Insolvency in the waste sector – risk management options for lenders

Out-Law Analysis | 29 Aug 2016 | 11:07 am | 4 min. read

FOCUS: A combination of legislative changes, sustainability initiatives and poor economic conditions have rendered the traditional waste business model unsustainable, leaving many businesses struggling to remain relevant in a changing and increasingly fragmented market.

EU waste management legislation has significantly changed the UK's approach to waste management, away from landfill-based waste disposal towards re-use, recycling and recovery processes. At the same time, economic pressures and reduced consumer spending over the last decade have also contributed to a reduction in commercial, industrial and household waste.

The shift away from waste disposal and the reduction in waste volumes has caused the UK waste market to become increasingly competitive with a significant number of SME's becoming particularly active in fields such as recycling repair and innovation. Unfortunately, the fact that cash flows in the same direction as supply in the waste sector can very quickly compound short-term financial difficulties for such firms.

For insolvency practitioners, environmental risk is an important consideration when accepting an appointment – and this is even more the case where the company operates a regulated business. Being aware of the issues, and being able to spot potential problems before they arise, can help avoid unexpected expenses – or, at worst, personal liability attaching to the insolvency practitioner.

A case study

To see how this could work in practice, consider the example of a low-end skip business which sorts commercial and industrial waste, then recycles metal from that waste and from end-of-life vehicles.

The business, Overtrading Ltd, is struggling with cash flow. In the waste sector, the originator of the waste usually pays 'gate fees' to the recycler or waste-to-energy processor, which in turn pays gate fees to a third party for the disposal of any unusable residues remaining following processing. To ease the pressure, Overtrading continues to take on waste and receives gate fees as a result, but ceases payment of onward gate fees to third parties for the disposal of post-processed waste.

Although this course of action keeps Overtrading going in the short-term, it also results in waste being stockpiled on the site. Eventually, the amount being stored exceeds overtrading's permit and becomes an offence under the Environmental Permitting Regulations 2010 (EPR), which as with many such permits restricts the tonnage of waste allowed on site at any one time.

Breaches of the EPR can result in criminal prosecution by the Environment Agency (EA), and/or a third party civil claim for nuisance or negligence if the pollution escapes off-site and causes damage to neighbouring land. The EA can also pursue individual company officers who have consented, connived or by their neglect caused the company to commit a breach of the EPR, and can seek confiscation of monies generated from such illegal activities from both the company and individuals under the proceeds of crime legislation.

Overtrading's lender becomes aware of the issues when the EA issues an enforcement notice requiring the company to stop operations at the site. It then engages an insolvency practitioner (IP) to review the options. There are a number of options that the IP can consider.

Pre-pack business sale

The EA will generally be supportive of permit transfer applications in these situations - subject, of course, to being satisfied of the transferee's competence and ability to deal with the stockpile of waste and bring the site back into compliance in a timely fashion. Ultimately, the EA will be keen to avoid 'disclaimer' of the permit, and the resulting liability falling back on the EA.

Early liaison with the EA is generally advisable in these cases.

Trading administration with a view to business sale

The environmental permit will remain in force until it is revoked, or is surrendered and its surrender accepted by the EA. The operator remains subject to its conditions until that time, regardless of the appointment of an IP. The operator must still continue to comply with the terms and conditions of the permit, and will be guilty of an offence if it fails to do so.

It is therefore often necessary to ensure that in-house expertise in waste management matters is retained during the period of administration, so that the administrators can have the benefit of the necessary technical expertise to help them take these decisions. Sometimes it is necessary to appoint a specialist consultant to provide advice.

The IP would only commit an offence if it acted outside of its role as an agent of the company. While IPs enjoy some specific protection from personal liability in relation to contaminated land, the EPR provides for individual liability where a senior company officer "consents or connives" in the commission of the offence by the company, or the offence can be attributable to their neglect. This could potentially include an IP.

Lender enters the site as mortgagee in possession

If no pre-pack sale is achievable and the IP will not accept the appointment as administrator for trading or even shutdown because of the environmental risk, the lender could itself enter the site as mortgagee in order to achieve a sale of the property to recover some of its debt. However, the lender will then be exposed to liability as even if the EA was to revoke the environmental permit, a lender which takes possession of land in order to sell it may become liable to remove the wast

e and/or clean it up under the Environmental Protection Act of 1990.

Liquidation and disclaimer

If none of the above options can be made to work, the directors could consider appointing a liquidator who could seek to quickly disclaim both the site and the environmental permit as 'onerous property' under section 178 of the 1986 Insolvency Act.

There has not yet been any English case law determining whether environmental permits are disclaimable as onerous property under this regime. However, in the Celtic Extraction case in 1999, the Court of Appeal held that waste management licences, which are now a form of environmental permit, were disclaimable.

However, liquidation will not aid removal of the waste, leaving the directors potentially vulnerable to action by the EA.

Excess stockpiles of waste on sites are a classic sign of distress in the waste sector. This case study is a great example of why directors should seek help early in the decline curve to maximise the changes of recovery.

The EA does not want to see orphan sites. If, in our example, none of the above options are available the lender can release its security over the site to avoid the risk that it unwittingly becomes a mortgagee in possession if the directors hand the keys back, which would leave the EA with the costs of a clean-up it can ill afford.

For this reason, carrying out effective due diligence and early, ongoing liaison with the EA will manage and mitigate the risks associated with taking an appointment as an officeholder over a waste management company subject to an environmental permit.

James Cameron is a restructuring law expert and Claire Gregory an environmental law expert at Pinsent Masons, the law firm behind