EPA's Tools for Settling Civil Penalty Cases

TASA ID: 1582

Federal environmental statutes authorize the imposition of civil penalties for violations of environmental requirements.  For example, Section 309(d) of the Clean Water Act states:

In determining the amount of a civil penalty, the court shall consider the seriousness of the violation or violations, the economic benefit (if any) resulting from the violation, any history of such violations, any good-faith efforts to comply with the applicable requirements, the economic impact of the penalty on the violator, and such other matters as justice may require.

Based on this and similar provisions in other environmental laws, the EPA issued statute-specific civil penalty policies.  Although the specifics of these policies differ from one environmental medium (i.e., clean air, clean water, solid waste) to another, their purpose is to establish a highly structured process for negotiating civil penalty settlements. 

In general, most of these policies require the alleged violator to pay a penalty that has two major components:  (1) an "economic benefit" component that is usually based on amounts of money the firm or municipality delayed and/or avoided spending in a timely manner, and (2) a "gravity" component that corresponds to the "seriousness of the violation" or the resulting environmental harm.

The EPA litigation team may adjust these initial penalty amounts upward within certain limitations in light of the intentional nature of the violation and/or the entity's prior history of violations.  It may also adjust the amount downward for "good-faith efforts to comply," "such other matters as justice may require," litigation risks, the entity's limited ability to pay, and/or its agreement to perform "supplemental environmental projects" (SEPs), that is, environmental mitigation projects not required by law.

Calculation of Economic Benefit

To estimate the benefit obtained by the alleged violator, EPA uses its "BEN" model.  As of the date of noncompliance, BEN calculates the present value of the costs that the entity would have incurred assuming "on-time" compliance, and subtracts from that figure the present value of the costs that have resulted or will result from "delayed" (or actual world) compliance.  These costs include capital costs associated with the purchase and installation of pollution control equipment, the cost of operating and maintaining that equipment over time, and any one-time expenses, such as the cost of performing a study to determine the design capacity of the equipment.

To perform the necessary calculations on an after-tax basis, BEN also requires the following inputs:  the dates of noncompliance, compliance, and assumed penalty payment; an inflation rate; the entity's marginal tax rate in every relevant year; and a "discount rate" to be used to adjust cash flows over time.

Once the model has subtracted the present value of the delay case from the present value of the on-time case, the difference is compounded forward to the assumed date of penalty payment by using the discount rate as an interest forward rate for the relevant time period.

Calculation of the Gravity Component

Each statutory-specific civil penalty policy provides a unique way of calculating the gravity component of the penalty.

For example, the Clean Water Act civil penalty policy establishes four criteria for calculation of gravity:  significance of the violation, health and environmental harm, the number of effluent limit violations, and significance of non-effluent limit violations.  All of the scores for these criteria are added together and multiplied by $1,000 to determine the gravity component of the penalty.  Then, various adjustment factors apply.

The Clean Air Act stationary source civil penalty policy uses a very different framework that places dollar values on the percentage by which the highest documented violation exceeds the applicable emission standard, the toxicity of the pollutant, the sensitivity of the environment, the duration of the violations, the importance of the violations to the regulatory scheme, the size of the violator (which is based on its net worth), and various adjustment factors.

The Resource Conservation and Recovery Act civil penalty policy is based on two matrices:  a gravity-based component and a multi-day component.  Each of these matrices attempts to classify the violations as fitting into one of nine boxes organized by "the extent of deviation from the requirement" on one axis and "potential for harm" on the other.  These boxes are classified as major, moderate, and minor based on each of these criteria.  The penalty policy provides examples to aid in the classification of specific violations.

Ability-to-Pay Analysis

EPA uses its computer software known as "ABEL" to screen corporations' claims that they cannot afford to pay civil penalties.  ABEL is a convenient tool for analyzing three to five years of a corporation's federal tax return information.  It produces two types of outputs:  (1) a financial profile based on commonly used financial ratios that indicate the liquidity, solvency, tendency toward near-term bankruptcy, and general financial health of the firm; and (2) a probability-based forecast of the firm's future cash flows that can be used to assess the entity's ability to pay fines, Superfund cleanup costs, and other types of incremental environmental expenditures. 

EPA's MUNIPAY and INDIPAY models perform similar functions, respectively, for municipalities and individuals.

In Beyond ABEL:  Ability to Pay Guidance (1993), EPA stated:

When an ABEL run produces a positive result, [EPA] staff can be certain that the entity is able to pay.  A negative or ambiguous result, however, does not necessarily indicate that the entity is unable to pay.  ABEL may produce a negative result when, in fact, funds are available.

For example, the company may be able to reduce its expenses and thereby generate additional cash flow, sell off non-essential assets, assume more debt or refinance debt, reduce the salaries of its officers, or draw upon the financial resources of a parent or affiliated firm.  Beyond ABEL draws attention to key information in the alleged violator's tax returns and financial statements and provides step-by-step instructions on how to investigate these potential sources of funds.

Supplemental Environmental Projects

EPA's PROJECT model is designed to calculate a credit for SEPs that can be used to reduce the gravity component of a civil penalty.  SEPs must meet certain criteria EPA enumerated in various policy statements.  Depending on the characteristics of the individual project, EPA may grant substantially less than a dollar-for-dollar credit for the after-tax present value of a SEP.

How to Negotiate Civil Penalties

Alleged violators and their counsel need to be aware of the nuances and weaknesses of BEN, ABEL, PROJECT, MUNIPAY, and INDIPAY, and EPA's statute-specific civil penalty policies.  The alleged violator should make a strong effort to verify that the inputs EPA uses in its models are factually accurate and take full advantage of their penalty-minimizing aspects wherever they exist.  EPA staff members using these models are not typically economists or financial analysts, and their analyses do not always hold up under critical review. Additionally, EPA staff will not necessarily calculate civil penalties with attention to details that could benefit the alleged violator.  It is, therefore, necessary to proceed cautiously and tactfully but also with appropriate insight and analytical support.

This article discusses issues of general interest and does not give any specific legal, medical, or business advice pertaining to any specific circumstances.  Before acting upon any of its information, you should obtain appropriate advice from a lawyer or other qualified professional.

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