Law and the Environment

More CFOs Taking on Responsibility for Managing Non-Financial Risk

A report published by IBM Business Services entitled "Thinking Through Uncertainty:  CFOs Scrutinized Non-Financial Risk," a trend is identified showing that CFOs are taking on more and more responsibility to evaluate company non-financial risk.

The report concludes as follows:

"At the large U.S. companies interviewed for this research, the traditional wall between financial and non-financial risk is breaking down. These companies have begun to take a broader view of risk, and are creating an ongoing, unified internal discourse about all forms of risk, both financial and non-financial.

In the process, the finance function is often tasked with finding new ways to assess the impact of events in non-financial areas on business performance. The finance function typically has the best resources with which to view and assess the entire company, and so is naturally positioned to orchestrate if not lead these enterprise-wide efforts. CFOs are adding risk assessment and management responsibilities to their already expanding portfolio of strategic tools they contribute to successful business performance."

As environmental risk management and environmental disclosure converge as related risks companies must address, the CFO may become increasingly involved in managing or evaluating environmental risks companies face and, thus, may have a better understanding of the need to account more completely for and disclose environmental risks and liabilities.  Climate change risks and potential disclosure obligations raise complex risk issues CFOs may be required to manage.

Supreme Court Ruling on Greenhouse Gas Regulation Could Have Direct Impact on D&O and Environmental Insurance

After the ruling in Massachusetts v. EPA, corporate officers and directors may be reviewing their corporate strategy on addressing their greenhouse gas emissions and how the case may affect their companies.  In making these decisions, the issue of coverage of potential shareholder claims in any future litigation against the directors and officers and their companies raises a currently much discussed issue--Would any shareholder suits based on climate change and the effect on share prices be covered by director and officer insurance policies?    For further reading you may want to refer to David White's blog on Law and Insurance.

Seminar Addresses Environmental Compliance and Financial Disclosure: Managing Internal Controls and Information Flow

Thompson & Knight LLP, Kestrel Management Services, and Frank Crystal & Company jointly sponsored a seminar on Wednesday, February 7, 2007 "Environmental Compliance and Financial Disclosure: Managing Internal Controls and Information Flow."  The seminar addressed the challenges of managing both environmental regulatory compliance and environmental financial disclosure obligations.

Companies today face the challenge of increasing their return on investment while complying with an ever-changing framework of laws and regulations, including rules governing financial disclosure and environmental, health and safety issues. In many cases, companies now must estimate financial liabilities that, until a few years ago, were not subject to accounting scrutiny. In addition, many companies are not completely familiar with these new reporting and disclosure requirements, and management and director knowledge may be even more limited. 

With recent cases ruling that officers and directors are not covered for shareholder claims arising from failure to disclose environmental liabilities, the need for director understanding and involvement in financial disclosure is imperative. In response to these challenges, some companies are spending significant resources developing appropriate internal controls relating to environmental disclosure. Often however, these procedures are developed independent of any operational management system and are lacking a basis for continual performance improvement. Instead, compliance activities become  a reactive process driven by auditors. The result is often inefficient non-value added activities and unreliable compliance.

Other companies have failed to adopt any but the most rudimentary processes for addressing environmental disclosure. This program will provide a practical approach to developing a corporate understanding and strategy for sustainable compliance with environmental financial disclosure requirements. Ways of identifying opportunities will be discussed for developing both risk management strategies and extracting business value from these compliance initiatives.

The lineup of speakers was as follows:

Environmental Financial Disclosure after FIN 47 and Sarbanes-Oxley

- Scott Deatherage, Thompson & Knight LLP

Operationalizing Internal Controls – from Project to Process

- Tom Kunes, Kestrel Management Services

Operational Sustainability and Performance Improvement

- Paul Cattermole, Kestrel Management

Services

Officer and Director Roles and Responsibilities: The Need for

Corporate Environmental Disclosure Policy and Strategy

- Scott Deatherage, Thompson & Knight LLP

Risk Management Strategies

- Dan Persha, Frank Crystal & Company

The presentations are available for downloading at If you have any questions regarding these materials, please send me an email and I will contact you.

http://www.tklaw.com/resources/documents/Environmental%20Compliance%20Seminar%202007%20Handout.pdf

Directors and Officers May Face Uninsured Liability for Failure to Disclose Environmental Liabilities

Officers and directors face a variety of risks of incurring personal liability. The large number of shareholder suits that are filed every year alleging failure of the officers and directors to disclose properly the financial condition of their companies coupled with the increased stringency of financial disclosure requirements imposed by the Sarbanes-Oxley Act, creates a heightened level of concern for officers and directors who oversee financial disclosure. To address these risks, companies typically purchase insurance policies (D & O policies), which generally contain exclusions for claims based on environmental matters. The scope of these exclusions, specifically the extent to which these exclusions can be read to address shareholder claims for alleged failure to disclose potential environmental risks and liabilities of the company to shareholders, is an increasingly important issue for directors and officers and their companies.

This question was the subject of recent opinions by the federal Fifth and Sixth Circuit Courts of Appeal.  Although the two courts arguably reached differing conclusions as to whether environmentally-related exclusions apply to shareholder claims, read together against the backdrop of the state laws that each court applied and the specific language of two different exclusions involved in each case, the two opinions might provide a preliminary road map for evaluating these types of coverage issues. The Sixth Circuit, applying Ohio law, held that an asbestos exclusion was not clear enough to exclude claims based on financial disclosure of  company liability for asbestos claims. The court reasoned that the asbestos issues were too removed causally from the alleged financial misrepresentation. The Fifth Circuit applied Texas law and held that a broad pollution exclusion did not cover the alleged failure of the officers and directors to disclose potential environmental liabilities known to the officers and directors.

The apparent divergence in the opinions resulted in part from the differences in the language used in each exclusion. The pollution exclusion construed by the Fifth Circuit used terms such as “directly or indirectly” and specifically referred to claims alleging damages to the company or its securities holders. The asbestos exclusion, construed by the Sixth Circuit, did not. The Sixth Circuit opinion may suggest some protection may be afforded under  D & O policies for suits alleging improper disclosure regarding asbestos litigation under the wording of the particular policy. The Fifth Circuit case illustrates a risk to officers and directors and their companies that they may not be effectively insured from liability under D & O policies from shareholder litigation alleging improper or insufficient environmental disclosure.

In the Sixth Circuit case, Owens Corning v. National Union Fire Insurance Co. of Pittsburgh, PA., No. 97-3367, 1998 WL 774109 (6th Cir. Oct. 13, 1998), the court concluded that the asbestos exclusion in the D & O policy obtained to protect the officers and directors of Owens-Corning and the company itself did not exclude coverage for shareholder derivative claims for  misrepresentation of or failure to disclose the potential liability of the company for asbestos-related claims. The underlying claim in the Owens Corning case involved shareholder assertions that the officers and directors failed to disclose adequately and misrepresented the potential liability of the company for asbestos litigation. The alleged misrepresentations focused on notes in the financial statement on contingent asbestos litigation liabilities. The class action lawsuit was

settled for almost $10,000,000. Id. at *2.

The court’s analysis focused on whether the exclusion, which clearly excluded claims for

liabilities directly caused by asbestos exposure, was broad enough also to preclude claims for misrepresentation of or failure to disclose the liability for those claims. The district court had ruled that the claims relating to financial disclosure of asbestos liability were excluded from coverage under the National Union D & O policy.

The Sixth Circuit did not agree. The court analyzed the exclusion under Ohio law, which

the court held provided for a narrow construction of insurance policy exclusions. The court interpreted Ohio law to require that the exclusion be “specific, clear, and exact.” This turned out to be a very strict test, as applied by the Sixth Circuit. The critical question was whether the claims for inaccurate financial disclosure of asbestos liability were “based upon, arising out of, or related to” asbestos, use of asbestos or asbestos products liability claims. Id. at *4.

The court’s opinion defined these three terms. First, the court concluded that the class action suit was not “based upon” the use of asbestos or any product liability issue, but was a claim regarding financial disclosure. Id. Second, as for “arising out of” products liability for asbestos products, the court reviewed Ohio law and concluded that there must be a direct causal relationship between the initial event and the damages claimed. In the context of a claim based on financial disclosure, the court determined that the asbestos use or injury were too distant from the alleged wrongdoing for the financial disclosure claim to be deemed to arise out of the asbestos activity of the company. The court ruled that it was the misrepresentations–and not the asbestos products–that were the cause of the harm the plaintiffs alleged. Id. at *4-5. Third and finally, the court ruled that the claims did not “relate to” asbestos matters.

Since the business of Owens Corning primarily involved asbestos, if all shareholder derivative claims related to asbestos were excluded, the court reasoned then that the policy would effectively exclude all shareholder claims. The court believed this result would be inconsistent with the intent of the policy. Id. at *5.

In National Union Fire Insurance Co. Pittsburgh, P.A. v. U.S. Liquids, Inc, 2004 U.S.

App. LEXIS 2694 (5th Cir. Feb. 17, 2004), the Fifth Circuit ruled that a director and officer insurance policy effectively excluded claims filed by shareholders against directors and officers alleging they failed to disclose environmental liabilities in filings with the Securities and Exchange Commission and in press releases.  In this case, the company and its directors and officers sought to reverse a declaratory judgment issued by the federal district court that the pollution exclusion in the company’s D & O insurance policy excluded any claims filed by shareholders against the directors and officers alleging that the stock price of the company had fallen when previously undisclosed environmental liabilities of the company became known to the public.

In the underlying lawsuits, the plaintiff shareholders alleged U.S. Liquids had acquired other waste management businesses without regard to their environmental liabilities and without disclosing the environmental practices or liabilities of these companies to shareholders. Id. at *3-4. An FBI investigation of operations of one of the acquired companies discovered what the government alleged was the knowing discharge of hazardous wastes into a city sewage system and the knowing illegal transport and disposal of hazardous waste. This investigation led to an expensive cleanup and the closure of one of the acquired company’s waste management facilities. Id. at *5. The shareholder plaintiffs alleged the directors and officers actively concealed the illegal activities of the acquired company from the shareholders and the public. When this information became known to the public, the price per share of U.S. Liquids fell $10.75. Trading of the company’s stock was halted for six days and analysts downgraded the rating of the stock. Id.

In interpreting the pollution exclusion under Texas law, the Fifth Circuit noted that it applied to any loss in connection with a claim “alleging, arising out of, based upon, attributable to, or in any way involving, directly or indirectly” pollution matters. Id. at *2-3. The exclusion specifically stated “including but not limited to a Claim alleging damage to the Company or its securities holders.” Id. at *3. In particular, the court cited Texas case law holding that the exclusion in an insurance policy “need only bear an incidental relationship to the described conduct for the exclusion to apply.” Id. at *8. The court applied a “but for” test, and concluded that “but for” the underlying illegal activities related to pollution, there would be no shareholder claims against the officers and

directors. Id. at *17.

Taken together, the Owens Corning and U.S. Liquids cases highlight the importance to officers and directors of understanding their obligations to review and disclose environmental liabilities of the public companies they manage. Not only are companies and their officers and directors potentially exposed to claims for failure to make proper environmental disclosure, but if the D & O policies contain broadly-worded pollution exclusions, particularly in jurisdictions in which such exclusions are loosely construed, the officers and directors, and any company that is obligated to indemnify its officers and directors, may be exposed to an uninsured risk. If coverage is not included in the policy, is ambiguous, or is otherwise a concern, the company may want to consider evaluating additional insurance or endorsements to existing policies to protect the officers and directors in the event a claim is asserted relating to environmental disclosure.

Managing an Environmental Crisis: Legal Issues, Liabilities, and Managing Risk

In the course of an environmental crisis, environmen­tal legal liabilities and regulatory re­sponsibilities arise and must be man­aged to attempt to minimize the risk of financial loss to the company in crisis and to preserve any rights or opportunities that may exist to recover cleanup costs and legal defense costs. Legal counsel will play an important role in advising the company in the course of developing strategy and tactics in responding to the environmental release or spill itself and in reacting to asserted and potential legal claims by government agen­cies and private individuals and entities.

Several critical issues must be consid­ered when an environmental crisis occurs:

Prepare For a Crisis Before It Occurs. To reduce the risk in the first place of a re­lease, good management practices should be developed to reduce the chances of a spill. Of course, all regulatory requirements gov­erning spill planning and spill prevention should be met. A plan as to who you will call in terms of legal counsel, an emergency response contractor, an environmental con­sultant, and a public relations firm should all be thought through and a plan prepared so that if the crisis arises, that plan goes into effect and all in-house and outside profes­sionals are contacted and put on the job to help the company manage the emergency.

Is the Government There to Help You? The practical answer is they are probably there to force you to respond to the release or spill, or threaten to take action and charge you a lot more money than you would spend if you did it yourself. It is important to keep in mind that the regulatory requirements that will be discussed below must be com­plied with, and therefore government agen­cies will need to be convinced in the short and long-term that you are complying with emergency response regulations.

Regulatory Compliance Is a Two-Edged Sword. The regulatory requirements generally consist of requirements relating to preventing a re­lease and actions re­quired once a release occurs. Reporting of a spill is something that should be ad­dressed within the statutory or regulatory deadlines. Follow-up written reports should be carefully prepared and submitted. The timeliness and content of reporting can be used against a party in any future govern­mental and private litigation, so care should be used in terms of the nature of these re­ports. It would be appropriate to have legal counsel review the reports before submitting them to the government. Compliance with regulations may affect the ability of a com­pany to recover for costs incurred in terms of any government fund, such as the federal Oil Spill Liability Trust Fund, or private in­surance policies.

What Happens After the Spill is Re­mediated? Often gov­ernment enforcement actions and private lawsuits are filed af­ter the remediation is complete or, at times, before it is complete. Government agencies may file claims against the party who owns or operates the facil­ity from which the spill or release occurred. Civil and criminal penalties may apply under both the federal and state statutes. If parties knowingly, or in some instances, negligently, caused the release, then the individuals in­volved may be criminally prosecuted and subject to imprisonment and fines. Com­panies can be criminally prosecuted for fines and remedial actions.

Recovery of Losses. Recovery of losses can be addressed in certain circumstances through submitting claims to governmental funds or insurance companies. For releases of oil, as an example, a claim could be sub­mitted to the federal Oil Spill Liability Trust Fund. One of our clients recovered millions of dollars from this Fund.

What Statutory Liabilities Can Be In­curred? A multitude of potential liabilities may be incurred from an oil or hazardous substance spill. First, the cost of remedia­tion and cleanup may be significant. Li­ability may arise from several state and federal statutes. Under the Oil Pollution Act (OPA) for example, the costs can be ex­treme. The OPA provides that the respon­sible party, such as an owner or operator of the facility from which the release occurred, can incur two types of liability: removal costs and damages. Removal costs are es­sentially the costs of removing the oil and remediating the property and water body. Damages include, among others, those to natural resources, such as to creeks, but also, according to the government, the effect on the ecosystem, such as the loss of the use of the affected area until it is restored or grows back, real and personal property, and lost profits or earning capacity because of injury to property or natural resources. For smaller companies, the cost of responding to an oil spill and cleaning it up can force the com­pany into bankruptcy. For mid-size firms, the impact can be significant.

What Private Claims Could Be Filed? Statutory or governmental obligations are unfortunately only the beginning of poten­tial losses. Landowners are the next level of concern. Private claims may include groundwater contamination claims, polluted property, destruction of crops and trees, and loss of economic profit from land or water ways. These claims can constitute as much or more of a loss than the statutory remedia­tion and natural resource type claims.

Manage the Release and Response in the Context of Potential Governmental and Private Claims. Legal counsel should be engaged immediately to assist in tactical and strategic decisions in not only how to manage the response in the context of regu­latory compliance, but also to assist in at­tempting to reduce or manage claims from the government and private parties. Un­derstanding and meeting insurance require­ments where the claims are covered by insur­ance is critical. Reporting obligations may be immediate under some policies.

In addition, involving the insurance company representative in the process to some extent may be required under the rel­evant policy.

Insurance—A Risk Management Tool Before the Spill. Many companies are not aware of or do not take advantage of environ­mental insurance. This may be a significant oversight to manage risk by these firms. En­vironmental insurance has now been around for several years. In my experience, compa­nies have suffered losses that easily could have been reduced by developing a corporate risk management strategy that includes environ­mental insurance. I have represented pipe­line companies, exploration and production companies, and marketing companies who have suffered significant losses because the insurance they had was insufficient to cover significant claims or was purchased in the context of one transac­tion for cer­tain assets, but no review was made of the purchase of insurance to cover other assets. In other cases, the policies were not negotiated to ad­dress the risks and conditions of the com­pany or its assets; as a result, the coverage in terms of policy amounts was insufficient to cover the loss. This is more common than one might think, in part because there seems to be a lack of awareness among many companies of the need for or the availability of environmental insurance coverage, and when such insurance is purchased, parties are not aware of or lack the expertise to in­terpret or negotiate the terms of the policy to ensure adequate coverage is obtained. Only specialized insurance brokers and attorneys are typically familiar with these policy issues and are able to assist the client in securing appropriate coverage.

Contribution Actions—Who Else Can You Invite to the Party? In respond­ing to and addressing a spill or release, it is important to manage potential evidence and gather evidence as time and events al­low to preserve claims that the firm may have against other individuals or entities. A particular release may be only in part from your company’s operations or facil­ity. You would want to develop the case to collect the appropri­ate portion of the loss from the party or parties whose opera­tions or facilities also contrib­uted to the release. The release may have been caused by faulty equipment, metal, piping, or instruments. Preserving such material or equipment is key to preserving your claim against the manufac­turer or supplier of the defective material or equipment.

Marshalling the Defense. On the oth­er hand, it is important to preserve evidence and develop your defense to claims from various parties. Private parties will likely as­sert negligence claims. Demonstrating the exercise of due care requires preserving and gathering of documents and information.

Preserve Documents and Evidence in Any Event—Don’t Make the Response Worse than the Event. It is important not to make the reporting or response worse than the event. Destruction of documents, emails, electronic files, or physical evidence may make matters worse. A little known provision of the Sarbanes-Oxley Act created new criminal provisions that cover commu­nications with a government agency during a government proceeding. If a governmental civil or criminal investigation is conducted, and false information is given to the govern­ment, individuals and their employers may be prosecuted under the federal Criminal Code—remember the Arthur Andersen case. Thus, care should be taken in what statements or documents are submitted to the government to address accuracy and completeness of those statements and corre­spondence. In private litigation, spoliation of evidence can result in the judge striking pleadings, defenses, and even the so-called “death sentence” where the jury is instructed to conclude you caused the harm, and the only issue is to evaluate damages.

Conclusion. For many businesses, the liabilities associated with an environmental crisis may be minimized through a measured plan of response. Having a plan for dealing with an environmental crisis, and having the professional capability to successfully imple­ment the plan, will factor heavily in the abil­ity of a company to manage, if not reduce, liabilities that may arise from the crisis.