Oct. 03, 2019 - Chapter 2 of Davies Governance Insights 2019
Director & Officer Environmental Liability: Cleaning up after the company is gone
The Ministry of the Environment (MOE) in Ontario has recently taken an aggressive stance in environmental cases involving insolvent companies by seeking to impose environmental liability on directors and officers (D&O). The basis for this stance is questionable as a matter of legal substance, but difficult to challenge as a matter of process. In the insolvency of Northstar Aerospace (Canada), Inc. (Northstar), an order was issued directly against the D&O when there were substantial unfunded environmental liabilities associated with the former manufacturing site that was be sold under the Companies’ Creditors Arrangement Act (CCAA). Unable to require further action by the company, the MOE targeted the current D&O without regard to whether the individuals were involved in the discharge of the contamination. The Northstar D&O faced significant remediation costs while they attempted to appeal the MOE orders. A close look at this risk of exposure is required to help D&O of Canadian companies anticipate and protect against potential environmental liabilities.
Northstar operated a manufacturing facility in Cambridge over several decades. The facility had contaminated groundwater beyond the boundaries of the site, affecting more than 500 residential properties. Northstar began voluntary remediation while it still operated the facility but when the MOE issued orders for remedial work plus the provision of approximately $10 million in financial assurance, the company sought protection under the CCAA and all but two of the company’s D&O resigned. In the initial order under the CCAA, the remaining D&O were provided with indemnification for liabilities incurred in the proceedings, secured by a charge of $1.75 million.
With no financial assurance and the potential for human health effects at downgradient residences due to the termination of operation of the remediation systems, the MOE attempted to prevent the sale of Northstar’s assets or to have the sale proceeds reserved for remediation activities. This decision was based upon the ruling of the Supreme Court of Canada (SCC) in Newfoundland and Labrador v AbitibiBowater Inc. in which MOE orders were found to be compromisable claims if there was “sufficient certainty” that the regulator would undertake the remedial work. Justice Morawetz found that the MOE would likely take over Northstar’s remediation activities as there was no purchaser that would continue such work. The MOE’s orders were found to enforce payment obligations of the company and, therefore, were monetary in nature and mere claims in the CCAA process. The MOE was unsuccessful in its efforts to secure a claim in the insolvency. The decision of Justice Morawetz was later upheld on appeal to the Ontario Court of Appeal.
Upon Northstar’s subsequent bankruptcy, the Company terminated its remedial activities and the site was abandoned by the trustee. In a rare undertaking spurred by concern over potential health effects, the MOE reinitiated the remedial activities in the residences itself. Perhaps not surprisingly, the MOE did not avail itself of its right to a “superlien” on Northstar’s contaminated property under section 11.8(8) of the CCAA. Instead, the MOE issued an order against the former D&O to carry out a more complete remediation. The order alleged that the D&O were “persons” who had permitted the discharge of contaminants into the environment and/or had management and control of the site and remediation systems. The D&O appealed the MOE order to the Environmental Review Tribunal (“ERT”, in the case of Baker v. Director, Ministry of Environment) on the basis that the company, and not the D&O, had been responsible for the environmental issues connected to the site both at the time of discharge of the contaminants and in the course of the remediation. As well, the D&O brought a motion to the Commercial Court in the CCAA proceeding for recovery of the costs of complying with the MOE order and a motion to the ERT seeking a stay of the order pending the appeal. The ERT denied the motion on technical legal grounds - irreparable harm to the D&O could not be established while the potential for recovery of funds under the initial charge remained. Without a stay, the D&O were responsible for interim remediation costs of approximately $1.4 million/year. Adding insult to injury, the Commercial Court refused to distribute the indemnification charge under the initial order for such interim costs on the basis that this would provide the MOE with funds “it could not achieve directly”.
Unsuccessful in the recovery of the reserve funds and facing the burden of disproving liability for tens of millions of dollars in remediation costs without the benefit of any stay as against them, the Northstar D&O agreed to settle with the MOE for $4.75 million. It will never be known whether the Northstar D&O could have refuted liability by demonstrating that (i) they did not cause or permit the discharge of the contaminants, and (ii) that they did not have the requisite degree of management or control of the property or the remediation to be required to complete such work. Case law, which has yet to be fully developed, suggests that this would require significant factual analysis of whether the D&O influenced the environmental management systems of the company (which may include decisions to undertake remediation and provide financial oversight). Even if the D&O had been successful in their appeal, they would not have recovered interim costs as Ontario does not have a statutory reimbursement regime for successful appellants (like that in British Columbia) and litigation cost awards are rarely granted by the ERT.
While the case of the Northstar D&O did not increase the risk of remediation liability for individuals, it highlights the aggressive stance of regulators and the expense D&O may face in the course of challenging such orders, especially in the aftermath of the SCC’s decision in Abitibi. Without legislative reform, there are few options to protect against such interim liabilities: availability of reserves and indemnities may be challenged under the CCAA and the threshold to secure a stay is prohibitive. Instead, D&O should focus on ensuring that remediation liability cannot attach to their conduct. Look closely at the environmental management systems in the company and ensure that these are professionally managed without direct involvement of D&O. Decisions to initiate, reduce or terminate environmental programs (and related funding), including remediations, should be made with careful consideration of legal obligations and consequences. In addition, and perhaps most importantly, D&O should be ready to vigorously defend themselves against remediation liability, so that regulators may be less inclined to issue orders against individuals.
Oct. 03, 2019 - Davies Governance Insights 2019 is a comprehensive report that analyzes the governance trends and issues most important to Canadian public companies. Now in its ninth edition, Governance Insights is designed to be a playbook for navigating the diverse and complex challenges facing...