Financial responsibility for environmental obligations: Are bonding and assurance rules fulfilling their promise?
| DOI | https://doi.org/10.1016/S0193-5895(02)20021-4 |
| Published date | 15 August 2002 |
| Date | 15 August 2002 |
| Pages | 417-485 |
| Author | James Boyd |
FINANCIAL RESPONSIBILITY FOR
ENVIRONMENTAL O B LI GATI O N S:
ARE BONDING AND ASSURANCE
RULES FULFILLING THEIR PROMISE?
James Boyd
ABSTRACT
Financial assurance rules, also known as financial responsibility or
bonding requirements, foster cost internalization by requiring potential
polluters to demonstrate the financial resources necessary to
compensate for environmental damage that may arise in the future.
Accordingly, assurance is an important complement to liability rules,
restoration obligations, and other regulatory compliance requirements.
The paper reviews the need for assurance, given the prevalence of
abandoned environmental obligations, and assesses the implementation
of assurance rules in the United States. From the standpoint of both
legal effectiveness and economic efficiency, assurance rules can be
improved. On the whole, however, cost recovery, deterrence, and
enforcement are significantly improved by the presence of existing
assurance regulations.
An lntroduct/on to the Law and Economics of Environmental Policy: Issues in Institutional
Design, Volume 20, pages 417-485.
Copyright © 2002 by Elsevier Science Ltd.
All riots of reproduction in any form reserved.
ISBN: 0-7623-0888-5
417
418 JAMES BOYD
1. INTRODUCTION
A bedrock principle of environmental law and regulation is that pollution costs
should be borne by their creators. U.S. environmental laws and regulations
give this principle form by making polluters liable for property, health, and
natural resource damages and unperformed resource reclamation obligations.
Unfortunately, many environmental obligations, despite being well defined in
theory and in law, are not always met in practice. Bankruptcy, corporate
dissolution, and outfight abandonment are a disturbingly common means by
which polluters avoid responsibility for environmental costs)
Financial assurance rules, also known as financial responsibility or bonding
requirements, address this policy problem. Assurance rules require potential
polluters to demonstrate - before the fact - financial resources adequate to
correct and compensate for environmental damage that may arise in the future.
Accordingly, assurance acts as an important complement to liability rules,
restoration obligations, and other compliance requirements. 2 A benefit of
assurance rules is that they can harness the expertise and scrutiny of private,
third-party financial providers. The insurers, sureties, and banks who
provide the financial products used to demonstrate compliance, for their own
commercial reasons, train an extra, self-interested set of eyes on the financial
and environmental risks posed by potential polluters. In this way, assurance
rules can yield a flexible, market-based approach to compliance and monitoring.
Financial assurance is demanded of a wide variety of U.S. commercial
operations, including municipal landfills, ships carrying oil or hazardous cargo,
hazardous waste treatment facilities, offshore oil and gas installations,
underground gas tanks, wells, nuclear power stations, and mines. Firms needing
assurance can purchase it in the form of insurance, surety obligations, bank
letters of credit, and deposit certificates. Alternatively, firms can establish trust
funds or escrow accounts dedicated to future obligations. Most programs allow
wealthy and financially stable firms to comply via demonstration of an adequate
domestic asset base and high-quality bond rating. A wealthy financial parent
can in some cases guarantee the obligations of a subsidiary or affiliate via an
indemnity agreement.
This study provides an overview of financial assurance policies based on a
review of the rules' implementation in the U.S. Relatively little analysis of the
rules' practical implementation exists. 3 The goal is not an exhaustive review of
specific regulatory programs, but rather a synthetic overview of the many issues
common to environmental assurance programs. From the standpoint of both
economic efficiency and legal effectiveness assurance rules can be improved.
Assurance programs raise a set of design issues, including the level of
Financial Responsibility for Environmental Obligations 419
assurance to be required, the financial mechanisms to be allowed, the
conditions under which bonds are released, and the interaction of assurance
rules with other areas of law; most importantly, bankruptcy law. This report
illustrates those issues and identifies a set of correctable weaknesses present
in some assurance programs. For instance, in some regulatory contexts
inappropriately low levels of assurance are required; in others, the mechanisms
used to demonstrate responsibility undermine the goal of cost internalization.
Despite a set of criticisms regarding the details of policy, this report
should be read as a spirited defense of financial assurance's desirability as a
regulatory tool. Absent assurance, too many finns can and do abandon
obligations. As will be evident from the cases and data cited in this report, the
evasion of environmental liabilities and cost internalization by defunct or
insolvent firms is relatively common. On average, 60,000 U.S. finns declare
bankruptcy each year and an untold number cease or abandon operations without
even entering legal bankruptcy proceedings. 4 Clearly, not all of these firms leave
unfunded environmental obligations behind them; but many do. Mandatory
assurance addresses the insolvency problem in a direct way, and thereby
strengthens the effectiveness of environmental regulation and law.
1.1. The Underlying Problem - Unperformed Obligations and
Non-Recoverable Liabilities
Conceptually, polluter cost internalization is nearly unassailable as a guiding
principle for environmental regulation. Cost internalization by responsible
parties yields the most equitable means of victim compensation, the alterna-
fives being no compensation or compensation provided by public funds. Polluter
cost internalization also promotes deterrence, risk reduction, and innovations to
reduce environmental harm. 5 Accordingly, with few exceptions, most U.S.
environmental laws make polluters liable for damages caused by commercial
activities that injure the public health or that cause property or natural resource
damage.
Unfortunately, cost internalization's importance in law and regulation is not
always matched by its achievement in practice. Even the most unassailable legal
obligation can quickly evaporate when presented to a bankrupt, dissolved, or
absent polluter. Consider first the implications of bankruptcy. Generally
speaking, debtors are protected from creditors by the "automatic stay"
provision of the U.S. bankruptcy code. 6 This means that both private and public
environmental claims can be discharged in bankruptcy. 7 In other words,
environmental costs are only partially recoverable once bankruptcy occurs, if
they are recoverable at all. 8 To compound the problem, firms may purposefully
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