United States: EPA Wins Another Challenge To Indirect Oversight Costs Imposed Under Superfund

Article by Gregory A. Bibler, Robert L. Brennan and Charlotte L. Bednar

In August, a federal district court upheld application of the Environmental Protection Agency’s controversial revised methodology for computing CERCLA response costs, awarding EPA over $11 million in indirect costs. In United States v. W.R. Grace and Co.¸ 2003 U.S. Dist. LEXIS 15928 (D. Mont. 2003), the court rejected W.R. Grace’s arguments that EPA’s methodology was flawed and that EPA was asking the company to pay for more than the costs attributable to its site. In ruling against W.R. Grace, the court endorsed EPA’s application of a region-wide indirect cost rate which W.R. Grace had challenged as excessive and inconsistent with generally accepted accounting standards.

While W.R. Grace represents the first judicial decision reviewing application of EPA’s new indirect cost assessment calculus, it extends a line of federal court decisions that have upheld large awards under CERCLA for costs over and above site-specific labor and cleanup costs.

This Advisory reviews application of EPA’s indirect cost recovery policy and discusses the methods by which responsible parties may still limit or challenge indirect costs.

Under CERCLA, EPA is authorized to recover both direct and indirect costs in connection with site remediation.

In general, "indirect costs" are costs of administering the Superfund program that cannot be identified with any particular site. They include compensation and benefits for personnel, travel, rent, communications, utilities, contracted services and supplies necessary for EPA’s administrative and non-site Superfund activities. In contrast, "direct costs" are such costs as assessing, investigating and cleaning up a particular site, site-related oversight and enforcement activities, the costs of classifying a site, and research and development costs. These categories and EPA’s revised methodology for calculating indirect costs were first announced in a June 2000 document entitled Guidance on Exercising CERCLA Enforcement Discretion in Anticipation of Full Cost Accounting Consistent With the "Statement of Federal Financial Accounting Standards No. 4". 65 Fed. Reg. 35,339 (June 2, 2000).

Prior to the June 2000 guidance document, EPA calculated the indirect costs of a particular site as a percentage of the labor hours for that site. However, the agency revised its methodology in response to the Federal Financial Management Improvement Act of 1996 which directed all federal agencies to adopt cost accounting methods that "consistently and accurately" report the "full costs" of their activities.

Under its new policy, EPA identifies a "pool" of indirect costs to allocate to sites. The pool consists of: (i) agency-wide costs such as facilities and human resources management, (ii) the regional administrative, support, and management costs for all regions combined; and (iii) the regional and nationwide costs of running the Superfund program. Once the pool has been established, EPA calculates the percentage of nationwide, site-specific direct costs attributable to each EPA Region and assigns an "indirect rate" to each Region.

Thus, regions in which more direct costs are incurred are assigned higher indirect cost rates. For an individual site, EPA identifies the total annual direct costs for the site and then multiplies that total by the corre-sponding year’s indirect cost rate for the region. The resulting number is that year’s indirect cost allocation. For example, if a site has incurred $1 million in direct costs during a given fiscal year and it is located in a region with an indirect cost rate of 30% for that year, that year’s indirect costs for the site will be $300,000.

Indirect cost rates have been established by EPA for the years 1990 through 2001 and projected for 2002. Sites that were not assessed indirect costs under the prior "dollars per work-hour" formula are subject to retroactive calculation under EPA's revised methodology.

Provisional Indirect Cost Rates by EPA Region

for Work Performed in FY2002-2003

The revised indirect rates became effective on October 2, 2000. The intended effect, as stated in the guidance document, was to increase the amount of indirect costs allocated to Superfund site-specific activities. Although the exact effect of the revised rates will be different for each individual site, based on its direct costs and the indirect rate assigned to its Region, EPA’s effort to allocate more of its indirect costs generally has resulted in higher payments by responsible parties.

One study published by Pricewaterhouse-Coopers LLP calculated that an average state-led cleanup involving $25 million in direct remedial costs will be assessed approximately $7 million more in indirect costs under EPA’s revised methodology.

Since its announcement in June, 2000, EPA’s new policy has been subject to sharp criticism. The biggest concern is that, by applying fixed region-wide indirect cost rates, the policy fails to take into account differences between individual sites and cleanup remedies that could affect the amount and type of indirect costs incurred. Industry groups like the American Chemistry Council have argued that indirect costs are not homogenous and should not be treated as one big pool for allocation on a percentage basis, and that EPA should take a more site-specific approach to the calculation of indirect costs, instead of applying a broad regional rate to every site.

Moreover, critics point out that it is possible that two sites incurring the same dollar amount of direct costs but employing different cleanup remedies may not cause the same amount of indirect costs. One remedy may incur more in terms of administrative and other indirect costs than another, even though the direct costs appear to be equal.

Another criticism arises from the fact that indirect rates vary widely among regions. The guidance document estimated a rate of 29.0% for Region 6, while it estimated a rate of 54.4% for Region 7. This disparity will likely continue to raise questions as to the accuracy of the new methodology.

Companies and industry groups have also challenged the new policy in court by arguing that it was improperly issued. In Atlantic Richfield v. EPA, 38 Fed. Appx. 614 (D.C. Cir. 2002) unpublished, several companies argued that EPA should have issued the policy as a regulation, allowing for a comment period to address industry concerns. The D.C. Circuit Court of Appeals dismissed their petition, holding that EPA’s policy merely referenced requirements imposed upon all federal agencies under the Federal Financial Management Improvement Act and imposed no additional obligation on EPA. Therefore, the court held that the guidance document was not a regulation promulgated under CERCLA, and it did not require a comment period.

In W.R. Grace, defendant W.R. Grace and Co. disputed the amount of indirect costs allocated to its site and argued that EPA’s revised methodology did not comply with "generally accepted accounting principles." Specifically, W.R. Grace argued that EPA used a different indirect cost accounting methodology than other agencies, that it included the indirect costs of independent contractors and other agencies working for EPA, and that it did not properly define the "outputs" of the Superfund program used to calculate indirect costs. In addition, W.R. Grace argued that the expenses included in the indirect cost pool were not homogenous and, as a result, should not be allocated to different sites on a simple percentage basis.

In rejecting these arguments, the court noted that independent evaluators had approved EPA’s revised cost methodology and that W.R. Grace’s cost expert was unable to articulate what alternative methodology EPA should have used. The court upheld EPA’s revised methodology as proper and in compliance with the Federal Accounting Standards Advisory Board’s (FASAB) published accounting guidelines. It also specifically approved of the methodology because it reflects the "magnitude and complexity" of the Superfund program’s activities.

The ruling in W.R. Grace is in line with an established trend in judicial decisions upholding EPA’s calculations of direct and indirect costs against most legal challenges. Courts have held that CERCLA’s broad definition of remedial actions encompass indirect costs and oversight activities. See United States v. Dico Inc., 266 F.3d 864 (8th Cir. 2001), cert denied; United States v. Domenic Lombardi Realty, Inc., 2003 U.S. Dist. LEXIS 18588 (D.R.I. 2003). Courts have awarded these costs even where they have been challenged as unreasonable and duplicative, and even where documented evidence of particular direct costs is next to non-existent. See e.g. United States v. Kramer, 913 F. Supp. 848 (1995); United States v. Outboard Marine Corp., 1997 U.S. Dist. LEXIS 10986 (1997).

Notwithstanding the case law upholding EPA’s assessed costs, responsible parties still may be able to reduce indirect cost assessments by challenging the direct costs that are multiplied by the applicable regional rate under EPA’s new policy. Despite their deference to EPA’s methods for calculating oversight costs, courts will not uphold charges, for example, that were billed to the wrong site, for illicit or prohibited purposes, or, more generally, in direct contravention to Superfund or its implementing regulations.

One method for challenging direct costs is to show that the underlying cleanup or oversight activities were inconsistent with the National Contingency Plan, which establishes procedures for selecting response actions. Typically, such challenges must show that the cleanup activities chosen by EPA or the state agency are "inconsistent with the NCP" because the agency acted "arbitrarily and capriciously."

In addition to the hurdles of proving that the cleanup or oversight activities were arbitrary and capricious, courts in several circuits have held that defendants also must show that the agency’s arbitrary and capricious actions caused avoidable and unnecessary costs "in demonstrable excess of costs that would not have otherwise been incurred." United States v. Burlington Northern R.R. Co., 200 F.3d 679, 695 (10th Cir. 1999); United States v. American Cynamid Co., 786 F.Supp. 152, 161 (D.R.I. 1992). The costs need not be reasonable.

Alternatively, responsible parties may challenge direct or oversight costs, and thereby reduce their indirect cost assessments, where they can show that the federal or state agency chose a cleanup response without following Superfund’s procedural requirements, and in contravention of warnings against proceeding with a clearly inappropriate remedy. In Minnesota v. Kalman W. Abrams Metals, Inc., 155 F.3d 1019, 1025 (8th Cir. 1998), the court found that the state agency had acted arbitrarily and capriciously by (i) failing to undertake studies required by the NCP before choosing a remedy; (ii) failing to give the public adequate notice before beginning the remedy, as required by the NCP; (iii) ignoring the warnings of an EPA contractor and other agencies that the remedy chosen was risky, costly and of questionable effectiveness; and (iv) failing to modify the response when problems arose. As a result, the court held that the state could not recover the costs attributable to these arbitrary and capricious actions.

The W.R. Grace decision is only one opinion from one federal district court. It generally is consistent with a long trend in judicial decisions, however, and therefore suggests that EPA’s revised indirect cost methodology likely will withstand broad challenges to the way in which EPA now calculates oversight costs.

Responsible parties are not without recourse. Because EPA assesses indirect costs at a fixed percentage rate against direct costs, challenges to direct costs, in fact, are of even greater significance. Errors in billing or calculating direct costs, and failures on the part of the agency to comply with procedural requirements during investigation, remedy selection or implementation or activities "inconsistent with the National Contingency Plan," may expose both direct costs and resulting indirect costs to challenge.