Opinion ID: 785944
Heading Depth: 3
Heading Rank: 2

Heading: The Appropriate Interest Rate

Text: 56 The methodology used by the District Court and those advanced by the parties do not exhaust the possible interpretations of economic benefit under § 1319(d). It will be helpful to analyze the options. There are, as we see it, two possible approaches. The first is the cost of obtaining capital-i.e., the interest rate necessary to acquire the capital with which to make the improvements (which were never made). The second is the use of the corporate offender's actual return on its capital, which, it is conclusively presumed, was not used to make the improvements. These are both highly variable factors, turning on the cost of money to the company (which depends not only on the general market forces but also on its financial strength and credit rating) or on the profitability of the company at a given time. 57 In view of this variability, we think that it would be inappropriate for us to decree which methodology should be used since in any given situation, leveling the playing field might be more readily achieved with one or the other. Therefore, we think that the choice of methodology should be left to the sound discretion of the District Court. 10 In this case, however, it is not clear that the District Court was aware of or considered the range of options available. 58
59 As noted above, economic benefit can be measured by an entity's cost of capital. In accepting the government's experts' position, the District Court adopted one such measure-WACC-but there are others. In commenting upon the cost-of-capital measure adopted by the District Court, we hope to provide some guidance as to what constitutes an appropriate cost-of-capital measure of economic benefit. 60 With respect to the cost-of-capital measure used by the District Court, we conclude that both the calculation and application are, at the very least, unsupported. The first problem is the government's calculation of the WACC. That calculation relied on values that were not ALC-specific. Instead of using the actual yield on bonds that ALC had issued, the government experts computed the WACC by using the yield on Standard & Poors A-rated bonds. While using the S & P figure might well have been a reasonable approximation of ALC's bonds' yield, a more accurate calculation could easily have been achieved by using figures specific to ALC's bonds. 11 61 The second problem is the government's application of the WACC. WACC averages are constructed on the basis of a company's existing capital structure (that is, the relative proportions of debt and equity). A WACC figure based on a company's existing capital structure at a given time is not, without further support, necessarily the same as a company's marginal or current cost of capital at that time (i.e., what it would cost to obtain additional capital) because new capital might come in a different mix of debt and equity. See Aswath Damodaran, Applied Corporate Finance 108 (1999) (In estimating [the current cost of capital using WACC], we have in a sense conceded the status quo in terms of financing mix, since we have estimated the cost of capital at the existing mix. It is entirely possible that a firm, by changing its mix, could lower its cost of capital.). Unless WACC is shown to be a good approximation for the marginal or current cost of capital, it sheds little light on how expensive it would have been for the company to go to the market for its capital, instead of diverting funds that should have gone to improving pollution controls. 62 As noted above, the government and the District Court relied on Smithfield Foods. But, upon closer analysis, Smithfield Foods does not help the government. There are reasons to suspect that in the food processing industry (in which Smithfield operated), the WACC may have been an entirely appropriate approximation of Smithfield's economic benefit, whereas conditions in the steel industry (in which ALC operates) are radically different. More precisely, it may have been that in Smithfield Foods that the WACC was a good approximation for the terms on which money could have currently been raised; the food processing industry is a stable industry where companies probably attract new capital on terms similar to their existing capital structure. The steel industry, in contrast, has been highly volatile and rife with stiff foreign competition, dislocations, and bankruptcies. Indeed, as the District Court noted, the industry is going through a brutal restructuring, and more than twenty-five United States steelmakers have sought bankruptcy protection since 1997. Thus, a company in ALC's position may not have, at the times in question, been able to raise capital on the same terms as its existing capital structure. We need not (indeed, cannot) resolve this; but for our purposes, it is enough that there was insufficient evidence for the District Court to say that ALC's existing capital structure was representative of the terms on which new capital would be raised. Thus, if the economic benefit to ALC is to be established by a cost-of-capital measure, the measure to use is ALC's marginal or current cost of new capital in the years in question. 12 Some courts appear to have endorsed this approach. See, e.g., Gwaltney of Smithfield, 611 F.Supp. at 1559 ([T]he actual rate Gwaltney itself paid on borrowed funds ... is a more accurate basis for determining Gwaltney's economic benefit from delay.). 63 It is of course possible that this approach might make an offender worse off than under the government's WACC proposal. For example, a company in dire financial straits may well have a marginal cost of capital (offered by lenders who see it as a high-risk investment) that exceeds its WACC. This is no anomaly. For companies that are hard up for capital and cannot afford to raise it in the market, it is doubtless all too tempting to forego the sometimes costly improvements and pollution controls that are required by the CWA and EPA regulations. But such companies must still be held to the law. To do otherwise is, in essence, to allow capital-strapped polluters to take out low-interest loans against the environment. 64 We of course intimate no view on what a remand may develop respecting ALC's situation in the 1990s. The government's experts' proffer shows debt costs for S & P A-rated bonds were in the 6.68% — 10.06% range in the 1990s. That is significantly lower than the 12.73% WACC figure relied on by the District Court. Moreover, in recent years, which would also figure in the calculations, interest rates have been very low. The record does not reflect ALC's actual financial strength, and it may (or may not) also have (or have had) a good credit rating throughout the relevant period. 65
66 We have so far been talking about measuring the economic benefit of additional capital by the cost to obtain that capital elsewhere. But the other option is to use actual rates of return on capital to compute economic benefit. The government's experts cited the importance of leveling the economic playing field in the same industry. It is obvious, for example, that ALC and the steel industry were not, at times relevant, enjoying stellar returns. Indeed, as noted above, it was uncontested at trial that ALC had a return on capital that was less than half the 12.73% rate used by the District Court. On this view, any advantage that ALC enjoyed over its competitors by avoiding the cost of CWA compliance is measured by the return that ALC actually realized on its retained funds or the risk-free return it might have enjoyed using those funds. We think that the return on capital is a quite viable means of leveling the playing field, along with the marginal or (then) current cost of capital. 67