Pollution Often Part of Package Deal With Eastern Bloc Firms : Environment: Western investors buying interests in state-owned companies may find themselves liable for cleanup.

Since privatization in the former Eastern Bloc first began five years ago, Western investors have spent billions of dollars to purchase interests in thousands of state-owned companies.

In many cases, they are also buying into a legacy of 40 years of environmental degradation that is some of the worst on the planet.

But a lack of clear legislation to determine liability means that investors have plenty of reason to be concerned that they will get stuck picking up the bill for forty years of communist hubris.

“The current fining and enforcement system is unclear, and what the future laws and enforcement system will be is unclear,” says Theodore Boone, head lawyer at Arnold & Porter’s Budapest office and former president of the American Chamber of Commerce there.

While environmental laws went virtually unenforced under communism, investors fear that will change with private ownership. Many also fear they will be the target of lawsuits by citizens aggrieved by past damage.

“Once a company is in private hands, all of a sudden there’s a deep-pocket private company and somebody might start thinking ‘Let’s go after them,’ ” Boone says.

Under a command economy driven by production targets, polluting technologies were the norm. The virtual absence of environmental regulation meant many industries simply dumped their waste out the back door or in neighboring fields.

According to studies sponsored by the European Union, the pollution has already taken a high human toll, particularly on children.

The high concentrations of dust and sulfur dioxide in the mining districts of the northern Czech Republic have increased the number of infants dying from respiratory problems five- to eightfold. Nearly 60% of the children in the center of Budapest have dangerous levels of lead in their blood. In the Romanian town of Copsa Mica, high lead levels have left as many as 70% of the children with mental retardation.

But environmental problems were a low priority for agencies under a mandate to privatize state-owned land and industries as fast as possible to get money for their cash-strapped countries.

Officials responsible for environmental enforcement usually have little input into the privatization process. In Poland, for instance, the Department of Environmental Protection reported that it found out about the sale of big polluters only through the newspapers.

The privatization agencies frequently don’t know the extent or nature of pollution on a property, because under communism environmental damage didn’t officially exist, and in many countries it was even illegal to publish information about environmental problems. The attitude of privatization agencies tends to be, “I don’t know what’s there; take it as is.”

“We thought our task was selling,” Janos Kerekes, a director at the Hungarian State Property Agency, says in explaining why his agency brought on an environmental expert only last month, after five years of operation. The SPA, like most privatization agencies, doesn’t routinely perform environmental audits before a sale.

Thus, investors bear the burden of looking for past damage, such as ground water or soil contamination. But even when the problems have been determined, vague and contradictory laws mean that potential buyers don’t know who’s going to be responsible for cleaning up the mess.

“Sometimes there are inconsistencies between the law and the practice, sometimes there are inconsistencies between environmental laws and other laws, and sometimes the laws are simply vague,” says Stephen Stec, regional environmental specialist for the American Bar Assn.’s Central and East European Law Initiative. “These are all pitfalls for investors.”

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Studies show that Western multinationals, which have spent billions of dollars purchasing state-owned companies, are generally aware of the problem. Environmental liability ranks above political instability and a lack of supporting infrastructure as primary concerns of Western firms investing in Central and Eastern Europe, according to a 1992 study by World Bank and the Organization for Economic Cooperation and Development.

That’s particularly true of American companies, because of their experience with the U.S. government’s Superfund program, which has assigned liability to polluters retroactively.

“Unless you negotiate something (with the privatization agency) up-front, you have to assume you will be responsible for on-site liabilities,” says Annemargaret Connolly, a lawyer specializing in environmental issues for the law firm Weil, Gotshal & Manges.

The question of who will be responsible for pollution on sites neighboring an industry--which isn’t revealed in environmental audits--is particularly sticky. Last year, the Czech Republic tried to implement rules specifically defining liability issues such as off-site pollution and past damages. But a number of the rules were successfully challenged as unconstitutional.

The lack of formal guidelines for dealing with environmental liability in privatization means it is negotiated on a case-by-case basis. The most common solution is a purchase price reduction based on the cost of cleanup. Alternately, a privatization agency might agree to set aside part of the purchase in an escrow account to be used for cleanup.

Privatization agencies occasionally agree to indemnify buyers against lawsuits, but these arrangements are fraught with complications. In Hungary, indemnities are usually limited to legal challenges within a year of purchase and for liabilities equal to less than 20% of the purchase price, compared to indemnities of up to 100% in the United States.

It is also unclear how easy it will be to enforce indemnity agreements. Hungary has a special fund set aside to cover liabilities it assumes under the agreements, but Kerekes says he is worried there is not enough money to cover all of the indemnities the SPA has granted.

Privatization agencies, unaware of the extent of environmental damage at a site and having no guidelines on how to deal with it, were often caught off-guard when investors first came to them with the results of their environmental audits.

Such was the case when Swedish company Electrolux purchased the Hungarian Lehel Refrigerator factory in 1991. The SPA knew the site contained buried “Gorjanc bombs”--boxes of improperly packed toxic waste, named for the Communist Party leader who formerly controlled Lehel.

But the surprise came when Electrolux announced it would cost about $27 million--half what it paid for Lehel--to clean up the oil, solvents and heavy metals in the soil and ground water on the factory site. While the transaction was under way, even more dump sites were discovered.

The case of Lehel is a “successful story, but a painful one,” Kerekes says. In his opinion, Electrolux used an excessive cleanup standard, and the SPA is fighting the company’s petition for a bigger discount on its acquisition cost. Rather than actually having the purchase price reduced, Electrolux is asking that more of its payments to the government be set aside for cleanup.

Hungary, like the other countries in the region, doesn’t have its own cleanup standards. Instead, they are determined on an ad-hoc basis. Multinational companies often use European Union standards as a measure, but Kerekes thinks those are too strict for Hungary’s struggling economy. Hungary is vying for EU membership, however, and will eventually have to meet those standards.

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In some cases, the environmental problems on a site are so bad that if they were figured into the selling price, governments would have to pay “buyers” to take sites off their hands, says Boone of Arnold & Porter.

When companies have particularly bad on-site pollution problems, privatization agencies sometimes carve them up and sell off the pollution-free parts. In one case, an investor who wanted to purchase a factory with soil contamination got around the problem by purchasing only the machinery, which he then moved to a new site.

Environmental experts criticize the practice, because it means the pollution probably won’t get cleaned up.

But even as investors clean up old sites and put in less-polluting technologies, danger still lurks. New, more efficient industries mean greater production, says Janos Zlinszky, legislative director for the Regional Environmental Center. While the technologies may be cleaner, he says, the increased productivity will create more waste.

Formerly, “production was causing the main pollution in this part of the world,” Zlinszky says. “We are now forced and lured into a lifestyle where our consumption will cause the bulk of the pollution.”