COFAN INDIAN elders from Ecuador lead demonstrators down a street in San Ramon, Calif., on May 22, 2003, on their way to the world headquarters of ChevronTexaco to demand the cleanup of the contaminated environment of the Cofans’ Amazonian homelands. (Photograph by Lou Dematteis.)

Because there is no statute of limitations in environmental law, multinational companies and their investors face enormous, potentially costly liabilities that will only continue to grow. As climate change issues move to the fore of the world’s consciousness, companies will increasingly be called to account (rightly or wrongly) for actions taken anywhere, at any time, in the past. The impact on these companies—and their investors—could prove devastating.

Most American investors might expect that a well-run company need not worry about environmental liability issues because any overt polluting the business might have done ended some time ago, and its board will have done all it can to ensure that it now abides by a strict environmental code. Unfortunately, this is not the case. A company can have the strictest corporate social responsibility policy and look absolutely squeaky clean, but actually be sitting on an unexploded minefield of historical environmental liabilities. Miscreant subcontractors or expanding environmental legislation can also catch almost any company unaware. Whatever the root cause, the potential liabilities for many large companies can be enormous and the costs widespread. Aside from tort liability expenses, firms face cleanup costs, fines levied by authorities and ongoing public relations issues—as Chevron found in Ecuador—that could ultimately diminish book value.

Governments are not the only source of potential concern for investors. Environmental issues now top many political agendas, in part because of pressure exerted by nongovernmental organizations that have become extremely effective in their lobbying efforts with regard to pollution and climate change. We can expect much more of this in the future. Just as labor and sweatshop issues dominated public discourse in the 20th century, environmental topics will dominate the 21st. Today, corporate environmental disasters do not require catastrophic events like Bhopal or the Exxon Valdez. They just need the right press release or a damning video clip streaming on YouTube.

Although the picture may seem bleak for investors, it doesn’t have to be. As a result of the dramatically increased environmental liability threat that global companies face, insurers now offer products specifically tailored to protect a company’s bottom line. Before investing in firms with potential liability, investors should examine, for example, the extent of a particular company’s awareness of environmental impairment liability insurance. Insurers can offer tailored solutions for multinational companies, including coverage for the sort of gradual pollution exposures that many standard liability policies simply exclude. Companies are increasingly purchasing this type of coverage not just for themselves, but for their more global supply chains as well.

Global Gadflies
Today, global companies are awakening to the legal realities of environmental liability, although this issue is hardly new. It is rooted, in part, in a substantial shift in public policy that began when President Richard Nixon signed the Clean Air Act Extension in 1970 and the 1972 Federal Water Pollution Control Amendments, which were later incorporated into the Clean Water Act. Since then, legislation in this area has grown substantially as awareness of the importance of environmental issues has increased.

Headline-making events in the United States in the 1970s and 1980s, such as the Love Canal tragedy in Niagara Falls, N.Y., and the evacuation of Times Beach in Missouri, also heightened public awareness. In terms of environmental damage, such events are minor when compared with other disasters—or potential disasters—such as climate change; yet these instances of industrial pollution captured the public’s imagination. Washington policymakers responded by establishing the Comprehensive Environmental Response, Compensation and Liability Act of 1980, commonly known as CERCLA or Superfund. This law provided a $1.6 billion trust to initiate the cleanup of abandoned hazardous waste sites and to respond to accidents that release toxic waste into the environment. Crucially, CERCLA also reinforced the principle that the polluter must pay for the damage it causes. The law imposed strict, retroactive liability for environmental pollution. Many companies were left reeling from massive liabilities they had not anticipated.

TOP VIEW As climate change issues make headlines around the world, multinational firms and their investors are becoming targets of litigation, sometimes for misdeeds allegedly committed decades earlier. As this trend grows, the potential impact on these companies—and their backers—could be devastating. Although businesses with liability insurance and strong social responsibility policies can protect themselves to some degree, environmental liability will cast a shadow over global commerce for many years to come.

The U.S. experience becomes important in understanding environmental liability and how it serves as both a public policy model and a cautionary tale. Other areas of the world are now taking up the issue of environmental liability, spreading the potential impact of such problems outside of specific economic or geographic regions. In many developing countries, for example, policymakers see environmental litigation as one weapon in a wide political attack focused around issues of social justice. Shell’s recent experience with its Sakhalin Island project in Russia serves as one example of the rise of resource nationalism, in which countries seek to exercise greater control over extractive projects within their borders, often using real or purported environmental damage as a pretext to exercise this control.

For the European Union, environmental legislation has risen to the top of the agenda in recent years. In 2004, Brussels implemented the Environmental Liability Directive (ELD), which member states had to incorporate into their own legislation by the end of April 2007. ELD is a watered-down version of CERCLA. However, European bureaucrats may find it difficult to fully implement this legislation due to the varied political and economic backgrounds of the EU member states. Many industries in Europe previously fell under state ownership, and plaintiffs may find their attempts to pillory government-owned defendants stymied. Public sympathy for plaintiffs withers when voters must ultimately pay damages.

Even though ELD might not turn out to be the transatlantic facsimile of Superfund that many environmentalists hoped for, it remains a powerful driver for much tougher environmental compliance because of its notion of strict liability. ELD also introduces the idea of holding countries responsible for damages to biodiversity, which will require a great deal of case law and regulatory guidance to establish what the specific impact on businesses, and investors, might be.

With such matters becoming more important within Europe, environmentalists and their lawyers will no doubt focus more attention on legacy issues. Consequent discussions of corporate liability and compliance are already being held in board rooms. In the United States, a new accounting rule known as FIN 47 forces companies to maintain sufficient reserves to cover retirement costs. Some have recently interpreted this to include environmental cleanup costs as well, leading to a rash of restatements and reserve increases as companies scramble to incorporate the true costs of environmental cleanup into their balance sheets. While specific guidance is pending, Europe is also experiencing this trend. And, because this has become a top-down accounting issue, the potential for significant insurance exposure (in the form of directors and officers liability) exists.

Corporate disasters no longer require catastrophic events like Bhopal or the Exxon Valdez. They just need the right press release or a damning video clip streaming on YouTube.

Even if the current legislation in Europe is not as strict as that in the United States, international businesses have no room for complacency. Public policy evolves, and the welcome investor one year can become the lighting rod the next. For example, asbestos liability has remained one of the thorniest issues both in the U.S. and overseas since the mid-1980s. Some of the largest companies in the world made asbestos, particularly after so many multinationals acquired a plethora of smaller manufacturing companies in the 1970s. We could potentially witness a new wave of asbestos-related lawsuits from employees of former state industries in Eastern Europe who are now part of the EU. Eventually, that wave could spread to Asia.

A corporate director or an investor cannot afford to remain complacent. One of the reasons most often cited for the migration of manufacturing industries out of the United States and Europe and into Asia is the environmental cost associated with this sector. Developed nations charge a premium for legal and regulatory stability, but such stability is often found lacking in developing countries.

Green-Eyed Monster
A new threat to international companies has emerged in recent years. They are becoming targets for political factions that use environmental issues as a pretext to simply make it more difficult to do business in a given area. The energy sector in particular seems very susceptible to these threats at the moment, and firms doing business in overseas territories must be aware that they might be accused of causing environmental damage merely as part of a greater political scheme. In this sense, environmental issues can become the straw man for deeper issues.

Many large companies now rely on local subcontractors to manufacture their goods, but this, too, can carry huge environmental implications. If that subcontractor is found to be responsible for causing pollution, the contractor may face a devastating public relations issue that can tarnish its image and deflate its share price overnight.

Take, for example, the situation in China. The country is undergoing what seems like 200 years of industrial expansion in three decades, with the resultant rise of a strong, consuming middle class. But a middle class is likely to demand not just consumer goods, but also a raft of quality of life improvements, such as clean air and clean water. The legions of companies rushing into China at the moment must surely harbor concerns that they could one day be saddled with punishing environmental liabilities. When the Chinese government finally decides it is going to get serious about the environment, it will certainly not target state industries first.

Karl Russek is senior vice president for Environmental Risk at ACE European Group in London.