Avoiding a Financial Fiasco

THE WASHINGTON-BASED U.S. Environmental Protection Agency (EPA) has announced that enforcement of financial assurance requirements will be a new national priority. This development should cause regulated companies to self-audit their compliance with financial assurance requirements. Among other things, waste companies should determine whether they have enough coverage and whether their third-party providers are financially stable.

EPA has shown growing interest in financial assurance issues during the past several years, and its Environmental Financial Advisory Board has been actively examining the issue. Recommendations for regulatory changes may emerge from this process. In the meantime, companies can expect greater enforcement of existing requirements.

Undoubtedly, regulators are intensifying their focus on financial assurance issues because of developments in the field. For example, in the next few years, some facilities closed in the past will be nearing the end of the 30-year period for which closure and post-closure costs were calculated. What then? The contamination may still exist, but the financial assurance coverage will have been calculated on the assumption that costs would extend for only 30 years. If the owner/operator disappears from the scene at that point, the financial assurance designed as a backstop may be inadequate to ensure continued care. Regulators are concerned about this.

Versions of financial assurance have been part of U.S. law for many years, and the specific rules can vary by statute — or even within statute — depending on the type of facility being covered. However, the Resource Conservation and Recovery Act's (RCRA) requirements for hazardous waste facilities are illustrative of some key issues.

Under Subtitle C, EPA — and through authorization, the states — must condition operation of hazardous waste facilities upon the owner's or operator's demonstration of financial ability to fund the ultimate closure of the facility and post-closure care. EPA's rules for RCRA-permitted facilities allow the owner or operator to establish financial assurance by selecting from several options — trust fund, surety bond guaranteeing payment into trust fund, surety bond guaranteeing performance of closure and/or post-closure care, letter of credit, insurance (or some combination of these) or corporate guarantee.

Generally, the corporate guarantee is the least expensive option. However, many owners/operators cannot satisfy the applicable financial tests. At the other end of the cost spectrum is the trust fund option, in which the company must fund a pot of money that eventually grows, through annual contributions, to the same size as the closure and post-closure obligations. In the first part of a facility's life, this option might be economically attractive, because the annual payments are a fraction of the total closure/post-closure obligations. However, as time passes and more and more cash is tied up in the trust, this option gets increasingly expensive.

The letter of credit option, which would be one alternative to these choices, requires an instrument in the full amount of the closure and/or post-closure obligation, and it may be undesirable for a company to tie up its credit line in this manner. Thus, many of the owners/operators that cannot comply with the law using a corporate guarantee opt for insurance policies or surety bonds, if these instruments can be obtained in today's tight markets.

The surety company must be among those listed as acceptable sureties on Federal bonds in Circular 570 of the U.S. Department of the Treasury. By contrast, an insurance company only need to be licensed to do business in the state where the policy is issued. It is possible to be licensed to do business, but not listed on Treasury Circular 570, so theoretically the insurance option could allow a weaker provider to write insurance coverage, but not surety bond coverage.

Failure to have adequate financial assurance constitutes a permit violation, which could be punished with civil or criminal penalties, depending on the circumstances. In addition, the permit could be revoked or suspended.

In anticipation of more active EPA enforcement regarding financial assurance, there are several steps a regulated company can take:

First, a company should ensure that its closure and post-closure estimates are current and that they bear some semblance to reality. Even when a current estimate has been calculated according to law, if it is obviously unrealistic, it will be a red flag for regulators and they may withhold or delay approval of other requested actions to effectively force the company into increasing the estimate.

Second, a company should make certain that coverage instruments are up to date and that coverage is in place for the amount required in the closure and post-closure estimates. Failing to keep coverage amounts current is a violation that may now draw greater scrutiny than in the past.

Third, where third parties, such as insurance or bond companies, provide coverage, an owner/operator should re-assess the financial strength of those providers. If the provider collapses, the company will have a very limited time in a tight market to find replacement coverage.

Fourth, depending upon the circumstances, it may be wise to spread the coverage among several providers, rather than putting all of one's eggs in a single basket. The importance of developing relationships with potential alternative providers is related to this. If it becomes important to move quickly to replace coverage, it is better to do so with friends than strangers.

Fifth, when a company discovers that it is violating financial assurance requirements, or has done so in the recent past, consideration must be given to voluntary disclosure of these facts to EPA. Penalties can be reduced if a company self-reports.

Finally, engage with regulators in the rulemaking process discussed at the outset of this article. Important changes may be coming to the world of financial assurance. Affected companies should not miss the opportunity to provide their valuable input to EPA.

Jeffrey Bromme
Environmental Practice Group
Arnold & Porter LLP