• What we learn about liability caps from the BP oil catastrophe Thursday, June 17, 2010
    University of Chicago law professor Richard A. Epstein

    University of Chicago law professor Richard A. Epstein

    One of the main topics in the aftermath of the oil catastrophe in the Gulf of Mexico has been the extent of BP‘s liability to compensate those who have been harmed.  The tone of that discussion changed Wednesday, when the company agreed to create a $20 billion fund to pay damage claims for Gulf Coast residents.  Until then, BP’s liability could have been limited, because under federal law covering the oil industry, the Oil Pollution Act of 1990, the “total of liability . . . with respect to each incident shall not exceed for an offshore facility except a deepwater port, the total of all removal costs plus $75,000,000.”

    University of Chicago law professor Richard A. Epstein said BP likely would have had to pay more than $75 million anyway:

    Fortunately, the law removes that cap if the incident was caused by “the gross negligence or willful misconduct” of any party, or its failure to comply with any “applicable Federal safety, construction, or operating regulation.”

    But Epstein goes on to argue, in an opinion piece in the Wall Street Journal, that there shouldn’t be any legal cap on liability in the first place.  It should be noted that Epstein would not be considered a knee-jerk liberal; a noted Libertarian, he is or has been affiliated with the Hoover Institution at Stanford University, the Manhattan Institute and the Cato Institute, all of which could be characterized as conservative.  All emphasize limited government, free markets, individual liberty and individual responsibility.

    And that’s where the civil justice system comes in, by making corporations (and others) accountable for their actions that cause harm.  Here’s Epstein’s explanation:

    Tort remedies are essential to protect people (and their property) who do not have contractual relations with defendants from harms such as air and water pollution.  The legal system should never allow self-interested parties to keep for themselves all the gains from dangerous activities that unilaterally impose losses on others—which is why the most devout defender of laissez-faire must insist, not just concede, that tough medicine is needed in these cases….

    The first element in the mix is a no-nonsense liability system that fastens full responsibility on the parties who run dangerous operations, no excuses allowed.  Accordingly, we have to be especially wary of statutory caps on tort damages…we’d all be much better off if there were no statutory liability cap and if operators both big and small were required to purchase insurance—amounting to the tens of billions if necessary—when they operate in dangerous waters or terrains.

    A tough liability system does more than provide compensation for serious harms after the fact.  It also sorts out the wheat from the chaff—so that in this case companies with weak safety profiles don’t get within a mile of an oil derrick.

    Epstein believes there is a role for government regulation as well, but he clearly feels the potential for literally paying the price for their misdeeds goes a long way toward keeping companies’ actions and behaviors in line.

    Another commentator, Daniel Indiviglio, not only thinks liability caps are misguided, he goes so far as to say the idea that BP’s liability could be capped at $75 million helped to cause the current catastrophe.  A former investment banker, Indiviglio writes on The Atlantic‘s website:

    If a liability cap had never been put in place, BP and other oil companies would have behaved differently….Without a net to catch the oil companies if they fell, BP probably would have been more careful.  Cheap insurance creates a moral hazard, where you are lulled into believing that your risks are fully covered at a low price.  Spending money on additional safety measures becomes a bad business proposition…

    Indeed, not only does this moral hazard result in behaving less prudently, but it also provides little incentive to put plans in place to respond to disasters.  Why bother?  No matter how bad the spill gets, you’ll only be responsible up to the government cap…

    The reasoning involved goes beyond the current catastrophe and is not limited to oil companies.  Epstein writes we should be “especially wary of statutory caps on tort damages.”  That logic can also be applied to California’s MICRA law that limits non-economic damages for victims of medical negligence to $250,000, an amount that has remained unchanged since the law was passed in 1975.  When they are exposed to paying full compensation for harm caused to patients, hospitals and health care providers have significant additional incentive to raise patient safety to the highest level.

    –J.G. Preston

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