Current liabilities and contingencies What about the environment? Objectives To

Question

Current liabilities and contingencies

What about the environment?

Objectives

To expose you to current issues facing the profession related to contingencies.

To provide you an opportunity to demonstrate and improve your communication skills.

To think critically about the current accounting and business environment.

To develop an opinion and articulate it.

Part I:

Background[1]

On the evening of March 24, 1989, the oil tanker, Exxon Valdez, left the Valdez oil terminal in southern Alaska and began its trip to Long Beach, California. The ship’s captain, Joseph Hazelwood, asked for and received permission from the US Coast Guard to steer out of the normal outbound tanker lanes because of icebergs. Sometime after 11:00 p.m., Captain Hazelwood left the wheelhouse and turned control of the tanker over to Third Mate Gregory Cousins. Within the hour, disaster struck; the ship ran aground on Bligh Reef in Prince William Sound, rupturing 8 of its 11 cargo tanks and spewing some 10.8 million gallons of crude oil into the sensitive subpolar ecosystem of the Sound.[2]

For 12 years, oil tankers carrying crude oil had safely passed through Prince William Sound more than 8,700 times with no major disasters and few serious incidents. Most people with knowledge of the practice, particularly the owners of the tankers, felt comfortable that the ships could operate safely with minimal risk of disaster.

The impact of the oil spill was enormous. The spill spread to 1,300 miles of shoreline. Detailed records were compiled in an attempt to assess the extent of the disaster. In the end, environmentalists working with the state of Alaska estimated that 250,000 seabirds, 2,800 sea otters, 300 harbor seals, 150 bald eagles, up to 22 killer whales and billions of salmon and herring eggs died as a direct result of the spill. The public was outraged. No one talked about Exxon’s loss of oil revenue and the cost to repair the oil tanker; the only concern was the far reaching environmental impact on the region.

Despite Herculean cleanup efforts between the time of the spill and 1992, and again in 1997, the oil is still present in the Sound today. Additionally, scientists have documented oil lingering from this spill on the Katmai Coast and Kenai Peninsula, more than 450 miles from the Sound.   Those monitoring the impact of the spill reported that only 2 species (the sea otter and the bald eagle) of the 28 directly affected animal species had fully recovered.

The spill took its toll in other ways as well. For instance, the commercial fishing industries in the area were severely hurt by the spill. Government officials canceled the 1989 fishing season and prohibited commercial fishing again from 1993 to 1996.

Exxon spent more than $2 billion in cleanup efforts in the four years following the spill and agreed, in October 1991, to pay $900 million over a period of 10 years under a civil agreement, $25 million for committing an environmental crime and $100 million for criminal restitution. In 1994, a jury awarded       $5 billion in punitive damages in a separate class action suit brought against Exxon by over 40,000 commercial fishermen and other interested parties.

As events to fix Exxon’s responsibilities unfolded, management provided disclosures in its annual reports attempting to inform stakeholders of the possible financial ramifications of the accident. These disclosures, in part, are reproduced below.

1991 Annual report disclosures:

On March 24, 1989, the Exxon Valdez, a tanker owned by Exxon Shipping Company, a subsidiary of Exxon Corporation, ran aground on Bligh Reef in Prince William Sound off the port of Valdez, Alaska, and released approximately 260,000 barrels of crude oil.

On October 8, 1991, the United States District Court for the District of Alaska approved a civil agreement and consent decree …. These agreements provided for guilty pleas to certain misdemeanors, the dismissal of all felony charges and the remaining misdemeanor charges by the United States, and the release of all civil claims against Exxon … by the United States and the State of Alaska. The agreements also released all claims related to or arising from the oil spill by Exxon…

Payments under the plea agreement totaled $125 million in fines and $100 million in payments to the United States and Alaska for restoration projects in Alaska. Payments under the civil agreement and consent decree will total $900 million over a ten-year period. The civil agreement also provides for the possible payment, between September 1, 2002 and September 1, 2006, of up to $100 million for substantial loss of decline in population, habitats, or species in areas affected by the oil spill which could not have been reasonably anticipated on September 25, 1991.

The remaining cost to the corporation from the Valdez accident is difficult to predict and cannot be determined at this time. It is believed the final outcome, net of reserves already provided, will not have a materially adverse effect upon the corporation’s operations or financial condition.

1993 Annual report disclosures:

1996 Annual report disclosures:

On September 24, 1996, the United States District Court for the District of Alaska entered a judgment in the amount of $5.058 billion in the Exxon Valdez civil trial that began in May 1994. The District Court awarded approximately $19.6 million in compensatory damages to fisher plaintiffs, $38 million in prejudgment interest on the compensatory damages and $5 billion in punitive damages to a class composed of all persons and entities who asserted claims for punitive damages from the corporation as a result of the Exxon Valdez grounding. The District Court also ordered that these awards shall bear interest from and after entry of the judgment. The District Court stayed execution on the judgment pending appeal based on a $6.75 billion letter of credit posted by the corporation. Exxon has appealed the judgment. The corporation continues to believe that the punitive damages in this case are unwarranted and that the judgment should be set aside or substantially reduced by the appellate courts.

The ultimate cost to the corporation from the lawsuits arising from the Exxon Valdez grounding is not possible to predict and may not be resolved for a number of years.

On January 29, 1997, a settlement agreement was concluded resolving all remaining matters between Exxon and various insurers arising from the Valdez accident. Under terms of this settlement, Exxon received $480 million. Income statement recognition of this settlement will be deferred in view of uncertainty regarding the ultimate cost to the corporation of the Valdez accident.

2007 Annual report disclosures:

A number of lawsuits, including class actions, were brought in various courts against Exxon Mobil Corporation and certain of its subsidiaries relating to the accidental release of crude oil from the tanker Exxon Valdez in 1989. All the compensatory claims have been resolved and paid. All of the punitive damage claims were consolidated in the civil trial that began in 1994. The first judgment from the United States District Court for the District of Alaska in the amount of $5 billion was vacated by the United States Court of Appeals for the Ninth Circuit as being excessive under the Constitution. The second judgment in the amount of $4 billion was vacated by the Ninth Circuit panel without argument and sent back for the District Court to reconsider in light of the recent U.S. Supreme Court decision in Campbell v. State Farm. The most recent District Court judgment for punitive damages was for $4.5 billion plus interest and was entered in January 2004. The Corporation posted a $5.4 billion letter of credit. ExxonMobil and the plaintiffs appealed this decision to the Ninth Circuit, which ruled on December 22, 2006, that the award be reduced to $2.5 billion. On January 12, 2007, ExxonMobil petitioned the Ninth Circuit Court of Appeals for a rehearing en banc of its appeal. On May 23, 2007, with two dissenting opinions, the Ninth Circuit determined not to re-hear ExxonMobil’s appeal before the full court. ExxonMobil filed a petition for writ of certiorari to the U.S. Supreme Court on August 20, 2007. On October 29, 2007, the U.S. Supreme Court granted ExxonMobil’s petition for a writ of certiorari. Oral argument was held on February 27, 2008. While it is reasonably possible that a liability for punitive damages may have been incurred from the Exxon Valdez grounding, it is not possible to predict the ultimate outcome or to reasonably estimate any such potential liability.

2008 Annual report disclosures:

A number of lawsuits, including class actions, were brought in various courts against Exxon Mobil Corporation and certain of its subsidiaries relating to the accidental release of crude oil from the tanker Exxon Valdez in 1989. All the compensatory claims have been resolved and paid. All of the punitive damage claims were consolidated in the civil trial that began in 1994. On June 25, 2008, the U.S. Supreme Court vacated the $2.5 billion punitive damage award previously entered by the Ninth Circuit Court of Appeals and remanded the case to the Circuit Court with an instruction that punitive damages in the case may not exceed a maximum amount of $507.5 million. Exxon Mobil Corporation recorded an after-tax charge of $290 million in the second quarter of 2008, reflecting the maximum amount of the punitive damages. The parties have filed briefs in the Ninth Circuit Court of Appeals on the issue of post-judgment interest and recovery of costs. Exxon Mobil Corporation recorded an after-tax charge of      $170 million in the third quarter of 2008, reflecting its estimate of the resolution of those issues.

Concluding remarks

Today, oil from the Exxon Valdez spill is decreasing at a rate of 0% to 4% per year. Those monitoring the lingering effects estimate that there is only a 5% chance that the rate is as high as 4%. However, even at this rate, it will take decades and possibly centuries for the remaining oil to disappear entirely.

Requirements

Go to the International Federation of Accountants (IFAC) Sustainability Framework Website at http://www.ifac.org/issues-insights/governance-sustainability.

Assume that Exxon accounts for contingencies using IAS 37. Prepare 3 paragraphs (4 sentences or less for each paragraph/question) addressing the following:

Explain why you agree or don’t agree that Exxon’s contingent liability disclosures were adequate.

Explain why you agree or don’t agree that IAS 37 provides sufficient guidance to provide users enough disclosure about environmental liabilities.

How does the concept of “sustainability” relate to the concept of “environmental liabilities”?

Explanation / Answer

Explain why you agree or don’t agree that Exxon’s contingent liability disclosures were adequate.

Exxon for losses suffered. The law provides two basic remedies. Compensatory damages are meant to compensate the plaintiff for losses incurred by the actions of the defendant. Punitive damages are meant to punish the defendant for its conduct and deter the defendant and others from engaging in that conduct in the future. Since punitive damages are awarded in excess of provable injuries, they are normally awarded only when defendant conduct is egregious or reprehensible. Punitive damage awards must be large enough relative to the defendant’s wealth to provide the deterrent effect. Exxon’s initial response to the spill was slow and did not proceed according to the contingency plan (Mauer 1989). The plan called for booms to be in the water within five hours of a spill. They did not begin putting booms in the water for ten hours. The plan specified seven oil-skimming vessels, but only two were at work a day after the spill. The contingency plan specified chemical dispersants as the chief method to break up a spill of this size, but the company was not prepared to apply chemicals until it was too late for them to be effective. By March 29, Exxon acknowledged it had lost the opportunity to contain the spill and would turn its attention and resources to cleaning it up (Egan 1989).

Explain why you agree or don’t agree that IAS 37 provides sufficient guidance to provide users enough disclosure about environmental liabilities

When another Standard deals with a specific type of provision, contingent liability or contingent asset, an entity applies that Standard instead of this Standard. For example, some types of provisions are addressed in Standards on: (a) construction contracts (see IAS 11 Construction Contracts); (b) income taxes (see IAS 12 Income Taxes); (c) leases (see IAS 17 Leases). However, as IAS 17 contains no specific requirements to deal with operating leases that have become onerous, this Standard applies to such cases; (d) employee benefits (see IAS 19 Employee Benefits); and (e) insurance contracts (see IFRS 4 Insurance Contracts). However, this Standard applies to provisions, contingent liabilities and contingent assets of an insurer, other than those arising from its contractual obligations and rights under insurance contracts within the scope of IFRS 4. Some amounts treated as provisions may relate to the recognition of revenue, for example where an entity gives guarantees in exchange for a fee. This Standard does not address the recognition of revenue. IAS 18 Revenue identifies the circumstances in which revenue is recognized and provides practical guidance on the application of the recognition criteria. This Standard does not change the requirements of IAS 18.

Even when an entity has taken a decision to sell an operation and announced that decision publicly, it cannot be committed to the sale until a purchaser has been identified and there is a binding sale agreement. Until there is a binding sale agreement, the entity will be able to change its mind and indeed will have to take another course of action if a purchaser cannot be found on acceptable terms. When the sale of an operation is envisaged as part of a restructuring, the assets of the operation are reviewed for impairment, under IAS 36. When a sale is only part of a restructuring, a constructive obligation can arise for the other parts of the restructuring before a binding sale agreement exists.

How does the concept of “sustainability” relate to the concept of “environmental liabilities”?

Over the past several decades, sustainable development as a paradigm for balanced development has made its way into the constitutional regimes of many nations. The justiciability of sustainable development, however —particularly in the context of environmental legal protection— remains problematic for many legal systems, including Mexico. This article traces the evolution of sustainable development within an international context; analyzes its influence on treaties that led to the European Union; and evaluates the use of environmental protection by the European Union’s Court of Justice (referred to hereinafter as “ECJ”). An analysis of the interplay of the concept of sustainable development in the primary and secondary legislation of the European Union as interpreted by the ECJ leads us to the following conclusion: regarding the legal protection of the environment in the European Union, sustainable development may be viewed as a general principle of law that articulates a series of sub-principles contained in the treaties. These sub-principles include the precautionary principle and the “polluter-pays” principle. We also conclude that the unsystematic use of these sub-principles in the secondary legislation of the European Union weakens the ECJ’s coherent handling of the concept in its decisions. This article also suggests that Mexican judges would be well advised to carefully study sustainable development as employed by the ECJ in cases involving constitutional and international collective environmental claims which may arise under the recent amendments to the Amparo Law.

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