ENVIRONMENTAL COSTS ON GOVERNMENT CONTRACTS

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1 ENVIRONMENTAL COSTS ON GOVERNMENT CONTRACTS Jonathan A. DeMella Traeger Machetanz Lisa M. Marchese Government Contracts Counseling & Litigation Practice Group Risk Mitigation & Cost Recovery Strategies for Government Contractors Overview CERCLA both a means of imposing liability and an avenue of cost recovery for government contractors US v. Shell FAR Cost Principles allowability & allocability of environmental costs Indemnification Clauses Anti-Deficiency Act and PL Environmental Compliance for Construction Industry Recommendations and Best Practices for Government Contractors

2 RISK EXPOSURE TO GOVERNMENT CONTRACTORS Government contractors have become enforcement targets for environmental liabilities and damages Government has struggled to manage mounting costs of environmental clean up at military installations and nuclear weapons complexes EPA policy adopted in 1988 to pursue the full range of [EPA] enforcement authorities against contractor operators of government-owned facilities... Government contractors face broad array of environmental liabilities: Contractor operating government owned facility Contractor leasing or occupying space at a federal facility Contractor produces products or materials for Government at contractor s facility Contractor performing environmental clean up at federal facilities or Superfund sites The Legacy of US v. SHELL Historically, Government has relied upon private sector to supply the military for materials for national defense In 1941 Government entered into series of contracts with oil companies for production of aviation gas following Pearl Harbor and US entry into WWII Mass production led to increased environmental waste or acid sludge Safe waste disposal could not keep pace with the demands of production Eventually, most of the environmental waste was dumped at a site in Fullerton, CA Government did not design the aviation fuel processes or own/operate the refineries or disposal site

3 McColl Waste Dump Fullerton, CA US v. SHELL Litigation was over 70 years in the making Focus on allocation of responsibilities not liabilities Government incurred over $100 million in costs when waste removed from Fullerton during 1990s Government sued Shell (oil companies) under CERCLA to recover clean up costs and oil companies counterclaimed In series of decisions from 1990s 2000s, oil companies were held liable for remediation costs to Government under CERCLA 9th Circuit found oil companies liable but reversed allocation to Government Oil companies sought relief in COFC, arguing that taxes clause in their contracts entitled them to indemnification for environmental remediation as charges Federal Circuit found that indemnification clause entitled oil companies to reimbursement for environmental remediation costs incurred

4 TAKEAWAYS FROM US v. SHELL Shell decision provides one path by which contractors can recover environmental clean up costs Contractors will face special defenses advanced by Government to allocation under CERCLA Double recovery Government has already paid for clean up costs in contracts Equitable Offset any CERCLA recovery by contractors be offset by contract amount Other avenues of recovery include: Advance Agreements FAR Contract Cost Principles Contractors should identify potential claims early on in tandem with cost recovery clauses and statutes Successful Approaches for the Recovery of Environmental Costs How have Government Contractors successfully recovered environmental costs? Current Contracts Indemnification Provisions CERCLA

5 Recovery Under Current Contracts Overview There is no specific cost principle governing allowability of environmental costs Past efforts of contracting agencies and FAR Councils to promulgate a clause failed. Why? Preventive costs allowable Remediation costs presumptively unallowable Current method for determining allowability Advance Agreements FAR , FAR , catchall allowability cost principle. Two key questions: Is cost reasonable? Is cost allocable? Recovery Under Current Contracts Allowability Cost is reasonable if: in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business. FAR (a). Reasonableness is largely a factual inquiry Contract auditors employ a totality of circumstances test If contractor violates law, disregards warnings of potential contamination, cost would be unreasonable and unallowable.

6 Recovery Under Current Contracts Allocability Cost is allocable if assignable or chargeable to one or more cost objectives on the basis of relative benefits received or other equitable relationship. FAR Historical environmental cleanup costs are generally accepted as a necessary business expense under FAR allocability provisions No universal mechanism for speading costs among operating units and contracts under applicable CAS Use any generally accepted method of allocating environmental costs Recovery Under Current Contracts Advance Agreements, FAR , DCAAM Advance Agreements are preferred means of addressing contractor s historical environmental costs AAs can address reasonableness, allocability, or allowability of certain costs AAs can be negotiated at any time but Must be in writing Signed by both parties Incorporated into applicable contracts Contracting Officers will not agree to treatment of costs inconsistent with cost principles

7 Recovery Under Current Contracts Obligation to Pursue Other Sources Only contractor s own environmental costs are allowable and allocable to Government contracts; costs incurred by contractor later deemed to be responsibility of others under CERCLA are unallowable. Predicting cost of cleanup, future recoveries from insurance companies, and identifying PRPs is highly uncertain so what is the rule? forecasted and incurred environmental cleanup costs and related legal costs that are allowable should be accepted contingent upon the Government participating in any insurance recoveries or the identification of PRPs at a later date. DCAAM sec (b) Contractor has obligation to pursue other sources of funding for environmental costs, including insurance coverage and other responsible parties, if costs submitted are above what it believes it is responsible for under CERCLA. Government will help recover. Environmental Costs Recovered through Indemnification In order to be enforceable, indemnification provisions must be either Authorized by statute, or Limited to the amounts appropriated U.S. Supreme Court confirmed that open-ended indemnification clauses violate the Anti-Deficiency Act because they constitute an agreement for future payments of money in advance of, or in excess of, existing appropriations. Hercules, Inc. v. United States, 516 U.S. 417, 427 (1996). Cases turn on whether the limitation to the amount appropriated violate the ADA.

8 Environmental Costs Recovered through Indemnification Public Law Coverage Permanent legislation enacted by Congress in 1958, carrying forward similar provisions in War Powers Act 1941 Government recognized that it must bear risk of loss for especially hazardous or unusually hazardous activity, for which insurance is unavailable, e.g., nuclear power, highly volatile fuels, missile programs Key issue for indemnification under P.L is the definition of unusually hazardous in your contract or agreement If broad enough to cover resulting contamination, then indemnification should cover all third party claims for bodily injury and property damage Construction Contractors Risk Allocation Remedy Granting Clauses in the World of Environmental Contracting DSC clause Changes clause Suspension clause

9 Construction Contractors Risk Allocation Continued Environmental Conditions Encountered in a Standard Construction Contract STOP!!! You don t want to be liable under CERCLA for spreading contamination Report You don t want to be a criminal Claim under Remedy Granting Clauses Environmental Remediation Contractors Does this look like an opportunity to you?

10 Environmental Remediation Contractors Continued Plans and Specs Environmental Remediation Contract Conditions Worse than Expected Claims Under Remedy Granting Clauses DSC clause what are the inconsistent indications Changes Clause Variation in estimated quantities Environmental Remediation Contractors Continued Performance Based Remediation Contract (PBC) Conditions Worse Than Expected Limitation of Remedies LMTCO case Superior Knowledge

11 DOH!! What about some prevention? Compliance Review Corporate Environmental Policy Statement Environmental Compliance Manual Project Checklist Project Planning and Contracting Allocation of Environmental Compliance Responsibilities to Appropriate Employees

12 Compliance Review Continued Implementation of Project-Specific Environmental Practices Environmental Awareness Training Internal Reporting System Compliance by subcontractors and joint venture partners Inspection and Compliance Review Procedures Best Practices Negotiate an advance agreement with the government on allowability and allocability of costs What environment costs are covered How the costs will be allocated Availability of other sources of recovery The mechanism for crediting future recoveries to the Government Maximize recovery from sources other than the Government, e.g. insurance and other potentially responsible parties

13 Best Practices Continued Focus on how the government was an owner or operator at the time of release Review all contract documents relating to the site to determine sources of indemnity and cost recovery These documents may be in government archives so consider hiring historical consulting firm Expert testimony may well be required on historical and technical arguments Be prepared to respond to the government s unique contract defenses CONCLUSION