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April 27, 2020

Environmental Financial Assurance After COVID-19

Coronavirus: Environmental Advisory
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Introduction

Financial assurance (FA) requirements are a common feature of many environmental programs. Parties remediating contaminated sites, or engaging in certain operations involving hazardous substances, must often demonstrate that they have the long-term resources and short-term cash flow to meet their obligations. While FA requirements can sometimes be satisfied by a showing that the obligated party or parties, or their affiliates, have the financial strength to guaranty the obligations themselves, often third-party instruments like bonds or letters of credit are required. Federal and state regulators impose these financial assurance requirements to ensure that, if potentially responsible parties (PRPs) or site owner/operators become unwilling or unable to perform, private funds are readily available for environmental regulators to complete any required remediation. The goal is to preserve public resources for sites and remediation projects where there are no viable private parties. FA obligations have been the subject of much comment and concern, especially from PRPs who see the additional costs of satisfying such requirements as unnecessary expenses in an already cumbersome and expensive remedial system.

As a result of the financial fallout from the COVID-19 pandemic, PRPs and owner/operators may find it increasingly difficult to satisfy their FA obligations. PRPs and owner/operators who have "self-guaranteed" their FA obligations based upon their balance sheets are likely to feel these impacts first. However, any entity with a significant FA obligation may want to reassess its options in the post-COVID economy. In this Advisory, we review several of the major programs that impose FA requirements, discuss options for satisfying these obligations, and provide some practical suggestions for what PRPs and owner/operators should do to respond to the COVID-19 crisis.

Federal FA Requirements

Resource Conservation and Recovery Act (RCRA)

RCRA and its implementing regulations establish minimum national standards for the management of hazardous waste; those standards apply to facilities that treat, store, or dispose of hazardous waste (TSDFs). An owner or operator of a TSDF must demonstrate that it has sufficient financial resources to properly close the TSDF when the facility's operational life is over and to provide for long-term, post-closure care.1 In addition to post-closure FA requirements, an owner/operator must also maintain accident liability coverage during the active life of its TSDF.

RCRA's FA requirements are the inspiration for most other federal and state FA programs. To satisfy RCRA's FA requirements, an owner or operator must prepare a closure cost estimate that includes the expenses for ceasing operation at the TSDF, safely closing the facility, cleaning up any remaining contamination, and maintaining the facility for a period of time once it is closed. Closure and post-closure estimates must be adjusted throughout the operational life of the TSDF. Once the regulators approve the closure and post-closure cost estimate, the owner/operator must demonstrate that it meets FA requirements using one of the mechanisms detailed in RCRA's implementing regulations. The options are: (i) establishing a trust fund earmarked for TSDF closure; (ii) procuring a surety bond guaranteeing that all closure requirements will be fulfilled; (iii) obtaining a letter of credit in favor of EPA or state authorities from an authorized institution; (iv) purchasing an insurance policy for a face value amount that is at least equal to the closure cost estimate, or (v) obtaining a written guarantee from another company. Alternatively, an owner/operator with a tangible net worth greater than $10 million may meet RCRA's FA requirements by satisfying one of RCRA's two financial self-guarantee tests.2

Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA)

In connection with consent decrees, administrative orders on consent, and unilateral administrative orders for remedial investigation and remedial activities under CERCLA, EPA generally requires PRPs to establish FA. Acceptable FA mechanisms for CERCLA purposes closely track RCRA requirements and include surety bonds, irrevocable letters of credit, trust funds, insurance policies, or a form of self-insurance in which the PRP demonstrates that it (or a corporate parent issuing a guarantee) meets certain financial test criteria.3 EPA requires PRPs to provide notice if the responsible party is no longer compliant with FA requirements, and to establish alternative financial assurance mechanisms if existing mechanisms fail. Failure to comply with FA requirements may trigger stipulated penalties.

The Superfund Task Force established by the EPA at the beginning of the Trump administration evaluated whether to reduce the financial burdens on cooperating PRPs by adjusting FA required under CERCLA enforcement documents, while ensuring that private resources are available to complete cleanups. Although the Task Force recognized that providing flexibility to PRPs could contribute to timely settlements and accelerate cleanups, the Task Force declined to recommend a generic approach, and concluded that any flexibility in FA mechanisms should be addressed in the context of site specific circumstances and considerations identified in the EPA's 2015 CERCLA Guidance on FA.

State FA Requirements—The New Jersey Program

New Jersey has a long industrial legacy and an aggressive site remediation program directed by the New Jersey Department of Environmental Protection (NJDEP). NJDEP has established detailed requirements governing all aspects of the remediation process, including how to ensure that responsible parties fund remediation. With limited exceptions, parties who are responsible for investigating and remediating contamination in the Garden State must establish and maintain a Remediation Funding Source (RFS) to ensure that funds are available should they fail to perform an adequate site investigation or construction of the remedy.4 The RFS must cover all costs expected to be incurred while conducting the remediation, including NJDEP fees and oversight costs as well as estimated costs to operate, maintain and inspect any long-term engineering controls. Under NJDEP's regulations, if the final remedial approach calls for contamination to remain in place subject to institutional and engineering controls (such as impervious caps), then the RFS will "transition" into FA. FA must provide for the future costs of operation, maintenance and inspection of any engineering control. There are differences between RFS and FA. For example, the PRP can draw upon the RFS to pay remediation costs, while FA cannot be used to fund the operation, maintenance and inspection of the engineering control.

In New Jersey, PRPs can use a letter of credit, line of credit, remediation trust fund, or environmental insurance policy to satisfy their obligation to establish an RFS or provide FA. A self-guarantee, which is often the least expensive and, therefore, the preferred alternative, can be used as an RFS but not as long-term FA.

The Practical Realities of FA

During economic downturns, questions and concerns about the ability of regulated entities to meet remedial obligations are inevitable. For parties that satisfy FA through self-guarantee financial test criteria, balance sheet stresses may threaten their continued ability to meet these requirements. EPA and nongovernmental environmental organizations monitor the market for news of stressed financial institutions, and RCRA owner/operators and CERCLA PRPs should be prepared to address questions as they arise. If balance sheets deteriorate so that the financial tests for a self-guarantee are no longer met, regulated entities may need to purchase a third-party instrument, which at the very least can be expensive and could become increasingly difficult to obtain from financial institutions that may be stressed themselves and worried about extending credit to an entity perceived by the government to pose a risk of nonpayment. If third-party instruments are not available, a cash trust fund would be required, which could present further logistical challenges when cash and credit are tight.

Where PRPs or owner operators of RCRA facilities are at risk of default under a remedial order or otherwise unable to perform, EPA may exercise the right to take over the work and access the FA in order to protect taxpayers from bearing the cost. Although work takeovers are relatively rare (and when they do occur, it is often in the context of a bankruptcy proceeding), EPA work takeovers will increase costs and will not protect respondents from additional cost recovery efforts or penalties under applicable order provisions.

Recommendations

Although EPA has issued a number of enforcement guidance documents which provide flexibility to those facing COVID-19 related challenges, it has not addressed the impacts of the pandemic on FA requirements. Given the extraordinary circumstances responsible parties may face due to the immediate economic downturn, EPA and state regulators might agree to more flexible project schedules and compliance financial tests, especially if it appears that the crisis will pass and more stable economic conditions will return quickly. However, these same regulators may also find themselves under pressure to preserve the limited public funds available for environmental cleanup, especially in a prolonged downturn. At present, it appears that most decisions on FA are likely to be made on a case-by-case basis. Therefore, regulated entities should anticipate and plan for challenges that arise in this space. To prepare for such a discussion, any regulated entity with significant FA obligations should consider developing an action plan which includes at least some of the following:

  • an analysis of all sources of financial assurance obligations, including federal and state regulatory requirements, as well as those arising from settlement agreements, consent decrees, and orders with environmental regulators;
  • a critical review of cleanup cost estimates to ensure that they reflect all work performed and any changes in applicable cleanup requirements, as well as allowable means and methods for conducting any remaining remediation tasks;
  • assembling and reviewing all existing FA instruments, including letters of credit and insurance policies to identify renewal requirements and timing considerations;
  • an evaluation of whether changing balance sheets will satisfy financial tests for self-guarantees, and consideration of replacement options while the self-guarantee is in place, rather than while under pressure to obtain new FA once the tests have failed;
  • where financial assurance is established through an insurance policy or surety bond developing a plan to monitor the solvency of the surety or insurer;
  • pricing all options for new/replacement FA mechanisms, and
  • developing all arguments and options to mitigate the risk of a work takeover, including the negotiation of schedules for restoring financial assurance compliance.

If COVID-19 related events render it unreasonably cost-prohibitive to comply with FA requirements, PRPs and site owner/operators may need to seek relief from regulators. Regulated entities that proactively develop reasonable proposals before they, or the financial institutions that they rely upon, are in default are likely to be at a considerable advantage when attempting to negotiate more favorable FA terms with EPA or state regulators.

© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.

  1. See 40 C.F.R. § 264.143 (addressing FA for closure).

  2. RCRA’s self-guarantee tests are detailed in 40 C.F.R. § 264.143(e)–(f). Basically, the owner/operator (or its corporate parent guarantor) must demonstrate that it meets specific ratio tests comparing its liabilities to net worth, income and/or assets; that it has net working capital and tangible net worth each at least six times the total estimated cost of the remedial work in addition to other remedial obligations; it has tangible net worth of at least $10 million; and it has assets located in the United States amounting to at least 90 percent of total assets or at least six times the total estimated cost of the remedial work in addition to other remedial obligations.

  3. While the financial test criteria may avoid third-party fees, the financial test criteria must be evaluated annually and may generate additional agency supervision and oversight costs.

  4. See generally 7:26C-5.

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