Environmental Agencies Place Renewed Emphasis on Financial Assurance

Corporate & Finance Alert
(Edward F. McTiernan)
May 5, 2009

Regulated entities, and companies performing clean-ups, are routinely required to demonstrate that they have sufficient financial resources to fund their future environmental obligations. This “financial assurance” is intended to protect the public in the event that the responsible party is unwilling or unable to pay. The regulated community often views financial assurance as an unnecessary encumbrance on reserves. Moreover, entities mired in long term clean-up projects, who find themselves funding the project with current cash and simultaneously bonding future clean-up activities, often view financial assurance as “double counting.” As a result of the financial crisis there is a heightened sense that regulated entities might not be able to fund the proper closure and long-term post-closure care of contaminated facilities. Financial assurance requirements are getting greater scrutiny from regulators at both the federal and state level. Companies that are subject to environmental obligations which require financial assurance must anticipate this extra scrutiny in an effort to avoid needless costs and inconvenience.

The primary purpose of environmental financial assurance is to provide private resources, now and in the future, to pay for the public benefit of environmental remediation. Financial assurance requirements apply to two related activities: present operations of certain highly regulated businesses involving hazardous chemicals and clean-up of past spills. The federal Resource Conservation and Recovery Act (RCRA) generally sets the rules concerning financial assurance requirements applicable to owners and operators of highly regulated businesses involving treatment, storage and disposal of hazardous chemicals, and owners and operators of underground tank systems. Financial assurance for clean-up and long-term maintenance of contaminated real estate is typically governed by state laws and regulations although, as discussed below, there may be an increasing federal role on the short term horizon.

In New Jersey, the financial assurance requirements are typically satisfied by posting a ‘remediation funding source.’ The requirements governing financial assurance for remedial sties are found in the Spill Compensation and Control Act (Spill Act) and the Technical Requirements for Site Remediation (Tech Regs). New Jersey’s Tech Regs governing remediation funding sources are generally very inflexible.

Failure to provide required financial assurance can have serious consequences. There are significant civil administrative fines and penalties under the federal RCRA program. In New Jersey, the Tech Regs list not less than sixteen different ways that a responsible party can be fined for violating remediation funding source requirements. In addition, environmental regulators are authorized to seek enhanced penalties to recover any economic benefit that might flow from the failure to provide financial assurance. Enforcement of financial assurance requirements can present some vexing policy questions. For example, what legitimate purpose is served by issuing civil administrative penalties against a responsible party that is solvent and willing to pay for clean-up activities out of current cash, but lacks the balance sheet and/or resources to do more than pay as it goes?

Although requirements vary by program and state, as a general rule, entities that are subject to financial assurance requirements can elect to satisfy their obligations by using one or more of the following mechanisms:

• self assurance/self guarantee;
• trust funds;
• letters of credit, and
• insurance.

Many regulated entities and parties responsible for site remediation prefer to use a self assurance/self-guarantee where permitted. To qualify for a self assurance/self guarantee, it is typically necessary to show both sufficient net worth and adequate cash flow to fund environmental obligations. This showing must be supported by a report from an independent auditor.

If an entity cannot demonstrate sufficient resources to qualify for a self-guarantee, the next best option is often a letter of credit. Typically, such letters of credit must have ever-green provisions. Unfortunately for entities performing clean-ups in New Jersey, neither the Spill Act nor the Tech Regs presently permit the use of letters of credit. Nevertheless, in the New Jersey remedial site program lines of credit are allowed. New Jersey also imposes a surcharge on most forms of financial assurance. This tax is used to fund the state regulators who oversee the site clean-up program.

The amount of the financial assurance is determined by environmental regulators based upon closure cost projections and modeling. Deciding how much money must be available is often very controversial. There is also an increasing focus on post-closure monitoring and maintenance obligations. Cost projections for these sorts of very long term liabilities are notoriously difficult to develop. Despite increasing efforts from the Environmental Protection Agency’s (EPA) Environmental Financial Advisory Board, and similar bodies, state agencies often have conflicting policies and informal guidance concerning estimating financial assurance amounts.

There has been a growing perception among certain environmental groups and government watch dogs, that regulated entities are not adequately prepared to fund their future obligations. Widely publicized bankruptcies, like the Chapter 11 filing of the mining company ASARCO, LLC -- which reportedly faced responsibility at more than 90 Superfund sites and total environmental liabilities of more than $1 billion -- are often cited as evidence of the need for greater action on financial assurance. The financial crisis has heightened these concerns. Several states have issued advisories warming of increased emphasis on financial assurance. Over the past year, New Jersey has clearly stepped up its efforts to monitor and, when necessary, take enforcement action.

Conversely, the regulated community has pointed out that in present circumstances, conservative financial assurance policies, especially rules that limit the use of self-assurance, can drive an AAA-rated company to purchase “protection” from a BBB-rated financial institution. Other commentators have noted that during a liquidity crisis it might not be prudent to adopt a belt and suspenders approach to financial assurance. Finally, financial assurance requirements can be a disincentive to settlements at complex multi-party clean-up sites, especially where each of the parties has a relatively small share of liability and therefore little or no incentive to guarantee the entire clean-up.

To add further confusion to the issue of financial assurance, in late February a federal district court ordered EPA to identify priority industries that will be subject to new financial assurance requirements under the Superfund program. Companies that may be affected by these new Superfund financial assurance requirements may want to carefully monitor these developments and participate in the formal rule-making.

As a result of the current climate, regulated entities can expect greater scrutiny of the entire financial assurance process. This extra scrutiny will start with a reassessment of the technical estimates used to support the amount of the financial assurance. Cost projections concerning long term monitoring and maintenance, discounting based upon net present value analysis and emerging technologies are likely to cause friction between regulators and responsible parties. Additional attention will almost certainly be paid to the self-assurance/self guarantee requirements as well as the auditors’ statements that support them. The lax approach to the timing of renewals -- that has been common in the past -- is being increasingly replaced with strict enforcement of deadlines. Moreover, environmental regulators are likely to be far more rigorous about insisting that the language of financial instruments used to satisfy these requirements strictly conform with applicable rules, guidelines and model documents.

Thus, entities with financial assurance obligations may want to undertake a critical self-assessment of their current financial assurance programs. At a minimum they will want to ensure that defensible cost estimates for all future environmental obligations are readily available. Most companies will also benefit by carefully tracking costs expended on site remediation and then promptly petitioning regulators to reduce the amount of the financial assurance and thereby minimize double counting. In addition, regulated entities will want to ensure that they start the renewal process early -- especially if they intend to rely upon a letter or line of credit issued by a commercial bank or an insurance policy. Planning and vigilance may help avoid needless costs and enforcement activity.

Should you have any questions regarding your own situation, please contact Edward F. McTiernan of our Real Property & Environmental Department or your Gibbons attorney in our Corporate Department.