Oil Pollution Act of 1990: New Limitations on Liability

Original OPA 90

The original text of OPA 90 provides that each “responsible party” is liable for all damages in connection with a vessel oil pollution incident. In the original OPA 90 text, “responsible party” is defined as any entity owning, operating or demise chartering a vessel. Consequently, under OPA 90 as originally adopted, a passive financing lessor holding title to a vessel was jointly and severally liable with the operator and the demise charterer for all pollution damages that occurred in U.S. waters.

The risk of liability of a passive financial lessor was highlighted by the various cases involving the tug M/V EMILY S, in which MetLife Capital Corporation, a lessor, was held to be an “owner” under OPA 90. In those cases, the court held that the entity that was the legal titleholder and documented owner of a U.S. flag vessel was an “owner” and therefore a “responsible party” under OPA 90. Because the insurances were insufficient and the operator/demise charterer bankrupt, as the only solvent entity in the transaction, the financial lessor was left holding the bag.

Of course, the lease documentation always can provide that between the lessor on one hand and the operator and/or demise charterer on the other hand, the lessor is protected by a full operational indemnity provided by the operator and/or demise charterer. Such an operational indemnity would certainly be required by a sensible lessor. However, as the MV EMILY S cases show, such an indemnity provides protection to a lessor only to the extent the indemnitor has sufficient assets, including insurance, to pay damages in connection with a pollution event. Many potential lessors stopped doing vessel lease transactions respecting vessels that operated in U.S. waters, simply because those potential lessors were not willing to entertain the risk of pollution liability if the operator and/or demise charterer were bankrupt and insurances were unavailable or insufficient.

The New Act Amendment to OPA 90

Section 703 of the New Act amends OPA 90 by redefining “owner” to exclude passive financing entities that are lessors in vessel lease financing transactions. Section 703 of the New Act accomplishes this by both parroting certain CERCLA text and incorporating by cross-reference some relevant definitions and other provisions in CERCLA, thereby making the definition of “owner” the same under both OPA 90 and CERCLA. Section 703(a)(26)(B)(ii) of the New Act states that owner or operator does not include a lender “that holds indicia of ownership primarily to protect the security interest of the person in the vessel … ” This principle is taken from, and conforms with, CERCLA.

The CERCLA Secured Creditor Exemption

There are two points in the definition of “owner and operator” in CERCLA, now incorporated by cross-reference in OPA 90 by the New Act, that are particularly relevant to lease structures. The first of these is whether a lessor is a “lender” within the meaning of CERCLA. This is answered by CERCLA in the affirmative ' the term “lender” includes passive financial lessors. Under CERCLA, specifically included in the definition of “lender” are entities not only affiliated with banks but also leasing companies and any person “that makes a bona fide extension of credit to … a non-affiliated person.” These definitions are broad enough to encompass most financial lessors, whether or not such lessors are affiliated with banks.

The second point raised by the Secured Creditor Exemption text in CERCLA is whether a lessor holds “indicia of ownership [eg, title] primarily to protect the security interest” of the lessor in the vessel. “Security interest” is a very broadly defined term including explicitly “a lease” or “other right accruing to a person to secure … any … obligation by a non-affiliated person” (42 U.S.C. '9601(20)(G)(vi)). A vessel demise charter would fall within the meaning of “security interest” by reason of either part of the definition quoted in the preceding sentence.

However, it is the word “primarily” that raises some question in the leasing context. Does a financial lessor hold the lease “primarily” to protect its security interest or “primarily” for another reason or for no single “primary” reason at all? This second point is not as clear as the first, but the view that a demise charter structure may accomplish several different purposes overall seems more in keeping with the purpose of the Secured Creditor Exemption. The legislative history of the 1996 amendments to CERCLA, which enacted the CERCLA Secured Creditor Exemption, and case law suggest that a passive financial lessor who holds legal title for multiple reasons, including in order to achieve the parties' desired tax and accounting treatment, may nevertheless enjoy the Secured Creditor Exemption if at least one of the reasons it holds legal title is “to protect its security interest.” The statutory text of the Secured Creditor Exemption specifically includes within the definition of “lender” an entity that holds title “in connection with a lease financing transaction.” The CERCLA legislative history also has a useful example of a typical lease situation. It states that a financial institution that held title but “also received tax benefits as a result of holding title would not be an “owner” for liability purposes.” Therefore, it seems likely that a lessor who has multiple rationales for holding legal title (including so that the parties receive the desired tax and accounting treatment) will be held by a court not to be an “owner” for CERCLA, and now OPA 90, liability purposes.

No Participation in Management or Operations

One important caveat is that the Secured Creditor Exemption covers only lessors who do not participate in management or operations. Under CERCLA and Section 703 of the New Act, the existence, inter alia, of financial covenants, environmental compliance covenants and the normal lease remedies do not constitute participating in management or operations. However, lessors should exercise care prior to taking any active role, whether before or after default, and weigh whether their intended action could be held to be participation in management or operations.

State Law

A word of caution is in order respecting a financial lessor's potential liability under state law. OPA 90 (see, 33 U.S.C. '2718) specifically authorizes states to adopt their own oil pollution liability laws. Many states have oil pollution liability laws that place responsibility on, inter alia, an “owner,” and in many states, the state law definition of “owner” means titleholder without regard to change by the New Act in the corresponding definition of “owner” under OPA 90. This means that a financial lessor may be protected from liability under the Secured Creditor Exemption under federal law, but be subject to liability independently under many state laws that mirror the original OPA 90 scheme of placing joint and several liability on “owners” together with operators and demise charterers. By and large, states have not yet reacted to the New Act, and consequently, it is not yet known whether all or most will fall in line with the New Act. However, one practical point that should comfort lessors is that there are no cases that have found oil pollution liability under a state law that did not find liability under federal law.

Conclusion

CERCLA, now incorporated into OPA 90 by the New Act, provides a broad passive financial lessor exemption to pollution liability. In recent years, there has not been extensive litigation with respect to the CERCLA Secured Creditor Exemption. The absence of litigation should be interpreted as a very positive sign for the vessel leasing industry by taking the issue of passive financial lessor pollution liability off the table.

Section 703 of the New Act should provide incentive for passive financing lessors to look again at vessel lease financing. Due to other substantive provisions in OPA 90 that are forcing the mandated phase-out of single hull vessels, lease financing should prove to be an increasingly attractive mechanism for financing replacement double hull tonnage.

The risk of oil pollution liability for financial lessors of vessels operating in U.S. waters under the Oil Pollution Act of 1990 (“OPA 90″), 33 U.S.C. '2701 et seq., has been substantially ameliorated under new U.S. legislation, thereby restoring leasing as a more lessor-friendly financing option for vessels that trade in U.S. waters.

The Coast Guard and Maritime Transportation Act of 2004 (Pub. L. 108-293, 118 Stat. 1028) (the “New Act”) became law on Aug. 9, 2004. Section 703 of the New Act amends OPA 90 to provide for exemption from environmental damages liability of certain financing lessors. The New Act imports into OPA 90 the terms of the so-called “Secured Creditor Exemption” found in the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), 47 U.S.C. '9601 et seq.

A ship financing lease is normally based on a demise (also called “bareboat”) charter (the maritime equivalent of a triple net lease) from the financial lessor to the demise charterer, who is thereby the lessee and operator of the vessel. The demise charter usually shifts all vessel maintenance, repair, insurance and all other operational responsibility to the lessee/demise charterer. The lessor retains legal title, status as documented vessel owner and, depending on lease structure, residual value risk. Commercial U.S. vessels are required to be documented with the U.S. Coast Guard, and the Coast Guard's interpretation of the relevant vessel documentation laws is that documentation can occur only in the name of the holder of legal title (not the lessee). As part of the documentation process, the lessor's legal title is publicly recorded with the Coast Guard's National Vessel Documentation Center.

Original OPA 90

The original text of OPA 90 provides that each “responsible party” is liable for all damages in connection with a vessel oil pollution incident. In the original OPA 90 text, “responsible party” is defined as any entity owning, operating or demise chartering a vessel. Consequently, under OPA 90 as originally adopted, a passive financing lessor holding title to a vessel was jointly and severally liable with the operator and the demise charterer for all pollution damages that occurred in U.S. waters.

The risk of liability of a passive financial lessor was highlighted by the various cases involving the tug M/V EMILY S, in which MetLife Capital Corporation, a lessor, was held to be an “owner” under OPA 90. In those cases, the court held that the entity that was the legal titleholder and documented owner of a U.S. flag vessel was an “owner” and therefore a “responsible party” under OPA 90. Because the insurances were insufficient and the operator/demise charterer bankrupt, as the only solvent entity in the transaction, the financial lessor was left holding the bag.

Of course, the lease documentation always can provide that between the lessor on one hand and the operator and/or demise charterer on the other hand, the lessor is protected by a full operational indemnity provided by the operator and/or demise charterer. Such an operational indemnity would certainly be required by a sensible lessor. However, as the MV EMILY S cases show, such an indemnity provides protection to a lessor only to the extent the indemnitor has sufficient assets, including insurance, to pay damages in connection with a pollution event. Many potential lessors stopped doing vessel lease transactions respecting vessels that operated in U.S. waters, simply because those potential lessors were not willing to entertain the risk of pollution liability if the operator and/or demise charterer were bankrupt and insurances were unavailable or insufficient.

The New Act Amendment to OPA 90

Section 703 of the New Act amends OPA 90 by redefining “owner” to exclude passive financing entities that are lessors in vessel lease financing transactions. Section 703 of the New Act accomplishes this by both parroting certain CERCLA text and incorporating by cross-reference some relevant definitions and other provisions in CERCLA, thereby making the definition of “owner” the same under both OPA 90 and CERCLA. Section 703(a)(26)(B)(ii) of the New Act states that owner or operator does not include a lender “that holds indicia of ownership primarily to protect the security interest of the person in the vessel … ” This principle is taken from, and conforms with, CERCLA.

The CERCLA Secured Creditor Exemption

There are two points in the definition of “owner and operator” in CERCLA, now incorporated by cross-reference in OPA 90 by the New Act, that are particularly relevant to lease structures. The first of these is whether a lessor is a “lender” within the meaning of CERCLA. This is answered by CERCLA in the affirmative ' the term “lender” includes passive financial lessors. Under CERCLA, specifically included in the definition of “lender” are entities not only affiliated with banks but also leasing companies and any person “that makes a bona fide extension of credit to … a non-affiliated person.” These definitions are broad enough to encompass most financial lessors, whether or not such lessors are affiliated with banks.

The second point raised by the Secured Creditor Exemption text in CERCLA is whether a lessor holds “indicia of ownership [eg, title] primarily to protect the security interest” of the lessor in the vessel. “Security interest” is a very broadly defined term including explicitly “a lease” or “other right accruing to a person to secure … any … obligation by a non-affiliated person” (42 U.S.C. '9601(20)(G)(vi)). A vessel demise charter would fall within the meaning of “security interest” by reason of either part of the definition quoted in the preceding sentence.

However, it is the word “primarily” that raises some question in the leasing context. Does a financial lessor hold the lease “primarily” to protect its security interest or “primarily” for another reason or for no single “primary” reason at all? This second point is not as clear as the first, but the view that a demise charter structure may accomplish several different purposes overall seems more in keeping with the purpose of the Secured Creditor Exemption. The legislative history of the 1996 amendments to CERCLA, which enacted the CERCLA Secured Creditor Exemption, and case law suggest that a passive financial lessor who holds legal title for multiple reasons, including in order to achieve the parties' desired tax and accounting treatment, may nevertheless enjoy the Secured Creditor Exemption if at least one of the reasons it holds legal title is “to protect its security interest.” The statutory text of the Secured Creditor Exemption specifically includes within the definition of “lender” an entity that holds title “in connection with a lease financing transaction.” The CERCLA legislative history also has a useful example of a typical lease situation. It states that a financial institution that held title but “also received tax benefits as a result of holding title would not be an “owner” for liability purposes.” Therefore, it seems likely that a lessor who has multiple rationales for holding legal title (including so that the parties receive the desired tax and accounting treatment) will be held by a court not to be an “owner” for CERCLA, and now OPA 90, liability purposes.

No Participation in Management or Operations

One important caveat is that the Secured Creditor Exemption covers only lessors who do not participate in management or operations. Under CERCLA and Section 703 of the New Act, the existence, inter alia, of financial covenants, environmental compliance covenants and the normal lease remedies do not constitute participating in management or operations. However, lessors should exercise care prior to taking any active role, whether before or after default, and weigh whether their intended action could be held to be participation in management or operations.

State Law

A word of caution is in order respecting a financial lessor's potential liability under state law. OPA 90 (see, 33 U.S.C. '2718) specifically authorizes states to adopt their own oil pollution liability laws. Many states have oil pollution liability laws that place responsibility on, inter alia, an “owner,” and in many states, the state law definition of “owner” means titleholder without regard to change by the New Act in the corresponding definition of “owner” under OPA 90. This means that a financial lessor may be protected from liability under the Secured Creditor Exemption under federal law, but be subject to liability independently under many state laws that mirror the original OPA 90 scheme of placing joint and several liability on “owners” together with operators and demise charterers. By and large, states have not yet reacted to the New Act, and consequently, it is not yet known whether all or most will fall in line with the New Act. However, one practical point that should comfort lessors is that there are no cases that have found oil pollution liability under a state law that did not find liability under federal law.

Conclusion

CERCLA, now incorporated into OPA 90 by the New Act, provides a broad passive financial lessor exemption to pollution liability. In recent years, there has not been extensive litigation with respect to the CERCLA Secured Creditor Exemption. The absence of litigation should be interpreted as a very positive sign for the vessel leasing industry by taking the issue of passive financial lessor pollution liability off the table.

Section 703 of the New Act should provide incentive for passive financing lessors to look again at vessel lease financing. Due to other substantive provisions in OPA 90 that are forcing the mandated phase-out of single hull vessels, lease financing should prove to be an increasingly attractive mechanism for financing replacement double hull tonnage.