-------
I
I
I
I
I
i
i
i
I
i
i
i
i
I
i
i
i
i
i
3-5
EXHIBIT 3-2
INTEREST EARNINGS ON ONE-TIME INVESTMENTS
Year I Year 2 Year 3 Year 4
14.2 Percent
Amount in Fund at Beginning
of Year $1,000,000 1,113,600 1,240,105 1,380,981
Amount Invested a 800,000 890,880 992,084
Amount of Investment 913,600 1,017,385 1,132,960
Year-End
8.5 Percent
Amount in Fund at Beginning
of Year $1,000,000 1,068,000 1,140,624 1,218,187
Amount Invested a 800,000 854,400 912,499
Amount of Investment 868,000 927,024 990,062
Year-End
This example assumes 80% of the fund's balance is invested.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
1
I
I
I
I
I
3-6
EXHIBIT 3-3
INTEREST EARNINGS ON ANNUAL INVESTMENTS
$ Amount in Investment
Fund at end of
each year, assuming
8.5% interest
compounded annually 4'
($ millions)
3--
2--
. 1
0.87.
80% of new revenues
invested annually
60%
40%
20%
4 years
-------
I
I
I
I
I
I
I
I
I
I
I
i
i
i
i
i
I
i
i
3-7
Another type of return that should be included in projections is the
indirect effects that investing in certain assets will have on the state. For
example, when demand deposits, time deposits and certificates of deposit are
invested in in-state banks, the availability of capital for use locally is
increased, in turn this increased availability of financing can multiply local
income and thus increase state general fund tax revenues. Therefore, although
Treasury Bills and commercial paper yield a higher rate on face value, demand
deposits and certificates, of deposit, by indirectly generating income and tax
revenue, may provide- a higher return to the state, though not necessarily to
the state's response fund, than originally recognized.
3.3. PROCEDURES FOR ESTABLISHING OPTION
Most states currently invest the unused balances of at least some selected
state accounts. Consequently, implementation of this option would not
normally require establishing the financial and administrative capability to
invest unused balances in the states response fund -- the response fund
investments would be managed as are other invested accounts and trust funds in
the state. Instead, the primary issues in applying this option to a state's
response fund concern obtaining the authority to invest and to be credited
with the earnings of this investment.
At least three possible situations may explain why a state response fund
is not currently earning interest and being credited with the interest
earned. The authority to invest unused balances and retain the earnings may
exist, but may not have been considered when the fund was established.
Clearly, in this instance, the state should reconsider whether the fund
presently is managed so as to provide the greatest benefits to taxpayers. In
other states, the authority to invest unused balances may exist, but earnings
must be credited to the state's general fund, not the response fund. This
second situation arises most frequently when the response fund is financed at
least in part by appropriations from the general fund. In yet other states,
the applicable law may state that "unless otherwise expressly provided by
law," interest earnings are to revert to the state's general fund, not to the
response fund. Possible means of crediting interest earnings to the response
fund are discussed below for these last two situations.
Where the authority exists to invest the response fund's balances, but
where interest earnings are required to be credited to the state's general
fund because appropriations from the general fund finance a portion, but not
all, of the response fund expenditures, several possibilities may exist. For
example, one alternative might involve an amendment stipulating that in no
event could the percentage of interest earned and credited to the response
fund in any one year exceed the percentage of response fund revenues derived
from sources other than the general fund in that fiscal year (or in the
preceeding fiscal year). This would ensure that interest earned on general
fund appropriations would revert back to the general fund, while interest
earned on other revenues would be retained by the response fund. A second
alternative may be to establish, for accounting purposes, two accounts, one
for general fund appropriations and one for special fees or taxes contributed
by industry. Interest earned on the former would revert to the general fund
as required by state law. Interest earned by the latter account's investments
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
3-8
would be" credited to that account. State expenditures to be paid from the
response fund would be required to be drawn from both accounts so that, at the
end of each fiscal year, the expenditures from each bore the same proportion
as their respective sources (general fund or industry fees or taxes)
contributed to the total available in the fund for that year.
Other alternatives may.be possible in those states where the general rule
is that interest accruing from the investment of state monies is required to
be credited to the state's general fund, unless certain conditions are met,
such as "unless otherwise expressly provided by law." In these states,
managers of response funds should consider whether they could demonstrate that
conditions defining the exception are indeed met by the response fund. For
example, in state enabling statutes establishing the response fund which are
modeled upon the federal Superfund, the state statute may utilize language
such as that found in CERCLA Section 223(b)'(2): "The income on such
investments shall be credited to and form a part of such Trust Fund."
Alternatively, it may be possible to show that by virtue of the purposes
.for which the state response fund was created, the requirements of CERCLA for
state matching funds, and by the way the state fund is administered to comply
with its legal responsibilities under the federal law, the state's response
fund is authorized by law to be credited with its interest earnings. For
example, some state enabling statutes provide that the response fund is
created wholely or in part to provide the matching funds required by federal
law. CERCLA Section 104(c)(3) prohibits use of the federal Trust Fund unless
the state first provides "assurances deemed adequate by the President [EPA]
that (A) the State will assure all future maintenance of the removal and
remedial actions provided for the expected life of such actions . . . and (C)
the State will pay or assure payment of . . ."10 or 50 percent of the costs
of certain responses. Clearly, subpart (A) of CERCLA §104(c)(3) requires a
long-term assured capability to finance operation and maintenance of response
actions. In some states, such assurances without caveat can be provided only
by a mechanism such as the interest earnings on a fund's investment of unused
balances, or other long-term investments of trust fund monies, since only this
method could assure a future revenue stream. Where the state law establishing
the response fund indicates the legislature's intent that the fund be used to
fulfill state responsibilities under CERCLA, it could be argued that interest
earnings credited to the response fund were contemplated as a means of
fulfilling CERCLA §104(c)(3)(A). This conclusion could also be strengthened
by conditions placed in the EPA-state cooperative agreement or contract
required by CERCLA §104(c)(3). Reasoning similar to this example has been
employed by some states' attorney generals to authorize deposit of interest
earnings in special state trust funds created for other purposes (e.g.,
control of radioactive materials in Agreement States) in states prohibiting
such credit of earnings "unless otherwise expressly provided by law."
3.4 MAJOR FACTORS TO CONSIDER
There are several factors which each state must examine when implementing
this option. These factors include, but are not limited to, the applicability
of such a program to the individual state, administrative costs, the amount of
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
3-9
funds likely to be generated, equity, risk, and the political hurdles that
must be overcome in adopting this option.
3.4.1 Applicability to States
Each state must carefully evaluate its laws and procedures as each state
has its own constitutional, statutory, and administrative guidelines that
govern which funds may be invested and regulate portfolio management. State
statutes or regulations will dictate which funds can be invested
independently, which must be invested through the state, and to what account
the interest earnings may be credited. States' procedural guidelines
generally dictate the amount of money in the fund that may be invested. For
example, this could range from a system based on cash flow, to a specific
percentage of the fund's balance, to all excesses not needed on a daily
basis. Once the amount to be invested is determined, the portfolio's
composition must be'designed. Many states have set specific guidelines as to
what assets investments may be made, and what percentage of total investment
they may be; these guidelines will be used by those state officials
responsible for portfolio management of pooled state monies being invested.
This set of guidelines is based on such characteristics as investment yield,
liquidity, and security of the asset. Finally, guidelines for determining the
time period of the investment must be determined. These guidelines may be
based on a cash flow analysis, specific limitations per asset, or left to the
discretion of the state treasury or investment board.
3.4.2 Administrative Costs
One factor of the administrative costs involved in an investment program
is salary costs. These costs depend on whether the investments would be
administered by a special committee, an operating board, a single official, an
investment director not currently"employed by the government, or by outside
investment counselors. An in-house investment board tends to be less
expensive than a private financial institution primarily because salaries are
generally lower. For example, in 1974, the Wisconsin Investment Board had an
expense ratio of 0.0208 percent, which was substantially lower than those of
selected insurance companies and nonprofit investment firms. This low
administrative expense can be accounted for by the lower salaries and number
of staff employed than in private financial companies, and by the lower broker
and trader commissions that could be obtained because of the concentration of
capital achieved through pooling most of the funds managed by the state.
3.4.3 Hurdles to Overcome in Adopting an Investment Program
Political Factors. There are two main groups that are likely to be
affected in the investment of the state's response fund and the crediting of
the interest earned to its account. In the situation where the response fund
currently is not being invested by the state, the bankers will be affected.
The banks will be adverse to losing the earnings from the state deposits when
the fund is withdrawn for investment purposes. If the response fund currently
is being invested with earnings credited to the state's general fund, some
elements of state government may be affected. These elements of state
government may be opposed to this option as they will be losing revenue to the
-------
I
I
I
«
w
I
I
I
I
I
I
3-10
response fund that otherwise would have been deposited in the general fund,
thus possibly denying them discretion in the use of these earnings.
Another factor to take into consideration is that of industry's concern
I Another factor to take into consideration is that of industry s concern
that its money is being used as efficiently as possible. When a response fund I
is financed by special industry taxes or fees, these taxpayers have a right to |
I
I
I
1
I
_ prererring a nigner asset security tnan asset yiexa.
3.5 SOURCES OF FURTHER ASSISTANCE I
expect that the state will make the most cost-effective use of their taxes
paid for response activities. Where states have response funds financed in
part by such special taxes, and these funds either are not investing
unobligated balances or are investing balances but the earnings are being lost
to other state programs through the. general fund, the state cannot assure
industrial taxpayers of the most efficient use of their taxes or fees.
Financial Risk. Financial risk is controlled in state investments by
state guidelines. Each state has its own restrictions on the composition of
its investment portfolio. On average, states tend to invest primarily in
predictable and partially predictable assets such as demand deposits, time
deposits, marketable government bonds, certificates of deposit, and commercial
paper, rather than in relatively unpredictable assets such as corporate stocks
and bonds. The average state portfolio consists mainly of highly liquid
assets which reduce the probability that a treasury would have to borrow
additional funds under less favorable terms. Most states tend to avoid risk,
preferring a higher asset security than asset yield.
The State of Wisconsin Investment Board
Tom Ingersoll, U.S. Environmental Protection Agency
The Council of State Governments
Bureau of Government Services, University of Kentucky
-------
I
i
I
I
I
I
I
I
I
I
I
I
I
I
1
I
I
I
I
CHAPTER 4
MULTI-STATE OR MULTI-COMPANY SYNDICATIONS
4.1 INTRODUCTION
Hazardous waste cleanup efforts to date have been undertaken primarily on
a site-by-site basis, and in many cases only after protracted enforcement
actions by the state or federal government. While this approach may be
unavoidable in some, circumstances, in others it can lead to inefficiencies in
cleanup operations. Among these inefficiencies are time lost in litigation,
an inability to capture economies of scale during cleanup activities, and
failure to recognize potential untapped sources of private funding or
financing. If these inefficiencies could be corrected even to a small degree,
states may be able to reduce their costs of remedial actions.-
A syndication of parties interested or active in cleanup efforts is one
way to correct these inefficiencies. Essentially, a syndication would pool
the resources of several parties to address one or more hazardous waste sites
in a geographic area. The syndication concept may be applicable to several
contiguous states sharing similar needs or to a number of corporations
operating within one or more contiguous states. The members might include
state or local governments, oil, chemical, and manufacturing companies, or
other interested third parties. The syndicate can take a number of
organizational forms and undertake a variety of activities (from making
financial contributions to direct cleanup actions), depending on the needs of
the participating corporations and the extent of government participation.
Savings would accrue to the states as the syndication absorbed a portion of
the state's matching requirement for federally-funded programs or reduced the
total cost of cleanup activities.
Syndicated or cooperative efforts are not a novel proposal. Indeed, many
of the concepts presented in this Chapter, primarily as a means of achieving
cost savings in state hazardous waste cleanup activities, have been tested by
syndications in other areas where the public and private sectors share common
concerns. Cooperative real estate development programs in older urban areas
which combine mixed income housing and commercial property, for example, have
assured states or municipalities of additional low- and middle-income housing
while allowing developers to earn an adequate return on their investment. Nor
does a syndicated effort have to be profitable to attract participants. The
oil spill cleanup cooperatives, for example, do not engage in profit-making
activities. They do, however, allow participating companies to capture
savings in the purchase, maintenance, and use of needed emergency response
equipment. Similarly, more than 200 private electric utilities plan to
contribute to the cleanup of the damaged Three Mile Island nuclear reactor.
The timely and efficient cleanup of the problem is seen by the utilities as
vital to protecting their own credit standing among investors. While there
are, to date, no known syndicates formed specifically for hazardous waste site
cleanups, several major chemical companies and localities are considering the
concepts presented here for application to their own hazardous waste problems.
-------
I
I
I
1
I
I
I
i
i
i
i
i
i
i
i
i
i
i
i
4-2
This Chapter examines a number of issues concerning the use of syndicates
for hazardous waste cleanup, including their structure, activities, and
financial and legal considerations. The next section discusses who would
participate in a syndication, what they might accomplish, and how their
actions would result in cost savings for the states. Section 4.3 examines the
specific objectives to be addressed by the syndicate (contribution of funds,
economies of scale, private sector provision of equipment and services, and
alternative financing) and the most likely organizational approach to .achieve
each objective. Section 4.4 presents several detailed examples of syndicates
to illustrate their applicability in different circumstances. Section 4.5
addresses issues of organizational structure, financial incentives, and legal
considerations (particularly liability questions) and their implications for
syndicates. Finally, Section 4.6 presents several case studies of oil spill
cleanup cooperatives which exemplify some of the syndication ideas in practice
today.
4.2 SYNDICATION PARTICIPANTS AND ACTIONS
The parties interested in forming a syndicate to address hazardous waste
sites include both state or local governments and businesses operating in an
area, particularly those who handle hazardous materials. Governments are
concerned not only with protecting the public health and welfare, they are
also particularly interested in cost-effective methods of remedying the
problems of hazardous wastes. The need for cost-effective response is
especially acute in the federal Superfund program, which requires state or
local governments to pay a portion of the costs of major response actions.
Businesses in a state or region may also be interested in participating in
a syndicated cleanup effort for several reasons. First, many businesses are
concerned with improving their public image, especially in states where they
are highly visible. In situations where an industry or company is identified
closely with the problems of hazardous wastes, companies recognize a need to
be perceived by the public as moving positively, and voluntarily, to address
hazardous waste issues. Second, businesses are concerned with preserving
their relationship with a state, particularly where businesses historically
have had cooperative and productive inter-actions with the state. Further,
businesses recognize that by helping a state or local government meet its
cleanup needs in the most cost-effective way possible, they may reduce the
likelihood of future assessments (through taxes or the courts) against
business for those costs. Third, for their own operations and activities,
businesses may be able to capture economies of scale by addressing several
hazardous waste sites at once or by tapping available resources for those
activities, such as idle capacity or underutilized equipment. Many companies
which have handled hazardous substances in the past recognize that they may
eventually face additional responsibility at more than one waste site. The
capability developed now to remedy hazardous waste problems may eventually be
put to use at other sites as well. Companies which continue to handle
hazardous substances as a normal part of their business operations may find it
advantageous to pool emergency response capabilities to handle hazardous
substance spills or releases. By pooling the purchase and maintenance of
expensive, but infrequently used, emergency response equipment, companies can
capture economies of scale and reduce their per-unit emergency response costs.
-------
I
I
I
1
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-3
These business interests can be turned to the state's benefit by creating
a mechanism to pool the resources and contributions of the various parties,
and by providing incentives to industry to participate in a syndication.
Trade associations or states could help create or sponsor an organization
specifically to finance or undertake hazardous waste cleanup activities, such
as a cleanup syndicate or trust fund. Companies would contribute to or
participate in cleanup activities and receive public recognition for those
actions, but at the same time would be shielded from direct association with
the problems at the sites where remedial actions are being undertaken. States
could also offer incentives to companies voluntarily participating in cleanup
actions at sites for which they were not responsible by giving the companies
tax credits against state hazardous waste taxes for their cleanup
expenditures, or by offering low-interest loans for equipment needed for
remedial activities.
Savings would accrue to the states in three ways. First, any money
provided by private parties which would not otherwise have been expended for
cleanup activities will directly reduce the amount of money a state would have
to provide for a cleanup action, either for its own operations or as part of
the federal Superfund matching requirements. If companies established a
hazardous waste trust fund, for example, to which they made contributions in
the interest of furthering remedial actions, and the trust fund made grants to
the state for site cleanup, that money could be applied to the state's share
of cleanup costs. Second, if companies undertook cleanup actions themselves,
either at sites where they have a potential liability or in a joint effort
with a number of parties at several sites, they would obviate the need for
federal or state expenditures. There are often tax benefits available to
private parties that are not available to a state or local government
(investment tax credits and depreciation deductions, for example) which would
help lower the effective cost of cleanup to private parties. Third, if the
states are able to capture economies of scale in their own cleanup operations
by addressing multiple sites in a region or by working with several interested
parties (government or private) at several sites, they will reduce the
per-unit cost of their cleanup actions.
The syndication concept may be most applicable in states or localities
where certain conditions exist. To benefit from the contributions of private
parties, a locale would most likely contain several currently operating
companies who have handled or still are handling hazardous substances or
generating hazardous wastes. To improve their public image as a responsible
operator, companies may be willing to contribute to or participate in a
cleanup activity that enjoys a strong positive public image. This may be
particularly useful in addressing sites where liability is uncertain, but
where companies are potentially culpable and wish to avoid enforcement action
and the negative image of being forced (by the courts) to take remedial
steps. To capture economies of scale, a syndicate would operate most
effectively in an area (within one state or several contiguous states) where
there are a number of sites to be cleaned up. The syndicate could purchase
special equipment or facilities that are needed temporarily at each site (such
as earth moving equipment or mobile incinerators), and be assured of a higher
utilization rate, and thus a lower per-unit operating cost. In addition, a
syndicate could utilize contributions of equipment or in-kind services made
-------
I
I
I
I
I
I
I
I
I
I
I
I
1
I
I
I
I
I
I
4-4
available by member companies, reducing the actual cash expenditures that
would have to be made for a cleanup operation.
4.3 OBJECTIVES OF SYNDICATIONS
A syndication could perform various activities under several
organizational forms, depending on the needs of its members and of the
locality being served. A syndicate could be designed to achieve one or more
of the following objectives: (1) stimulate a direct contribution of funds by
private parties; (2) capture economies ofscale in response activities; (3)
allow for the private sector contribution of equipment, personnel, and in-kind
services; and (4) allow states access to alternative financing. Each of these
objectives and their effects on states' savings is discussed below. The
organizational format most likely to achieve the objective is mentioned and
fully demonstrated in the syndication examples presented in Section 4.4.
4.3.1 Contribution of Funds
Any contribution of funds by third parties will directly reduce the cost
to states of hazardous waste cleanup. Many companies that regularly handle
hazardous substances have a keen business interest in maintaining good public
relations, including the public perception of their industry as being aware of
and concerned with the consequences of their business activities on the
environment and the health of citizens, and in taking steps to ameliorate
serious problems that their operations may generate. For example, a number of
national companies with facilities in Louisiana are considering a syndication
with several parishes to clean up sites in the heavily industrialized areas of
the state.
Companies closely identified with the problems created by hazardous wastes
may enhance their public image by contributing voluntarily to an organization
established to help clean up hazardous waste sites. Such an organization
could shield the companies from direct association with the problems at
certain sites. Voluntary participation by companies in a nonprofit
organization with limited liability may be especially desirable where the
liability for a site or sites is uncertain, and where the companies wish to
avoid legal action against themselves.
Companies seeking to make the most of the public relations value of their
contributions will find their efforts best rewarded when made in an organized
and public manner. They could publicize their contributions by establishing a
fund to assist the state in paying the cost of remedial actions. A nonprofit
association or trust fund could be created so that contributions would qualify
either as expenses associated with a company's business, or as donations to a
charitable organization. In either case, contributions would be deductible
from the gross income of the contributor, making the after-tax cost to the
contributor less than the dollar value of the contributions themselves. In
general, the contributions provided by the interested private parties reduce
the direct outlays of the state in meeting its required matching share of
cleanup costs.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-5
One organization to which interested private parties could contribute
money for the cleanup of hazardous waste sites is a nonprofit association or
corporation, which would be run by a board of directors and a financial
officer. The nonprofit group's account would receive companies' contributions
which would be deductible from their gross income. The association would then
finance cleanup activities at specified sites either by contracting with a
cleanup firm for designated work at these sites or by providing funds to a
state or local government's cleanup operations. The association would not
directly undertake specific cleanup activities at the sites to avoid incurring
liability for any unforseen consequences.
Alternatively, businesses could contribute to a trust fund established to
assist the cleanup operations of state and local governments. The trust fund
would make grants to aid specific cleanup operations of state or local
governments. This arrangement would enhance the public image of the companies
without associating them directly with the problems at sites where cleanup
operations are undertaken. Further, by financing via grants administered by a
trustee, the trust fund would eliminate the possibility that contributing
companies would be held liable for the entire cleanup cost or damages
resulting from cleanup actions. The trust agreement could specify the
criteria which would be considered for the disbursement of funds.
The trust fund approach would allow companies to define carefully what
kinds of sites they wish to support. The creation of a trust fund would have
good public relations value to contributing companies, and would express
industry's desire for expeditious site cleanup. The companies would be
credited with reducing the state and local governments' costs, and with
expediting the cleanup of sites, but would not be associated directly with any
particular site.
Contributions to a nonprofit association or trust fund do not necessarily
reduce the amount of money a company would otherwise pay for cleanup purposes
if the state ultimately chooses to raise the needed funds through taxes or
fees on industry. However, if states allow, companies a partial tax credit
against state hazardous waste taxes for companies' expenditures at sites for
which they were not responsible, there could be a real cost savings to
participating companies in addition to the public relations value of their
expenditures.
4.3.2 Economies of Scale
Both businesses and state or local governments have an interest in
performing the cleanup of hazardous waste sites in the most cost-effective way
possible. This includes capturing any economies of scale which may be
available in cleanup operations, either by sharing equipment and services or
by addressing several sites at once. Economies of scale are possible when a
greater demand for services or equipment can be created by coordinating.the
activities of several parties at one or more sites. Specifically, cost
savings can be realized when a number of parties lease or purchase response
equipment, facilities, or services which, if bought unilaterally, would be too
costly or be used too infrequently to warrant the expenditure. Examples of
-------
I
1
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1
I
4-6
possible purchases by syndicates include mobile labs, mobile treatment units
such as activated carbon treatment systems or incinerators, or heavy equipment.
A syndicate could be formed by the governments of several contiguous
states or locales sharing similar needs at sites, or by a number of
corporations within one or more contiguous states to address multiple sites.
The members of the syndicate could be private parties or state and local
governments. The syndicate would purchase equipment or contract for services
to be made available at several sites. Joint access to equipment or
facilities would give members services at a lower cost than if they were
purchased individually. Savings would accrue to the companies by capturing
economies of scale and to the states by lowering the total cost of cleanup and
thus the state's proportionate share of cleanup costs. If the work is
contracted out, the contractor may also realize significant savings: by
dealing with multiple clients simultaneously, the contractor has lower
transaction costs for acquiring the work; by handling several sites at once or
in succession, the contractor is assured of greater utilization of equipment
and personnel, lowering the per-unit cost of cleanup. Some of these savings
may, in turn, be passed on to the state in the form of lower contract costs.
Economies of scale can be captured most readily when there are multiple
sites which require use of expensive equipment or facilities and when these
items are needed at each site only temporarily. For example, there may be
several sites within a region slated for cleanup activities, some to be paid
for directly by responsible parties and some to be paid for by the state
(along with federal cost-sharing), all of which require the intermittent use
of equipment dedicated to hazardous waste cleanup activities, including mobile
laboratory analysis units, submersible pumps and compressors, containment
vessels and booms, dredges, personnel protective equipment, backhoes,
front-end loaders, cranes, and trucks. Cleanup operations may also require
the use of expensive on-site toxic waste treatment or incineration facilities.
A syndicate of interested private companies could arrange for each member
to contribute to the purchase of common equipment or facilities needed at
several sites. The equipment or facilities would be owned by the companies as
tenants-in-common. An agreement would divide the use of equipment among each
owner and would establish a priority schedule for its utilization at the sites
being cleaned up. The arrangement might also allow a member to exchange the
use of privately-owned equipment, or to transfer equipment from private
ownership to ownership by the companies as tenants-in-common, in return for
the additional use of some equipment already owned by the group. Economies of
scale would be realized by the time-sharing of expensive equipment required
for short-term use by participating parties.
Alternatively, the syndicate could contract with a service company to
acquire and maintain equipment for them, and make it available through a
leasing arrangement to the members and to state and local governments for
their cleanup operations. The service company would hold title to the
equipment, and would claim the appropriate investment tax credits and
depreciation expenses. When negotiating the contract with a service company,
the syndicate could assure that some of those tax savings, as well as the
service company's lower transaction costs and greater market penetration.
-------
I
1
I
I
I
I
I
I
I
I
I
I
i
i
t
i
t
i
i
4-7
provided by dealing with an association of companies or government bodies, are
passed along to the members in the form of lower lease charges. In addition,
the ownership, maintenance, and handling of equipment by a single contractor
may assure proper care, and thus a longer serviceable life, of the equipment.
A syndication of several states' hazardous waste management agencies also
could be used to capture economies of scale in cleanup operations. While
state syndications cannot benefit from the tax savings available to private
companies for cleanup expenditures and equipment investments, they can achieve
some savings through multi-site efforts. For example, several states with
sites in close geographic proximity (such as along a river basin) might agree
to share the services of state-owned equipment or facilities. This assures
the borrowing state of access to specialized or expensive equipment and
assures the contributing state of a higher utilization rate for equipment
needed for a limited time in a cleanup operation. Multi-state syndications
may be desirable in regions where there is a concentration of sites.needing
remedial actions, and particularly where a number of sites are publicly owned,
requiring 50 percent cost-sharing on the part of the state or local
government. There are a number of regional governors' groups (such as the
Coalition of Northeastern Governors and the Southern Governors' Conference)
which could be used to coordinate arrangements between state hazardous waste
management agencies. This approach would be well-suited to the Northeast, for
example, which has a number of National Priority List sites, including 23 of
the 52 publically owned sites on the list.
A review of several oil spill cleanup cooperatives has shown that these
economies of scale can be substantial. Oil refiners, drillers, and shippers
in a number of coastal areas have joined together in organizations or joint
ownership arrangements to make available specialized equipment needed for
response to oil spills by the member companies (and sometimes to spills of
nonmembers as well). These companies have been able to reduce the cost of
establishing and maintaining a response capability (sometimes required by law)
by sharing the use and cost of the equipment. A more thorough discussion of
the oil spill cleanup cooperatives is presented in the case studies in Section
4.6.
4.3.3 Contribution of Equipment and Personnel Services
Interested businesses could also contribute equipment, facilities, or
experienced personnel for cleanup operations, often at a cost less than a
government could contract for the same services from a cleanup firm.
Companies with idle capacity at their facilities or underutilized equipment or
employees could provide certain services for the marginal cost of those
services.
A cooperative association would organize individual company contributions
of equipment, facilities, or personnel for cleanup actions. Idle capacity in
a company's capital plant or equipment stock is expensive to carry and often
cannot be rented out or otherwise utilized, especially during slack economic
times. Examples of facilities and equipment appropriate to remedial actions
include: laboratory analysis units,.high temperature incinerators, personnel
safety equipment, and vehicles capable of hauling special-hazard chemicals or
-------
I
I
I
I
I
I
I
1
I
I
4-8
wastes. While the equipment is being used for cleanup purposes, the company
would continue to deduct depreciation of the property from its gross income as
a business expense. Similarly, companies may contribute the use of qualified
personnel to perform certain services. Their activities may, however, be
limited to support services (such as lab analysis or planning and evaluation
activities) to avoid potential liability to the contributing company for
injury or damages suffered or caused by a worker. Companies may be able to
limit their liability by indemnification or hold harmless agreements between
the owners and users of equipment and services. This is a common practice
among the oil spill cleanup cooperatives, which often use member personnelfor
response activities (see Section 4.5 for a discussion of liability and Section
4.6 for a description of the oil spill cleanup cooperatives).
In the bidding and negotiations with contractors for hazardous waste
cleanup projects, the state would ask for bids based on having private parties
provide a specified portion of the general and special cleanup equipment or
facilities for use by the contractor. Because the cleanup contractors would
be supplied equipment, at least in part, by private parties at no cost to the
contractor, they would not have to secure as much equipment or arrange for
special facilities, which would lower their total costs. In turn, the state
could expect to receive bids from contractors lower than full cost, the
differential being near the value of the equipment or services being supplied
by the private parties. The cost to the contributing companies may in many
cases be less than the dollar value of the contribution if the tax benefits of
the investment are fully realized. The tax benefits available to property
owners, which include the investment tax credit, depreciation deductions, and
t deductions for the interest payments on related loans, can be realized only by
individuals and private'businesses, and not by governments. Given these tax
advantages, a company's contribution of cleanup equipment may be less costly
than a direct cash contribution to support government cleanup operations.
4.3.4 Alternative Financing Arrangements
To provide monies when needed for the states' matching share for Superfund
remedial actions or for other response actions, states may be forced to borrow
funds for a short time in anticipation of future tax revenues or legislative
appropriations for hazardous waste cleanup purposes. Normal state borrowing
procedures may not be available or may be prohibitively costly or difficult to
utilize due to state borrowing restrictions, insufficient collateral to secure
a loan or bond, high interest rates, or high transaction costs. In addition,
the time involved for legislative action on appropriations or bonds may make
it difficult to obtain cleanup funds quickly enough to provide immediate
response when required at sites.
A group of interested private parties could offer to provide the financing
necessary to meet the state matching share for Superfund sites or other state
response actions without the delay or transaction costs incurred in a state
bond issue or bank loan. A group of companies interested in the cleanup of
the sites could advance to the state agency or treasury funds sufficient for
short-term cleanup needs. The advance would be in anticipation of approval of
a bond issue or legislative appropriation, or other revenues dedicated to
hazardous waste activities, which would be used to repay the loan. The
I
I
I
I
I
I
I
I
-------
I
I
I
I
1
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-9
financing could take the form of a lease-purchase as discussed in Chapter 7.
In this case, however, the purchaser/lessor would be a syndication of several
companies. By joining together, several companies may be able to take
advantage of the savings available in lease or purchase arrangements (such as
lower cost loans or tax-exempt interest income) that would normally be
available only to a larger firm. The sponsors of the loan gain public
recognition for aiding the state in expediting the cleanup of sites. In
addition, if any of the tax benefits are passed back to the states in the form
of lower lease or rental payments, it will lower the effective cost to the
state of the cleanup operations.
4.4 SYNDICATION EXAMPLES
The following scenario will be used to illustrate the syndication options
discussed in the previous sections. It provides the background setting for
the specific examples of syndications which could be undertaken.
Along a large eastern river, there are concentrated a number of hazardous
waste sites in need of cleanup and a highly concentrated industrial corridor
of chemical processing plants which are continuing to generate hazardous
wastes. There are additional sites nearby in an adjacent state. There are
four sites where a responsible party has been identified and negotiations for
the cleanup activities are proceeding with enforcement officials. These four
responsible companies and six other companies have been associated with a
dozen other sites in that portion of the state in a series of local~and
national news reports, and the public image of these companies has suffered
significantly. However, direct responsibility for the hazardous wastes at
these 12 sites will be difficult to prove conclusively, so any response
actions at these sites are expected to proceed under the provisions of the
federal Superfund program or under a totally state-funded program.
Furthermore, several of the sites were owned by local governments at the time
of the disposal of hazardous wastes, which means these governments will be
required to pay at least 50 percent of the remedial costs instead of the usual
10 percent matching requirement of Superfund. An aroused public is angered by
the inaction of government and industry, and is demanding immediate steps be
taken to remedy the problems. However, the size of the state cleanup fund and
its cash flows have been insufficient to meet the matching requirements,
forcing the state to seek alternative sources of financing to provide
sufficient funds to secure federal cost-sharing.
All ten companies want to protect and improve their public relations with
regard to hazardous wastes and are concerned about the adverse images fostered
by the local sites. They have met recently and are searching for ways to
participate in the cleanup of these sites and publically demonstrate a
willingness to bear some of the costs of response if they can avoid further
implication for the problems created by the hazardous wastes. The four
companies with potential direct responsibility for site cleanups are
especially interested in lowering their cleanup costs, and the other companies
are concerned about their public image and the burden of expensive cleanups
should they become directly implicated at the other sites in the future.
Several options are available to the interested companies to combine their
resources for cleanup activities and remove some of the financial burden
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
'*s
I
I
t
I
I
4-10
impeding access to federal funds by state and local governments, and to
demonstrate their concern for the safe handling of hazardous materials in the
state, while minimizing the appearance of admitting responsibility for the
hazardous waste problems. These options include:
A syndicate to purchase cleanup equipment;
A syndicate to contract for equipment and response
services; and
A nonprofit association to contribute funds for
cleanup actions.
4.4.1 Option One: Pooled Purchase of Cleanup Equipment
The ten companies decide to jointly provide some of the cleanup equipment
needed at most of the sites in the area (whether the state, one of the four
responsible companies, or the group of companies is undertaking the cleanup
operation) in order to assure that the equipment will be available at minimum
cost to all interested parties. After reviewing the site characteristics, the
companies recognize that all of the sites in the area will require the use of
a sophisticated and expensive mobile laboratory for positioning on-site during
response actions, and that for a number of sites on-site treatment of some
liquid wastes in an activated carbon treatment system would be more
cost-effective than removing the wastes for treatment and disposal. A
decision is made to utilize a mobile carbon treatment system which could be
moved from one site to another. The more frequent (though not continual) use
of other equipment such as excavation machinery, special transport capability,
pumps, monitoring devices, and personnel protection equipment also seem to be
common requirements of cleanup actions at the sites. The coordinated use of
special equipment at a number of sites in the same area captures economies of
scale and lowers the total cost of cleanup. In addition, the tax benefits
available to the companies for their share of the property (including
investment tax credits and depreciation deductions) reduces the out-of-pocket
cost of the expenditures.
The tax advantages of capital ownership can be realized in two ways.
First, the companies can gain the benefits directly through a joint ownership
arrangement. Capital equipment could be acquired by the companies acting as
tenants-in-common. Alternatively, the companies could contract with a service
company to acquire and maintain equipment and to make it available through a
leasing arrangement to member companies or state or local governments. The
service company would hold title to the equipment, and would pass back to the
syndicate some of the tax benefits in the form of lower lease charges. This
is presented below in.option two.
The companies interested in jointly owning cleanup equipment would form an
association and appoint a board of directors, which would decide what
equipment to purchase. Each company would contribute cash for the purchase of
new equipment, or would transfer some of its own equipment to the syndicate.
All property of the association would be owned by the members as
tenants-in-common. Contributions of property would be valued at the fair
-------
I
I
I
I
I
I
I
I
I
I
I
I
J
I
I
I
I
I
I
4-11
market value and would count toward a company's proportionate share in the
tenants-in-common arrangement.
The participating companies would authorize the association to maintain
the equipment and make it available for the use of the state environmental
agency in its cleanup operations or designated contractors of the state, and
to member companies when they are performing their own cleanup operations.
The board of directors of the association would develop an equipment access
schedule based on a list of site priorities developed in conjunction with
state authorities and the companies undertaking their own site cleanup
activities.
The savings obtained by the joint purchase arrangement derive primarily
from the economies of scale in the provision of equipment needed by those
responsible for the cleanup of waste sites. By having the association schedule
the use of equipment, a higher utilization rate can be achieved and the
per-unit cost would be reduced, thus maximizing the benefit of the purchase
outlays. The tax advantages available to the owners help reduce the total
cost of the purchase.
Liability for injuries or damages may arise from the use of the
association's equipment. Liability may, in some areas, be limited by
indemnification or hold harmless agreements between the owners and users of
the equipment. Under such an arrangement, the user of the equipment, whether
one of the owners or not, would agree to indemnify or hold harmless the owners
for any injury or damages resulting from the use of the equipment. Liability
for injury or damages would be the sole responsibility of the user. This is
common practice among the members of the oil spill cleanup cooperatives.
In the following example, the ten companies agree to purchase a mobile
carbon treatment system to be used by the state and the companies in their
cleanup operations. Each of the ten companies contributes $100,000; the
syndicate then purchases $1 million worth of equipment. The participating
companies own the equipment as tenants-in-common, and each member is entitled
to take a 10 percent share of the investment tax credit and depreciation
deductions. The equipment qualifies for 5 year accelerated cost recovery and
an 8 percent investment tax credit (ITC). The marginal corporate tax rate is
46 percent; a 10 percent cost of capital is used to discount the deductions in
future years. The cash flows for any one member are presented in Exhibit 4-1.
Each company's investment represents a cash outflow of $100,000 when the
equipment is purchased. The expenditure qualifies for an investment tax
credit of $8,000, which is deducted directly from taxes payable in the first
year. In subsequent years, depreciation deductions on the equipment would
reduce taxable income, thus reducing the company's tax payments in future
years. This tax shield is worth 46 percent of the depreciation deduction in
each year. These savings are then discounted by 10 percent for each year out
to give a net present value of the investment of $58,237. In other words, the
company made a $100,000 investment at a present value cost of $58,237.
The syndicate may also be able to make use of an industrial development
bond (IDB) in cooperation with the state, if the state has the discretion to
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-12
EXHIBIT 4-1
INDIVIDUAL SYNDICATE MEMBER'S CASH FLOW FOR
$100,000 INVESTMENT
a
Year Investment
0 -100,000
1
2
3
4
5
TOTALS -100,000
Depreciation
Tax Investment
Shield (46%) Tax Credit
+6,900 +8,000
+10,120
+9,660
+9,660
+9 , 660
. +46,000 +8,000
After-Tax
Cash Flow
-100,000
+14,900
+10,120
+9,660
+9,660
+9,660
-46,000
Discounted
(10%)
Cash Flow
-100,000
+13,545
+8 , 364
+7,258
+6,598
+5,998
-58,237
Credits are taken at the end of the year. Year 0 represents the
beginning of the first year.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-13
issue an IDS for such purposes. IDBs are tax-exempt instruments (that is, the
interest they pay does not represent taxable income to the investor), and as
such usually carry a lower interest rate. This would lower the cost.of
raising funds for the syndicate's purchase. However, some of the interest
savings is partially offset by the Internal Revenue Service restriction
allowing only half of the investment tax credit for purchases financed by
IDBs. Some of the limitations on the use of IDBs are discussed in Section 4.5.
The net present value of the investment ($58,237) represents only a
portion of the savings that accrue to the syndicate members. In addition,
each company in the pooled purchase has gained access to $1 million worth of
equipment while financing only $100,000 of the investment. A company acting
individually would have to increase its investment by 10 times to purchase an
equivalent amount of response equipment. Acting together, companies can
obtain the same response capability for a fraction of the cost.
There are additional savings that are not quantified by this example. For
instance, if the equipment is to be used at a number of sites, this assures a
greater utilization rate and lower per-unit or per-site operating cost than if
the equipment were purchased for only one or a few site cleanups. In
addition, coordinated planning for all of the equipment needs at several sites
may allow for the most cost-effective use of each piece of equipment. It
should be evident that the economies of scale available in a pooled purchase
extend well beyond the initial investment savings.
4.4.2 Option Two: Joint Contract for Cleanup Equipment
In an arrangement similar to a joint purchase agreement, interested
companies could form an association to contract for the provision and
maintenance of remedial response equipment. Companies participating in the
association would be assessed an initial membership fee, which would be placed
in an operating fund. In addition, members would pay annual dues according to
an agreed upon equity formula. The association would then contract with a
service company to acquire and maintain equipment; the contractor would lease
the equipment to the association for use in an emergency. The cost of the
initial equipment investment would be amortized in the lease charges from the
contractor over a certain period (36 months, for example). Maintenance costs
would also be specified in the lease. Usage fees would be charged to members
when they call for and use the equipment. Nonmerabers could also be allowed to
utilize the emergency response equipment; in that case, usage fees would be
higher than those paid by members. The association may agree to make response
equipment available to government users at the member rates, or at a special
government rate.
The initial membership fee and annual dues would be deducted by members as
a normal business expense. The contractor, who would hold title to the
equipment, would claim the appropriate investment tax credits and depreciation
expenses. When negotiating the contract with a service company, the
association could assure that some of those tax savings, as well as the
service company's lower transaction costs and greater market penetration
provided by dealing with an association of companies, are passed along to the
member companies in the form of lower lease charges.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-14
4.4.3 Option Three: Nonprofit Association
Alternatively, the ten concerned companies could decide to establish a
nonprofit association to expedite cleanup of local hazardous waste sites,
counteract adverse publicity, and facilitate use of federal funds by
alleviating some of the fiscal hardships imposed on the state and local
governments by the 10 percent and 50 percent cost-sharing requirements of the
Superfund program. The board of directors consists of one representative from
each company; a local bank is retained as a financial officer. The board
investigates the current and future needs for site cleanup funding, and the
members agree to support a certain level of association activities.
The board of directors establishes an interest-bearing trust fund with an
initial endowment and engages their bank to act as fiduciary and trustee for
the disbursement of the funds according to a specific plan. Association
members contribute to the fund according to an agreed upon proportional share.
The fund, once it is endowed and a trust agreement has been made, is then
independent of the association. In the trust agreement, the trustee is
authorized to receive applications from the state environmental agency and
from local governments for grants to aid specific cleanup operations. The
trust agreement would define waste site evaluation criteria for approving a
grant request. The amount of funds dispersed in each grant would be based on
the total cost of cleanup and .the cost-share of the government unit applying
for funds, perhaps limited to a fraction of the total cost being covered by
the applicant.
Using the trust fund approach, companies are able to define carefully what
kind of sites they wish to support and can in this way avoid future pressure
to fund specific site cleanups. The creation of a fund for the benefit of the
government may have especially valuable public relations results by expressing
industry's concern for expeditious site cleanups. The companies will be
credited with contributing to several cleanups without being associated
individually with any of the sites.
4.5 ORGANIZATIONAL, FINANCIAL, AND LEGAL CONSIDERATIONS
4.5.1 Forms of Organizations
There are several organizational forms a syndicated operation could take,
and different financial and legal implications for the companies involved.
Those which are considered below include:
Partnership;
Joint venture;
Limited partnership;
Business corporation;
Nonprofit association or corporation; and
Tenants-in-common. .
Partnership. A partnership is an association of two or more persons or
corporate entities organized to carry on a business for profit as co-owners.
Partnerships are usually a formal agreement and are locally registered.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-15
Partners share control and unlimited liability and divide profits evenly or
according to a partnership agreement. The assets subject to liability for
business actions undertaken for the partnership by any member include the
personal wealth of all members and are not limited to the value of a member's
share in the partnership. Profits (or losses) of the partnership are
distributed to members directly and are taxed as personal income to the
partners. Further, tax deductions and credits for property of the partnership
accrue to the partners individually according to the shares of the partnership
agreement.
Joint Venture. A joint venture is a business undertaking by two or
more persons or corporate entities organized for a particular profit-making
venture (and dissolving upon its completion) and similar to, though often less
formal than, a partnership. Decisions are made jointly, as in partnerships,
but the authority of a member to bind another member without direct consent is
limited by agreement and by the narrow scope of the partnership activities.
The liability of each member for actions of the partnership is unlimited.
Joint venture profits or losses are distributed to members and then taxed as
members' income at whatever rate applies.
Limited Partnership. A limited partnership is a partnership in which
there is at least one general partner and at least one limited partner.
Limited partners are limited in their ability to control business decisions;
management is provided by the general partner(s) while limited partners may
contribute cash or capital but not services. The personal liability of
limited partners for actions of the partnership is limited to their share of
the business. Limited partners may not take an active part in the control of
the business and must make clear to creditors their status as limited
partners, otherwise they may be subject to unlimited liability. General
partners are always subject to unlimited liability. Partners contribute to
the partnership's ventures and receive profits according to their share of
interest in the partnership. Most states have adopted a form of the Uniform
Limited Partnership Act which includes the above restrictions.
Business Corporation. A business corporation is a formal, registered,
and potentially perpetual enterprise which operates for the benefit of
shareholders and is directly taxed. Shareholder control of the business is
indirect, via the election of a board of directors which makes most business
decisions. Liability for debts and actions of the corporation is limited to
the value of the assets of the corporation itself. Thus, shareholders'
liability is indirect and limited to the value of their stock in the
corporation.
Profits of the corporation are taxed first as corporate income and second,
if distributed, as personal income to shareholders. Tax credits and
deductions to corporate tax liability pass indirectly to shareholders through
increased dividends and/or as increases in the value of the stock. Thus, if a
corporation ordinarily has no profits to distribute or is organized as a
nonprofit, there is no tax liability against which a tax credit or deduction
can be taken and shareholders receive no such tax benefit.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-16
Nonprofit Association or Corporation. These groups qualify under the
Internal Revenue Code (Section 501) as being exempt from federal taxation in
their primary activities (e.g., corporations and foundations organized and
operating exclusively for charitable or scientific purposes, civic leagues or
organizations not organized for profit but operated exclusively for the
promotion of social welfare, etc.). Under the provisions of state law,
nonprofit groups can be organized similar to partnerships but without the
vesting of shares in profits or property. Unless organized as a nonprofit
corporation, liability for actions taken toward the primary purpose of the
group with the members' authorization might be extended to the individual
members of the association.
Since a nonprofit association or corporation does not earn money or pay
taxes, members of the organization.receive neither dividends nor tax benefits,
such as depreciation deductions and tax credits, from the organization's
activities or ownership of property. Cash contributions to groups organized
and operated exclusively for charitable purposes may be deductible from the
taxable income of the contributor, under Section 501(c) of the Internal
Revenue Code. Contributions of property are valued at market value, however,
contributed services are deductible only to the extent of out-of-pocket
expenses incurred in providing the services.
Tenants-In-Common. A group of individuals or companies can own
property jointly for their own purposes without organizing as an independent
business enterprise. One form of joint ownership is a tenancy-in-common. The
arrangement does not earn income and is not taxed; it is not a business
organization, but rather an ownership arrangement. The federal tax status of
property owned as tenants-in-common is the same as that of partnership
property; the tenants-in-common receive the tax benefits of ownership
individually, according to their share of ownership. The tenants-in-common
could agree that the property be used as directed by authorized managers as
part of the ownership agreement or as a separate contract.
Each of the tenants-in-common may be liable for damages caused in
conjunction with the use of the property. However, liability may be limited
to cases where one or more of the property owners has been negligent, for
example, in maintaining safe equipment. Authorized users of the property
could be required to indemnify and hold harmless the owners, and thereby would
have the primary liability for any damages caused by their use of the property.
4.5.2 Financial and Tax Incentives
The cost of hazardous waste cleanup activities is often a major factor in
a company's willingness to participate in a syndicate. Many firms think of
the cost of waste cleanups as dollars taken directly out of profits.
Actually, cleanup costs are treated no differently than any other expense
incurred by the firm. Like other expenses, they are deducted from income
before taxes are determined, or credited against the firm's tax liability,, so
that each dollar spent on cleanup activities is partially offset by lower
corporate income taxes due. In addition to tax considerations, there are also
financing methods available which can effectively lower the cost of cleanup
activities. Tax-exempt financing made available through a governmental unit
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-17
can lower the cost to participating firms of raising funds for cleanup
expenditures. Leasing arrangements (discussed in Chapter 7) can also lower
the cost of raising funds for expenditures for cleanup purposes.
This section describes the tax and financing incentives available to
companies which can offset some of their cleanup costs. The incentives fall
into three broad categories: deductions from income1 (either as a direct
expense or depreciation deduction); credits against taxes owed;2 and
tax-exempt financing. Each of these categories is explained in more detail
below.
Deductions from Income. Section 62 of the Internal Revenue Code allows
taxpayers to deduct certain costs incurred to carrying on a trade or business
prior to computing taxable income. These deductions may be taken either as
direct expenses in the year incurred or as capital cost recovery
(depreciation) deductions over a period of several years.
Direct expenses include expenditures for personnel and yearly operating
and maintenance costs. Personnel expenses are deductible if they constitute
reasonable allowances for salaries or for other compensation for personnel
resources. Operating and maintenance costs are deducted in the year made if .
they are ordinary and necessary for carrying on a trade or business. In
addition, contributions to charitable organizations are deductible in the year
made, as are the payments of any state fees or taxes (such as waste end taxes).
Investments made in depreciable, tangible property (recovery property) and
placed in service during or after 1981 can be recovered through the use of the
Accelerated Cost Recovery System (ACRS). Property purchased and put into
service prior to 1981 is subject to the old depreciation schedules.
Depreciation deductions, in effect, allow a firm to recover over time some of
the costs of the investment by reducing the firm's taxable income. Prior to
1981, the recovery period was linked to an estimate of the useful life of the
equipment. The new ACRS methods often allow costs to be recovered much more
quickly, which can provide additional savings to firms making capital
investments.
The Accelerated Cost Recovery System is complex, and a detailed analysis
is beyond the scope of this report. However, there are several features of
ACRS that are important to mention here. First, eligible property, called
"recovery property," includes investments in tangible and intangible personal
and real property, with certain limitations. Second, the period of cost
recovery depends upon the selected recovery method and the type of property.
For example, under the regular ACRS method, the recovery period is 3, 5, 10,
or 15 years, depending upon the type of property (e.g., a liquid waste hauling
*A "deduction" decreases the taxable income of a firm.
2A tax "credit" decreases the income tax due; thus each dollar of a tax
credit saves a dollar of taxes that would otherwise be owed.
-------
I
I
I
I
I
I
i
i
i
i
i
i
i
i
i
i
i
i
i
4-18
truck, an incinerator, or a treatment facility). The type of property and
recovery period will determine the amount of the investment to be recovered
each year. For example, for 5 year personal property, the cost recovery
schedule is 15 percent in the first year, 22 percent in the second year, and
21 percent in the next 3 years, for a total of 100 percent in 5 years.
Investment Tax Credits. Investments in eligible property may qualify
for an investment tax credit (ITC). Tax credits are applied directly to
corporate taxes due, thus reducing dollar for dollar the taxes that would
otherwise be owed. There are several different kinds of credits that may be
applicable to investments made for hazardous waste cleanup purposes. These
include: the regular investment tax credit; the qualified rehabilitation
credit; and the tax credit for incremental research expenditures.
Under Sections 46 and 48 of the Tax Code, taxpayers can claim the regular
investment tax credits for qualified investments in recovery property and
other kinds of depreciable property defined in Section 38 of the Code. The
amount of the credit varies according to the nature of the property: 6
percent of qualified investments for 3 year property (e.g., light general
purpose trucks, some earth excavation equipment, and property used in research
and development); and 10 percent for 5, 10, and 15 year property (e.g., an
activated carbon treatment system, a building containing waste treatment
equipment). The maximum amount of the credit is limited to $25*000 of the
taxpayer's tax liability plus 85 percent of the tax liability in excess of
$25,000. If the taxpayer cannot use the credit because of tax liability
limits, then the tax credit may be carried back to the 3 preceding years or
carried forward for up to 15 years.
There are several additional restrictions on the use of the investment tax
credit. If the ITC is taken, then the basis of the property for the purpose
of depreciation must be reduced by 50 percent of the value of the tax credit '
(for example, the basis is reduced to 95 percent of the purchase cost when a
10 percent ITC is taken). If taxpayers elect a 2 percent reduction in the ITC
(say, from 10 percent to 8 percent), they need not make a basis adjustment.
The ITC may be claimed only for property purchased and used by a business
taxpayer. Property used by nonprofit organizations or government units does
not qualify for the ITC.
Tax credits are also available for substantial rehabilitation of real
property as long as: (1) the expenditures are capitalized and are made for
real property with a 15 year recovery period; (2) improvements have a useful
life of 5 years or more; and (3) the qualifying^expenditures over the tax year
and the preceding year exceed the greater of the adjusted basis of the
property or $5,000. Qualifying expenditures in an older industrial building
where hazardous chemicals are stored might include such remedial measures as
installation of a sump and sump pump, a fire detection and control system, new
storage tanks, and measures to secure against entry. Such measures may be
especially appropriate in the interim while a remedial action is being
designed. The rates for the credit vary between 15 and 25 percent depending
upon the age and characteristics of the building (e.g., with a 15 percent
rehabilitation tax credit, qualifying expenditures of $50,000 would actually
cost $42,500). A taxpayer cannot claim both the rehabilitation credit and
-------
I
I
I
I
I
I
i
i
i
i
i
i
i
i
i
i
i
i
i
4-19
regular investment tax credit for the same property that qualifies for the
rehabilitation credit.
Incremental research expenses for the development of hazardous waste
remedial actions may also qualify for a tax credit. Section 44F of the Tax
Code provides that firms may claim as a tax credit 25 percent of the increase
in qualified research expenses for the tax year that exceeds the average
qualified research expenses in a base period (the two years immediately
preceding the tax year). If a firm contracts for the research and development
work, only 65 percent of the eligible research expenses are eligible for the
tax credit.
Limitations on claiming the research and development credit include the
following: (1) the base period research expense cannot comprise less than 50
percent of the qualified research expenses for the tax year for which the
credit is computed; (2) qualified expenses do not include expenses incurred in
connection with a business; and (3) qualified expenses do not include costs
incurred in connection with ordinary product testing or the inspection of
materials and products for quality control.
Tax-Exempt Financing. Tax-Exempt Industrial Development Bonds (IDBs)
may be made available to provide participating companies with low-cost
financing of some remedial actions. A tax-exempt IDB is a debt issue that
allows a corporation to borrow at the municipal bond rate rather than at the
higher corporate rate. The tax-exempt interest rate is, on the average, 2
percent lower than the corporate rate. During the 25 to 30 year term of the
bond, the savings in interest costs can be substantial. The availability of
low-cost financing should be particularly attractive to companies during
periods of high interest rates.
IDBs are nominally structured as municipal bonds and are issued by a state
or local authority according to the governing state laws. The proceeds from
the sale of these bonds must be used for a "public purpose," which has been
defined to include the construction of industrial or commercial facilities and
the purchase of pollution control devices. The facility is then leased to a
private corporation through the arrangement of a municipal lease, installment
sale, or loan. The lease, loan, or installment sale payments from the
corporation are specifically structured to cover all the costs of the bonds,
including principal and interest payments. -The bonds, therefore, are backed
solely by the corporation (and not by the issuing government unit) and as such
are actually corporate credits.
State laws, not the Internal Revenue Service Code, determine who may issue
an IDB and how they are structured. The issuing authority varies from state
to state. For example, in California, the Pollution Control Financing Agency
can issue IDBs for pollution control. In New York, the Environmental
Facilities Corporation has the authority to issue IDBs on the behalf of
private companies. In some states, government subdivisions (such as
municipalities) may issue their own IDBs, while in others only the state can
issue IDBs. IDBs are not available automatically; they must be approved by
the elected representatives of the government unit issuing the bonds
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-20
(following a public hearing), or by voter referendum and by the government
unit issuing the bonds in the area where the site is located.
Not all IDBs are tax-exempt; the IRS reserves the right to rule on the
tax-exempt status of an IDB according to Section 103 of the Federal Tax Code.
Current interpretations of the Federal Tax Code expressed in proposed IRS
regulations3 place limitations on the tax-exempt status of IDBs for
financing hazardous waste facilities. According to the Tax Code, issues are
tax-exempt only if they are used to finance air or water pollution control
facilities and sewage or solid waste disposal facilities. This definition is
simplified by proposed IRS regulations which require that a facility must be
used to abate or control pollution and that the pollution must be "realized"
if it is to be eligible. A facility that is designed to prevent the creation
of pollution is not eligible for tax-exempt status.
Despite the fact that these regulations are only proposed, and have yet to
be promulgated as final rules after almost eight years (the regulations were
proposed in August 1975), their existence has led to the recommendation that
industrial development or revenue bonds are not a viable financing mechanism
for the construction of hazardous waste management facilities because they
would not qualify as tax-exempt issues. In a study for the New York State
Environmental Facilities Corporation,* it was found that a state-sponsored
proposal for a regional hazardous waste management facility would not be
eligible for tax-exempt IDB financing, under the IRS Tax Code. The proposed
facility was viewed as property which would not control realized pollution,
but would prevent the possible release of pollutants, including hazardous
substances. It was being proposed to increase the off-site commercial
hazardous waste disposal capacity for generators of hazardous waste within the
state.
There are, however, instances where cleanup activities have been financed
by tax-exempt IDBs. The California Pollution Finance Authority has issued
IDBs to finance cleanup actions to remedy contamination of drinking water
wells and to clean up polluted drinking water from lumber mill runoff.
Excavation of contaminated soils from an abandoned hazardous waste site has
also been financed by tax-exempt IDBs. New York's Environmental Facilities
Corporation has issued an IDB for the development of wastewater treatment,
incineration, and burial facilities for General Electric Corporation.
Clearly, tax-exempt IDBs can be used as a mechanism for financing at least
a portion of hazardous waste cleanup activities. For example, in a situation
where a dump site has resulted in groundwater contamination, a typical
response action might be to contain the contaminated groundwater plume by
constructing an impermeable slurry wall around the site and capping the site
3 Federal Register, Vol. 40, No. 162.
* Technical, Marketing, and Financial Findings for the New York State
Hazardous Waste Management Program. Camp, Dresser & McKee, March 1980.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-21
to prevent clean water from entering the dump area and creating more
pollution. The contaminated plume might then be treated by pumping
groundwater through a treatment system designed to remove the specific
contaminants and reinjecting the treated effluent back into the ground. The
portion of this project that "controls" the "realized" pollution, that is, the
slurry wall, the extraction well, the treatment system, and the injection
well-, would be eligible for tax-exempt financing under the current"
interpretation of the Tax Code. The surface capping of the site could be
construed as a "preventive" measure, thus 'disqualifying it from tax-exempt
status.
There are additional restrictions on the issuance and use of tax-exempt
IDBs, including the following:
Collateral. Payment of the principal or interest
on the obligation must in whole or in large part either
be secured by an interest in the property used in a
trade or business or must be derived from payments
resulting from the use or future use of property or
borrowed money in a trade or business.
Small Issues. The Tax Equity and Fiscal Responsi-
bility Act of 1982 eliminated small issue IDBs entirely
after 1986. Until that time, it is possible to issue
"small issue" IDBs, that is, issues of $1 million or
less, or, at the election of the issuer, $10 million or
less. There are no restrictions on the pollution
control functions of "small issue" IDBs. These capital
limits do not include research and development
expenditures if a firm elects to deduct these
expenditures currently. The elimination of small issue
IDBs after 1986 provides an incentive for prompt
cleanup activities where IDE financing is possible and
is being offered by the government.
Bond maturity. The average maturity of all IDE
obligations of an issue is limited to no greater than
120 percent of the average economic life of the assets
financed by the bonds. Land is presumed to have a
useful life of 50 years.
4.5.3 Liability
Syndications undertaking hazardous waste cleanup activities may be liable
for injuries or damages that result from their actions. Concern for potential
liability and the costs of defending against such liability may inhibit
companies from participating in a syndicate. While concern over liability is
warranted, there are also protections that may effectively limit a company's
exposure to liability. The following discussion is designed to clarify the
risk of liability for syndicates assisting hazardous waste response actions
and to identify methods of limiting liability and spreading the risk of
liability. The discussion is organized around the following four issues:
when liability might be incurred at a site (before, during, or after a cleanup
-------
I
i
i
i
i
i
i
i
i
i
i
i
i
i
i
i
i
I
i
4-22
operation) and the type of harm that is involved; the sources of liability for
the resulting harm; the possible defenses to liability; and the methods of
limiting the liability of the syndicate and its members.
Period of Liability and Types of Harm. Liability for injuries or
damages may arise at different times at a site, depending on the situation and
the actions undertaken at the site. In particular, liability can be
categorized according to three time periods:
(1) Liability for causing or contributing to the
environmental problem at the site. This includes
CERCLA Section 107 liability for response costs and
natural resource damages;
(2) Liability arising during the response for actions
(both on-site and off-site) taken in connection with
response. This includes injuries to workers or third
parties for acute injuries caused by accidents, or
property damage caused by accidents or the release of
hazardous substances; and
(3) Liability that occurs after completion of the
response, usually caused by an inadequate or failed
remedy. This includes the cost of repairing or
replacing the remedy or of injury or damages to
workers or third parties, including chronic or
long-latent illnesses caused by exposure to hazardous
substances.
This section does not.discuss liability for response costs or natural
resource damages. While it is important to note that responsible parties are
liable for response costs and natural resource damages, this liability exists
regardless of the formation of syndicates to undertake cleanup activities.
Syndicate members may, at times, include persons responsible for the original'
problem. Indeed, their desire to find a more cost-effective way to provide
cleanup services at a site may motivate them to join or form a syndicate.
However, their liability under CERCLA Section 107 does not extend to other
members of the syndicate, and has no bearing on the liability of syndicate
members for injuries or damages caused by the syndicate's activities.
Three types of harm may be caused by a syndicate's participation in
response actions:
(1) Damages to workers engaged in the cleanup or in
cleanup-related activities;
(2) Costs of repair or replacement of inadequate or failed
remedies; and
(3) Harm to third parties, including the costs of personal
injury or death, or the loss of personal or real
property.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-23
Persons engaged in cleanup operations or related activities may be injured
by exposure to hazardous substances or other types of accidents. The harm may
be caused by on-site or off-site work. Injuries to the workers may include
acute or chronic illness (immediate or long-term), disability, death, or loss
of wages. Liability for these injuries, in many cases, will be governed by
state worker compensation laws.
The remedy at a site may be inadequate or may fail to mitigate the
problems created by the hazardous wastes. For example, a clay liner at a
disposal site-may be improperly designed or constructed and fail- to contain
the wastes. The party responsible for the failure may be required to repair
or replace it, or take other measures at the site, such as install a
groundwater decontamination system, to assure that the"danger is completely
removed. The need for rectification will usually occur after the remedy has
been completed.
Third parties may be injured by accidents during the response actions or
by a failed or inadequate remedy. The scope of harm may include death,
personal injuries, lost wages, medical expenses, real or personal property
damage, and natural resource damages. Persons exposed to hazardous substances
may develop diseases with long latency periods; thus, the extent of liability
for injuries to third parties may not be known until many years after the
completion of the cleanup action.
Sources of Liability. The source of liability for harm caused by a
syndicate's participation in a response action will be determined largely by
the type of harm involved. More specifically:
Worker injuries are governed by state workers'
compensation laws;
* Liability for repair or replacement of a remedy is
usually governed by contract provisions or the
principles of contract law;, and
Liability for third party damages are determined by
various state and federal laws.
Liability for harm to workers is broadly defined by state worker
compensation laws. All states have established workers' compensation
systems, In 47 states and the District of Columbia employers are required by
law to participate in the systems.5 In the other states participation is
voluntary. The systems include several key provisions:
Relief from the system is generally the injured
worker's exclusive source of compensation;
5Lawson, "Victim Compensation: The Policy Debate," Government Research
Corporation, Jan. 1983, p. 33.
-------
I
I
I
I
I
I
I
1
I
I
i
I
i
i
i
i
i
i
i
4-24
Compensation is awarded on the basis of strict
liability standards. The employee's negligence or the
employer's lack of negligence will not bar recovery;
Employers are required to obtain insurance or self
insure to cover their liability;
Some types of employers (e.g., those with less than a
certain number of employees) or types of employees
(e.g., farmworkers) are not required to participate in
the system. The exemptions vary considerably from
state to state; and
The amount of compensation that can be awarded is
limited by a formula established by statute.
Workers engaged in response actions who suffer acute injuries as a result
of their employment are usually limited to seeking compensation through the
workers' compensation systems. Workers who suffer chronic diseases caused by
their employment, on the other hand, have traditionally been unable to obtain
recovery through that system, and have sought relief with some success in the
courts. Liability in those court actions often will be based on the same laws
that serve as the source of liability for damages to third parties.
"If~a syndicate or one of its members provides workers to assist cleanup
operations, it will need to determine who is responsible for providing
workers' compensation coverage for those employees. In the absence of
required coverage, injured workers are usually able through the courts to seek
unlimited compensation directly from the employer. The laws of the particular
state where the company is located or where the response action takes place
will govern that responsibility. Furthermore, state statutes will determine
the ability of injured workers to seek compensation in the courts for chronic
diseases contracted as a result of employment in the cleanup operations.
Liability for failed or inadequate remedies, the second type of harm,
usually will be governed by contract provisions and the law of contracts, the
Resource Conservation and Recovery Act (RCRA) or similar state regulations,
and/or statutes concerning emergency cleanup of hazardous waste spills or
releases. The contracts for response actions at. specific sites will determine
the responsibility of the contractor and subcontractors for repair or
replacement of a remedy that fails. If the contractor fails to install the
remedy according to the specifications of the contract, then the contractor
would be responsible for the costs of repairing or replacing the remedy.
Under the provisions of contract law, if the government selects the remedy
to be installed at a site and a syndicate agrees to to install that remedy and
properly installs the remedy in accordance with the specifications of the
agreement, then the syndicate would not be responsible for the performance or
adequacy of the remedy. On the other hand, if the syndicate assisted the
government in the selection of the specific remedy and thereby, or otherwise,
implicitly or explictly warranted that the remedy would be proper for the
site, then the syndicate could be liable for correcting the mistake.
-------
i
I
i
i
i
i
I
i
i
i
i
i
i
i
i
I
i
i
i
4-25
In some response actions the nature of the remedy and the responsibility
for the performance and adequacy of the remedy may be governed by RCRA
regulations or state government regulations. In those cases, syndicates would
need to refer to the applicable regulations to determine the parties liable
for injuries or damages.
Litigation by third parties may also require the repair or replacement of
failed or inadequate remedies. As part of the relief granted to plaintiffs
seeking either compensation for injuries caused by release or prevention of
injuries caused by threatened release of hazardous substances from sites where
response actions have been completed, a court could require the responsible
party to abate the danger by repairing or replacing the remedy.
Liability for harm to third parties is based on federal and state statutes
and common laws. The most likely source of liability would be state law
because relief for personal injuries has traditionally been the domain of
state, not federal, law. Liability for harm to third parties varies
considerably from state to state, particularly when the harm has been caused
by exposure to hazardous substances. Most states have enacted statutes
designed to prevent releases of hazardous substances and to determine
responsibility for the cleanup of releases that do occur, but only a few have
enacted statutes specifically designed to enable persons injured by exposure
to hazardous substances to recover compensation for their damages.6 Thus,
in most cases injured third parties must seek compensation by relying on
common law theories of tort law or statutes which reiterate those causes of
action.
Relief under state common law could be based on strict liability,
negligence, nuisance, trespass, or product liability theories. The
applicability and terms of those causes of action vary considerably from state
to state. Moreover, the common law of liability for hazardous substances is
not well developed. Few cases have been successful, in part because of
barriers to recovery caused by difficulties of establishing causation,
restrictive statutes of limitation, and scientific uncertainty.7 Many
important issues have yet to be determined, including the standard of proof
(strict liability or negligence) and the allocation of culpability among
numerous defendants. Persons considering establishing or joining syndicates
to assist reponse actions must recognize both the uncertainty in the -law and
the possibility that future judicial decisions or legislation will have a
significant impact on potential liability for harm to third parties.
6"Injuries and Damages from Hazardous Wastes Analysis and Improvement
of Legal Remedies: A Report to Congress in Compliance with Section 301(e) of
the Comprehensive Environmental Response, Compensation, and Liability Act of
1980 (P.L. 96-510) by the 'Superfund Section 301(e) Study Group,'" Committee
Print No. 97-12, Senate Committee on Environment "and Public Works,. August,
1982 (2 Vols.), Vol. II, Appendix E.
7 Ibid., Vol. I, pp. 25-146.
-------
I
I
I
i
I
i
I
i
i
i
i
i
i
i
i
i
i
i
i
4-26
The principal source of federal liability for injuries caused by release
of hazardous substances is CERCLA. That statute provides an extensive strict
liability scheme, yet that liability is only for response costs and natural
resource damages. CERCLA currently excludes liability for personal injuries
or real or personal property damages.
Liability under CERCLA generally does not apply to response actions.
Section 107(d) states:
No person shall be liable under CERCLA for damages as
a result of actions taken or omitted in the course of
rendering care, assistance, or advice in accordance with
the National Contingency Plan or at the direction of an
on-scene coordinator appointed under such plan, with
respect to an incident creating a danger to public health
or welfare or the environment as a result of any release of
a hazardous substance or the threat thereof. This
subsection shall not preclude liability for damages as a
result of gross negligence or intentional misconduct on the
part of such person. For the purposes of the preceding
sentence, reckless, willful, or wanton misconduct shall
constitute gross negligence.
Thus, syndicates assisting response actions will generally not need to be
concerned about liability under CERCLA, however they should recognize that the
preceding exemption applies only to CERCLA liability; it does not create an
exemption from liability under other statutes or common laws.
The other major federal statute with implications for syndicates assisting
response actions is RCRA. That statute employs a regulatory scheme to control
the operation and closure of hazardous waste management facilities. In some
cases the management of sites after response actions have been completed may
be governed by-RCRA regulations. RCRA does not create liability for harm to
third parties, nevertheless, compliance with the regulations may be important
for liability determinations under other laws. For example, the failure to
comply with the regulations may warrant a finding of negligence.
The federal common law is not likely to be a source of liability for harm
to third parties. The federal common law is only partially developed and
recent U.S. Supreme Court cases may have undercut its applicability in
hazardous waste cases.*
Federal law, as well as state law, may change considerably in the future.
The changes may have important ramifications for the development of
syndicates, particularly with respect to liability for harm to third parties.
'Hinds, "Liability Under Federal Law for Hazardous Waste Injuries,"
6 Harvard Environmental Law Review I (1982); Milwaukee v. Illinois, 101 S.
Ct. 1784 (1981).
-------
i
I
I
i
i
i
i
i
I
i
i
i
i
i
i
i
i
i
i
4-27
Recent proposals before Congress would establish new sources of liablity for
damages caused by releases of hazardous substances. Furthermore, changes in
the law after the completion of response actions may be applied retroactively
in a manner that affects the liability for harms caused by cleanup efforts.
Defenses to Liability. Syndicates which assist cleanup operations
will not necessarily be held liable for all the harm caused by the cleanup and
related activities. Rather, they may be held liable for the harm caused or
contributed to by their participation in the cleanup. Thus, to the extent
that any harm is caused by the cleanup activities, the syndicate may be found
responsible or partially responsible for the acts or omissions that caused the
harm. Syndicates may claim one of two defenses to liability: first, that
they did not act negligently in following a federal or state cleanup plan; and
second, that they are protected by Good Samaritan laws.
Federal or state responsibility for and control of cleanups may make
syndicates and other parties who assist or are employed in the cleanup effort
liable only for the damages they cause through negligence. Federal or state
government liability for damages caused by response actions may be judged by a
negligence standard because the actions are conducted pursuant to a public
duty imposed by statute. Therefore, persons who assist the response may not
be liable for damages they non-negligently cause. For example, a company that
supplies or donates equipment that turns out to be inappropriate for the type
of hazardous substances at the site, may not be liable unless it knew or
should have known that the equipment was inappropriate, or unless it was
responsible for the. government's choice of equipment.
Good Samaritan laws may also provide a defense to liability. Without
special provisions in the law, persons are discouraged from voluntarily
protecting the interests of others because of the fear of being liable for
harms caused by their assistance. All but three states (Kentucky, Vermont,
and Washington) have enacted Good Samaritan laws to reduce this
disincentive.9 These statutes are generally similar to Secion 324A of the
Restatement of Torts, Second, which states:
One who undertakes, gratuitously or for consideration, to
render service to another which he should recognize as
necessary for the protection of a third party or his
things/ is subject to liability to the third person for
physical harm resulting from his failure to exercise
reasonable care to protect his undertaking, if
(a) His failure to exercise reasonable care increases
the risk of-such harm, or
9Myers, "The Need for Good Samaritan Laws In Hazardous Materials
Emergencies," 1982 Hazardous Materials Spills Conference Proceedings, p. 357.
-------
I
I
I
i
i
i
i
i
I
i
i
i
i
i
i
i
I
i
i
4-28
(b) He has undertaken to perform a duty owed by the
other to the third person, or
(c) The harm is suffered because of reliance of the
other or the third person upon the undertaking.
The statutes do not, however, insulate Good Samaritans from liability for
gross negligence or intentional misconduct.
The applicability of these statutes to a syndicate's voluntary assistance
in cleanup efforts needs to be examined further. Unresolved issues include:
Whether the urgency of a response action is
sufficient for the Good Samaritan laws to apply;
The effect of membership in the syndicate of one or
more parties responsible for the original environmental
problem; and
Whether the laws apply when the government is
directing the effort.
In recent years four states (South Dakota, Tennessee, Texas, and
Washington) have created Good Samaritan laws designed specifically to
encourage volunteer assistance to emergencies involving hazardous
substances.1" Other states have enacted Good Samaritan laws for compressed
gases or liquified petroleum gas.11 These laws may protect syndicates from
liability in limited situations. States could enact Good Samaritan laws to
provide protections from liability for persons engaged in*response actions
under the direction of the state or federal government as an incentive to
companies to participate in syndicates for hazardous waste cleanup activities.
Methods of Limiting. Liability. Syndicates may be able to limit their
exposure to liability in one of three ways: first, by limiting their
activities to the provision of funding, or by undertaking only certain
response actions at a site; second, by selecting an organizational structure
which limits the liability of the members; and third, by securing insurance or
indemnity agreements for their actions. Each of these mechanisms is described
below. A discussion of oil spill cleanup cooperatives serves to illustrate
the use of these mechanisms to limit the liability of members of the
cooperatives. In addition, the use of indemnity agreements by federal and
state governments when contracting for cleanup services is examined.
1D National Conference of State Legislatures, Hazardous Waste
Management; A Survey ofState Legislation, 1982.
11 Ibid.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-29
The nature of a syndicate's participation in response actions will
determine the types of harm it may be liable for, if any. A syndicate could
avoid the threat of liability by contributing only money to the effort. A
syndicate established to donate or channel money to others engaged in the
actual cleanup would not be liable for harm caused by the response action.
If a syndicate participates in the actual cleanup or related efforts, then the
nature of its participation will determine the types of harm for which it
could be found liable. If the syndicate does not assist in the selection,
design, construction, or maintenance of the remedy at a site, it would not be
liable for the costs of repairing or replacing a failed or inadequate remedy.
If the syndicate chooses to lend equipment to others engaged in the cleanup,
then it may be liable only for the harm caused by the equipment, and even then
only to the extent that the equipment was defective or improperly maintained,
or to the extent a warranty was violated. If the syndicate does not supply or
employ workers engaged in the cleanup or related activites, it would not be
liable for obtaining workers' compensation coverage for those persons.
The organizational structure of a syndicate would determine the extent to
which its members would be liable personally for the organization's
liabilities and debts. The syndicate, as an entity, cannot shield itself from
responsibility for liability; syndicate assets are routinely available to
persons with unsatisfied claims against the syndicate. However, the extent to
which claimants can reach the personal assets of syndicate members depends on
the structure of the organization. For example, if the syndicate is organized
as a corporation, then its members, the shareholders, would not be liable for
corporate obligations beyond the value of their shares in the corporation.
Alternatively, if the syndicate is organized as a partnership, then each
member or partner would be personally subject to unlimited liability for the
liabilities and debts of the partnership that are not satisfied by the
partnership assets.
Most forms of organization are available to both profit-making and
nonprofit groups. Thus, the defenses to personal liability based on
organizational structure apply to both types of syndicates.
Syndicates assisting response actions may be able to spread or shift the
costs of liability they may incur by obtaining insurance or using indemnity
(hold harmless) agreements. Their ability to use these devices will depend on
the type of harm for which they may be liable.
Syndicates which provide or employ workers for cleanup activities would
have little difficulty obtaining insurance for harm to those workers. As
previously mentioned, state workers' compensation laws may require the
syndicate to obtain insurance or to self insure against workers' claims.
State operated insurance pools are often created by those laws.
A syndicate must assure that the required coverage is obtained. If the
required coverage is not obtained, then injured employees may sue in court for
unlimited damages. Furthermore, other insurance policies the employer may
have often will exclude coverage of harm to workers required to be covered by
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-30
workers' compensation,12 In cases where workers are exempt from coverage,
or in states where coverage is optional, employer's liability coverage will
generally be available to cover liability for death or injury to employees.13
Insurance for the cost of repairing or replacing failed or inadequate
remedies has, in the past, been more difficult to obtain; however, recent
changes in insurance practices may make such coverage easier to obtain.
Insurance traditionally available to construction contractors provides
coverage for damages or injuries that arise in connection with the performance
of their contract. Insurance has also been available for architectural and
design firms. Both types of insurance may cover costs arising as a result of
design defects. Recently, coverage has become available for construction
defects as well. "Because the construction defects liability coverage is
relatively new, it is not clear whether it will be provided for firms doing
remedial design and construction work at uncontrolled hazardous waste
sites."1" However, if this coverage is extended to hazardous waste
activities, syndicates may be able-to purchase insurance for the costs of
failed or inadequate remedies caused by design defects and possibly for
construction defects as well.
Insurance for harm to third parties will be easier to obtain for liability
that occurs during response actions than for liability that arises after the
completion of the response. Widely available comprehensive general liability
policies cover most types of injuries to third parties that could be caused by
participation in response actions, except for harm caused by non-sudden or
gradual release of hazardous substances.15
Environmental impairment liability insurance policies typically cover
non-sudden or gradual releases of hazardous substances, the most important
cause of harm after response actions are completed. However, syndicates and
other parties engaged in cleanup activities may find it difficult to obtain
these policies. Although coverage for non-sudden accidental occurrences is
required by RCRA for existing hazardous waste management facilities and a few
insurance companies may be willing to write policies for those facilities,
nevertheless, similar policies may be more difficult to obtain for hazardous
waste sites that have been subject to response actions. A recent analysis of
the scope of coverage of insurance policies for harms caused by hazardous
substances found that the availability of insurance coverage on closed sites
""Analysis of the Scope of Coverage of Pollution Liability Insurance
Policies," Wyatt Company Report (May 1982) pp. 19-20.
I2Bailey, "Liability and Insurance Aspects of Cleanup of Uncontrolled
Hazardous Waste Sites," 1982 Management of Uncontrolled Hazardous Waste Sites
Conference Proceedings.
14 Ibid.
15See Wyatt Company, supra note 12.
-------
i
I
I
i
i
i
i
i
i
i
i
i
i
i
i
i
i
i
i
4-31
is almost non-existent at the current time. Insurers presently are
concentrating on those sites which are in active operation.l*
The only type of environmental impairment liability policies which are
currently available are "claims made" policies. They provide coverage for
claims made during the life of the policy. Thus, syndicates which dissolve
after completion of cleanup operations at one or more sites would find it
difficult to obtain insurance protection for liability to third parties that
arises after the dissolution of the syndicate.
The availability of insurance for third party damages may change
considerably in the future. It will be influenced by experience under RCRA
which requires financial responsibility for harm to third persons caused by
sudden and non-sudden releases of hazardous substances from permitted
facilities. In addition, the possible development of state and federal
financial responsibility requirements for corrective action at RCRA sites and
for response actions could have a direct bearing on the availability of
insurance for syndicates.
Syndicates also may utilize indemnity agreements to spread the risk of
liability. Whereas insurance is purchased from an insurance company,
indemnification agreements are made in contracts between the parties to the
contract. Indemnification agreements require that if only one party (the
indemnitee) incurs a specified type of liability, the other party (the
indemnitor) will reimburse- the indemnitee or directly pay for the costs of
that liability.
Indemnity agreements can be written so that either the government
indemnifies the contractor or the contractor indemnifies the government.
Likewise, the risk of liability can be shifted in either direction between
contractors and subcontractors. Indemnification agreements are frequently
written to require the indemnified to obtain insurance; the indemnitor is then
responsible for the costs that are not covered by the required insurance.
Indemnity agreements may be particularly valuable for syndicates which
directly assist and participate in response actions. For example, if a
syndicate lends or leases equipment to be used in the cleanup, it could
require that the borrower or lessee indemnify the syndicate for any liability
that may arise as a result of the use of that equipment. Alternatively, if a
syndicate is hired by a cleanup contractor to assist in the cleanup, it could
require the contractor to indemnify the syndicate for any liability the
syndicate might incur.
In most situations indemnity clauses provide adequate protection and have
been upheld by the courts. In a few situations the agreements may not be
effective. For example, the indemnitor may go out of business. In some
situations, intentional or reckless misconduct by the indemnitor may cause a
16
Ibid., p. 21.
-------
I
I
I
I
I
I
I
I
1
I
I
4-32
court to find the indemnification clause unconscionable or void as against
public policy.
In the last two decades, a number of oil companies have established
cooperatives to provide for efficient and cost-effective emergency response
capability in the event of an oil spill. These oil spill cleanup cooperatives
either develop their own emergency response capability (by buying or sharing
equipment, for example) or contract with a service company for cleanup
services. The cooperatives' financial and service arrangements are discussed
more fully in the next section. In this discussion, they serve to illustrate
how companies involved in cleanup activities have dealt with liability issues.
The types of liability of greatest concern to the oil spill cleanup
cooperatives are: (1) liability arising during the cleanup for accidents,
including liability for harm to workers or harm caused by equipment furnished
by the cooperative; -and (2) liability arising after the cleanup for natural
resource damages. Unlike most hazardous substances, oil generally does not
cause chronic or long-term illness; thus, oil spill cleanup cooperatives are
concerned about liability for that type of harm to a lesser degree.
The threat of liability to companies participating in oil spill cleanup
cooperatives does not appear to have inhibited the formation and development
of these cooperatives. The cooperatives which pool resources to purchase and
maintain equipment for use in cleanups by members, and sometimes by
nonmembers, have been able to protect themselves from liability which could"
arise from the use of that equipment by the use of indemnity agreements. For
example:
The Clean Atlantic Associates Oil Spill Agreement
provides that cooperative members using equipment
furnished by a contractor to the cooperative agree to
sole responsibility for the liability and costs
incurred by the use of the equipment. The member using
I the equipment agrees to indemnify the cooperative, the
contractor that furnishes the equipment, and the
cooperative members for all costs and liability they
f might incur as a result of damages caused by the
indemnitor's use of the equipment. The indemnity
agreement applies whether or not the indemnitees were
_ negligent. The agreement is not affected by insurance
that the indemnitor may possess.
I
1
I
The Agreement for the Gulf of Alaska Cleanup
Organization provides that each participant in the
cooperative shall hold harmless and indemnify each
other participant or subsequent participant, the
executive committee, and the agents, servants and
employees of the foregoing, against and for all
liability, and costs incurred, including, but not
limited to, attorney's fees, expenses, claims, fines
and damages which the affected parties suffer or
sustain or become liable for by reason of any
-------
I
I
I
I
I
I
I
1
I
>**
I
I
I
1
I
I
I
I
4-33
accidents, damages or injuries, either to the persons
or property of the foregoing parties or to the person
and/or property of any third party, including, but not
limited to, federal and state governments and agencies
thereof, in any matter arising out of or connected with
the furnishing of equipment and materials hereunder to
the indemnifying party....The foregoing indemnity and
hold harmless provisions by a participant...shall be
applicable whether or not the accident, damages, or
injuries indemnified against were caused or contributed
to in whole or in part by the negligence of the
indemnitees ... The indemnitor also covenants and
agrees that the indemnity and hold harmless provision
granted to all the parties hereunder or subsequent
parties hereunder shall not be limited, restricted or
in any way affected by the amount of insurance obtained
by indemnitor."
Similar indemnity provisions could be included in agreements establishing
syndicates to assist the cleanup of hazardous waste sites.
The agreements establishing oil spill cleanup cooperatives also frequently
contain provisions concerning insurance that the cooperative, its members, or
contractors must obtain. For example, the operating agreement for the Gulf of
Alaska Cleanup Organization provides that the executive committee of the
Organization is responsible for obtaining needed workers1 compensation
coverage. The executive committee can also require that its contractors
obtain insurance desired by the cooperative members. In addition, the members
can direct the executive committee to obtain other insurance coverage. All of
the preceeding types of insurance are required to include the Organization and
its members as named insureds.
The experience 'of the oil spill cleanup cooperatives demonstrates that the
terms of the agreement establishing a cooperative can provide protection
against harm to workers and harm caused by use of equipment furnished by the
cooperative. Nevertheless, it should be recognized that the technology used
in the cleanup of hazardous wastes is less well developed than the technology
for the cleanup of oil spills, and mistakes in hazardous waste cleanup may not
be discovered until years after the cleanup is completed.
Contractors hired by the state or federal government to clean up hazardous
waste sites may face the same threats of liability as syndicates voluntarily
assisting a cleanup operation. The federal government requires contractors to
obtain liability insurance coverage. Moreover, it broadly indemnifies the
contractor for the costs of liability in excess of that covered by the
required insurance. The EPA's Hazardous Site Remedial Response RFP contract
states:
The Government will hold harmless and indemnify the
Contractor against claims (including expenses of litigation
or settlement) by third persons (including employees of the
Contractor)for death, bodily injury, or loss of or damage
-------
1
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-34
to property arising out of performance of this
contract, to the extent that such a claim is not
compensated by insurance or otherwise. Any such claim
within deductible amounts of the Contractor's insurance
will not be covered under this article. Reimbursement
for such liabilities to third persons will not cover
liabilities for which the Contractor has failed to
insure as required or to maintain insurance as approved
by the Contracting Officer.17
Similar agreements could be made between contractors or subcontractors and
syndicates assisting the cleanup.
State contracts for remedial actions often shift the risk of liability in
the opposite direction. For example, the contracts for remedial actions in
New Jersey and California provide that the contractor partially or totally
indemnify the state from liability for third party claims.18 The indemnity
provisions may apply to liability that arises after the remedial action is
completed for harm caused by the remedial action.19 The nature of the
indemnity provisions in the contracts will influence both the number of
contractors willing to bid for a response action contract as well as the size
of the bids.
The type of indemnity provisions included in the contracts with the state
or federal government may influence the creation of syndicates. Response
contractors may be less likely to indemnify syndicates if the contractor did
not shift its risk of liability to the government. Whether the contractor's
liability arising after completion of the cleanup is shifted to the government
would be particularly important because insurance coverage for those costs may
be difficult to obtain.
Conclusion. The threat of liability should not preclude the
development of syndicates for hazardous waste cleanup activities. In many
situations the syndicate may have a valid legal defense to liability. In
other cases, the types of liability the syndicate members are most concerned
about could be avoided by limiting the nature of the syndicate's activities.
Moreover, most types of liability can be readily insured against and the risk
of liability for all types of harm can be shifted by indemnity agreements. In
addition, the syndicate's organizational structure could be designed to limit
the extent to which syndicate members would be personally responsible for
liability incurred by the syndicate.
1'Reprinted in Bailey, supra note 13.
iaSanders, "Liability for Remedial Cleanup Failures," Waste Age, June
1982, p. 102.
I9lbid.
-------
I
I
1
I
I
1
I
I
I
I
I
I
I
I
I
I
I
I
I
4-35
Liability for harm caused by the release of hazardous substances from the
site after the cleanup has been completed is potentially the most uncertain
liability facing a syndicate. The extent to which insurance will become
available for spreading the risk of such liability is unclear. States could
effectively encourage syndicates to participate in all phases of response
actions, including activities that could lead to liability for later releases
from the site, by agreeing to indemnify cleanup contractors for those costs.
Such an indemnity agreement would make the contractors more willing to
indemnify syndicates for the same type of liabilities. The enactment of Good
Samaritan laws for voluntary participation in response actions could also
encourage wider syndicate assistance in the cleanup of hazardous waste sites.
4.6 CASE STUDIES
4.6.1 Oil Spill Cleanup Cooperatives
Oil spill cleanup cooperatives are an example of the application of
syndication concepts to a problem closely related to hazardous waste site
remedial actions. Several oil spill cooperatives were formed as long as
twenty years ago, and many more were started in the wake of the 1969 Santa
Barbara Channel oil well blowout. Since then oil companies have expended both
time and money to eliminate oil spills by means of improved employee training
and operations and maintenance procedures. The risk of spills, however,
cannot be completely eliminated, so the oil industry has made investments to
minimize the effects of the spills that do occur. Oil spill cleanup
cooperatives are one way of establishing an emergency response capability in
an efficient and cost-effective way. Today there are more than 90
cooperatives in the country designed to provide cleanup equipment and response
capabilities to their members. Some of these cooperatives are organized to
handle releases of hazardous substances as well as oil spills.
The oil spill cleanup cooperatives tend to be defined by a geographic area
(for example, the Santa Barbara Channel, the South Texas Coastal Bend, Greater
New York Harbor, or the Alaskan Beaufort Sea). Companies operating in an area
have found it advantageous to develop a mutual response capability so as to
share the costs of equipment and services that may be needed in an emergency.
The cooperatives take one of several basic forms: industry-wide (oil
companies in an area); community-wide (oil companies, other companies,
government agencies, and public organizations in an area); and subscription
(combined sponsorship of a local contractor who supplies equipment, materials,
and key labor). All three arrangements allow for the pooling of resources to
achieve cost savings, as well as other advantages.
There are several benefits to companies participating in a cooperative.
First, by pooling their resources to purchase or contract for the specialized
equipment needed in a cleanup effort (containment booms, deployment boats,
skimmers, etc.) companies can save a considerable amount of money by not
having to purchase and maintain the equipment individually. Second, by using
better equipped and better trained personnel, companies are assured of an
improved response capability. Third, the establishment of an oil spill
containment and cleanup capability may satisfy government permitting and
contingency plan requirements for operations. Fourth, the companies' public
-------
I
I
I
1
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-36
image may be enhanced if they are perceived to be moving cooperatively and
voluntarily to mitigate the environmental effects of their operations.
The cooperatives generally establish their response capability in one of
two ways: by purchasing equipment for the use of association members or by
contracting for equipment or cleanup services. Examples of each of these
arrangements are described' below.
Footed Purchase of Equipment. Many of the oil spill cleanup
cooperatives undertake the responsibility of purchasing and maintaining
equipment for their members' use. Ownership of the equipment is retained
either by the cooperative or by its members. The different ownership
arrangements and their financial implications for the cooperative members are
best illustrated by two cooperatives, The Corpus Christi Area Oil Spill
Control Association and the Gulf of Alaska Cleanup Organization.
The Corpus Christi Area Oil Spill Control Association was formed in
1970 as a nonprofit cooperative of 41 oil companies, refiners, and all levels
of local government (state, county, and city) to function cooperatively in an
emergency situation. The Association owns and maintains $250,000. worth of
special equipment (such as booms and skimmers) available for emergency, use.
In addition, a contingency plan contains an inventory list of other available
equipment owned by member companies and made available to others for
emergencies as well. The Association has cleaned up more than 500 spills from
ships, barges, and pipelines since it was formed in 1970; 27 cleanups were
made in 1982, including a spill of 2,600 barrels of oil which required 16 days
of cleanup operations.
Initial funding of $72,000 for the acquisition of equipment, supplies, and
facilities came from federal grants as well as grants from industry, state,
and local governments interested in establishing an emergency response
capability for the Corpus Christi harbor area. Sustaining memberships
purchased by oil companies and local government bodies help pay
administrative, training, equipment purchase, and maintenance costs.
Ownership of equipment is held by the Association; each member's contribution
or membership fee is treated by the individual companies as a business expense
and is deductible from gross income.
The Association stores and'maintains the equipment at warehouses located
strategically around the harbor area. A full-time staff of six professionals
is available to provide cleanup assistance to both member and nonmember
companies. The Association is designated by its members to handle all cleanup
operations, and most routine spills are cleaned up entirely by its own
personnel. For larger spills, operation of the standby equipment is handled
by marine and labor contractors with whom the Association has working
agreements to supplement its own forces. In all cases the Association directs
the cleanup work. The Association carries liability insurance to cover any
injuries or damages that may result from their actions. In addition,
nonmembers are required to sign a hold harmless agreement before the
Association will undertake a cleanup effort for them.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-37
The Association responds to requests for assistance from members as well
as from governmental agencies (the U.S. Coast Guard or the Port of Corpus
Christi, for example) and nonmembers who need oil spill cleanup services. No
governmental approval is required for the Association to respond, which
assures quick response to an emergency situation and helps hold the effects of
a spill to a minimum. Members are charged a fee for the labor and equipment
expended during a cleanup operation. Nonmembers are charged at a higher rate
for response costs because they made no initial or yearly contributions to the
purchase and maintenance of equipment and response services.
The Association had an annual budget of $227,000 in 1982. Most of this
was covered by the user fees charged to members and nonmembers for response
activities. Any shortfall between costs and revenues is apportioned among the
members as their membership fee.
The Gulf of Alaska Cleanup Organization was formed in 1977 to provide
the resources for mutual assistance and cooperation in the control of oil
spills in the Gulf of Alaska. The Organization includes 14 companies which
conduct oil and gas exploration and development activities within the area
covered by the Organization (it is, essentially, an industry-wide
cooperative). The Organization serves primarily as an equipment holding.
company, buying and maintaining equipment for the use of members and
nonmembers in the event of an oil spill.
All capital equipment and materials acquired by the Organization are
co-owned by the members as tenants-in-common. Each member's ownership
interest is determined by a participation formula based on the size of each
member's operations in the area. Thus, each member has a partial investment
in the equipment and materials held by the Organization and is entitled to
whatever tax benefits may arise from that ownership. For example, a member
may elect to expense its share of the investment'in materials with a
relatively short useful life (protective clothing, batteries, fire
extinguishers), or depreciate its share of capital equipment (booms, skimmers,
boats, pumps, generators).
The Organization maintains equipment worth more than $6 million. The
initial funding for the investment in capital equipment came from an advance
of $25,000 from each original member. Subsequent members also pay a
proportionate share of the value of the assets held by the Organization. This
payment represents the capital investment made by each member and entitles
them to co-ownership of any property, and is most likely depreciated as a '
capital expenditure by each member. In add-ition, each member pays a yearly
membership fee to cover operating expenses arid additional capital
investments. That portion of the membership fee which covers operating costs
is treated as an expense, while the remainder is treated as a capital
investment. One advantage of co-ownership is that members may capture their
share of any investment tax credit available for capital expenditures as well
as the usual depreciation deductions.
The equipment is stored and maintained at several locations in and around
the Gulf of Alaska. In the event of a spill, any member may utilize the
equipment and materials of the Organization. Upon notification to the
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
4-38
Organization, the requested equipment and materials are released to the member
for its use. During the cleanup, complete control and responsibility for
activities- is retained by that member. The member may elect to use its own
personnel in the cleanup operations or hire a contractor to use the equipment
provided by the Organization. In either case, the responsible member agrees
to hold harmless and indemnify each other member for any costs or- liability
which may be incurred in the use of the Organization's equipment (including
accidents, damages, or injuries to persons or property of the members or of
any third party).
Members are required to return the equipment and materials in the same
condition or to replace expended materials; beyond that there is no charge to
the user. Nonmembers (including government agencies) may also request the use
of the Organization's equipment under the same provisions available to
members. However, to compensate members for the cost and expenses incurred in
providing and maintaining equipment and materials, nonmembers are charged a
rate which reflects the investment and maintenance costs of the equipment. A
government agency having jurisdiction over a spill (such as the U.S. Coast
Guard) may request the use of the Organization's equipment for the cleanup of
spills from an unidentified source. The charges for their use are based on
the costs incurred during the operations.
Joint Contract for Emergency Response Services. Several of the oil
spill cleanup cooperatives provide emergency response capabilities to their
members by contracting with a service company for that capability. One
example is the operation of Clean Gulf Associates in New Orleans. Clean
Gulf Associates (CGA) was formed in 1972 and currently has 75 members, all of
them companies operating in the Gulf of Mexico.
CGA has contracted with Halliburton Services to act as its representative
in the acquisition and maintenance of equipment. Halliburton's
responsibilities as service contractor are: (1) to purchase equipment as
directed by CGA; (2) stockpile the equipment at strategic locations selected
by CGA; (3) lease the equipment to CGA; (4) provide marine supervisors to
maintain the equipment in operating condition and assist member company
personnel in its proper use; and (5) to assist in new equipment design and
evaluation.
CGA is partially funded by an initial fee of $5,000 per member company,
which is placed, into an operating fund. The actual equipment investment
(close to $5 million) is amortized in the operating lease charges from
Halliburton over a 36 month period. In addition, members pay annual dues
according to an agreed upon equity formula based on a member's oil production
volume. The initial fee and annual dues help defray the capital investment
and maintenance costs, which are reflected in the lease charges. Usage fees
are also charged to members when they call for and use the equipment. These
charges cover the actual cost of operations during a cleanup. Nonmembers may
also use the equipment at a usage charge greater than that for members (to
recognize the capital investment made by members). Usage charges are used to
reimburse Halliburton for any expenses incurred in a cleanup operation.. Any
additional usage fees from nonmembers are used to reduce the annual dues of
the members.
-------
I
I
I
I
I
I
t
I
I
I
I
I
I
I
I
I
4-39
The initial fee and annual dues are deducted by members" as a normal
business expense. The service contractor, who holds title to the equipment,
claims the appropriate investment tax credits and depreciation expenses. When
negotiating the contract with the service company, a cooperative could assure
that some of those tax savings, as well as the service company's lower
transaction costs provided by dealing with an association of companies, are
passed along to the member companies in the form of lower lease charges.
4.6.2 Mutal Assistance Networks
Chemical companies have also taken steps to establish emergency response
capabilities to deal with spills or releases of hazardous substances. The
organizations are usually formed as mutual assistance networks to provide aid
in the event of the release of a particular substance. Mutual assistance
networks offer companies with nationwide operations a means of establishing an
effective emergency response capability to deal with emergencies arising
anywhere in the country. These networks are particularly attractive to
chemical companies who depend on long-distance transport of their feedstocks,
finished products, and wastes.
Mutual assistance networks differ from the cooperatives described
previously in that they generally do not establish a single equipment center.
Rather, member companies provide response to emergencies within their
geographic area, or regional response centers are established throughout the
region or continent. For example, the Chlorine Emergency Plan (CHLOREP) was
established by members of the Chlorine Institute to provide nation-wide
assistance in the event of a chlorine release. When a release occurs, the
member closest to the spill provides on-scene technical advice and cleanup
assistance for any other member's spill. The responder is then usually
reimbursed by the member responsible for the spill.
The Transportation Emergency Assistance Plan (TEAP), formed by the
Canadian Chemical Producers' Association (CCPA), is another example of a
mutual assistance network. TEAP has established a network of ten emergency
response teams to provide on-scene assistance to emergency personnel
responding to transportation accidents involving hazardous materials owned by
CCPA members. Ten regional response centers send fully-equipped TEAP response
teams to accident sites to aid and advise local response personnel. The
centers operate from the sites of ten individual CCPA member companies located
throughout the country, with each center completely funded and staffed by its
sponsor company. Each center has emergency equipment worth $60,000 to $80,000
and a staff trained in emergency response.
All CCPA member companies participate in the program by signing a contract
with the other members. The contract guarantees that a TEAP team will respond
to the spill of a hazardous material within six hours of its occurrence. The
team also guarantees to remain at the scene for up to 24 hours while the owner
of the spilled materials assembles a backup response team to relieve the TEAP
team.
-------
I
4-40
I
t
I
I
I
1
I
I
I
I
I
I
I
I
I
I
I
The owner of a spilled material pays the TEAP team's sponsoring company a
fee for the response service. This helps defray some of the cost of the
sponsoring company's investment in equipment and personnel training. The
sponsoring companies (all multi-national organizations), as owners of the
equipment, most likely take the investment tax credits and depreciation
deductions available for their equipment expenditures.
-------
I
I
I
I
i
I
i
i
t
i
i
i
i
I
i
i
i
CHAPTER 5
MUNICIPAL BOND BANKS
5.1 INTRODUCTION
Several states have organized state bond banks to purchase local
government bonds and reissue the debt under their own authority. These bond
banks are designed to reduce the high costs of issuing municipal bonds by
providing access to potentially better bond ratings and capturing economies of
scale in covering fixed costs by including local government bonds within
larger bond issuances. Since 1970, Vermont, Maine, North Dakota, Alaska, and
New Hampshire have organized active, general-purpose bond banks and have
issued in excess of $585 million in local government debt, but none have yet
been used to finance cleanup of a hazardous waste site. State bond banks may
be especially helpful when small unrated, or poorly rated local governments
must issue bonds to help pay for the remedy of publicly-owned or operated
hazardous waste sites. In such instances, state bond banks could help to
reduce the high costs of issuing bond by such local governments, thereby
reducing remedial action costs and delays due to the inability of these local
governments to market bonds at acceptable costs to them. The financial
savings offered by bond banks may in some instances be limited, however, by
the size of the economies attainable and the uncertain bond security that can
be provided by small, unrated or poorly-rated jurisdictions financing the
cleanup of hazardous waste sites..
Chapter 5 is organized into five sections. The first section describes
how some local governments can incur substantial costs in the process of
financing waste site cleanup with municipal bonds. The second section
describes the state bond bank option by first discussing the procedures for
establishing a bond bank and then how it would operate. The next section
assesses the potential cost savings to be realized. The fourth section
describes important factors which condition when a bond bank may be an
applicable option and identifies states where it could be considered. The
final section summarizes the experience of a number of existing states1 bond
banks and similar environmental bonding authorities.
5.2 FACTORS AFFECTING THE COSTS OF BOND ISSUANCE
Many municipalities have difficulty arranging to issue long-term debt and
consequently incur relatively high costs in the process of issuing such debt.
Commercial banks are reluctant to tie up funds in municipal bonds for long
periods of time and often cannot offer attractive interest rates. Bond buyers
in the national market are reluctant to invest in low grade and often unrated
bonds of lesser known municipalities and may require substantial price
discounts from the expected value of the bond's earnings. These problems are
especially important impediments for smaller municipalities and arise from the
following characteristics of the bond market and municipal finance:1
1See J. Jarrett and J. Hicks, The Bond Bank Innovation; Maine's
Experience. 1977, Council of State Governments, Lexington, Kentucky.
-------
I
I
I
I
I
5-2
Smaller municipalities enter the bond market
infrequently and their debt issues tend to contain only
one or several bonds at relatively low total dollar
amounts. Because the overhead costs in marketing bonds
(e.g., printing costs, financial and legal advice)
rises less than proportionately with the dollar size of
the bond issue, these small issues typically experience
large overhead costs per $1000 of debt issued.
A municipality with less experience in issuing bonds
I is less likely to have received sound financial advice
; before and during the issue. Similarly, such
communities are less likely to have received or be able
I to obtain a bond rating; rating agencies will not rate
governmental units below a minimum level of outstanding
debt. In addition, these communities also are more
_ likely to have greater difficulty in quickly providing
accurate, detailed financial information to a bond
"-' rating agency or to prospective bond buyers.
I
I
I
I
I
I
1
I
I
I
Smaller municipalities, and some larger ones,
typically have low bond ratings if they are rated at
all. These lower bond ratings may result from their
smaller capacity to carry debt and their inability to
gain access to the larger bond markets. These
difficulties force greater reliance on single
purchasers, especially local commercial banks, who may
be the only parties familiar with the municipality's
finances and may charge much higher rates of interest.
5.3 DESCRIPTION OF OPTION
5.3.1 Procedures for Establishing a Bond Bank
The bond bank, as an agency of the state, must receive legislative
authority to issue bonds and to use the proceeds to purchase the debt issues
of municipalities and other political subdivisions, such as water and sanitary
districts, which have the authority to levy taxes to cover their debt
obligations. The bank's bonds, however, are not obligations of the state
government and the bank does not itself have taxing authority. The bank has
legal standing similar to, but authority broader than, the many special state
bonding authorities which state legislatures have authorized.
The bond bank's obligations are secured first by the full faith and
credit, or specific tax revenue, pledged by the participating local
governments to repay any of their bonds held by the bank. Second, the bond
bank's obligations are secured by the bank's reserve fund which is created
from the profits of the bank and is usually maintained at a level sufficient
to pay all upcoming bank principal and interest obligations in the next year.
Finally, the obligations of the bond bank are secured by the "moral
commitment" of the state to cover any deficiency in the bond bank's reserve
fund. Because the bonds are not backed by the "full faith and credit" of the
-------
I
I
I
I
I
I
I
1
I
I
1
I
I
I
I
I
t
I
5-3
state, the bank's bonds usually receive a rating one level below that of the
state's general obligation bonds, but they may rise to equal the state general
obligation bond rating after bond market investors become familiar with the
bank. j
Bond banks are relatively simple to organize. Bond banks can be operated
independently or by the state treasurer's office, which would assign some of
its staff part-time to manage the bank's purchases and marketing of bonds, as
well as arrange for the counsel and compliance with other fiduciary and
statutory requirements. The benefits of the bond bank are realized in the
state's lower costs (interest payments and initial overhead) of issuing local
government bonds and so are obtained in the first bond issues, which could be
organized on several month's notice after the bank's statutory authority is
received.
Political opposition may arise while a state legislature is considering
the enactment of statutory authority for such a bond bank. Opposition is most
likely to come from the commercial banks in the state which often are relied
upon to purchase hard-to-market municipal bonds. However, the benefits of the
real-cost economies from a bond bank can be considerable and accrue to all the
local taxpayers. These benefits may, if publicized, create widespread
political support for the authorization of the bond bank. In addition, the
shifting of this new long-term debt to the national bond market allows local
banks more flexibility in their investment decisions and releases cash for
local private sector investments. Further, commercial banks still will have
the option of bond investment available, but only at market interest rates
since the bond bank will attract only municipalities who are in good financial
condition but who would, but for the bond bank, have difficulty selling their
bonds. It has been suggested that a bond bank's issues might act to lower the
rating or lessen the market acceptance of a state's general obligation or
other state authority bonds. This has not occurred and seems unlikely because
bond buyers are usually quite aware of the degree of state obligation
supporting a bond issue by a state agency or bond bank.
5.3.2 Operating Procedures of Bond Banks
To participate in the bond bank's issues, a local government must fulfill
its own obligations under state and local laws (e.g., receive public
approval). A participating local government must submit to the bond bank an
application including information on expected tax collections, assessed
property value per capita, percentage of tax delinquencies, and other
outstanding debt. The bond bank's officers and financial advisor then decide
whether any of the applications should be denied because inclusion would
detract from the marketability of the bank's bonds. Since the security of the
bank's bond issues depends first on the financial capacity of the original
local debt issuers, the bank's rating can suffer if the bank relies on the
income from risky local debt issues to repay its own bonds.
When at least $5 to 10 million in local debt issue participation is
guaranteed, the bank arranges to purchase the local government's notes and
simultaneously to issue through its own bonding authority an equal amount of
debt through dealers in the national market. Maturity dates for the bank's
-------
I
I
I
I
I
I
1
I
I
I
I
I
I
I
I
5-4
bonds coincide with those of the local bonds, so that scheduled payments from
the local governments are paid in time to pay the bond bank's principal and
interest obligations. This $5 to 10 million level of bond issues is large
enough to accrue economies in marketing the bonds, yet allow issuances to be
frequent enough (usually every 6 to 12 months) to serve the financial needs of
the local governments. The bond bank may also provide interim financing for
the local governments between issues by purchasing from them bond anticipation
notes of the same size as the prospective bond issues. In this manner, the
bond bank could help shorten the delay in making money available to finance
reponse actions at hazardous waste sites.
The marketing and operating expenses are paid out of the "profits" of the
bond bank. These profits are realized by purchasing the bonds of the
participating local debt issuers at a rate o.f interest which is slightly
higher than that at which the bond bank's own bonds are sold. These profits
accumulate in an interest-bearing reserve fund, but if they are insufficient
to cover the preparation and marketing costs of a-particular bond issue, the
participating local governments can be assessed directly for the shortfall.
The state can contribute money as an initial endowment for the bond bank's
reserve fund to reduce the cash flow problems in the first issues and provide
for start-up costs. This contribution by the state can be repaid after the
bond bank's profits begin to accumulate from the savings gained in the bond
issuances.
»
5.4 POTENTIAL COST SAVINGS
The cost savings available to municipalities participating in a bond bank
derive from acheiving economies of scale in marketing their bonds, and by
gaining access to higher bond ratings and the more competitive national bond
market and, therefore, lower interest rates. The savings to a local bond
issuer become more significant the smaller the issue and the lower the rating
of local bonds, the larger the size of the bond bank's issue, and the higher
the rating of issues from the bond bank. Based on the data from the first
five issues of both the Vermont and the Maine Bond Banks (both with Aa bond
ratings), Martin Katzman has estimated the relation of probable cost savings
to bond characteristics; these findings are presented in Exhibit 5-1.2
Exhibit 5-1 indicates (last column) a range of potential cost savings of
0.9 to 5.7 percent of the size of the bond. In Vermont, 89 percent of the
local participants' bonds were rated either Baa or were unrated; in Maine the
corresponding percentage was 72 percent. Consequently, the total savings as a
percent of the total dollar size of the first five issues of 11 to 15 year
bonds by each states' bond bank averaged 3.8 percent in Vermont and 4.4
percent in Maine.
2Martin T. Katzman, "Municipal Bond Banking: The Diffusion of a
Publie-Finance Innovation," 33 National Tax Journal 149 (1980).
I
-------
I
I
I
I
I
I
1
I
I
I
I
I
I
1
I
I
I
I
I
5-5
EXHIBIT 5-1
BOND BANKS POTENTIAL COST SAVINGS
Percent Distribution of Cost Savings by Source
Local Bond's
Rating
Aa
State
Vt
Me
Vt
Me
Vt
Me
1 nterest
0
0
56
71
73
81
Underwriting
0
2
9
5
6
4
Other Marketing
97
98
35
24
21
15
Savings
of Total
1.1
0.9
2.4
2.8
4.2
5.7
as %
Issue
Baa or
Unrated
The Vermont and Maine experience (last column of Exhibit 5-1) suggests
that cost savings of approximately 5 percent of the total size of the bond
issue can be expected for local governments rated Baa or unrated when the
state bond bank has a rating of Aa. In such instances, the reduction in
interest rates is likely to account for most of .the cost savings.
5.5 APPLICABILITY OF BOND BANKING
Although there are direct overhead cost reductions from collecting a
number of relatively small debt issuances within one larger bond series,
Exhibit 5-1 shows that much greater savings are obtained when the rating of
the participating local governments (which can be expected to have an average
rating of Baa) is one or two levels below the rating-of the bond bank's
bonds. Because a bond bank usually is rated one level below that of the
state's general obligation bonds, we suggest the use of bond banking only in
those states which have general obligation bond ratings of Aaa, Aal, and
possibly Aa\ As shown in Exhibit 5-2, of the 21 states with publicly-owned
(50 percent cost-share) sites on the National Priority List (NPL), 13 have
ratings of Aa or better. Bond banks formed in other states (some of which
have no outstanding general obligation debt and consequently no listed rating)
might receive ratings too low to allow significant savings for their local
governments.
A bond bank will save localities bond issuing costs only if the state has
a number of low-rated or unrated bonds being issued by local governments or
anticipates such issues in the future. Of course, such local government
issues need not be limited to the purposes of hazardous waste response. Some
of the local governments of the more populous states listed in Exhibit 5-2
have fair to good bond ratings and also have had experience in issuing bonds
to buyers other than commercial banks; such localities may find no savings
from participating in a bond bank.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
5-6
EXHIBIT 5-2
GENERAL OBLIGATION BOND RATINGS OF STATES WITH POTENTIAL
50 PERCENT COST-SHARE NPL SITES
Aaa:
Aa:
Al:
A:
No General
Obligation
Bond Rating:
fl. A
New Hampshire, New Jersey, Tennessee, Minnesota,
Missouri, Utah
^
Maine, Florida, Kentucky, Michigan, Ohio, Arkansas,
California
Massachusetts, Delaware
New York, Pennsylvania
Indiana, Iowa, Colorado, Arizona
State has or is currently considering forming a bond bank.
Source: Moody's 1982 Municipal and Government Manual.
Finally, the applicability of this option is affected by the need for bond
security -- the physical collateral or government taxing power supporting an
issue of debt. State bond banks are required to act as responsible
fiduciaries of the participating local governments' funds and usually are
given little flexibility in using established criteria to assess risk and
anticipated returns on bonds.in deciding which local debt applications to
approve. The bond bank is expected to appraise a local government's financial
condition (or the soundness of the project being financed) under the same
standards applied by a reputable bond rating agency. It is doubtful that a
local bond issued to pay for the cleanup of a hazardous waste site (which
would be expected to have little subsequent increase in capital value) and
which is unsupported by a definitive local government obligation or taxing
authority, could be purchased by a bond bank without lowering the bond bank's
credibility -and possibly its own bond rating.
Thus, any local bonds issued for such risky investments as a response
action (i.e., issued either through a bond bank or alone on the market) must
offer a»special tax assessment or a politically-accepted general obligation of
a financially-stable government to secure the debt. Remembering that the bond
bank can reduce local bond issuing costs only for smaller, lower-rated bond
issues, it is clear that bond banking serves mainly jurisdictions with smaller
financial capacities; small bond issues of larger and better-rated local
governments can be completed just as easily as through a bond bank if the
locality itself has frequent and large bond issuances. Large bond issues for
hazardous waste response actions backed by the general obligation of a large,
financially-stable local government might sell on the bond market alone just
as favorably as if sold through a bond bank. Large bonds issued by smaller,
less financially capable local governments who can otherwise benefit the most
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
5-7
by using bond banks, are more likely to over-extend the localities' debt
obligations and thus may cause the bond bank to deny participation to these
entities.
^
Consequently, the bond banking option is most applicable to small local
governments issuing general obligation bonds of $1 million or less for planned
removal or remedial response actions at hazardous waste sites. Bond banks
will, undoubtedly, be useful to local governments for any general obligation
hazardous waste cleanup bonds they need to issue in states which have such
banks already. Bond banks could also be started for full time use in the
other 10 states and include hazardous waste cleanup bonds among their issues.
A one-time bond bank issue for 4 or more local governments use in financing
cleanup of hazardous waste sites would also be possible, but its cost savings
would suffer from limited savings for overhead and from lack of good bond
market recognition.
5.6 CASE STUDIES
5.6.1 Maine Municipal Bond Bank
This most widely reviewed general purpose bond bank has also been the most
active. Since its inception in 1972, Maine's Bond Bank has handled $350
million in local bonds, most of them financing water projects and the
construction of schools. The State of Maine has not pledged its "full faith
and credit" but rather only its "moral obligation" to cover any shortfalls
which might exist after a complete default by a locality and the exhaustion of
the Bank's reserve fund. Nevertheless, because this is unlikely to occur and
the Bank has a good reputation on the bond market, the Bank retained its Aa
bond rating even after Maine's general obligation bond rating fell from Aaa to
Aa. The Bond Bank has repaid the initial $10,000 endowment to the reserve
fund provided by the state.and the $60,000 in start-up costs from the Bank's
"profits." The Bank has an independent full-time staff of two with an office
in Augusta. The executive director is HenryBouchard [telephone (207)
622-9386].
5.6.2 North Dakota Bond Bank
The North Dakota Municipal Bond Bank was organized under statutory
authority granted by the Legislature in 1975, and has had one bond issue in
1977 and one in 1979, each of about $15 million. The Bank is arranging for
another issue in 1983. The Bank serves primarily small municipalities; in
both of its issues the Bank purchased more than 60 local general obligation
bonds, most of them in the $20,000 to $200,000 range. Though legally a
separate entity, the Bond Bank's operations are coordinated through the staff
of the State Bank of North Dakota, headquartered in Bismarck. Questions
should be directed to the Bond Bank's attorney, Gary Bower [telephone (701)
224-5600].
5.6.3 Virginia Public School Authority
In 1962, Virginia was the first state to organize an agency adopting the
operational format of a bond bank. The Virginia Public School Authority is
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
5-8
authorized to purchase bonds issued by school districts for the purpose of
constructing or improving school buildings and to. reissue this debt in the
form of its own bonds in order to reduce the overhead preparation and
marketing costs and to gain a better rating for the bonds. Bonds issued by
the authority are not debt of the Commonwealth of Virginia; security for the
bonds is provided by the reserve fund accumulated from the profits of the
authority and an initial endowment. Security also is provided by the
obligation of the tax revenues of the individual school districts to repay the
bonds held by the authority. The prospectus for the 1982-C series bond issue
of $6.8 million shows that a total of $322 million of local school authority
bonds have been purchased and that $193 million (some reinvested in local
bonds) is held in the Bank's reserve fund. The Authority's operations are
coordinated by George Calvert in the Department of the Treasury's office in
Richmond [telephone (804) 225-2142].
5.6.4 State Bonding Authorities
Many states have authorized special agencies to issue bonds for public or
private sponsors of particular kinds of municipal and industrial projects,
such as housing, wastewater treatment facilities, irrigation systems, schools,
and highways. Most of these authorities act as the agent for those who are
repaying the bonds, providing advise and bond preparation and marketing
services. The bonds usually are exempt from federal taxation if they conform
to the Internal Revenue Service (IRS) rules which apply to Industrial
Development Bonds (IDE's). Authority bonds usually are backed by the "moral
obligation," but not the "full faith and credit," of the state.
The California Pollution Control Financial Authority (CPFA) issues bonds
only for private pollution control facilities and has financed tax-exempt
bonds for on-site facilities to clean up hazardous waste contamination. CPFA
handles bonds ranging in size from $100,000 to $70 million and provides bond
agent services, such as legal advice, bond issue preparation, and marketing.
The New York State Environmental Facilities Corporation (EFC) is
authorized to provide a wide range of bond issuing services for municipal and
industrial environmental control facilities. EFC has constructed and operated
municipal pollution control facilities and can provide environmental design
expertise and financial and legal advice. EFC will act as bond agent for
individual projects, but the bond's rating depends on the financial condition
of the issuer (company or municipality). EFC has financed a remedial action
at a landfill with a bond qualifying for tax exemption under IRS rules.
»
5.6.5 Other Existing Bond Banks
Other states with bond banks, their date of organization, and extent of
financing activity include:
Vermont (1970), total.$100 million issued;
New Hampshire (1972), total $36 million issued;
* Alaska (1975), total $70 million issued;
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
5-9
New York (1972), disbanded with no debt issued; and
New Jersey (bond bank currently under consideration
in the state legislature).
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
CHAPTER 6
MUNICIPAL BONDS
6.1 INTRODUCTION
One of the most common means of accelerating a state's or municipality's
cash flow is by bonding. A bond is "a written promise to pay a specified sum
of money, called the face value or principal amount, at a specified date or .
dates in the future, called the maturity date(s), together with periodic
interest at a specified rate."1 States and municipalities have typically
relied on bonding to raise large sums of money for activities undertaken
today, and then repaid those funds over time. The activities financed through
bonding are primarily capital expenditures, that is, expenditures for
long-lived assets such as schools, highways, wastewater treatment plants, and
housing, to name a few. The timing of the outlays for such projects cannot be
synchronized with the timing of the benefits derived; the expenditures are
made over a relatively short period of time, but the benefits are received
over a longer period. Some financial managers hold that states .and localities
should pay for such assets as they are installed (the theory of "pay-as-
you-acquire") because the choice of the expenditure is made by today's
government. Proponents of debt financing argue that payments should be made
as the benefits are derived from the capital expenditure (the theory of
"pay-as-you-use"). Bonding is an extension of the pay-as-you-use philosophy;
it attempts to match the payments for the capital expenditures with the
consumption of the benefits received.
Bonding may be considered an appropriate means of financing remedial
actions at hazardous waste sites. The expenditures made today result in
benefits extending long into the future, those benefits being reduction or
elimination of the threat of an imminent or future release of hazardous
substances. The financial resources proposed to repay the bond may include
general fund tax revenues or they may include existing (or, in some cases,
new) fees or taxes placed on generators, transporters, and disposers of
hazardous substances or wastes. These fees and taxes are intended to finance
remedial actions undertaken as soon as possible at the many existing waste
sites, but are stretched out over a number of years to relieve the financial
burden on industries required to pay the fees or taxes. A state can
accelerate the accumulation of funds by issuing a bond secured by those tax
receipts, and then retiring the debt as the fees and taxes are paid in future
years.
One of the greatest attractions of bonding is that it creates an
immediately available pool of resources which can be used to finance major
cleanup efforts. The advantages of being able to raise funds through bonding
are well suited to solving some of the problems traditionally encountered in
National-Committee on Governmental Accounting, "Governmental
Accounting, Auditing, and Financial Reporting." Washington: 1968.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
6-2
financing hazardous waste cleanup activities. The most significant advantages
of bonding include the following:
Large sums of money can be raised relatively quickly
when the demand for cash is high. Remedial actions can
begin immediately, and do not have to await the
accumulation of sufficient revenues in a hazardous
waste cleanup fund, which could take years to build up.
States may be able to lower the cost of cleanup
activities by undertaking response actions at several
sites within the same time period. Economies of scale
could be captured by using one contractor for multiple
sites, or by utilizing equipment and personnel more
efficiently at several sites.
Ongoing cleanup operations provide the public with
evidence that the problems posed by hazardous
substances are being rectified. The public can see an
action being undertaken as fees or taxes are paid,
rather than merely accumulating in a fund for future
activities.
The program manager is assured of multi-year
financing provided by the bond revenues, and does not
have to rely on annual appropriations to fund cleanup
actions. This allows a manager to begin remedial
actions that span several budget cycles with the
assurance that funds will be available every year. The
manager will be able to plan and contract for a
multi-year remedial action, matching the cleanup
activities to the needs of a site rather than to budget
allowances.
A program manager is provided flexibility in the
design of the cleanup program, and can respond to
changing conditions at a site or to new information as
it becomes available. The manager is not constrained
by the limited cash flows from the state fund's annual
collections, or by the uncontrollable fluctuations in
other sources of revenues (including federal funds,
revenue sharing, or state appropriations), but can
reallocate resources as needed. This is particularly
important in hazardous waste cleanup activities, where
it is extremely difficult to estimate accurately the
cleanup costs prior to extensive studies and actual
initiation of response actions, and where new problems
as well as new sites are continually being discovered.
Further, a manager has the flexibility to respond
quickly to emergency situations arising at a site (such
as the flooding of the Missouri dioxin sites,
hurricanes at sites in Louisiana, or the explosion and
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
i
i
i
i
i
i
6-3
fire- in 1980.at the Chemical Control site in Elizabeth,
New Jersey). A portion of the bond revenues can be
used as a reserve to handle these sudden or unforeseen
problems. This allows for response to new sites or
emergency situations without disrupting the remedial
actions currently being performed.
At the same time, bonding has its disadvantages. Chief among these is the
cost of borrowing. Like any other resource, money has a cost. The interest
charge on a bond represents the cost of borrowing money, and in today's market
of high interest rates, that cost can be substantial. Bonding, by providing a
multi-year revenue stream, may also reduce substantially the public and
legislative review of the response program. While there are advantages to a
program manager in being shielded from the fluctuations inherent in the annual
appropriations process, it is still one of the major ways for the public to
shape the public policy agenda. These disadvantages must be weighed carefully
against the benefits of bonding for hazardous waste activities.
This chapter examines the use of bonding for financing hazardous waste
response actions. Section 6.2 outlines the types of bonds available to states
and municipalities, their applicability to hazardous waste response, and the
benefits and drawbacks of each type of bond.' Section 6.3 presents a more
detailed analysis of the factors that must be evaluated when issuing a bond.
These factors include: the issuing authority; the revenue streams to support
the bond; the overall debt capacity of the state's hazardous waste fund; the
actual bond structure; and the general planning process for a bond issue.
6.2 TYPES OF BONDS
There are several types of bonds available to states and localities. The
type of bond issued depends on the method by which funds are raised to pay the
coupon and maturing principal of the bonds (the debt service). The major
classes of debt, based'upon security pledged, are described below.
Genera! Obligation Bonds are secured by the issuer's
pledge of its full faith, credit, and taxing power for the
payment of the bond. If the taxes levied initially are
insufficient to meet the debt service payments in any
period, the issuer is legally obligated to either raise the
tax rate or broaden the tax base to obtain the necessary
funds. If bonds are secured by the full faith, credit, and
taxing power of the issuer'but the issuer's taxing power is
limited to a specified maximum tax rate (either by the
state constitution or by statutes), the bonds are still
general obligation bonds, but they are "limited tax bonds"
and purchasers are informed of the limitation on the taxing
authority of the issuer.
Revenue Bonds are payable from revenues derived from
tolls, charges, or rents paid by those who use the
facilities constructed with the proceeds from the bonds
(such as toll road bonds) or other facilities owned by the
-------
I
I
I
I
I
I
i
i
i
i
i
i
i
i
i
i
i
i
6-4
issuer of the bonds (such as Port of New York Authority
Consolidated Bonds which are payable from net revenues
of certain facilities owned by the Authority, from net
revenues of all other existing Authority facilities,
and from the general reserve fund). If bonds payable
primarily from revenues of a particular facility are
also secured by a pledge of the full faith, credit, and
taxing power of .the issuer, the bonds are general
obligations (such as sewer bonds, payble primarily from
revenues of the sewer system but also secured by the
full faith, credit, and taxing power of a city). These
hybrid obligations are referred to as "double-barreled"
bonds. For purposes of general classification,
"special tax" bonds are sometimes classed in the
general category of "revenue" bonds because they are
payable only from a special fund, as distinguished from
general obligation bonds which are secured by the
general funds of the issuer.
Special Tax Bonds are payable only from the proceeds
from a special tax (such as highway bonds payable only from
a gasoline tax). This category also includes "special
assessment" bonds payable only from assessment against
those who benefit from the facilities constructed with the
proceeds from the sale of the bonds (such as special
improvement bonds for curbs and gutters).
6.2.1 Applicability to Response Actions
How would these different types of bonds be used to finance response
actions? The type of bond the state or local government issuer chooses
depends on a number of factors, including, for example, the nature and size of
the undertaking, the legal authority and constraints of the issuer, and the
political appeal of the response action. Both political and legal
considerations play an important part in the choice of bonds. For example, in
most states, general obligation bond issues have to be approved by the voters;
revenue bonds do not usually need such approval. Therefore, response actions
that may not have a sufficiently large political appeal, or that cannot be
delayed until a bond referendum has been held, may be financed by revenue
bonds even though they may be principally public goods. Revenue bonds are
also exempt from most of the state and local debt ceilings applicable to
general obligation bonds. As a result, revenue bonds may be favored if the
issuer is close to the legal debt ceiling or expects to issue large amounts of
general obligation bonds to finance other projects with a higher priority. On
the other hand, some response actions, which may appear to be best suited to
revenue bond financing, may not be backed by sufficient state response fund
revenues to meet the debt service payments. These response actions would then
need to be financed by general obligation bonds or by a bond secured by a
combination of response fund revenues and general revenues (commonly referred
to as a "double-barreled" general obligation bond).
-------
I
i
i
i
i
i
i
i
i
i
i
i
i
i
i
i
i
i
i
6-5
The choice of bond financing also raises questions of equity, that is, who
benefits from the actions financed by the bonds, and who pays to retire the
debt. If the benefits of the project accrue to all members of the community,
then generally the cost should be borne by the community as a whole, such as
through the sale of general obligation bonds. If the benefits accrue
primarily to a readily identifiable group of beneficiaries or users, then
generally the costs should be borne primarily by those beneficiaries, through
special tax or revenue bonds.
General obligation bonds are the most obvious choice of bond type where
states can claim that the general public benefits from cleanup activities,
where the issuance process will not unduly postpone response actions, and
where debt ceiling constraints do not prohibit the use of general obligation
bonds. Several states have already taken steps towards financing response
activities with general obligation bonds. New Jersey currently has the
authority to issue up to $100 million in general obligation bonds for this
purpose, although none have been issued to date. Massachusetts is seeking
approval for such authority, and plans to issue $25 million in general
obligation debt.
For states willing and able to issue general obligation bonds for
hazardous waste cleanup, the state may enhance the attractiveness of those
bonds by including a pledge of any other appropriate revenues. While most
general obligation bonds are secured only by the general taxing powers of the
issuer, some bonds are also secured by earmarked revenues which flow outside
the general fund. For example, if any hazardous substance or waste taxes or
fees are also pledged to the repayment of the general obligation debt, and if
the revenues flow to the fund out of which the debt is repaid, the bonds are
considered to have a "double-barreled" security. These bonds are often
considered to have a stronger credit than straight general obligation bonds,
which could result in lowered interest costs.
Revenue bonds are commonly issued to finance projects that can pay their
way via user charges. However, the term has been applied to other kinds of
debt obligations that have been developed to circumvent states' constitutional
or statutory restrictions on borrowing, including bonds payable only from the
proceeds of some nonproperty tax, for example. Revenue bonds may be
appropriate for financing hazardous waste response where the existing state
hazardous waste fund is financed in whole or in part by special industry fees
or taxes (e.g., waste end taxes, permit fees, hazardous substance transfer
taxes, etc.). The revenue stream, or a portion of that stream, from the
various fees and taxes could be pledged to the repayment of the bonds. This
approach does not increase the taxes or fees collected from industry, it
merely borrows against their future payment. Similarly, a revenue bond does
not increase the total amount of money that will be available to the response
fund over a certain period of years; rather, it speeds up future cash flows
and thus makes more of the fund's money available for response actions
undertaken now. At the same time, though, bonding will reduce the amount-of
funds available in future years, because that money will be needed to pay the
interest expense on the borrowed funds.
-------
I
i
i
i
i
i
I
i
i
i
i
i
i
i
i
i
i
i
i
6-6
Special assessment taxes have traditionally been used by cities, counties,
and special districts to finance large capital improvements that benefit
particular property, usually within a defined geographic area. The tax is
assessed on real property, and is based on the benefit conferred by the
project, that is, the value of the improvements to the landowners. Special
assessment taxes are frequently used in conjunction with general local
government tax revenues. The general revenue pays for the general benefit
while the special assessment pays for particular benefits accruing to an
identifiable group. There is usually a provision for exemption from the tax
for those parties within the geographic area of the tax who do not benefit
from the improvement.
A "common application of the special assessment tax is to sell special
assessment bonds to finance a new sewer line to a group of homes or an
industrial area; the property owners serviced by the new line are taxed to pay
for the bond over a period of years. Special assessments have also been used
to eliminate public nuisances, such as for snow removal or tree trimming.
There are several analogous applications of the special assessment tax to
hazardous waste cleanup. For example, a special assessment could be levied
against businesses in an industrial area for the cleanup of a site used by the
businesses to dispose of wastes. Alternatively, businesses in an area with
existing or threatened groundwater contamination could be assessed a special
tax if the cleanup of a site would improve or protect their raw water supply.
These bond revenues may be appropriate to finance a remedial action or the
operation and maintenance costs at a site where a cleanup action has been
completed. Unlike revenue bonds, which would be secured by an existing
response fund's future revenues, the special assessment bond would impose new
taxes, but only on those who benefit from the project or have some
responsibility for the problems caused by the site.
Each bond has different consequences for the issuer, depending on a
state's particular circumstances. A closer look at the advantages and
disadvantages of each type of bond are provided,below to help states and
municipalities choose which bonding mechanism to use. The advantages and
disadvantages of each bond arise primarily from issues of equity, legality,
timing, flexibility, and cost.
6.2.2 Advantages and Disadvantages
General obligation bonds pledge the full faith, credit, and taxing
power of the issuer for the repayment of the bond. This implies that the
general taxpayer carries the burden of the debt, which creates both equities
and inequities. On the one hand, cleanup actions may benefit the health,
safety, and welfare of all citizens in a state or region, and it may therefore
be appropriate for everyone to pay a portion of the cost. On the other hand,
general obligation bonds shift the cost of cleanup to the general taxpayer,
while the benefits of past (and now clearly threatening) disposal practices
were originally enjoyed by industrial generators, transporters, and disposers,
who were able to dispose of hazardous wastes relatively inexpensively. Some
innocent victims of past unsafe disposal practices may already be paying for
these mistakes (through increased risk of illness, loss of property, loss of
-------
I
I
I
I
i
i
i
i
i
i
i
i
i
i
i
i
i
i
i
6-7
income, or loss of the use of natural resources); it may therefore be a
further inequity to them to place the burden of cleanup costs on the general
taxpayers.
In most states, general obligation debt is limited by statute or by the
state constitution to an absolute dollar amount, or to a proportion of total
property value or tax collections. For states or local governments nearing
their debt limits, they may be unable to issue general obligation bonds.
Most general obligation debt also requires electoral approval before it
can be issued. While this provides a check upon the actions of government
agencies and public officers, it also delays issuance of a bond and increases
the costs of issuance. A referendum can disrupt response planning by delaying
cleanup activities, and by providing the opportunity to politicize the
decision of where and how money will be spent for remedial actions.
The security of general obligation bonds (the full faith and credit
pledge) is usually sufficient to meet investors1 confidence in the bond
without the establishment of a special reserve fund. This allows more of the
proceeds from the bond sale to go to hazardous waste activities.
The full faith and credit pledge is ordinarily the strongest pledge
available to a state or local government. Therefore, it will-usually produce
the lowest interest cost. However, the exclusive use of general obligation
bonds can result in an overloading of the local taxing power, and may impose -a
severe tax burden on the owners of taxable property.
Revenue bonds are frequently used to finance activities of a
revenue-producing nature (e.g., airports or wastewater treatment plants). In
the case of remedial actions, the special fees or taxes paid by generators,
transporters, or disposers of hazardous substances and wastes are considered
as the net revenues of a cleanup project. As such, revenue bonds may be
considered more equitable than general obligation bonds because the cost of
the response action is borne primarily by that class of society which created
the problem, that is, the generators, transporters, and disposers of hazardous
substances and wastes.
Revenue bonds frequently can be issued without electoral approval and are
not subject to the debt limitations applied to general obligation bonds.
However, the authority to issue a revenue bond usually resides in a special
purpose agency (such as a water and sewer commission, a housing agency, or a
pollution control authority). If no agency exists with the power to issue
revenue bonds for hazardous waste purposes, one would have to be created under
the authority of the state or by legislative action.
If an issuing authority does exist, a revenue bond may be issued with
relatively little delay. This is particularly important in today's market
where interest rates have been consistently high, but where an occasional drop
in interest rates allows governments which can act quickly to take advantage
of lower-cost borrowing.
-------
I
I
I
I
i
i
i
i
i
i
i
I
i
i
i
i
i
i
i
6-8
A revenue bond often provides greater flexibility in arranging the
patterns of debt service to match the anticipated revenue streams intended to
repay the debt. General obligation bonds, on the other hand, often are
required by law to follow certain repayment patterns.
The costs of borrowing money with revenue bonds are generally higher than
for general obligation bonds. In most cases the revenue bond will carry a
higher interest rate than the general obligation bond of the same government.
In addition, there frequently are other miscellaneous cos'ts, such as special
legal fees or insurance, or reserve requirements which increase the cost of
the bond. However, in the case of a revenue bond which also carries the dual
pledge of net response fund revenues and the full faith and taxing power of
the issuer, it may enjoy a credit rating superior to either a general
obligation or,a revenue bond.
Special assessment bonds have been used to apportion the cost of
certain improvements among the properties which are benefitted. The
imposition of a special assessment is typically supported by the premise that
the improvement being undertaken preserves or increases the.value of the
property being served. For hazardous waste response actions, the commercial
and industrial businesses in an .area where a cleanup is undertaken may enjoy
reduced employee health risks, improved environmental quality, preservation of
natural resources (e.g., water supplies) on which they are dependent, and
increased property values or, at least, preservation of the value of their
existing investments in-property. The special assessment would be even more
equitable if it were levied against the businesses and industries operating in
an area, or using certain disposal facilities or practices, which created the
waste site problem in the first place. Special assessment bonds would not
appear to be appropriate in instances where those who would be taxed are
residents who already bear the increased risk of exposure to threatening
conditions at the site, and who have no connection with the site other than
their geographic proximity.
Special assessment debt has been used in some instances to circumvent
constitutional borrowing restrictions. Most states, though, treat special
assessment debt as part of their overall debt burden and apply the state's
debt limitations. Some legislative action is. usually required to impose a
special assessment and to establish an authority to collect the fees and issue
the bonds. This can cause considerable delay in raising revenues for
hazardous waste response actions.
Despite these limitations, there, are advantages to using special
assessments to raise revenues. Using a special assessment preserves the
general obligation pledge of a state or municipality. In periods of economic
adversity their use preserves the general revenues of the local government for
support of other essential ongoing services of government. The cleanup of
hazardous waste sites to remove public health hazards can be carried out
without detracting from the other services normally provided by the
government. At the same time, though, use of a special assessment will likely
require the continuation of the assessment until all of the bonds are
retired. This can result in the continuation of the assessment long after a
cleanup action has.been completed. While the benefits from the cleanup action
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
6-9
continue, justifying the continuation of the special assessment, those paying
the assessment may not perceive the need for continued special assessments
when the cleanup activities are completed, and may lobby for the repeal of the
assessment. This could cut off the funds needed to repay the special
assessment bonds.
There are ordinarily no limitations on the amount of special assessment
debt beyond what the market will purchase. However, the interest cost on
special assessment debt will usually be higher than that of general obligation
bonds because of the limited assessment power of the issuing authority.
6.3 FACTORS DETERMINING A STATE'S BONDING CAPABILITY
States which are considering issuing bonds to finance hazardous waste
cleanup operations must evaluate a number of factors to determine whether they
have the capability (legally, financially, and politically) to support a
bond. The first factor is whether the state has the authority -to issue a
bond, who has jurisdiction over the issuance, and what restrictions there
are. Second, the state must review the funding mechanisms which will be used
to retire the debt (e.g., the hazardous waste fees or taxes), and whether
accurate estimates of future revenues can be made. Given those revenue
streams, the state can then determine the amount of debt that can be supported
by the revenue streams. The bond is then structured such that the fees or
taxes cover the debt service in each year. The last factor is the actual
planning for issuance of the bond, including who is involved-and their
responsibilities. The discussion which follows focuses primarily on revenue
bonds secured, at least in part, by the future stream of special fee or tax
revenues used to fund the state's response fund, since this is a new concept
which states may wish to consider in lieu of or in addition to general
obligation bonds.
6.3.1 Issuing Authority
The authority to bond varies both from state to state and according to the
type of debt to be issued (e.g., general obligation or revenue bonds).
Several broad principles usually can be applied, though. General obligation
debt, which is incurred for the benefit of the entire state, is issued
directly by the state and usually requires voter approval through a referendum
or similar mechanism. General obligation bonds are subject to the debt
limitations of a state; this can be in the form of an absolute dollar amount,
a proportion of property value, or a proportion of tax collections. Debt
limitations are set by statute or in a state's constitution and can,
therefore, be exceeded only by popular referendum or by legislative or
constitutional amendment. Revenue bonds, on the other hand, are not a direct
obligation of the state and are not restricted by debt limitations, nor do
they normally require voter approval. Revenue bonds usually are issued
through a special authority established by the state to carry out a designated
activity. For example, a state water and sewer authority may issue bonds to
finance the construction of a wastewater treatment plant and retire the debt
from the collection of water and sewer charges.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
6-10
It appears, then, that states have several alternatives for issuing
revenue bonds for hazardous waste cleanup purposes. First, the state could
levy a special assessment (e.g., a waste end tax or fee, permit fees, a
hazardous substance transfer tax, etc.). It could then use its borrowing
authority to issue special assessment bonds. The state could, alternatively,
create a new authority to finance hazardous waste response efforts, giving the
authority the power to issue revenue bonds, and assuring that the state's
hazardous waste fees and taxes are allocated to that authority for its
operations and debt retirement. Establishing a new state authority almost
always requires specific legislative approval, although this is not always the
case at the local level. The time required to obtain legislative approval
varies from state to state, but it can be assumed that this would be a fairly
lengthy procedure requiring at least one year, and possibly, a minimum of two
years in those states with biennial legislatures.
Another option is, essentially, to piggyback the responsibility for
hazardouswaste activities onto an existing authority. The most desirable
pairing would be with an authority that has a similar and compatible public
purpose and that has substantial and secure revenue sources. For example, a
state environmental pollution control or financing authority could be used to
issue bonds for hazardous waste cleanup financing. Or a port authority, with
management responsibility over a jurisdiction containing an existing hazardous
waste site, could use its bonding authority to raise money for the site's
cleanup. Using the revenue generating capacity of a vital service to cover
the revenue requirements of another service is not unheard of. A wide variety
of enterprises, including water and sewer commissions, public utilities, and
municipal hospitals, have had their mandates extended to include the provision
of peripherally-related services. In effect, surplus revenues from one part
of their operations are being used to cover losses in another.2
Several examples of combined public authorities exist. A water and sewer
authority, which is charged with providing the public with a safe and adequate
supply of water, might legitimately undertake hazardous waste cleanup
activities as a means of ensuring continuing safe use of raw water supplies
provided by ground and surface waters. Another option would be to combine
responsibility for financing hazardous waste response actions with ongoing
waste disposal activities, either of hazardous or non-hazardous materials.
The state or local agency responsible for financing current disposal
activities would thus be given additional responsibility for financing the
cleanup of existing hazardous waste sites in their service area.
The problems with modifying an existing authority in some cases may be as
troublesome as establishing a new authority. Legislative approval may be
required and coufd involve an intense political struggle. Thus this approach
may be most successful where the responsibility of a public authority is being
reorganized for another reason.
2Henry Lee, et al., "Financing the Cleanup of Uncontrolled Hazardous
Waste Sites - A Handbook." Harvard University: 1982.
-------
I
I
i
i
i
i
i
i
i
i
i
i
i
i
i
i
i
i
i
6-11
It is clear from this discussion that the speed and ease with which a
state may issue revenue bonds for hazardous waste response actions is highly
dependent upon the availability of an appropriate authority to issue the debt,
or the ease with which an authority could be created.. The checks placed on
the issuance of debt serve the purpose of providing public oversight of the
state's activities. There are many reasons to believe that the public will
find bonding for hazardous waste response a legitimate undertaking of the
state and would approve a bond issue. New Jersey voters, for example,
approved a $100 million general obligation bond issue. Where special tax and
fee mechanisms are already in place, and where the revenue projections from
those taxes and fees.can be estimated accurately and are of adequate size to
support a bond issue, states may be willing and able to issue hazardous waste
revenue bonds, either through an existing agency or a new authority.
6.3.2 Revenue Streams
The next issue to consider when exploring the possibility of bonding for
hazardous waste cleanup is what revenues would be available for repaying the
debt. Since the purpose of this Handbook is to examine ways to increase the
purchasing power of existing state funds, it does not consider any funding
mechanisms which are not already in place. Instead, it focuses on the 22
states which have funds for remedial action purposes, and more specifically on
those having industry tax or fee schedules which serve as a source of revenues
for the fund. Of course, the discussion is equally applicable to states
considering establishing such a trust fund or state accounL. The first
interest is whether a state can determine accurately the amount of revenues
which can be generated by its fees or taxes. The next section discusses
whether those funds are sufficient to support a bond issue.
The security for a revenue bond is provided by the monies to be collected
by the issuer of the bond, in .this case the fees and taxes now flowing to the
state's response fund. Revenues derived from these fees or taxes make the
bonds appear to be even more secure than a traditional revenue bond because
the receipt of revenues is not contingent upon the success of the project
(i.e., the fees or taxes going into the response fund will be collected
regardless of the cleanup activities which occur). In contrast, most revenue
streams supporting revenue bonds are highly dependent upon the success or
failure of the demand for the public service being provided. In either case,
the issuer must be able to demonstrate that the revenue projections are indeed
accurate, and that they are sufficient to cover the debt service. Therefore,
the study examined eight states with various fee or tax schemes, and which
currently have at least some money in their response funds, to review their
experience with revenue projections and collections (the states included
California, Florida, Illinois, Indiana, Kentucky, Massachusetts, New Jersey,
and New York). Of the eight states, only three currently have sufficient
information upon which to base their revenue projections: California, New
Jersey, and New York. The experience of each state is described below, and
serves to illustrate the states' capabilities to project revenues based on
hazardous waste fees and taxes.
California's Experience. California's Hazardous Waste Control Law,
passed in 1981, provides for hazardous waste management and site cleanup. The
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
i
i
i
i
6-12
law establishes the Hazardous Substance Account and allows the Department of
Health Services to spend up to $10 million each year on remedial actions,
either as part of the federal Superfund match or for response actions financed
entirely by the state. The law also establishes a tax on generators of
hazardous wastes to fund the Hazardous Substance Account. The formula for
determining the tax rate annually is statutorily prescribed and structured
such that the tax generates $10 million in any one year (which is also the
fund's yearly expenditure limitation). A sunset provision limits the
imposition of this tax to ten years.
The California Board of Equalization, which collects the tax, receives an
annual report of wastes disposed of by each hazardous waste generator in the
state. The figures in these reports are then entered into a formula to
determine the base tax rate necessary to yield $10 million for that year. The
formula is weighted to account for waste toxicity so that generators of
extremely hazardous wastes pay accordingly to the fund. Waste generators are
divided into four categories: generators of wastes from the extraction,
beneficiation-, and processing of ores and minerals who pay 1 percent of the
base rate; generators of wastes exempt from EPA regulations who pay 15 percent
of the base rate; generators of extremely hazardous wastes who pay 2 tiroes the
base rate; and generators of all other hazardous wastes who pay exactly the
base rate.
In March, 1982, the Board received the first reports of hazardous waste
disposal in the state for calendar year 1981. Using these figures, it then
computed a base tax rate of $6.52 per ton to be paid by all waste generators
according to the category and amount of wastes they reported. The Board
subsequently collected $9 million, $1 million less than the goal. The state
attributed this shortfall to their inexperience with the tax (1982 was its
first year in use) and to inaccurate reporting or filings by hazardous waste
generators.
In March, 1983, the Board received hazardous waste disposal reports for
1982 activities. Based on these volumes, and subtracting the unobligated
balance in the Account (an estimated $633,000), the Board established a base
tax rate of $9.29 per ton. Using this tax rate, the state expects to collect
$9,363,000; actual collection figures were unavailable for this analysis.
New Jersey's Experience. New Jersey has some of the oldest programs
addressing the problems of hazardous wastes. Funding for hazardous waste
cleanup and management is provided through six pieces of legislation. They
generate funds through taxes, fees, bonding, appropriations, incentives, and
other contributions for the various financial needs associated with hazardous
substances. The major piece of legislation addressing remedial actions is the
Spill Compensation and Control Act of 1976 and its subsequent amendments. The
1976 Act identifies the storage and transfer of petroleum products and other
hazardous substances as a hazardous undertaking which imposes risks of damage
to persons and property within the state. It therefore imposes a tax on the
transfer of oil and other hazardous substances to insure compensation for
cleanup costs and damages associated with any discharge of hazardous
substances, including hazardous wastes.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
i
i
i
i
i
i
6-13
The tax is imposed on owners and operators of major facilities handling
oil and hazardous substances, and is to be paid at the time of transfer; the
same barrel of oil, or products derived therefrom, are taxed only once at the
point of first transfer within the state. The tax rate is set in the statute
at $0.01 per barrel for petroleum or 0.4 percent of the fair market value of
the product for products other than petroleum. The tax is collected each year
until the fund balance reaches $50 million. If the fund balance subsequently
drops below $40 million, the tax is reimposed. In the event of major
discharges of hazardous substances, the law contains an escalator provision
raising the tax rates to as much as $0.04 per barrel or 0.8 percent of the
fair market value of the product, which will remain in effect until the
balance in the fund equals 150 percent of pending claims against the fund.
The Hazardous Discharge Bond Act, passed in 1981, authorizes the issuance
of up to $100 million-in general obligation bonds of the state. The proceeds
from any bond sale would be deposited to the Hazardous Discharge Fund. These
bonds serve only as a backup to the Spill Compensation and Control Act; if the
funds provided by the Spill Compensation and Control Act are insufficient to
meet the cleanup commitments of the state, then bonds may be issued and the
revenues of the Hazardous Discharge Fund used for cleanup actions. To date,
New Jersey has issued no bonds under the Act and does not anticipate issuing
any bonds in the near future.
For the four-year period 1977 to 1981 approximately $33 million was
collected by the fund, or an average of $685,000 a month. For the last two
years, the taxes have been generating between $800,000 and $850,000 a month.
During an emergency period in 1982 the rates were raised in accordance with
the escalator clause, and the fund took in approximately $1.2 million a
month.' The fund is, essentially, expenditure driven, such that when hazardous
waste programs dictate the expenditure of funds, the taxes self-adjust to
provide the necessary revenues, to the extent permitted by the Act imposing
the transfer taxes.
New York's Experience. In July 1982, New York State passed a toxic
waste bill creating a state "Superfund" to be used for hazardous waste manage-
ment and cleanup. Funds are to be raised through appropriations, penalties,
and waste end taxes. The Hazardous Waste Remedial Fund's annual revenue
collection is limited to $10 million; that is, when the fund balance reaches
$10 million, no taxes are collected for the rest of the year. The tax levied
on generators is $-12 per ton of hazardous waste disposed of in landfills, $9
per ton of hazardous waste treated or disposed of off-site (excluding disposal
in landfills), and $2 per ton of hazardous waste that is incinerated on-site.
The tax rate was determined based on tonnage estimates of wastes
transported and disposed of in the state. This information was obtained from
historical data contained in the manifests filed with the state as required by
state law. Based on this data, the state projected that it would collect $10
million in the 1982-1983 tax year. First quarter collections from the tax
were only $657,000, however, and the state now estimates that it will collect
only $2.7 million for-the entire tax year. The state attributes this
substantial shortfall in revenues to a number of factors, including: the
recent decline in economic and manufacturing activity; inaccurate waste volume
-------
I
I
I
I
1
I
I
I
I
I
I
I
I
I
I
I
I
I
I
6-14
projections based on insufficient data; under-reporting of on-site waste
management practices and non-compliance with the state's manifest
requirements; increased recycling of wastes as well as abuse of the tax
exemption for recycling; and a decrease in wastes sent .to the state for
disposal.
It is clear from even this brief survey that at least in the first year of
a new tax or fee there can be severe limitations on using the revenues of
these taxes and fees as security for a bond to fund cleanup activities.
First, most of the 22 state funds appear to have extremely low annual
revenues, limiting their usefulness as unilateral security for a revenue
bond.3 This may be the result of low tax rates, low waste generation or
disposal rates within the state's jurisdiction, or non-collection of the tax
by the state. Second, a state must be able to track the stream of taxed
materials within the state, both for determining a tax rate and estimating the
revenues, and for the actual levying and collection of the taxes. In
California, the tax rate fluctuates with waste volume, such that the total
amount collected equals $10 million annually. In contrast, New Jersey's tax
rate is variable, depending on the need for emergency response. However, if
there were a drop in the volume of petroleum or other transfers (which are
subject to the tax), the tax rate does not automatically increase. In times
of fewer transfers, there is also a reduced likelihood of a spill or other
release, so that the need for cleanup funds may also be lowered. Both states
appear to have estimated fairly accurately the volume of taxed materials
transported or handled in their states. New York, on the other hand,
estimates that its first year collections will fall far short of the projected
$10 million for 1983. Finally, states must be able to assure the imposition
of those taxes or fees for the life of the bonds. Otherwise, there is no
guarantee of a revenue stream being available for the retirement of the debt
when it matures. California's ten year sunset provision, for example, makes
it "difficult for them to issue bonds secured by those revenues which would
mature later than 10 years from now.
6.3.3 Debt Capacity
Normally, the first step in planning a bond issue is to determine the
precise cost of the project to be financed. This will dictate how much debt
needs to be issued, and when, to complete the project. The user charges to be
applied to the service and the revenues derived from those charges are then
estimated, A proper.maturity structure is designed such that the estimated
3In February, 1983, the balances in the 22 state funds available for
remedial actions included: 8 states with balances between $1 million and $14
million; 12 states with balances between $5,000 and $700,000; and 2 states
with no fund balance. These fund balances may or may not relate to annual
revenues; some fund balances are the result of legislative appropriations
while others result from the collection of state fees or taxes. Thus, the
actual size of a state's remedial action fund may be unrelated to a state's
ability to support a bond issue.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
6-15
annual revenues from the user charges adequately cover the debt service
payments. Generally, the longest maturity should not exceed the estimated
usable life of the project or the last year for which significant net revenues
are estimated.
For financing remedial actions with revenue bonds based on hazardous waste
taxes or fees, a different approach to determining debt capacity is
necessary. Instead of looking at the project cost to determine funding needs,
the state would look at the revenue estimates of its taxes and fees, and use
the estimate to determine the size of the bond issue which can be supported by
those revenues.
Considerations Affecting Debt Capability. This approach recognizes
several factors specific to hazardous waste activities: first, remedial action
cost estimates are, of necessity, subject to unexpected changes; second, the
income stream is likely to be generating income in advance of even initiating
the project; and third, the response action's scope and costs must, by
necessity, be scaled to the amount of money to be made available. Planning
the bond issue in this manner has a number, of important prerequisites.
First, the state must have in place some form of industry fee or tax
(e.g., a waste end tax, permit fees, a hazardous substance transfer tax,
etc.). These fees or taxes should be free from present legal challenge by
those against whom it is assessed to assure investors that the revenues
securing the bonds will be collected. New Jersey's transfer tax, for example,
was challenged on the grounds that CERCLA Section 114(c) precluded states from
levying similar taxes on industry to cover the state's hazardous waste cleanup
costs (Exxon Corp. v. .Hunt, No. 82-619). The tax court of New Jersey ruled in
favor of the state; the Justice Department, in a related case (Lesniak v.
United States, No. 81-977), stipulated that the state law was not preempted by
the federal statute. Further, any sunset provisions for the fees or taxes
must be taken into consideration. California's taxes, for example, are
limited to a collection period of. ten years.
Second, the state must be able to estimate accurately the revenues to be
collected from the fees or taxes, or limit the proportion of tax or fee
revenues used to secure the bond to an amount certain to be collected. As
discussed previously, estimating revenues is not always a simple procedure.
Taxes on wastes may fluctuate with changes in production volume, disposal
practices, economic activity, or other unforeseen developments. The best
estimates may be those based on historical evidence such as New Jersey's, yet
many of the current taxes and fees are too new to provide any historical data
(New York and California, for example). Any projections 'must be based on
reasonable assumptions of future operations, waste streams, disposal patterns,
or whatever foundation upon which the revenues are based. As seen in the
prior examples, this can meet with a greater or lesser degree of success.
Third, the administering state agency must decide how much of the tax or
fee revenue will be dedicated to the repayment of bonded debt. Remedial
actions may be only one of many activities financed by the state's fund. The
agency must therefore examine the cost of other activities, the cost of
remedial actions, and the funding priorities of the state fund. The agency
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
6-16
should recognize that a commitment of funds for debt repayment will remove
those funds from the agency's discretionary budget for as long as the bonds
are outstanding.
Examples of Debt Capacity Determination. At this point, the state can
determine how much debt can be supported from the dedicated revenue streams.
This is usually an iterative process, and can best be illustrated with a
simple example. First, consider a $10 million, 15 year bond, issued at a 10
percent interest rate. A portion of the debt will be retired each year
through a sinking fund,* such that as the principal is reduced, the interest
portion of each payment declines. This can be structured to produce a level
debt service for the entire life of the bond (see Exhibit 6-1). In this
example, the annual debt service would be $1,314,737 for 15 years. The total
debt service over 15. years is $19,721,067, of which.$10 million is the
repayment of principal and $9,721,067 is the total interest paid. These
interest payments represent the cost of borrowing $10 million at 10 percent
when repaid over a period of 15 years. Thus, for a state to issue a $10
million bond, for 15 years at 10 percent, it would need to be assured of
revenues that could be allocated exclusively to debt service of at least
$1,314,737 per year for the life of the bond.
A $10 million bond could also be repaid over 30 years. Again, at a 10
percent interest rate, with a portion of the debt service retiring some
principal each year, the annual debt service would be $1,060,793. This would
result in total debt service of $31,823,774 ($10 million in principal and
$21,823,774 in interest payments).
If, instead, a state knew that it would be collecting $1,000,000 per year
in hazardous waste fees or taxes, how long would it take for the state's fund
to accumulate $10 million if all the money were saved (i.e., none were used
for other purposes)? If the state could invest those funds at the current
lending rate, the annual collections would grow to $10 million in something
less than 10 years. How much less depends on the interest rate the fund
earns. At 5 percent, $1 million invested at the end of each year will grow to
$10 million in about 8 years. Invested at 10 percent, the fund would reach
$10 million in just over 7 years. This assumes that the interest earned by
the fund is retained by the fund and reinvested at the lending rate;
otherwise, ten years of savings would be required before $10 million would be
available for the remedial action. This comparison illustrates both the
benefits and the costs of bonding to pay for response actions; bonding may
enable response actions to be undertaken more extensively or much more
quickly, but at the cost of using future revenues to pay for the interest
charges.
These two examples serve to illustrate several other points. First, the
annual debt service for the same amount of debt ($10 million in this example)
*A sinking fund is a fund accumulated by an issuer over a period of time
to be used for retirement of debt, either periodically or at one time.
-------
I
i
I
I
I
1
I
I
I
I
I
I
I
I
I
I
I
I
I
6-17
EXHIBIT 6-1
$10 MILLION BOND ISSUE
(15 Years, 10 Percent Interest)
Year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
Principal
Repaid
$ 314,737
346,211
380,382
418,916
460,807
506,888
557,777
613,334
674,668
742,135
816,348
897,983
987,782
1,086,560
1,195,216
Interest
Charges
$ 1,000,000
968,526
933,905
895,821
853,930
807,849
757,160
701,403
640,069
572,602
498,389
/ 1 X «* f t
416,754
326,955
228,177
119,521
Total Annual
Debt Service
$ 1,314,737
1,314,737
1,314,737
1,314,737
1,314,737
1,314,737
1,314,737
1,314,737
1,314,737
1,314,737
1,314,737
1,314,737
1,314,737
1,314,737
1,314,737
TOTAL
$10,000,000
$9,721,067
$19,721,067
Columns may not add to totals due to rounding.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
1
I
I
I
6-18
can vary depending on the length of the borrowing period. Second, the total
amount of interest paid will increase with the length of time for repayment of
the bond. Similarly, the interest rate will affect the annual debt service
and total interest paid (see Exhibit 6-2 for a complete comparison of the
effects of interest rates and term of the bond on debt service and interest
expense). These are both important factors for an agency to evaluate when
considering a bond issue. A more detailed examination of the bond structure
is presented in the next section.
Now suppose a state knows with some degree of certainty that its hazardous
waste fees or taxes will generate $1 million a year for the next 10 years.
Assume the state has estimated that one-half of those collections ($500,000)
are needed for administrative and other program expenditures. The state would
like to capture the present value of the remaining $500,000 per year by
issuing a revenue bond and dedicating the fee and tax collections to repayment
of the bond. How much cash could it raise today?
The state knows that it will be collecting $500,000 per year for 10 years
to retire a bond, so taking into consideration interest payments, it knows it
will be able to issue something less than $5 million in bonds. How much less
depends on the interest rate the issuer must pay. The bond can be structured
such that a portion of-the debt is retired each year, and a level debt service
is maintained over the life of the bond. If the state can borrow at 8
percent, it can raise $3,350,000 today, with an annual debt service of
$499,248, or just below the $500,000 available (Exhibit 6-3). If, however,
the interest rate is 10 percent, it could raise only $3,070,000, which would
require annual debt payments of $499,628 (Exhibit 6-4). A 2 percent change in
the interest rate cost the state $280,000 in revenues available today, or more
than 8 percent of the total amount of money it could have raised at the lower
interest rate.
One final consideration is whether the state can spend effectively the
money raised by issuing such a large bond. In the previous example, it was
shown that a state with an annual dedicated revenue stream of about $500,000,
which was relatively certain to be maintained for 10 years, could raise $3.35
million now with a 10 year bond issued at 8 percent interest. The $3.35
million would allow that state to provide a 50 percent match for a Superfund
financed $4 million remedial action at a publically owned site.($2 million
provided by the state), plus a 10 percent match for a $13.5 million remedy at
another Superfund site ($1.35 million provided by the state). Whether, this
level of response action is within the capability of the state to administer
will be dependent on each state's particular program and whether the state or
EPA will have lead responsibility for managing the response. For example, New
Jersey, which has one of the oldest and best staffed hazardous waste
management programs in the country, collects between $800,000 and $1 million a
month. In turn, it is capable of spending money at a rate of $50,000 a day,
or $1 million a month. It has, at times, spent as much as $500,000 a week (or
$2 million a .month). Some New Jersey officials suggest that the state has
found that for its current program, a moderate expenditure level (around
$800,000 a month) can achieve the maximum efficiency in government-managed
response actions.
-------
I
1
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
6-19
EXHIBIT 6-2
EFFECTS OF BOND TERM AND INTEREST
RATE ON TOTAL DEBT SERVICE
$10 Million Borrowed $10 Million Borrowed
at 5 Percent at 10 Percent
15 Year Maturity
Annual Debt Service $ 963,432 $ 1,314,737
Total Interest 4,451,343 9,721,067
Total Principal 10,000,000 10,000,000
Total Debt Service3 14,451,343 19,721,067
30 Year Maturity
Annual Debt Service $ 650,514 $ 1,060,793
Total Interest 9,515,431 21,823,774
Total Principal 10,000,000 10,000,000
Total Debt Service8 19,515,431 31,823,774
aVariance in totals reflects rounding of the annual debt service.
-------
I
I
I
I
I
I
I
I
1
I
I
I
I
I
I
I
I
I
I
TOTAL
6-20
EXHIBIT 6-3
$3.35 MILLION BOND ISSUE
(10 Years, 8 Percent Interest)
Year
l
2
3
4
5
6
7
8
9
.10
Principal
Repaid
$ 231,248
249,748
269,728
291,307
314,611
339,780
366,963
396,320
428,025
462,267
Interest
Charges
$ 268,000
249,500
229,520
207,941
184,637
159,468
132,285
102,928
71,223
36,981
Total Annual
Debt Service
$ 499,248
499,248
499,248
499,248
499,248
499,248
499,248
499,248
499,248
499,248
$3,350,000
$1,642,487
$4,992,487
-------
I
I
I
I
1
I
I
I
I
I
I
I
I
I
I
I
I
i
I
6-21
EXHIBIT 6-4
$3.07 MILLION BOND ISSUE
(10 Years, 10 Percent Interest)
Year
1
2
3
4
5
6
7
8
9
10
Principal
Repaid
$ 192,628
211,891
233,080
256,388
282,027
310,230
341,253
375,378
412,916
454,207
Interest
Charges
$ 307,000
287,737
266,548
243,240
217,601
189,398
158,375
124,250
86,712
45,421
Total Annual
Debt Service
$ 499,628
499,628
499,628
499,628
499,628
499,628
499,628
499,628
499,628
499,628
TOTAL
$3,070,000
$1,926,280
$4,996,280
Columns may not add to totals due to rounding.
-------
I
1
I
I
1
I
I
I
I
I
I
1
I
I
I
I
I
I
I
6-22
In conclusion, states must consider their financing needs and spending
capability carefully before determining whether to use bonds and the size of a
bond issue; If response actions are stalled because of a lack of cash,
bonding would provide that cash. If a state needs to make an initial payment
to EPA to meet the 10 percent matching share and thereby release 90 percent of
the funds necessary for a cleanup, bonding could meet that cash need as well.
6.3.4 Bond Structure
There are a number of features of a bond which will affect the total
annual debt service required to cover a bond's principal and interest
payments. The previous example illustrated the influences of the length of
the bond (15 years versus 30 years) and of the interest rate (5 percent versus
10 percent) on the yearly debt service and total amount of interest paid, and
thus on the total debt capacity which could be supported by a given revenue
stream. Another important feature that affects debt service is whether the
bonds are term bonds or serial bonds (the previous example was essentially a
serial bond).
A term bond is one which calls for the maturity of all of the bonds of
a single series on the same date, when all of the bonds will be paid off.
Ordinarily in the issuance of a term bond, the law, bond resolution, or other
-agreement that constitutes a part of the contract between the issuing
government and the bondholders, requires the issuing government to make
deposits to a sinking fund. These are required to be made on a periodic
basis, e.g., monthly, quarterly, or semiannually. The amount of such periodic
deposits, together with the interest earned thereupon, is estimated to be
sufficient to "sink" the debt, i.e., to pay off the debt at its maturity. In
the absolute form, such term bonds are known as sinking fund bonds. The
absolute form of sinking fund has been replaced by either serial bonds or the
modified type' of sinking fund bonds under which portions (or all) of the
sinking fund asset must be exhausted at regular intervals to redeem some of
the bonds, either by call,5 purchase, or tenders in the open market.
Under modern indentures, sinking funds are used primarily for the
accumulation of funds intended to be used to retire debt in advance of its
maturity. The modern indenture ordinarily contains a schedule for mandatory
retirement of given amounts of debt by stated dates. To the extent that funds
are available in the sinking fund in excess of the amounts necessary to retire
the maturing debt, the issuer has the option of investing such funds (see
Chapter 3) or accelerating retirement of the debt.
A serial bond is a portion of a bond issue which has a maturity
different from other portions of the same issue of bonds. Ordinarily a serial
bond issue is organized in a manner such that a portion of the bond matures
each year, usually on an anniversary of the date of the bond sales, commencing
5 A call provision allows an issuer to redeem a bond prior to the
specified maturity date at a specified price at or above par.
-------
I
I
I
i
I
I
1
I
I
I
I
i
I
i
i
i
i
I
6-23
on an early anniversary. The sum of the maturities for all of the years will,
of course, equal the full amount of the series. Thus, in a sense, a serial
bond issue consists of a series of term bonds with different maturities and
ordinarily without the requirement that a sinking fund be developed. However,
serial bond issues are sometimes accompanied by sinking funds or other kinds
of reserve funds to enhance the attractiveness of the bonds to Investors.
Serial bonds may be structured to produce several patterns of annual debt
service requirements. The earlier examples illustrated a level annual debt
service pattern, in which the sum of the maturities (principal being retired)
and interest for each year approximates that of each other year for the life
of the issue. A second pattern establishes an equal annual principal .
maturity, where an equal amount of the bonds mature in each year over the life
of the issue. For example, a $10 million, 10 year bond would call for
maturities of $1 million per year. A third alternative is an irregular serial
maturity pattern, which can result in a wide range of debt repayment
schedules. These range from accelerated maturities producing very high
relative debt service requirements in the early years to patterns of deferred
maturities in which very few of the bonds are matured until the final few
years of the bond issue.
The patterns of annual debt service created by the structure of the, serial
bonds may be used to match more closely the anticipated revenue streams of the
hazardous substance taxes with the debt service requirements. Different
states may wish to establish different debt retirement patterns depending on
their experience with the imposition and collection of hazardous substance
taxes. For example, a state may impose a minimal tax on the incineration or
on-site disposal of hazardous wastes, and a substantially higher tax on wastes
disposed of in a landfill. Such a tax may encourage a preferred disposal
method (i.e., incineration) but may also result in lower revenues in later
years as generators alter their disposal practices. Under these circumstances,
a state may choose to structure a serial bond issue with accelerated maturities
.which produce higher debt service requirements in the early years, when tax
revenues are expected to be at their peak, and lower debt service requirements
in later years as the tax revenues decline. Alternatively, a state may impose
a tax scheme which produces greater revenues in later years. In this case,
the bond would be structured with deferred maturities, to be retired in later
years when tax revenues increase.
Some bond issues are developed as a combination of serial bonds and term
bonds. The term bonds in such a combination ordinarily contain a call
feature, inasmuch as it is the intent of the issuing government to provide for
redemption of the term bonds in advance of maturity if conditions warrant
(e.g., if interest rates decline substantially). An example of a combination
serial and term bond is presented below to show the effects the bond structure
can have on debt service requirements.
In this example, a $10 million bond issue is broken into two parts, $5
million in serial bonds and a $5 million term bond. The bond is issued
January 1, 1983; $1 million of the serial bonds matures each year beginning in
1985, while the term bond matures in 1995. The serial bonds are issued at 8
percent interest, and the term bond at 10 percent interest. In addition, the
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
6-24
term bond requires an annual payment to a sinking fund which will be used to
retire the debt in 1995. The sinking fund payments begin when the serial
bonds are retired, and are expected to be invested at 8 percent (the
short-term interest rate used here). Thus, annual sinking fund installments
of $681,577 for six years, invested at 8 percent, will grow to $5 million in
1995 and be used to retire the outstanding bonds. The total debt service
needed each year reflects the interest payments on the outstanding debt, the
serial maturity retirements, and the sinking fund installments. As
illustrated in Exhibit 6-5, the annual debt service fluctuates from year to
year, varying with the amount of interest paid and debt retired. The payments
are higher in the first few years, then gradually decline as the interest
charges decline. A level debt service is achieved in the last six years of
the bond issue. This pattern of debt service may be appropriate where a state
is fairly certain of relatively large revenue streams in the first few years
($1.8 million per year) as well as continued revenues throughout the life of
the bond ($1.2 million per year). Alternatively, the state may anticipate a
constant $1.2 million per year, but expects that additional appropriations in
the near term will be used to retire the maturing serial bonds. The total
debt service for the $10 million bond is $16,689,462, reflecting the cost of
borrowing funds for expenditures made today.
6.3.5 Planning a Bond Issue
The actual planning of any state bond issue will be done most likely by
the issuing agency (the state treasurer's office for a general obligation
bond, the independent authority for a revenue bond at the state level).
However, it is useful for the hazardous waste program manager to be familiar
with the bonding process in order to provide the most beneficial data to the
issuing agency, and to evaluate the implications of bonding for the hazardous
waste response program.
The issuing authority usually works closely with a financial advisor
(either in-house personnel or an outside consultant) when planning a bond
issue. With revenue bonds, the financial advisor examines the user charges
(in this case fund fees or taxes) and the state's estimate of response fund
revenues which will be devoted to remedial actions. This information will be
used to determine the terms of the bond issue, including the maturity
schedule, interest payment dates, call features, and any other provisions of
the bond. The financial advisor will advise on the timing of the bond issue
(when it is best to go to the market) and on the method of marketing (either
by competitive sale or by negotiation with an underwriter). The advisor will
assist in the preparation of the official statement, notice of sale, and
solicitation of bids.
The aid of an independent bond counsel is also necessary when planning a
bond issue. The bond counsel provides an independent evaluation of the
legality of the issue to determine whether it complies with the applicable
state and local statutes and qualifies for exemption from federal (and
sometimes state) income taxes. The bond counsel reviews the official
statement to make sure the legal information is correct, and examines the
proceedings for the sale of the bonds to ensure that the bonds are sold
legally.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
6-25
EXHIBIT 6-5
$10 MILLION REMEDIAL ACTION BONDS, ISSUED JANUARY 1, 1983
$5 MILLION SERIAL BONDS
a
Amount
$1,000,000
1,000,000
1,000,000
1,000,000
1,000,000
Maturity
1985
1986
1987
1988
1989
Coupon Rate
8%
8
8
8
8
Matures on January 1st of year
$5 MILLION 10 PERCENT TERM BOND DUE JANUARY 1, 1995
DEBT SERVICE REQUIREMENTS
Year Ending
January 1
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
TOTAL
Serial
Maturities
_
$1,000,000
1,000,000
1,000,000
1,000,000
1,000,000
-
-
-
-
-
-
Sinking Fund
Installments
-
-
-
- -
$ 681,577
681,577
681,577
681,577
681,577
681,577
Interest
Charges
$ 900,000
900,000
820,000
740,000
660,000
580,000
500,000
500,000
500,000
500,000
500,000
500,000
Total Annual
Debt Service
$ 900,000
1,900,000
1,820,000
1,740,000
1,660,000
1,580,000
1,181,577
1,181,577
1,181,577
1,181,577
1,181,577
1,181,577
$5,000,000
$4,089,462
$7,600,000 $16,689,462
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
6-26
With the assistance of these professionals, hazardous response program
managers should be able to assess the applicability of bonding to their
funding needs and spending capabilities and plan for the use of bonds if they
are determined appropriate.
-------
I
I
I
I
I
I
I
I
i
i
i
i
i
i
i
i
i
i
i
CHAPTER 7
FINANCE LEASES AND REMEDIAL ACTIONS
7.1 INTRODUCTION
State and local governments have relied upon several financing
alternatives to provide their share of the clean-up costs, including use of
trust funds financed by special industry taxes or fees and general revenues,
revenue transfers from state or federal government if available, and sale of
municipal bonds. Municipal finance leases are another alternative or
supplement to these more traditional approaches. To date municipal finance
leases have not been tried as a means of helping state and local government
pay the costs of remedial actions. Nevertheless this funding method is
receiving increasing use in financing other public projects, such as fire-
fighting equipment, public transit, wastewater treatment plants, resource
recovery facilities, and solid waste collection equipment, among others.
Municipal finance leases may, in some instances, be more attractive or
reliable than using current revenues, bonding, or intergovernmental grants to
finance remedies because they minimize such common problems as high costs of
bond issuance, the difficulty in passing bond referenda, cutbacks in
intergovernmental revenue sharing and transfers, competing demands for
spending in excess of general fund revenues available for essential services,
and statutory or constitutional debt, tax or spending limits.
This chapter will consider lease-purchase agreements which may be used
to help pay the public costs of remedial actions by: acquiring equipment,
structures, and other capital assets required for the remedy using long term
financing, without resort to the bond market or large cash downpayments.l
*
In a lease purchase arrangement (sometimes called a sale contract), the
government rents assets to be used in the remedy, but with an option to buy
them. The arrangement is essentially an installment sale contract that does
not require an initial large cash downpayment. The government user of the
asset agrees to make payments of the purchase price plus interest over a
period of years and has the right to purchase the property at a nominal fee at
the end of the contract period. In return, the private sector participants
1Another form of leasing is the operating lease. In an operating lease,
the government (lessee) rents an asset for a fraction of its useful life from
the private sector (lessor). The lessor is responsible for insurance, taxes
and maintenance. The lessor also may claim tax benefits such as depreciation,
however, the investment tax credit is unavailable if the lessee is a
governmental unit. This form of municipal leasing is common and its
advantages and disadvantages are well known; thus, it is not discussed further
here. A third form of municipal leasing, sale-leasebacks also are not
discussed in this chapter.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
i
i
i
i
i
i
7-2
providing the equipment (and long term financing) receive tax exempt interest
along with the installment payments.
This chapter provides an assessment of municipal finance leases as an
option for state and local governments to increase the purchasing power of
current state resources, The material is organized and presented in the
following sections:
* Description of the finance lease option,
Examples of municipal finance leasing transactions,
* Applicability to hazardous waste cleanup,
Procedure for establishing finance leases,
Major factors to consider in evaluating this option
including:
applicability to states;
amount of additional funds likely to be
generated;
ease of administration;
financial and legal risk;
transaction costs; and
equity.
7.2 DESCRIPTION OF OPTION
This section provides a discussion first of the assets that can be
involved in a lease-purchase agreement. Next, the section provides the form
of the lease agreement and its usefulness for both the public and private
sectors. Finally, this section concludes with an explanation of leveraged
finance leasing, that is, leasing involving third party financiers.
7.2.1 Assets Involved
The assets involved in a lease-purchase arrangement will always be part of
the remedial action- since this transaction is really an installment purchase
of the assets needed to implement the remedy; rather than being a means to
provide the government with new revenue. The assets financed in a
lease-purchase may be any of a wide variety of equipment, structures, or site
improvements needed for the clean-up. For example, the leased assets may be
an on-site permanent or mobile waste treatment or incineration facility,
trucks and other earth moving equipment, a new storage structure, or new drums
and overpacking, etc. If groundwater contamination is involved, the leased
assets might involve a grout curtain, a leachate collection system, equipment
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
i
i
i
i
i
i
7-3
for groundwater pumping, treatment and reinjection, and new monitoring wells.
If surface or groundwater raw water supplies have been rendered unsafe for
human consumption, the leased assets may include a new source of water supply,
a new or upgraded water supply treatment system, and a new distribution system
or individual add-on treatment units at wells. Such equipment, structures or
site improvements all share two important attributes (which will be discussed
shortly) of assets that may be financed by municipal leasing -- they are
eligible for at least accelerated depreciation deductions, and in some
instances, certain tax credits and other tax benefits under the Internal
Revenue Code.
7.2.2 Form and Use of the Lease-Purchase
Form of the Lease-Purchase. In the lease-pur chase of assets needed to
implement a remedial action the government leases the asset supplied by the
private sector and has the option at the end of the lease term to buy the
asset for a nominal, or no, additional amount. This arrangement is equivalent
to the purchase of an asset from the private sector on an installment basis.
The private party providing the asset is, in effect, loaning the public agency
the money needed to acquire the asset.
The government takes receipt of the asset with its initial installment
lease payment. The government's periodic lease payments include both payment
of principal and interest on the unpaid balance of the loan. The interest
portion of these payments is tax exempt. This tax free income (interest) is
what makes lease-purchase transactions attractive to high bracket taxpayers.
The principal portion of the payment, which is in effect a rental fee, is
taxable income to the lessor.
Title to the leased asset passes to the municipality, subject to the
original owner's lien. With this passage of title, the government is
responsible for insurance, taxes and all the risks associated with ownership.
Also usually included in a lease purchase agreement is a "fiscal funding"
(or nonappropriation) clause calling for the termination of the lease-purchase
for nonappropriation of public funds sufficient to make the next fiscal year's
rental payments. Inclusion of this clause ensures that the obligation for
lease payments would not extend beyond the typical annual public entity's
appropriation cycle and, therefore, isn't considered an installment purchase
which would obligate the public agency for debt beyond a one year period.
This provision differentiates finance lease obligations of governmental units
from bond and note obligations, which are ordinarily subject to debt
limitations and debt incurrence procedures in state and local law.
Lease-purchase transactions involving government have ranged in size from
as small as $50,000 to as large as $27 million. The typical contract length
is from two to seven years, depending primarily on the useful life of the
property being acquired. It has been estimated that the 1981 total dollar
volume of governmental lease purchases is in excess of $1 billion. In
contrast, in 1977 dollar volume was estimated at $250 million.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
i
i
i
i
i
i
7-4
0>
4J
t, 0)
O IA
d- 3
*> 0)
C *>
0) £D
(0 Q)
O.E
OT3
o c
CO
a>
01 -P
1- ffi
TO UJ
u>
re
o
I."
O (D
4J (.
U
0) JJ
CA CO
0 C
-P CO
CO O
^ ij
Q.C
CD
co E
. to
*» a> co
03-0 a
in > c
co o
a.
z f e
co E
4J (A
C CO)
CD O C
4J O '-S
in a o to
+>
U U
CB «A T)
CO C C CD
01 a.
0) CO (A CO
f- 3 O
*>
«9 CO JJ
O C 0) O O '»
CB 43 O O OTS
J£
UJ
0
X
SC.
Ld
^
X
- (£
1 =>
r a.
i
I- Ld
ffl <
UJ
X _l
X
UJ U.
o
CO
h-
u.
UJ
Ld
00
EC
O
t-
0
Ld
V)
Ld
5
>
K
a.
Q>
U
C
C CO
4*0
iwS
Q) 4-*
X C C
09 09 CO
E 0
X >»
CB CB
J-> O.T3
-»
is *>'ce
to en Q.
>£§
09 U
0 *> 09
09 CJ=
CC AJ
CO
I-
L.
Ld
Ld
a
Q
<
CA
Ul
(A
0) ^ JQ en c
tO - JC C Q>
CO > CO
£ c
U co 3 iJ O W E «-
C. ~ IA (A
3 u t- a>fc- co a
D. C O > O C CO
CO C 09 C
o c a> *>J=C9»
*> c .P c c
(h- ^5 ^3 j (Q- Q} *
(A CO C O Ci- C C3I
10
.
o
O>«-
O) « C TO E O
£4J|A 3 CO E eocBcoC**
at- eo £ c o co
4J O ** 1- *> U O43
C3*- -C Cl ' «-
0>C7 C09OC03M
E 09 W O E *» *» a-
C C C W -D O><
t- ^ » 43 E- CJIJ3 Q9 CO * Ci
>COO> («*>*>«CB
cS 3 S
U
CA
O
C£.
2
LJ
-------
I
I
I
I
I
I
I
I
I
I
I
i
i
i
i
i
i
i
i
7-5
Use of Lease-Purchase by the Public Sector. In effect, a lease
purchase provides the public sector with a no-down payment 100 percent
financed short or long-term loan with which to purchase the asset needed in
clean-up. Thus, the lease-purchase enables the state or local government to
provide a substantial match for federal Superfund money now, while stretching
out full payment of the match over a number of years. Equity accrues as the
loan is paid off and warranties and guarantees on equipment so acquired flow
completely through to the public sector. The installment payments defer cash
outlays of government and spread payments throughout the life of the project,
just as would bond financing. However many of the objections to bond
financing are avoided.
A lease-purchase agreement can be especially well suited to a local
government unable to finance the cleanup from current revenues and unable or
unwilling to raise the necessary capital by selling municipal bonds or raising
taxes in order to pay cash from general fund appropriations. Among typical
local government problems with sale of some municipal bonds are legal limits
on bond indebtedness, poor credit rating, lengthy, time consuming public
review and approval processes, and in some instances, a historic aversion to
long-term debt financing.
In addition to these public sector advantages, other attractive features
of lease-purchases include:
._ . jn cases where direct borrowing from a bank by a
government is prohibited, leasing may enable a local or
state government to raise intermediate-term capital.
Local government units with little or no access to
traditional credit markets may be able to finance
equipment and facilities through lease-purchases.
Lease-purchases may increase flexibility in cases
where the cost of certain equipment is too small for a
bond issue but too great for financing from current
revenues.
Government cash flow may be enhanced by leasing
without deferring needed equipment acquisitions.
Although the interest rate is almost always higher on
a lease than for a bond issue, leasing has no other
costs in contrast to the substantial fixed costs of a
bond issue.
' Because leases are completed as private placements,
the government as lessee has greater control of timing
and is not constrained by bond market fluctuations.
Lease-purchases can sometimes be the least expensive
means of financing.
-------
I
I
1
I
I
I
i
i
i
i
i
i
i
i
i
i
i
i
i
7-6
Use of Lease-Purchase by the Private Sector. In exchange for these
public advantages, the private supplier of the asset (or as explained shortly,
third party financiers) receive tax exempt interest payments on the unpaid
loan balance until fully amortized. For example, a municipality could finance
the construction of a leachate collection system at a site via a
lease-purchase which provided the clean-up contractor (and/or financial
backers) with periodic repayment of the loan principal (rental) plus
tax-exempt interest payments on the unpaid balance of the loan.
Other advantages of lease-purchase arrangements for the private sector
participants include:
* A hedge against swings in the economic cycle is
provided by the short or intermediate length term of
the agreement.
A higher interest rate than other tax-exempt
obligations of equal term is often realized.
A more frequent payment schedule, as well as payment
of principal and interest, offers the investor
accelerated cash flow and an earlier return on invested
capital, when compared to municipal bonds. Such bonds
typically pay investors interest only until the
maturity date of the bond, at which time principal is
repaid.
7.2.3 Leveraged Municipal Finance Leases
A variant of the lease-purchase arrangement is the leveraged lease
approach. Often, the size of the transaction in municipal lease-purchases may
require that the government lessee (in a lease-purchase), borrow part of the
purchase price of the asset. In such cases, a third party lender is brought
in to help finance the transaction. The third party might be a public
authority (e.g., port authority or waste management authority) issuing tax
exempt bonds, or a bank making a loan and selling certificates of
participation in the loan to investors who can benefit from the tax exempt
interest. The parties involved in leveraged municipal finance leases must
take into consideration current bond financing rates and make sure that the
interest portion of the lease payment is tax-exempt. In the leveraged finance
lease transaction diagrammed in Exhibit 7-2, the lease contract is used as
security for the loan.
With leveraged lease-purchase transactions of relatively small size,
financing may be provided by a single investor or lender such as a bank or
insurance company. When the dollar amount is large, a number of investors may
be involved in purchasing certificates of participation executed by a bank.
The sale of the certificates could be made through an underwritten public
offering, or a limited placement to an institutional investor, depending on
the size of the transaction, its complexity and the security features
involved. Typically, the manufacturer or the vendor of the property will
assign its right to receive installment payments under the lease contract to
-------
7-7
EXHIBIT 7-2
DIAGRAM OF LEVERAGED FINANCE LEASING
I
I
I
I
buy certificates provides
£ of participation financing leases asset
f \f
| individual (often lending lessor lessee
investors occurs) party
I
I
I
I
I
i
i
i
i
i
i
i
i
"sells certificates repays loan and makes lease
(investors benefit a security payments
from tax exemption) interest in asset
the third party providing the financing. The investor puts up the amount of
principal the government owes in exchange for receiving the government's lease
payments of both principal and tax exempt interest. The investor, therefore,
serves as the lessor and usually retains the lease contract for the term of
the financing. There are two ways this can be accomplished. The first is by
the vendor or manufacturer assigning its rights, title and interest in the
lease to the investor; the second is by creating a trust which will act for
future or existing investors. In the case where certificates of participation
are issued, the holders of the .certificates gain the right to receive the
installment payments, and the nominee bank which issued the certificates acts
as trustee, receiving the payments from the government unit and distributing
them to the certificate holders.
7.3 EXAMPLES OF MUNICIPAL FINANCE LEASING TRANSACTIONS
7.3.1 Memphis: Lease-Purchase
A lease-purchase agreement, in which the city effectively purchases an
asset through installment payments, was negotiated by Memphis, Tennessee. By
using the lease-purchase, the City avoided having to come up with the full
price of the assets when they were acquired. The City arranged to acquire
200,000 carts from a leasing company via a lease-purchase when it switched
from backyard to front yard trash pickup.
The lease-purchase of the carts was arranged as follows. The City's
finance officials gained approval from the City Council to receive bids from
vendors of the carts on two installment sales totalling $2.8 million and $4.6
million respectively. In the first round of bidding for the $2.8 million
installment sale, the City received hundreds of bids from vendors. The lease
term advertised by the City was five years', with installment payments made
-------
I
I
I
I
I
I
I
I
I
I
I
i
i
i
i
i
i
i
i
7-8
semi-annually and backed by the full faith and credit of the City. Unlike
most cities, Memphis allows guaranteed multi-year funding to the lessor for
leases up to five years. Upon award of the lease purchase contract and with
the first lease payment, Memphis held title to the carts subject to the
leasing company's lien.
For Memphis' second round of bidding of $4.6 million, the City received
only one bid which was too high to accept. City finance officials believe the
number of bidders was drastically reduced because they required a $95,000
"good faith" deposit from each bidder and because of a substantial drop in the
bond market on the business day before the bids were to be received.
Memphis differs from most other cities because it lacks many of their
financing restrictions. Memphis has no debt limitations or bond referendum
requirements, which are often reasons why a city might turn to leasing
options. Despite the absence of such restrictions, one major reason that
Memphis chose the lease-purchase option, rather than borrowing the capital
needed by issuance of bonds, was the term 'of the lease. The lease term was
five years compared with the twenty year repayment schedule for long term debt
financing by bonds. The shorter repayment schedule of the money loaned
through the lease-purchase provided an important benefit to taxpayers --
acquisition of the carts for less than total cost. More importantly, since
the useful li'fe of the carts is less than 20 years, their acquisition by long
term bonds would have required continuing repayment long after the carts had
been replaced. Further, transaction costs for the lease-purchase agreement
were not a major cost factor. The advertising costs for the lease-purchase,
were much lower than for long term bonds. Legal fees for the lease-purchase
were only required for the first offering. And, finally, there was virtually
no printing charge in the lease-purchase.
7.3.2 Kansas City: Leveraged Lease-Purchase
In 1981, Kansas City, Missouri set up a leveraged lease-purchase to
acquire 25 new ambulances for the City's ambulance service. Kansas City's
ambulance service consisted of private companies with no consolidated
communication system. The City first decided to subsidize a citywide
dispatcher system and consolidation of the firms into a single entity.
However, after consolidation, the City decided to buy out the still inadequate
ambulance service and expand it, including by acquiring 25 new ambulances.
To provide these increased services, the City Council approved a $2.5
million leasing arrangement with payments scheduled over 5-1/2 years. While
looking at their leasing options, the City's finance officials discovered they
could save paying excise and sales taxes if the municipality purchased the new
ambulances directly from the manufacturer rather than from a leasing company.
This would amount to a savings of 16 percent.
The City's Finance Department then drew up a $2.5 million leveraged lease-
purchase agreement and advertised for third party financing to help cover the
purchase price of the ambulances. A local bank that offered a 12 percent rate
of interest, Metro North State Bank of Kansas City, Missouri, was chosen to
provide the financing. The bank offered in-house certificates of
-------
I
I
I
I
I
I
I
I
I
I
I
i
i
i
i
i
i
i
i
7-9
participation to five other banks in order to raise the funds which were
loaned to the City. The entire amount borrowed from the bank was put into an
escrow- account yielding 16 percent interest.
Because the $2.5 million in equipment costs consisted of a variety of
equipment being purchased from different manufacturers and vendors, it was not
possible to make a one-time initial procurement of all the equipment.
Instead, the equipment was acquired over an eighteen month period. The
manufacturers and vendors were paid in full at the time of each purchase from
the City's working capital fund. This working capital fund is in turn
reimbursed by the interest-earning funds loaned by the banks and deposited in
the escrow account.
The manufacturers and vendors of the ambulances and equipment assigned
their rights to receive the City's installment payments on the lease-purchase
to Metro North State Bank and in turn, the bank assigned these rights to the
five holders of the certificates of participation.
The City's rental payments to the bank constitute a current expense of the
City; and are due the first day of each month, paying for the City's use of
the equipment during the prior month. The interest portion of the City's
payments to the bank is tax exempt and this exemption is passed through to the
five other banks. Title to the ambulances passed to the City with the first
payment to the bank and has been pledged in the form of a lien to the bank
until the City's 66 monthly payments-complete the purchase of the equipment.
Kansas City's benefits from entering into this lease-purchase agreement
include:
*
Avoidance of a $2.5 million full cash outlay all at
once;
Payment for the equipment over 66 months, as in long-
term debt transactions, but without incurring such
municipal bond problems as debt limits, voter approval
of long-term debt, and high transaction costs;
* Reduced financing charges (12 percent tax-free
interest rate paid to banks) for long-term borrowing,
but without the above municipal bond problems; and
Avoidance of 16 percent in excise and sales taxes.
7.4 APPLICABILITY TO HAZARDOUS WASTE CLEANUP
Lease-purchases, as well as their leveraged variants, can be used to help
pay for hazardous waste cleanup. Because state and local governments cannot
take advantage of tax benefits such as accelerated depreciation deductions, it
can be profitable for government to negotiate finance lease agreements to pass
on these unused benefits to the private sector.
-------
I
I
I
I
I
I
I
I
I
I
I
i
i
i
i
i
i
i
i
7-10
Lease-purchase agreements can be very advantageous in long-term financing
of hazardous waste cleanup. Like long-term borrowing through municipal bonds,
a lease-purchase enables government to stretch out the payment of major
capital expenditures, but it does so without incurring the numerous costs and
time delays normally encountered with issuing bonded indebtedness. As a
consequence, lease-purchases can be an attractive means of providing
substantial local or state in-kind matching funds for federal Superfund
sites. The lease-purchase arrangement has few, if any, additional costs. In
Comparison, a general obligation bond requires referendum costs, legal fees,
printing costs, underwriting fees, closing costs, and advisory and accounting
fees. A lease-purchase also gives the government an opportunity to use
long-term financing when debt limitations or other laws prevent or restrict
long-term borrowing through bonds. In a tax-exempt lease-purchase, a lower
interest rate can be negotiated. In effect, if the government chose to
purchase the equipment needed for the leachate collection and treatment system
in the above example through a lease-purchase agreement, the equipment
supplier, remedial contractor, or third party financiers obtained by these
parties as part of their bid would be loaning the government the money needed
to purchase the equipment. The rental payments the government would make
would be lower than the debt service payments would have been if the money
actually had been borrowed. This is because the interest portion of the
rental payments is tax-exempt and the private investor would pass on some of
this benefit to the government in the form of lower lease payments.,
7.5 PROCEDURES FOR ESTABLISHING FINANCE LEASES
This section covers the general procedure a state or local government
would follow in establishing a finance lease and ensuring compliance with
state and federal law.
In establishing a lease agreement, the government must first make a
careful evaluation of its financial needs. Once its precise needs are
determined, and the type of financing lease is chosen, the municipality must
evaluate the legal limits imposed by state and federal law. Under federal
law, in order for a lease to be qualified as a tax-exempt obligation under
Section 103(b) of the Internal Revenue Service Tax Code, the government unit
must qualify as a "political subdivision" or be an entity acting "on behalf
of" such political subdivision. The lease must be an "obligation" of the
governmental unit as explained in Section 103(a) of the Tax Code. In the case
of a lease purchase, the obligation must be structured as an installment sale
rather than as a true lease, and the interest portion of the installment
payments must be separately stated in the contract in order for that amount to
be treated as tax-exempt interest rather than as some other form of payment.
The state or local government must also determine if a third party lender
is necessary to help finance the purchase of the asset. If a third party
lender is to be used, and certificates of participation are to be issued to
the public, the municipality must comply with federal securities law regarding
disclosure requirements and the distribution of a prospectus to potential
investors. If the certificates of participation are to be sold through a
limited placement to an institutional investor, a placement memorandum must be
prepared for prospective investors.
-------
I
I
I
I
I
I
I
I
I
I
I
i
i
i
i
i
i
i
i
7-11
The local or state agency must also comply with state law. Tax exempt
lease financing must be permitted in the state for the governmental unit. The
government agency must also comply with state law regarding debt. If bonds
are to be issued, a city may have to develop an authority, to issue these
bonds, so as not to incur debt. When a lease-purchase requires issuance of
tax-exempt bonds in order to provide funds for the government to acquire the
asset, many states require that the issuer of these bonds be an entity other
than the municipality. And finally, the government agency must comply with
state usury laws with regard to interest rates.
7.6 MAJOR FACTORS TO CONSIDER IN EVALUATING LEASE
FINANCING OPTIONS
In considering finance leasing, government must examine how the
prospective transaction will be affected by state and local restrictions on
the acquisition and divestiture of property and on incurring debt. The ease
of administering the option, the financial risks involved, equity, and
transaction time and cost may also influence the option's feasibility.
7.6.1 Applicability to States
Tax-exempt lease financing is permitted in many states, but not all. The
laws of each state must be examined to determine whether the tax exempt lease
agreement is valid in the state for the particular governmental unit in
question. In general, the state laws are similar, but they do vary. Most
states are subject to debt limitations which will require a non-appropriation
clause to be included in the finance lease. This clause will enable the lease
agreement not to be considered government long-term debt, subject to debt
limitations or debt incurrence procedures.
7.6.2 Amount of Additional Funds Likely to be Generated
Lease-purchase agreements do not actually "generate" funds; they provide
alternative financing, ease cash-flow problems by stretching out payments, and
lower the cost of buying the needed asset. In effect, the private party is
lending the government money, although no debt is incurred.
7.6.3 Ease of Administration
Most of the administrative costs and complexity in finance leases occurs
with the first lease arrangement. Subsequent leases are substantially easier
to set up and administer. Some of the documents that might need to be issued
in a lease-purchase agreement are:
* Lease-purchase contract;
Evidence of security interest retained by vendor;
Compliance with competitive bidding requirements for
property involved;
-------
I
I
I
I
I
I
I
I
I
I
I
1
I
I
I
I
I
I
I
7-12
EXHIBIT 7-3
PROCEDURE FOR ESTABLISHING FINANCE LEASES
Evaluate
financial needs
and limits
Choose type
of financing
lease
Tax-exempt lease
financing must be
permitted in state
for the government
unit in question
Comply with
state and
federal law
Lease must qualify
as tax exempt
obligation under
the Tax Code
Comply with
state law
regarding debt
Comply with
state usury laws
with regard to
interest rates
Determine if third
party lender is necess-
ary to help finance
purchase of asset
If certificates
of participation
issued, comply
with federal
securities law
Advertise for
third party
lender
-------
I
I
I
I
I
1
I
I
I
1
I
I
I
I
I
I
I
1
I
7-13
Disclosure documents where required;
Escrow or trust agreement;.
« An arbitrage certificate; and
Legal opinion by bond counsel.
7.6.4 Financial Risk
In a lease-purchase agreement, the government has the usual operating
risks of owning property, such as the continued justification for owning the
asset and the possibility of obsolescence prior to the end of the lease
contract. The problem of generating the cash flow needed to make the lease
payments is also present. The private party faces the risk of the government
failing to appropriate sufficient funds in future years for the lease payments
and, therefore, risks owning property that might not be able to be sold or
disposed of. To reduce this risk, a non-substitution clause is usually
included in the lease contract which states that the government will not
replace the property with similar property for some period of time. This
clause eliminates the risk for the private party of the government terminating
the lease for any reason other than its inability to appropriate the necessary
funds.
7.6.5 Transaction Costs . "'
The transaction time and costs of finance leases will be highest for the
first lease agreement and will greatly decrease for subsequent transactions.
Transaction time for lease agreements can run from as little as 2-3 months, to
2 or 3 years, depending on state and county laws, whether approvals are taking
long, if a hearing is required, and what happens in the market with investment
bankers. Transaction costs run about 5 percent of the purchase price. This
percentage would increase if investment brokers and underwriters are used, as
well as in smaller transactions. For example, Kansas City's lease-purchase of
the ambulances took four months until the contract was signed, with about two
weeks of actual administrative time. Lease purchases in Kansas City of about
$500,000 have taken only about seven weeks to complete with administrative
time of only a few days.
7.6.6 Equity
In a lease-purchase, the government is paying for the property. Savings
(or revenue), however, are received by the state or local government are
obtained by selling tax benefits to the private sector. These tax benefits
will result in a corresponding decrease in general revenues raised by the
federal government through income taxes and may result in a similar decrease
in state general fund revenues where the state also has a personal and
corporate income tax. Thus, finance leases result in the state's taxpayers
obtaining an inter-governmental transfer of funds at the expense of the
federal government's taxpayers.
-------
I
I
7-14
. 7.7 SOURCES OF FURTHER ASSISTANCE '
Charles M. Johnson, Commissioner
Purchases and Supplies Division, Finance Department,
City of Kansas City
Kansas City, Missouri
I* George Petersen
The Urban Institute
Washington, D.C.
* Tom Ingersoll
EPA
§ Washington, D.C.
(202) 382-2190
Municipal Finance Officers Association
(202) 466-2494
I
I
I
I
I
I
I
I
I
I
I
-------
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
APPENDIX A
INSURANCE AS MEANS .OF EXPANDING STATE PURCHASING POWER
A.I INTRODUCTION
Insurance is a well-known financial mechanism commonly used to cover costs
of probabilistic events incurred by the insured. While some insurance
policies are intended to be claimed eventually (e.g. insurance annuities), in
general, insurance is provided for situations in which the probability is
small that the insurable event will occur. Insurers provide coverage to a
broad base of policyholders, thus spreading their risk across many clients who
experience varying degrees of loss exposure. By charging premiums which
reflect the overall risk of loss, the amount of claims paid will be
compensated by the premiums earned from all policyholders, and the insurer's
profits will accrue from premiums and investment earnings on premiums received
in excess of the claims paid and expenses incurred.
Insurance is a flexible risk-spreading instrument which can be tailored to
meet a variety of needs. For example, the kinds of policies currently
available range from standard life and health insurance to property and
casualty insurance, including more unusual insurance policies covering
environmental impairment. Given the flexibility of insurance underwriters,
insurance for response actions taken by states, local governments, and/or the
private sector under the auspices of Superfund, or otherwise, may provide a
source of funds to cover certain risks arising during response actions.
This appendix briefly describes the conditions under which insurance may
be an appropriate option for increasing the purchasing power of state
hazardous substance response funds, and it identifies issues requiring further
investigation. It should be noted that this concept has not been fully
analyzed nor is it being promoted by EPA or by the insurance community. The
objective of this appendix is to present the idea and solicit comments from
the states as to their interest and needs for such insurance and from the
insurance community as to the potential for making such coverage available.
A.2 USE OF INSURANCE
Insurers do not generally provide coverage for known events, especially in
circumstances where the insured's lack of care in mitigating loss would result
in high claims. As a result, insurance would not likely cover the
contributions required of the state (or local government) as part of their
Superfund cost-share where these costs are certain. However, for emergency
responses (e.g., spills), unknown sites, and unexpected events which may occur
during a response and cause catastrophic losses or which increase the costs
above what is expected, insurance may be a viable means of covering the
insured's unanticipated costs. Therefore, in the case of responses to
Superfund sites and spills, insurance may be appropriate to cover the costs
incurred in four circumstances: (1) emergency responses to spills not covered
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
A-2
by federal funds; (2) catastrophic events that may increase costs associated
with response actions; (3) cost overruns -- costs incurred for responses to
unanticipated events which occur during a remedial action; and (4)
undiscovered sites.
Although experience with response actions is limited, unexpected events
that occur during response actions, such as hurricanes, floods, earthquakes,
snow melt, explosions, and fires, could and have resulted in significantly
higher response costs than originally anticipated. The recent flooding and
dispersion of dioxin at Times Beach, Missouri, is a vivid example of the kinds
of contingencies that could occur. For remedial actions which may take
several years to complete, catastrophic events may occur during the response.
Insurance could, potentially, be used to cover increased costs incurred as
a result of unanticipated needs that develop during the course of a response.
For example, unanticipated events leading to increased costs can include new
discoveries during the course of the response, such as: discovery of
additional wastes not originally detected, different waste types, or more
extensive contamination than originally expected; unexpected hydrogeologic
conditions causing a change in technical requirements; labor strikes; civil
disobedience; court injunctions; price increases; and shutdown of a RCRA
facility originally intended to be used for disposal of exhumed wastes.
A third potential use for insurance is to cover government response to
hazardous substance and oil spills which are not covered by the federal
Superfund. In general, while response to major spills are covered by the
federal Superfund, response to smaller spills are almost always the
responsibility of the state or local government. Even if the responsible
party has funds to cover the response costs and the costs can be recovered,
unless the responsible party itself responds to the emergency, the state or
local government may need to respond immediately to avoid additional damages.
If the state initiates the response, it must have ready access to a
discretionary source of funds allowing for an immediate commitment of money.
Insurance could, therefore, reduce the level of discretionary funds which
either a state or local government would need to budget for low-frequency
high-cost events.
Finally, unknown problem sites may be discovered, requiring states to
contribute additional funds which had not been planned for in state or local
budgets.
For all of these situation, insurance could potentially serve not only to
cover the unforseen excess costs of the actual response but also potential
third-party damages. This third-party coverage might include the costs of
third-party property damage as well as some occupational injuries.
Significant health threats to employees and nearby residents and third-party
property damage are possible, especially at sites where a catastrophic event
interrupts response activities.
-------
A-3
If insurance were available, it could possibly increase a state's
purchasing power and increase its capability to meet its share of Superfund
remedial action costs. An insurance policy would be especially attractive if
such excess or catastrophic coverage could be offered at a premium cost low
enough to enable the states to pay them with the interest made on investments
from their state hazardous substance response fund. By providing an assured
source of funds for emergency situations, insurance could release additional
funds that states would otherwise have had to reserve or budget for such
contingencies. Insurance could not only reduce the amount of money which must
be raised from taxes and held idle so as to cover unexpected response costs,
but also allow the state to stabilize response budgets. Increasing the amount
of state money available and dedicated to match federal funds may also avoid
delays in initiating Superfund remedial actions. Experience has shown that
delays in initiating and completing response activities often have led to
further damages which could possibly have been avoided if funds had been
available.
Similarly, insurance coverage could provide state response officials with
a ready source of discretionary funds to respond to emergency spills that
require immediate attention. For example, in the event of a transportation
spill, if the responsible party fails to respond, the state may need to commit
funds immediately to ensure a timely response. Insurance would serve as this
ready source of funds.
A.3 AVAILABILITY OF INSURANCE
Whether insurance is a viable option for increasing a state's purchasing
power will depend on: (1) the extent to which the states find that insurance
would be a more cost-effective means of covering response costs than would
self-insurance; (2) the willingness of the insurance community to offer this
type of coverage and the terms, conditions, and limits of the coverage; and
(3) the cost of the insurance.
Preliminary conversations with state officials about their interest in
insurance suggested that while, in general, states would be interested in
hearing a proposal from insurers, they are not, at this time,, in any position
to describe their needs nor the conditions under which insurance would be
appropriate. It may be that, in many cases, the tentative responses were due
less to a feeling that insurance would be inappropriate than to the fact that
the concept is somewhat premature at this early stage of implementation of
hazardous waste programs. It may also reflect an unfamiliarity with risk
management options by state environmental personnel, and a similar
unfamiliarity of state risk managers with the issues arising from Superfund
responsibility.
States are still uncertain about the amount of funds that they will
ultimately need for hazardous waste remedial activities. They are also
unclear about their ability to get funding from state legislatures and they
have not established the estimated size of their financing shortfalls. In
some cases, state officials expressed concern that they would prefer to hold
on to the funds they have and risk a potential high-cost, low-probability
event rather than use the funds to purchase insurance which may not be
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
A-4
needed. These responses appear to reflect a somewhat limited understanding
concerning potential uses and advantages of insurance. On the other hand,
informed representatives of one state whose program is in an advanced stage of
implementation are very attracted to risk shifting and other risk management
techniques offered by insurance and, in fact, they have already broached an
insurance concept with the insurance 'community.
To determine the potential availability, cost, terms, and conditions of
insurance for state coverage, initial contacts were made with representatives
of a variety of interests. Contacts included representatives of: domestic
and offshore insurance underwriters; insurance intermediaries; insurance
brokers, including ones currently in the pollution market; and risk
consultants.
At this time, the initial feedback has been very subjective and responses
often have reflected the degree of familiarity with the concept, personal
philosophies, and early perceptions of the advantages to be gained from
offering this type of insurance. Nonetheless, some members of the insurance
community appear to consider the concept worthy of further exploration.
A few of the key issues identified during initial conversations with
insurers as requiring further exploration to determine the availability of
insurance are described below.
First, the lack of fortuity to the concept, of insuring response actions is
a key concern. The problem is to distinguish known loss situations from
fortuitous events or from fortuitous elements of a loss situation. Whether
insurers will consider cost "overruns" as insurable events will depend on
their perception of whether such events are fortuitous and whether the risks
can be quantified. Insurance to cover budget overruns may be available if the
policy is designed so that the trigger to insurance company liability is not
under state control or influence. It also will be necessary to avoid
"financial guarantees" of the state's inability (or unwillingness) to pay for
known, expenditures. Insurers would have to be convinced that a state's
response program would cover actual catastrophic events unknown at the
initiation of insurance. Elements of fortuity might include interruption in
cleanup work, natural disasters, changes in planned remedial work due to
externalities, and some worker claims. It. was suggested by one broker that,
in some cases, "excess" cleanup costs might be covered by a difference-in-
conditions policy (DIG) which would cover the costs of an over-budget
catastrophe not covered by the standard Comprehensive General Liability Policy
(CGL). It was also suggested by one broker that "extra expense" coverage
should be scheduled separately from legal liability coverage. The point would
be to separate this special coverage to facilitate risk placement and
pricing. This coverage would most likely be made available only to scheduled
sites, although a fortuitous loss provision could apply to unscheduled sites
declared an emergency, or for spill situations.
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
A-5
While the concern about the lack of fortuity might foreclose a pure
insurance mechanism, it leaves open the possibility for a loss funding or loss
stabilization program either through individual policies or by setting up
pools of insured parties. Initial reaction to this idea, however, was guarded
because required payouts would be due relatively soon while advanced premiums
would not mature soon enough to build sufficient reserves. In addition,
states would not have as great an incentive to purchase this type of policy,
since they would not have the tax advantages of deducting their insurance
premiums. However, advantages such as budget planning and stop-loss
catastrophe coverage might make this an option worth exploring.
Second, insurers will need to be assured of a broad enough base of
potential insured parties (e.g., states, local governments, private firms) to
spread the risks.
Third, quantifying the risks involved will be difficult. Because the
estimates of the cost of cleanup and actual cleanup expenditures both are
under the control of the insured, loss control may be expensive. For example,
since the evaluation criteria used by the government to determine the extent
of cleanup required to be undertaken will affect cleanup costs, insurers are
concerned that the insured will have little incentive to keep the costs of
cleanup below the maximum policy limit.
Fourth, the availability of insurance may be limited due to the
uncertainty about the size and timing of the risks involved (see Chapter 2).
The costs incurred may be extremely high. The number of sites in need of
remedial activities is unknown. Even with high deductibles and limits on
maximum coverage, depending on the number of claims and how soon they are
made, the pressure to respond within a few years may necessitate involvement
by a large segment of the insurance and reinsurance market. Gathering
sufficient capacity could require widespread education of insurers regarding
risk definition and quantification.
A number of legal issues also may be important to consider in developing
this concept of insurance. They include:
Articulation of liability, including the triggers to
liability, for states;
Coordination of federal and state responses, cost
balancing, and funding obligations of states;
« Subrogation rights of states, municipalities, and
insurers;
Relationship of insurance to the rights of states to
recover costs from the federal Fund;
Restrictions on states from purchasing insurance
using private brokers; and
-------
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
A-6
Restraints on states commingling revenues, if group
or mutual schemes were pursued.
The range of premiums for this type of insurance'is unknown at this time.
Clearly a major concern among states will be the cost, and thus whether it is
cost-effective to purchase this coverage. If the premiums are low enough to
allow a state to pay for the premiums with interest made on investments of
their state funds, then insurance may be more attractive (see Chapter 3).
Premiums offered by insurers will reflect a subjective appreciation of the
risks and will depend to a large extent on the probability of loss,
characteristics of the insureds, limits of liability, and the size of
deductibles that are imposed.
-------