Addressing environmental liabilities during bankruptcy
The recognition, measurement and valuation of environmental liabilities
Environmental liabilities can be a significant contingent liability in a bankruptcy case. Environmental liabilities could render financial statement reserves unreliable when determining solvency. Therefore, understanding how these liabilities are recognized, measured and valued is critical either for plan confirmation or when identifying and prosecuting a claim.
Sources of environmental liabilities
Environmental liabilities can stem from a variety of federal, state and local statutes, regulations, ordinances and case law. Broadly speaking, they can be grouped into six categories:
- Compliance costs
- Remediation costs
- Fines and penalties
- Punitive damages
- Natural resource damages
Recognition of environmental liabilities
Environmental liabilities are recognized for financial statement purposes only when it is probable that a liability has occurred and when the amount of the liability can be reasonably estimated. A liability is probable if a claim or assessment has asserted, litigation has begun, or it is probable that the resolution of the litigation, assessment or claim will be unfavorable.
Measurement of environmental liabilities
Environmental liabilities are measured by accounting for the incremental costs directly attributable to the remediation effort, plus the expected post-remediation monitoring costs. It is also vital to determine whether there are other potentially responsible parties, to allocate costs appropriately among those parties, and to assess the ability of the other parties to help pay those costs.
Valuation of environmental liabilities
In a solvency analysis, environmental liabilities are valued according to the probability of the liability being realized using the probability discount rule. Thus, the value of the liability equals the face amount of the liability multiplied by the likelihood of its occurrence at a specific point in time.
None of these issues is easy. Together, they present a complex challenge. The Recognition, Measurement and Valuation of Environmental Liabilities, originally published in the American Bankruptcy Institute Journal, offers a detailed analysis of each step to help you make better informed environmental liability decisions.