v. Betoski,5 the Second Circuit held that a corporation that purchased the assets of another company that was liable for response costs under CERCLA could itself be held liable for those costs as a successor corporation based on a "substantial continuity" test. Under that test, successor liability is determined based on factors related to the continuity of the purchased business, i.e., "whether the successor maintains the same business, with the same employees doing the same jobs, under the same supervisors, working conditions, and production processes, and produces the same products for the same customers."6 The Court recognized that in adopting the substantial continuity test, it was departing from the traditional common law rules used to determine successor liability, which would operate to transfer the liabilities of one company to a purchaser of its assets only if: (a) the successor expressly or impliedly agreed to assume those liabilities; (b) the transaction may be viewed as a de facto merger or consolidation; (c) the successor is the "mere continuation" of the predecessor; or (d) the transaction is fraudulent. Under the mere continuation test, the required elements to hold a successor corporation liable are the existence of a single corporation after the transfer of assets, with an identity of stock, stockholders, and directors between the successor and predecessor corporations.7 The Second Circuit considered its departure from the traditional common law rules of determining successor liability in Betoski as consistent with CERCLA's broad remedial purposes.8

In holding NSI liable for the environmental infractions of Serv-All, the district court in National Service applied the substantial continuity test adopted in Betoski. It found that NSI had purchased Serv-All's customer contracts, customer lists, service inventory, accounts receivable, trucks, jackets bearing the name Serv-All, and the right to use or retire Serv-All's name.9 The district court held that NSI's operations were a substantial continuation of Serv-All's business based on the "seamless" transition following NSI's purchase of Serv-All, after which NSI employed Serv-All's truck drivers, used trucks that bore the name Serv-All, used Serv-All on its letterhead and took over the Serv-All telephone number.10

In its review of the district court decision in National Service Industries, the Second Circuit reevaluated the substantial continuity test in light of the United States Supreme Court's 1998 decision in United States v. Bestfoods.11 In Bestfoods, the Supreme Court considered the circumstances under which a parent corporation could be held liable under CERCLA for the actions of its subsidiary. The parent corporation had created a subsidiary to purchase the Ott Chemical Corporation, which manufactured various chemicals at a facility in Michigan. The subsidiary corporation, also called Ott Chemical Corporation, continued to manufacture chemicals at the same facility until the parent sold it to an unrelated corporation. The United States District Court for the Western District of Michigan had held that the parent was liable for cleanup costs subsequently incurred at the Michigan facility because it had actively participated in and exercised control over the subsidiary during a period of disposal of hazardous waste. The United States Court of Appeals for the Sixth Circuit reversed, holding that a parent corporation could only be liable for the actions of its subsidiary if state common law rules for piercing the corporate veil were met or if the parent had directly participated in the operation of the facility.

The Supreme Court held that the district court's test for determining the derivative liability of the parent corporation was improper, as it disregarded "time-honored" common law rules. The Court held that CERCLA's silence on such a fundamental matter "as the liability implications of corporate ownership demands application of the rule that 'in order to abrogate a common-law principle, the statute must speak directly to the question addressed by the common law.'"12 Since the language of CERCLA gave no indication that the entire corpus of state corporation law should be replaced because a plaintiff's cause of action is based upon a federal statute, the Court held that in determining whether liability under CERCLA passes from one corporation to another, courts must apply common law rules and not create CERCLA-specific rules.

The Second Circuit in National Service determined that based on the Supreme Court's holding in Bestfoods, it is no longer proper to apply the substantial continuity test in determining whether a corporation takes on CERCLA liability as the result of an asset purchase, as such test is "not a sufficiently well-established part of the common law of corporate liability to satisfy Bestfoods' dictate that common law must govern."13

The rejection of the substantial continuity test by the Second Circuit means that bona fide, arms length asset purchasers will be less likely to "inherit" CERCLA liability from the sellers of those assets. The rejection of the test will not eliminate all CERCLA liability for asset purchasers. For example, a purchaser of real property from which there have been releases of hazardous substances with respect to which the government or an innocent party has incurred response costs would still be responsible under CERCLA for reimbursement of those costs. However, the purchaser's responsibility would stem from its status as the current owner of the contaminated property, not from being considered as a successor to the seller.

The holding in National Service will likely have a significant impact in the area of "generator" liability, i.e., the liability of a company arising from the disposal of hazardous substance at an off-site location that later becomes the subject of a CERCLA cleanup. Asset purchasers will not be exposed to CERCLA liability for cleanup costs as successors to sellers in circumstances where the seller has liability as a "generator," unless liability would otherwise pass under traditional common law principles.

Another area in which National Service is likely to have an impact is in contribution actions among groups of responsible parties under CERCLA. In contribution actions, even if the asset purchaser becomes the owner or a contaminated facility, its share of responsibility will often be determined based on factors such as the number of years that it owned or operated the facility. If an asset purchaser is not deemed a successor to the asset seller, its allocated share of responsibility can be substantially less than it would be if the seller's period of ownership is "tacked on" to the purchaser's.

1 42 U.S.C. §§ 9601 et seq.
2 42 U.S.C. § 9607(a).
3 Id. §§ 9601(20)-(21).
4 2003 WL 22962155 (2nd Cir. (N.Y.)).
5 99 F.3d 505 (2d Cir. 1996).
6 Id. at 519.
7 See, e.g., United States v. Carolina Transformer Co., 978 F.2d 832, 838 (4th Cir. 1992).
8 99 F.3d at 519.
9 New York v. National Service Industries, Inc., 134 F.Supp.2d 275, 278-279 (E.D.N.Y. 2001).
10 Id. at 279.
11 524 U.S. 51 (1998).
12 Id. at 63.
13 2003 WL 22962155 at *4.

Richard G. Leland is a Partner and Karen L. Mintzer is an Associate at Kramer Levin Naftalis & Frankel LLP. Mr. Leland chairs the firm's Environmental Law Department, of which Ms. Mintzer is a member.

Please e-mail Mr. Leland at rleland@kramerlevin.com and Ms. Mintzer at kmintzer@kramerlevin.com with questions about this article.