Chapter 7 trustees play a vital and essential role in the United States bankruptcy system. In every Chapter 7 bankruptcy filing, a Chapter 7 trustee is appointed by the bankruptcy court to oversee the administration of the bankruptcy estate, namely to marshal and liquidate property of the bankruptcy estate for ratable payment of creditors. The trustee’s duties include investigating the debtor’s property, liquidating non-exempt property, and distributing proceeds to the debtor’s creditors.1 The Bankruptcy Code also empowers Chapter 7 trustees to recover property (or their value) that belong to the bankruptcy estate, such as by clawing back preferential and fraudulent transfers.
Another tool available to Chapter 7 trustees, in the course of carrying out their duties, is the power to not administer and otherwise abandon certain property. Section 554(a) of the Bankruptcy Code2 provides: "After notice and a hearing, the trustee may abandon any property of the estate that is burdensome to the estate or that is of inconsequential value and benefit to the estate."
Thus, where property is either burdensome or offers inconsequential value and benefit to the bankruptcy estate, a trustee is authorized to abandon the property. Once property is abandoned, it is no longer property of the estate; instead the property reverts to ownership by the debtor. While a trustee’s decision to abandon property is routine and typically undisputed, sometimes the decision to abandon property is contested and violates other laws, which is what occurred in the Supreme Court case of Midlantic National Bank v. New Jersey Department of Environmental Protection.3
In Midlantic, the Supreme Court held that a trustee may not abandon property in contravention of a state statute or regulation that is reasonably designed to protect the public health or safety from identified hazards. Quanta Resources Corporation (Quanta) processed waste oil at two facilities in New York and New Jersey respectively.
The New Jersey Department of Environmental Protection (NJDEP) discovered that Quanta had violated its operating permit at the New Jersey facility by accepting oil contaminated with a toxic carcinogen and issued an administrative order requiring Quanta to clean up the site. An investigation of the New York facility revealed that Quanta had stored similarly contaminated oil in deteriorating and leaking containers. The required clean up and disposal costs exceeded the site’s value. Facing financial difficulties, Quanta filed for Chapter 11 bankruptcy reorganization, which was then converted to a Chapter 7 liquidation case. The Chapter 7 Trustee appointed to the case sought abandonment of both properties (including the contaminated oil on the sites) as burdensome and of inconsequential value in light of the environmental obligations.4
NJDEP and New York objected to the Trustee’s pro-posed abandonment, citing public health and safety concerns and the fact that abandonment would violate state as well as federal environmental laws. They requested that property of the estate be used to bring the sites into compliance with applicable law.5
The Bankruptcy Court granted the Trustee’s request for abandonment, noting that the public agencies were better situated “in every respect” than the Trustee or creditors of Quanta to protect the public and otherwise clean up the sites. The District Court affirmed.
On appeal, a divided panel of the Third Circuit reversed and remanded for further proceedings. The Third Circuit found that when Congress codified the judicially developed doctrine of abandonment at Section 554(a) as part of its 1978 revisions of the Bankruptcy Code, Congress did not intend to pre-empt all state regulation, but only those grounded on policies outweighed by federal bankruptcy interests. Therefore, the Bankruptcy Court erred in permitting abandonment in contravention of environmental laws. The Chapter 7 Trustee appealed to the Supreme Court.6
In a 5 to 4 decision, the Supreme Court affirmed the Third Circuit’s opinion.7 Writing for the majority, Justice Powell held that prior to the 1978 revisions of the Bankruptcy Code, a trustee’s abandonment power was limited to a judicial equitable doctrine intended to protect legitimate state or federal interests. Thus, when Congress codified the abandonment power in 1978, there were already “well-recognized restrictions on a trustee’s abandonment power” that Congress presumably included.8 The Supreme Court further observed that neither Congress nor courts have ever granted trustees the power to abandon property in contravention of state or federal laws designed to protect public health and safety.9 Other sections of the Bankruptcy Code, for example, the automatic stay under Section 362, and other federal laws recognize exceptions for public health and safety, all supporting Congressional intent to incorporate longstanding restrictions on a trustee’s abandonment power.10 The Supreme Court held that bankruptcy courts do not “have the power to authorize an abandonment without formulating conditions that will adequately protect the public’s health and safety.”11
Midlantic has produced two lines of cases.12 “One line of cases hold that abandonment is appropriate unless there is a showing of imminent danger to public health and safety while the other line of cases holds that abandonment is appropriate only upon a showing of full compliance with the applicable environmental laws.” In the former, obligations to clean up property could be abandoned alongside abandonment of the property itself, which would pave the way for greater distributions to creditors, at a cost to enforcement agencies and potentially the greater public. In the latter scenario, cleanup costs would be borne by the bankruptcy estate at the expense of its creditors, meaning, cleanup costs would be prioritized over payment to creditors.
1 11 U.S.C. § 704.
2 U.S.C. 554(a).
3 Midlantic Nat’l Bank v. N.J. Dep’t of Envtl. Prot., 474 U.S. 494 (1986).
4 Id. at 496-97.
5 Id. at 498.
6 Id. at 499-500.
7 Id. at 496.
8 Id. at 500-01
9 Id. at 502.
10 Id. at 505-06.
This article originally appeared in the April 2018 edition of Riverside Lawyer magazine, a publication of the Riverside County Bar Association. Reprinted with permission.
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