Whistling past the site: directors' and officers' personal liability for environmental decisions and the role of liability insurance coverage.

• Author: Biel, William Scott

INTRODUCTION

Federal statutes imposing liability for hazardous waste cleanup costs raise numerous issues directly affecting the personal liability of directors and officers ("D&Os"). The most important issues of concern to D&Os are liability and funding. The liability issue deals with who will bear the cleanup costs; the funding issue deals with how those costs will be financed. Courts have resolved the liability issue with the apparently simple rule that under the Resource Conservation and Recovery Act of 1976 (RCRA)(1) and the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA),(2) "the 'polluter pays.'"(3) The issue of funding, on the other hand, has not been so easily resolved; determining how costs are to be financed often balances on how a court interprets the coverage provided by an insurance contract.

The problem underlying the funding issue is a basic flaw in the notion that "the polluter pays." Although such a notion is appealing in that it furthers the goals of expediting the cleanup process and reducing the amount of hazardous waste costs borne by taxpayers, it arguably hinders the cleanup process by raising the costs associated with a complicated litigation/settlement process.(4) The strict, retroactive, and joint and several liability of "the polluter pays" notion negates the relevance of cautionary steps taken by individuals. Because strict liability is imposed without regard to willfulness or negligence and retroactive liability is imposed for actions legally acceptable prior to the standard of care established under CERCLA, liability for environmental cleanup approaches absolute liability.(5)

Even those D&Os who are not directly involved in hazardous waste management or chemical industries are potentially liable under CERCLA. The challenges posed by the issue of hazardous waste cleanups are fundamental to almost all applications of the business management process.(6) First, wastes occur at all points in the production, distribution, and consumption cycle, including the discovery, recovery, processing, and transportation of raw materials, the fabrication and assembly of finished products, and the consumption and disposal of those products.(7) Hazardous wastes can be generated as by-products of manufacturing,(8) released from corporate equipment (such as factory machinery),(9) and even absorbed into the soil of property acquired for investment by a corporation.(10) Because waste is so pervasive in industrial activity, businesses without some nexus to any hazardous waste site are the exception. Second, hazardous waste is an unintentional by-product of business enterprise.(11) A chemical perceived as safe by present-day standards, may later engender a long-term hazard to the environment,(12) resulting in long-term liability for those individuals involved in its release. Even a company that performs the most current risk analyses and invests in monitoring costs and state of the art safety precautions cannot shield itself from liability if contamination occurs, or has occurred, due to former practices.(13) Third, the social costs of pollution are not necessarily absorbed by those who enjoy the social benefit of the good producing the hazardous waste by-products.(14) Therefore, without regulatory or market action, risk-creating activities are not internalized by commercial enterprises.(15)

In CERCLA suits, courts have held that common law principles of limited liability for D&Os, traditionally provided by the corporate structure,(16) are not applicable.(17) This loss of common law protection of business decisions is further compounded by judicial interpretations of D&O liability insurance coverage. Unable to deny D&O personal liability because of "the polluter pays" premise, the same courts have also found that D&O liability insurance does not cover insureds' environmental decisions. Indeed, even where the courts read general liability coverage into D&O liability insurance agreements, their means of finding coverage forebode an unstable body of state common law. Two problems result from these judicial interpretations: first, conventional insurance actuarial techniques in premium setting become inapplicable,(18) and second, because of the lack of tenable legal standards to guide decisions, corporate D&Os engage in risk-averse decision making.(19)

This Comment traces the development of individual D&O liability and analyzes the public and private sectors' reactions to increased individual liability. Part I of this Comment focuses on sources of liability for environmental decisions, including evolving notions of limited liability under the common law. In reviewing the reasons for common law protection in other areas, the appropriateness of common law limited liability protection for environmental decisions will also be considered. Part I concludes that standards, similar to business judgment rule standards, are warranted for environmental decisions.

If the courts will not provide common law standards to protect the decisions of D&Os in the environmental context, political and market alternatives must be provided. Part II considers the political alternatives to common law protection. State statutory responses, especially in light of their interaction with a federal statute such as CERCLA, will be considered, and the effects of limited liability statutes and the flaws of indemnification statutes will be shown. Part II concludes that state statutory responses to the lack of common law protection are desirable but may not be effective.

Part III analyzes D&O liability insurance as the market alternative to statutory and common law protection. The role of liability insurance in protecting D&Os from personal liability under CERCLA will be considered in light of judicial construction of D&O liability insurance coverage. In conclusion, part III suggests that even though the environmental risks associated with CERCLA liability may be insurable, the unstable body of law surrounding both D&O personal liability and the coverage provided by D&O liability insurance are too uncertain for conventional underwriting methods. Without legislative intervention or significant judicial rethinking of the role of insurance and its ability to protect potentially liable D&Os, insurance will not continue to be an effective alternative to the lack of public sector protection. CERCLA's absolute liability scheme provides no incentive for insurers to monitor the decision-making process, for if environmental liability is truly fundamental to the business management process, D&O environmental liability will be uninsurable.

1. DIRECTOR AND OFFICER PERSONAL LIABILITY UNDER CERCLA

   Even though CERCLA is the basis for general liability for environmental hazards, it is the federal courts that have created the "evolving principles of federal common law" which impose strict, joint and several, and retroactive personal liability on responsible individuals.(20) These evolving principles of federal common law conflict with state common law limitations on corporate liability. The traditional common law doctrine of limited liability provides that the corporate entity is usually liable for violations of statutes rather than those officers, directors, and shareholders who make up the corporate entity.(21) This common law doctrine of limited liability reflects the uncertainty and risk-taking implicated in every business decision:

   Businessmen make business decisions. They are not courts, able and willing to pursue a matter to the last argument in the search of the "right" answer. They are not researchers meticulously seeking truth. They are not scientists striving for ever more refined solutions in a field of narrow specialization.... The decisions the businessman must make are fraught with risk, and he is quite accustomed to making these decisions in a hurry on the basis of a hunch and manifestly sparse data. The businessman and the board of directors thrive or die in a sea of uncertainty.(22)

   In contrast to the state common law notion of limited liability are developing federal common law notions of individual liability for environmental decisions.(23) In the forum of CERCLA liability, this increased exposure of individual D&Os to personal risk is a result of broad judicial application of CERCLA's liability provisions compounded by heightened judicial standards in determining D&O liability for business decisions.(24)

   Since CERCLA imposes civil liability for environmental hazards,(25) whether this liability applies derivatively to D&Os is the fundamental question. "A corporate officer may not be held civilly liable for a corporate violation of [a federal environmental statute] unless either the Act itself authorizes such liability, or there are sufficient allegations and proof to permit negation of the corporate form."(26) When courts choose to apply individual derivative civil liability for corporate environmental violations, they circumvent the fundamental notions of the corporate form and the limited liability doctrine. Such decisions not only are questionable interpretations of statutory provisions, but they are also contrary to the body of law created to protect official decisions made using good business judgment.(27)

   Normally, the business judgment rule protects directors from shareholder suits for corporate losses. Similar protection from government suit would protect officers from derivative environmental liability. Such a rule should not protect D&Os who personally participate in environmental contamination by making reckless or grossly negligent environmental decisions, but should protect decisions to use the most environmentally safe means available at the time the decision is made. Such a common law rule, similar to the business judgment rule, may counteract the legal environment of increased personal exposure to environmental liability.

   1. CERCLA Liability of Directors and Officers...