ENVIRONMENTAL LIABILITY DIRECTIVE

A new era for
corporate liability?

The draft EU Directive on environmental liability has been more than a decade in the making. While it is not expected to take effect before 2007, it is already causing much speculation as to how companies will be affected. Many businesses remain unaware of the impacts of the new regime, which will widen the scope of operators environmental liability exposures and impose new formal reporting obligations and procedures for managing pollution incidents and potential hazards.

From the famous accident at a chemical plant in Seveso, Italy, in 1976 to the Baia Mare mine waste spills in Romania in early 2000, there has been a long history of industrial incidents in Europe which have caused serious pollution and environmental damage.

In future, the question of who pays for recovery and clean-up after such incidents and under what conditions will be addressed by an EU-wide liability regime for environmental damage, based on the "polluter pays" principle.

The move towards such a regime began in 1993 when the European Commission published a Green Paper on the subject. After years of controversial studies by consultants and stakeholder consultations, a White Paper followed in 2000. A draft Directive on environmental liability with regard to the prevention and remedying of environmental damage finally emerged in January 2002 (ENDS Report 324, pp 40-41).

As well as tackling liability for damage to water and land, the proposal broke new ground by providing for restoration of damage to biodiversity in the form of the protected habitats and species listed in the wild birds and habitats Directives.

Negotiations on the liability Directive are now in their closing stages, and it seems likely to reach the statute book before EU enlargement in May 2004. Member States will then have three years to transpose it into domestic law.

Several areas in the proposal remain ambiguous or have been left to the discretion of individual Member States, which could have a major bearing on how it will affect businesses operating in different jurisdictions. Questions also remain about how the new regime will be implemented and link in with existing legislation. Environmental lawyers anticipate many tricky cases and legal wrangles arising as result of the Directives complexity and uncertainty.

At present, most businesses have a low awareness of the Directives potential implications. There is some debate over whether it will have a significant impact on businesses in the UK at all, given that certain existing national laws are stricter than the proposed regime. However, there is also a view that the Directive heralds the beginning of a new era for corporate liability and industry should begin preparing for the changes now.

Environmental consultants and lawyers are actively advising some of their clients in this area, and anticipate a growing workload.

Scope and requirements

The draft liability Directive will apply to environmental damage, or the imminent threat of damage, caused by the operation of any of the activities listed in Annex III. These include:

  • Installations/processes covered by the integrated pollution prevention and control (IPPC) Directive
  • Manufacture, use, storage, processing, filling, release to the environment and on-site transport of dangerous substances, dangerous preparations, plant protection products and biocides
  • Transport of dangerous goods by road, rail, inland waterways, sea or air
  • Transboundary shipment of waste requiring authorisation
  • Waste management activities subject to a permit or registration
  • Wastewater discharges that require authorisation
  • Water abstraction that requires authorisation

In relation to damage to biodiversity, the Directive will apply to all other occupational activities.

Various activities and situations will be exempt from the Directive, such as national defence activities and damage triggered by an act of God or act of war. In addition, any damage caused by an emission or incident that occurs before the Directive comes into force will be exempt.

The Directive will require that measures are taken both to prevent damage to the environment and remedy any damage that has occurred where environmental damage is defined as "significant adverse change to the natural resource". For biodiversity damage, this will be determined with reference to the baseline condition and a set of specific criteria and thresholds set out in Annex I.

In the event that damage does occur, the operator must promptly inform the competent authority and take all practicable steps to immediately control, contain, remove or otherwise manage the pollutants concerned. The competent authority will determine the measures to be taken in consultation with the responsible party, and in certain circumstances may take them itself. Similar rules apply to preventive action where there is an imminent threat of damage.

The operator carrying out the damaging activity must bear the costs of any measures taken, irrespective of who actually carries out the remedial/preventive work. The operator will also be liable to compensate for any "interim losses" that is, the damage to natural resources or services that cannot be remedied immediately or at all. This will be in the form of so-called "complementary" or "compensatory" remediation.

However, there are various circumstances under which an operator may not be required to bear the full preventive or restoration costs for example, where he can show that damage was caused by a third party despite appropriate safety measures being in place.

In addition, a Member State may allow operators not to bear the costs where they can demonstrate that they were not at fault or negligent and that the damage was caused by:

  • An emission or activity conducted in accordance with an official permit or licence the "permit defence"
  • Emissions or activities which were not considered harmful according to technical knowledge at the time they were carried out the "state of the art defence"

The inclusion of these defences in the Directive attracted strong criticism from environmentalists. But under the agreement reached by Environment Ministers last June, Member States will be free to decide to what extent they will be valid in determining liability, if at all.

It is also left to the discretion of individual Member States to decide what rules to apply in apportioning liability in cases where multiple parties are at fault.

Impacts

Many specific environmental liability regimes are already in place across Europe some originating from existing EU legislation, but mostly from national policy. The stated purpose of the new Directive is to establish a "common framework" to ensure that future damage is restored or prevented.

In general, the Directive will increase operators potential liability exposures, particularly in countries whose current regulations are limited. Portugal and Greece have no regime to establish liability for contaminated land, for example.

Businesses with interests in the accession states will also need to tread more carefully, according to Simon Taylor, senior consultant at Environmental Resources Management (ERM). "In recent years, many companies have entered the Eastern bloc through buying out previously state-owned facilities, which have not been subject to any of these types of control before and are often at greater risk of causing future damage to the environment than privately owned enterprises," he says.

However, for operators in the UK, which already has a fairly strict regime of environmental liability through various regulations, "the new Directive will represent more of an extension to existing systems rather than a radical new approach," according to consultant Ece Ozdemiroglu of the Economics for the Environment Consultancy (Eftec). "But it will still widen the concept of environmental damage and the responsibility of the operator," she adds.

This could be particularly significant in respect of biodiversity damage, as designated wildlife conservation sites in the UK are often near industrial areas. However, the extent of the Directives impact in this area will depend largely on how it is applied in practice to species and habitats outside offically designated sites.

Chris Clarke, an independent consultant and specialist in environmental liability legislation, comments: "Although certain criteria for testing the significance of damage are set out in Annex I, it is not clear what this might mean and how damage can be interpreted at non-designated sites which are not characterised in the way that many official sites are."

Daniel Lawrence, environmental lawyer with Freshfields Bruckhaus Deringer, adds: "It is easy to imagine disputes arising in practice concerning the baseline characteristics of sites...In many cases, there may well be competing scientific evidence concerning the baseline data and whether the criteria for determining significant adverse change have been satisfied, particularly for sites which have not been studied before."

In terms of the impact on UK businesses, therefore, much will depend on how widely the Directive will apply and the thresholds for triggering its application. Other potentially significant changes will centre around the reporting and procedural obligations for operators, the enforcement duties placed on competent authorities, and the rights given to the public and non-governmental organisations to challenge authorities' decisions. These should "open up the whole process to enhanced transparency and consistency," says Simon Taylor.

Procedures and reporting

For industry, the Directives prevention and reporting requirements seem set to place greater emphasis on environmental and operational management systems.

"Procedural systems will need to be in place in order to understand when damage has occurred operators will need to know the physical characteristics of the site itself and what a damaging event under the Directive would constitute," says Simon Taylor.

Many operators will have already gone through the process of characterising baseline site conditions and identifying what parts of the environment are most at risk from their operations as a result of the IPPC and COMAH regimes. But the liability Directive will almost certainly require them to look further beyond the site boundaries, particularly in relation to any nearby wildlife sites.

ENDS understands that one Member State is considering the possibility of tying the liability Directive in with its environmental permitting regimes, with future permits being awarded on the basis that the operator is allowed to discharge a specified amount of a particular effluent provided it does not cause significant environmental damage. "This would appear to put the onus on the operator to monitor impacts in the downstream environment," says Chris Clarke, "which represents a significant change from the current focus on immediate end-of-pipe emissions and discharges."

In addition, operators will need to pay closer attention to ensuring that there are adequate operational management systems to handle any incidents. Simon Taylor notes: "All that an IPPC permit says is that normal operational processes will not cause pollution unless it is totally accidental, but it doesn't necessarily look at contingency plans."

However, the proactive reporting and remediation requirements may pose significant challenges for companies - for example, where the operator becomes aware of environmental damage during an environmental audit in the context of a proposed merger and acquisition.

"It will increase the potential for vendor-purchaser post-completion indemnity disputes," says lawyer Daniel Lawrence. "Voluntary or self-inflicted remediation costs are typically excluded from vendor indemnities, and clean-up undertaken pursuant to reporting will frequently raise the issue as to whether the relevant reporting requirement was triggered."

Role of authorities & NGOs

Another aspect of the Directive which should bring greater transparency to the handling of pollution incidents is the "access to justice" afforded to NGOs, private individuals and other affected parties. Article 12 states that they are entitled to submit to the competent authority observations on cases of environmental damage and request it to take action.

The authority must then respond within a specified period, providing a review of all the steps and measures it has taken or proposes to take to ensure the application of the Directive. Under current national laws, competent authorities are not obliged to give reasons for their decisions, acts or failure to act. The Directive will force them to tighten up their act.

Other potentially important advances on existing national laws include the duty on competent authorities to enforce remedial action and payment. Enforcement is relegated to a power under the contaminated land regime under Part IIA of the Environmental Protection Act 1990.

Compensation costs

The concept of interim losses and compensatory remediation is relatively new to the UK and Europe and remains one of the most controversial aspects of the proposed liability regime. However, it is well established in the US through the Superfund and National Oceanographic and Atmospheric Administrations natural resource damage assessment programmes.

The theory is that those responsible for the damage should be liable not only for the costs of primary restoration, but also for any interim or permanent loss of use or benefits from the natural resources. It also means that if natural attenuation proves to be the best primary remedial solution, the operator responsible will not be able to walk away without paying a penny. Compensatory remediation schemes may comprise additional improvements to the natural resources or services at the damaged site or an alternative location.

The methodologies for calculating interim losses and costing natural resources are highly complex and, as yet, ill-defined, and Chris Clarke can foresee a situation where this part of the Directive may not be rigorously enforced. "In the US, the way in which compensation costs are calculated based on economic evaluation and environmental assessment is fairly minutely defined, and part of the reason why the environmental insurance market has been able to develop in this area. But in Europe, we will need to do a serious amount of work to get to this point."

Eftecs Ece Ozdemiroglu worked on a 2001 study for the European Commission which looked at some of the key issues surrounding valuation and restoration of damage, including how monetary valuation techniques can be used to estimate the economic value of damage to natural resources, and to what extent cost-benefit analysis can be used to choose between remediation options.

She explains that the main difference between traditional commercial damage assessment and the approach taken under the liability Directive is that the latter relies on both economics and science. "By integrating the disciplines, we are not simply interested in carrying out an accounting exercise to replace quantities; it is about evaluating quality and quantity at the same time."

Eftecs report concluded that the whole process of assessing and evaluating damage against a baseline, selecting and designing primary restoration options, estimating interim losses and selecting and designing compensatory restoration schemes was "interdisciplinary work" for which "a minimum requirement would be ecologists, economists and lawyers."

Ms Ozdemiroglu says: "We dont know as yet who would be in charge of verifying remedial work carried out by regulators and operators, but it will most likely consist of a multidisciplinary team put together by the competent authorities."

Given the complexities surrounding this area, Daniel Lawrence predicts that "highly complex disputes" could arise as to how damage, remediation and/or compensation should be assessed.

"It will undoubtedly result in many cases that require a multidisciplinary approach, involving technical, scientific, legal and economic analysis," he says. Legal disputes could easily develop, for instance, over the proportionality of compensatory restoration schemes compared to the original damage.

Box 1 

Golden opportunity for consultants and lawyers?

The complexity and uncertainty of the Directive and potential for companies to be liable for significant sums of money will inevitably lead to disputes and litigation, and require the expertise of a broad range of specialists environmental consultants, lawyers, economists and insurers.

ERM consultant Simon Taylor says: "One key point about the Directive as a whole is that it involves several different environmental media air, ground, water, flora/fauna species so from a consultancy perspective it will be a case of using very specialised skills and techniques depending on the type of habitat that is damaged. Given that lawyers will be brought in to handle any legal wrangling, there is certainly potential for alliances among the different professionals involved."

However, he anticipates that the main role for consultants will be in carrying out site investigations, habitat assessments and remediation strategies, "which for ERM could involve a number of different teams on the technical side." ERM also expects to advise businesses on preventive measures such as improvements to operational management systems and is likely to be involved in assisting the Government to implement the Directive in a few years time.

"It could be a significant growth area for us, although I do not see it as being as big as climate change, for example, which formed a whole new area of consultancy. This is because the Directive builds on the existing systems in place, but makes them more consistently applicable to a greater number of situations," says Mr Taylor.

ERM is also well placed to benefit from any growth in demand for environmental insurance as a result of the Directive. Last year, it recruited two former city insurance brokers, Bob Martin and Marcel Steward, to head a new business venture, ERM Financial Solutions, which specialises in devising and placing financial packages to cover corporate environmental liability exposures.

According to Mr Martin, the primary drivers for specialist environmental insurance products in Europe at present are related to corporate governance issues, "but this could all change if financial security becomes mandatory under the Directive when it is reviewed in eight years time."

The services of environmental economists may also be required to assist regulators with damage assessment and valuation work, although Eftec is not anticipating a huge increase in the flow of work in this area.

"As economists, we probably won't get involved in the more mundane, straightforward cases where scientific assessment is all that is needed and everyone agrees on the level of compensation," says Ece Ozdemiroglu. "However, we are likely to be brought in for expert witness, statement preparation and public enquiry work in cases where a large amount of money is at stake and there are disputes over the calculated costs."

The potential for litigation under the proposed EU liability regime is in many ways much greater than under the Superfund law in the US, where liability is strict, defences are extremely narrow and the liable party cannot make an appeal until the remediation is completed and paid for. This can sometimes take more than a decade by which time the company could have gone out of business.

By contrast, the EU scheme has built-in grounds for defence. Consultant Chris Clarke believes that the scope for litigation will largely depend on how narrowly the courts interpret these defences or mitigating circumstances. "For instance, a company may only be able to take advantage of the defence that the damage was caused by an act of nature if all practicable safety measures have been taken," he says.

The advent of environmental tribunals, as proposed in a recent report by Professor Richard Macrory of University College London, could be an important UK initiative in this context (ENDS Report 345, p6). According to lawyer Daniel Lawrence: "Special environmental tribunals of the type contemplated in the UCL report would be well positioned to determine complex technical issues of this nature."

Disputes are also likely to arise over who is responsible for the damage, when the damage occurred, whether the damage is significant to the baseline condition and whether costs are proportionate. Consultant Jan Vernon of Risk and Policy Analysts can foresee that "disputes over the time that an incident took place will keep lawyers happy for days at a time" given that the Directive does not apply to historic contamination.

Deborah Lloyd, senior solicitor with Ashurst Morris Crisp, highlights one possible scenario that could prove particularly tricky to resolve. "An accident may have been building up for a while, but one single event could trigger an incident and tip the balance. This is where the mitigating factors may come in. But if there are mitigating circumstances which are reflected in the compensation costs and degree of liability found, the question remains who would then be liable to cover the costs of the remaining pollution?"

"At the same time, the operator may also be found to have retrospective liability under other regimes, and so the links with existing legislation also need clarification," she says.

Environmental liability already constitutes a significant stream of work for Ashursts and will continue to do so, according to Ms Lloyd. "But how much work will depend largely on how the new Directive is implemented, and whether for example, it will be used as an opportunity to review the contaminated land regime. However, clients are likely to become more alive to the potential issues as a result, so the workload will increase."

She believes that the complexity of the issues involved will require broader thinking on the part of lawyers, "particularly when it comes to the economic and insurance aspects which can be highly complex."

Similarly, Marcel Steward of ERM Financial Solutions believes that "greater cross-pollination of skills" will be necessary to ensure the development of the markets for environmental insurance and specialist financial instruments. "Few people, even specialist brokers, have good experience of environmental science getting the right skills is at present a major restraint on the development of the small, but fast-growing European marketplace."

Implementation uncertainty

Ultimately, whether or not the Directive does prove to be a revolution for corporate environmental liability will depend on how it is implemented. Chris Clarke comments: "Member States will have a choice of how to transpose it on top of existing laws. They also have a right to go further than the Directives requirements and impose, or retain, more stringent provisions."

This could include adding more activities and additional responsible parties. The latter could be significant in the UK given that under the current contaminated land regime any "knowing permitter" or land owner, as well as the polluter, can be held liable. The US has an even more widespread focus for contamination liability.

In this respect, it will be interesting to see how the liability Directive will link in practice with Part IIA of the Environmental Protection Act and other existing liability laws elsewhere in the EU, "which could potentially undermine it or be undermined," says lawyer Deborah Lloyd.

The UK Environment Department has yet to decide whether the Directive should be implemented as a single piece of legislation or alongside existing laws such as the Water Resources Act 1991 and Part IIA of the EPA. The latter seems likely given that these laws already allow steps to be taken to require polluters to remedy, or pay the costs of remedying, pollution from their activities. There are rumours that Part IIA may be reserved to cover historic pollution while the Directive will apply to new pollution, but this could lead to a paradoxical situation in which new damage is subject to less severe rules in certain respects.

Deborah Lloyd comments: "The whole question of the interaction of old and new regimes is a problem. For instance, where do site condition reports prepared under the contaminated land regime fit in? Will they be admissible as evidence in the event that damage occurs in future? And what value will a site condition report from 2004 have under the liability Directive regime in 2007?"

How can businesses prepare?

If and when hazards arise under the Directive the ensuing costs could be substantial. They may also seriously disrupt revenue-generating activity on the site. Anyone involved in industrial activities, therefore, needs to be aware of the potential liabilities they could face.

According to Simon Taylor, the impact of the liability Directive is one of the top five EU issues concerning ERM clients at present along with climate change, the water framework Directive, corporate assurance and chemicals policy "because it is so wide-ranging and has the potential to be expanded to cover more activities." However, very few firms have actually taken steps to explore what the Directive may mean for their business.

ERM is beginning to assist a few of its clients "at a strategic level" to identify how their environmental liabilities may change under the new regime, the possible cost implications and what action can be taken now in order to minimise the liabilities, such as more stringent operational management controls.

Lawyer Deborah Lloyd advises: "Operators should be asking themselves what they can they do to make their permits a watertight mitigating factor regular compliance audits should be seen as the minimum."

Companies should also pay greater attention to the environmental due diligence process during any transaction. "We expect to see increasing importance placed on environmental liability in contractual conditions," says Simon Taylor.

Businesses considering investing in the former Eastern bloc and other countries that do not have a strict contamination regime will need to take particular care. Meanwhile, in the UK, companies may have to go beyond standard due diligence in taking into account the location of operations relative to any Natura 2000 and other conservation sites, and the possible liabilities associated with them.

According to Deborah Lloyd, "information requirements for transactions vary between different jurisdictions in Europe and if consultants are being used to assess the risks in the due diligence process, a company might need some additional protection via warranties." However, she says, lawyers should already be asking consultants to look at what impact the Directive may have as matter of course.