VALUING POTENTIAL ENVIRONMENTAL
LIABILITIES FOR MANAGERIAL DECISION-MAKING

3. Environmental Liabilities: Definitions and Categories

The term "environmental liabilities" crops up in many discussions of environmental issues. Yet there is much confusion about the term. Often, "environmental liabilities" is used to refer to the potential for fines, penalties, and jail terms for violations of environmental laws. "Environmental liabilities" also frequently serves as short-hand to refer to the clean-up obligations under the federal Superfund and state counterpart laws for contaminated sites. Another common usage is to label the costs involved in complying with regulations as "environmental liabilities." In contrast, when companies perform or commission "environmental liability" assessments, they want to know their exposure to potential environmental liabilities even when they are in complete compliance with regulatory standards.

Clearly, "environmental liability" is an umbrella term. The following pages present a brief definition of the term and describe the major types of environmental liabilities in order to establish a framework for reviewing approaches and tools identified for expressing these liabilities in monetary terms. For readers who would like more information about the timing, likelihood, and uncertainty characteristics of the various forms of environmental liabilities, more information on these subjects is provided in Appendix A.  

3.1 Defining Environmental Liability

The term liability has important accounting and legal dimensions. Accounting institutions define liability as a Aprobable future sacrifice of economic benefits arising from present obligations to transfer assets or provide services in the future as a result of past transactions or events." More simply, a liability is a present obligation to make an expenditure or to provide a product or service in the future.

Liability has an important legal dimension as well. A liability is a legally enforceable obligation, whether it is voluntarily entered into as a contractual obligation, or is imposed unilaterally, such as the liability to pay taxes. The law both establishes liabilities and determines who is responsible for discharging them.

For the purposes of this document, an environmental liability is a legal obligation to make a future expenditure due to the past or ongoing manufacture, use, release, or threatened release of a particular substance, or other activities that adversely affect the environment. A potential environmental liability is a potential legal obligation to make a future expenditure due to the ongoing or future manufacture, use, release, or threatened release of a particular substance, or other activities that adversely affect the environment. An obligation is potential when it depends on future events or when a law or regulation creating the liability is not yet in effect. A "potential environmental liability" differs from an "environmental liability" because an organization has an opportunity to prevent the liability from occurring by altering its own practices or adopting new practices in order to avoid or reduce adverse environmental impact.

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3.2 Types of Environmental Liabilities

Environmental liabilities arise from a variety of sources. Federal, state, and local environmental statutes, regulations, and ordinances, whether enforced by public agencies or through private citizens' suits, give rise to many types of environmental liabilities. Another legal source of these liabilities is "common law" (i.e., judge-made law) that can vary from state to state. A detailed list of environmental liabilities would be very lengthy. Thus, this report distinguishes the following broad categories of environmental liabilities:

• compliance obligations related to laws and regulations that apply to the manufacture, use, disposal, and release of chemical substances and to other activities that adversely affect the environment
• remediation obligations (existing and future) related to contaminated real
• propertyobligations to pay civil and criminal fines and penalties for statutory or regulatory non-compliance
• obligations to compensate private parties for personal injury, property damage, and economic loss
• obligations to pay "punitive damages" for grossly negligent conduct
• obligations to pay for natural resource damages

The following paragraphs elaborate on each of these types of environmental liabilities. (Readers who are well-versed in the types of environmental liabilities may want to skip the following few pages and move on to Section 4.)

Compliance obligations. As laws and regulations are enacted that apply to the manufacture, use, or release of regulated substances, companies find themselves facing future compliance costs. In evaluating business plans, some companies may also consider the possibility that new laws and regulations will be enacted. Additionally, a company may discover that it is not in compliance with existing laws and regulations. The costs of coming into compliance can range from modest outlays required to conform to administrative requirements (e.g., recordkeeping, reporting, labeling, training) to more substantial outlays, including capital costs (e.g., to pretreat wastes prior to land disposal or release to surface waters, to contain spills, to "scrub" air emissions). Laws and regulations also impose "exit costs" (e.g., to properly close waste disposal sites and provide for post-closure care, and to decommission nuclear power reactors at the end of their useful lives).

Remediation obligations are sometimes subsumed under "compliance" because some property clean-up requirements have been enacted as part of regulatory programs applicable to operating facilities under, for example, the Resource Conservation and Recovery Act (RCRA) and the Safe Drinking Water Act's Underground Injection Control program. Also, it is easy to blur the distinction between the compliance obligation of routine closure of facilities at the end of their useful lives and the remediation obligation for cleaning up pollution posing a risk to human health and the environment. And meeting current compliance obligations may help minimize future remediation obligations. Nevertheless, remediation obligations are considered a separate category in this document because of some distinguishing characteristics of the liability and the attention that has been paid to this category of environmental liability. Remediation tends to be expensive, ranging up to many millions of dollars, and can include excavation, drilling, construction, pumping, soil and water treatment, and monitoring, and can include the response costs incurred by regulatory agencies. Remediation costs also can include the provision of alternate drinking water supplies for affected community residents, and, in some circumstances, purchase of properties and relocation expenses. Technical studies and the expenditure of management, professional, and legal resources add to the cost of remediation.

The remediation obligation is distinctive because a company may face remediation obligations due to contamination at inactive sites that are otherwise unregulated; at property formerly but not currently owned or used; at property it never owned or used, but to which its wastes were sent; and, at property it acquired but did not contaminate (e.g., in "Superfund liability" scenarios). Because many dollars will be needed in the near-term to remediate existing environmental contamination, particularly at inactive and abandoned sites, these liabilities often dominate (and can distort) a firm's assessment of its environmental liabilities. Therefore, it is helpful to distinguish between remediation obligations for existing contamination and potential remediation obligations for future contamination because managers can have more impact on ongoing and future activities and releases -- whether accidental or not -- that may trigger future remediation obligations.

Fines and penalties. Companies that are not in compliance with applicable requirements may be subject to civil or criminal fines or penalties for noncompliance and/or expenses for projects agreed to as part of a settlement for noncompliance. Such payments fulfill punitive and deterrent functions and are in addition to the costs of coming into compliance. Fines and penalties (and related outlays for supplemental environmental projects) can range from modest amounts to a few million dollars per violation. Generally, a civil penalty is assessed that is at least equal to the costs a company saved through noncompliance, thus removing any financial incentive to ignore a law. Other factors may add to or reduce the penalty amount assessed for a violation.

Compensation obligations. Under common law and some state and federal statutes, companies may be obligated to pay for compensation of "damages" suffered by individuals, their property, and businesses due to use or release of toxic substances or other pollutants. These liabilities may occur even if a company is in compliance with all applicable environmental standards.

Distinct subcategories of compensation liability include personal injury (e.g., "wrongful death," bodily injury, medical monitoring, pain and suffering), property damage (e.g., diminished value of real estate, buildings, or automobiles; loss of crops), and economic loss (e.g., lost profits, cost of renting substitute premises or equipment). Compensation costs can be fairly minor or quite substantial, depending on the number of claimants and the nature of their claims. Oftentimes, legal defense costs (potentially including technical, scientific, economic, and medical studies) can be substantial in handling such claims, even when the claims are ultimately determined to be without merit. Moreover, responding to compensation claims can consume management time and require expenditures in order to control damage to corporate image. Compensation liabilities may involve costs for remediation of contaminated property as well as provision of alternate water supplies, thus somewhat overlapping the remediation category.

Because of workers' compensation and employer liability laws, payments to compensate employees for occupational exposure and injury from hazardous or toxic substances are not generally determined through litigation against the employer or considered environmental liabilities. However, occupational claims sometimes may be brought against another party who is not the employer; for example, workers responding to a train wreck have sued the shipper of hazardous wastes released at the scene of the wreck; for the shipper, these claims can be viewed as environmental liabilities. Managers will want to understand the potential costs of occupational exposure and injuries, because actions taken to prevent or reduce environmental liabilities may also eliminate or reduce occupational liabilities.

Punitive Damages. To supplement compensatory payments to those harmed by the actions of others, the law allows the imposition of what are called "punitive damages" to punish and deter conduct viewed as showing a callous disregard for others. Unlike compensatory liability, the measure of punitive damages is not directly tied to the actual injuries sustained. Punitive damages are often many times larger than the costs of compensation; although rarely assessed, punitive damages in environmental litigation usually exceed $1 million. Punitive damages tend to be more common in product liability than environmental liability cases; the most notable recent imposition of punitive damages in the environmental context arose from the Exxon Valdez spill.

Natural resource damages. A relatively new category of environmental liability is best termed "natural resource damages." Established by state and federal statutes, notably Section 311 of the Clean Water Act, Section 107 of the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA or "Superfund"), and Section 1006 of the Oil Pollution Act (OPA), this liability generally relates to injury, destruction, loss, or loss of use of natural resources that do not constitute private property. Rather, the resources must belong to or be controlled by federal, state, local, foreign, or tribal governments. Such resources include flora, fauna, land, air, and water resources. The liability can arise from accidental releases (e.g., during transport) as well as lawful releases to air, water, and soil. To date, most natural resource damage payments have been relatively small.