Teaching BP

Robert J. Rhee

There are many teaching aspects to the BP disaster. The most obvious are lessons in environmental and tort laws. There are lessons in corporate law as well. As corporate entities, BP and its subsidiaries have limited liability. In addition to this standard subsidy for the shareholders of corporations in general, the oil industry has additional limited liability through a statutory cap on liability for an oil spill, though this cap does not apply if there has been gross negligence, willful misconduct, or violations of regulations. The economics of risk externalization would make for a nice class discussion in the torts or environmental law class. Another perspective is that the political process can contract the standard rule of limited liability, which was made clear by BP’s announcement of a $20 billion compensation fund. Thus, the default standard of limited liability is not only affected by the judicial doctrine of veil piercing, but also by the variable outcome of a political dialogue on the liability of an industry or a specific company.  This leads to a broader point.

Is BP’s primary problem a legal one (aside from the engineering problem)? The empirical world does not sort into discrete legal risk and analysis. At the end of the day, there is only the problem. The point is obvious but worth stating: in a mass disaster, legal analysis and strategy may not govern the decision standard. It did not for Exxon in the Valdez disaster and for the insurance industry on September 11, both of whom waived important defenses. For corporations like BP, legal risk is but one of many risks that must be managed. Its most pressing problem is not a large liability amount, not even $20 billion. A fixed, certain amount can be funded so long as the capital is correctly priced (though a correct price can inflict further pain on BP shareholders). BP’s bigger problem is a high level of uncertainty as to the final liability amount, obviously a big number, and the enhanced risk of bankruptcy. These heightened uncertainties have increased BP’s cost of capital, resulting in a 52% freefall of its stock price and a loss of market capitalization of approximately $95 billion in two months (on April 19, the day before Deepwater Horizon exploded, BP stock closed at 642.50 pence, and on  June 25 it closed at 305.73 with a market cap of £57.4 billion).

Legal liability (and recovery I might add) affects the bottom line. So does political risk (and subsidy I might also add) . . . and so too does interest rate risk, currency risk, commodity risk, terrorism risk, operational risk, technology risk, systemic risk, ethical risk, etc. These aggregate risks constitute an overall business risk for the corporation that must be reflected in the firm’s cost of capital. Ultimately, the fate of any corporation is governed by how well it manages risk and uncertainty.

For me, BP’s disaster emphasizes the importance of teaching legal risk in the context of a broader risk analysis, which increases the lawyer’s effectiveness and situational awareness. I make this point from past experience. In my former career as an investment banker, I have observed that even some seasoned corporate and M&A lawyers from national firms occasionally get mired in the thickets of legal risk only to lose sight of the context of the overall transactional risk, which ultimately disserved the client’s interest. Some of these infrequent instances, I suspect, can be explained by agency theory (it serves the lawyer’s pecuniary and reputational interests to eliminate legal risk entirely even beyond the point of marginal return). In other instances, a lack of situational awareness was probably the culprit. When I engaged lawyers as a client, the key parameter was whether he or she understood the role of legal risk in the overall transaction. BP can thus be taught not only from a litigation perspective of environmental and tort liability, but from a risk management perspective of a high stakes transaction affecting the corporate enterprise. This requires a holistic view of business risk and liability management from a transactional perspective.

Comments

[Tarball21]

It may also require a holistic view of the ways in which the regulators were totally captured.

One other question: are the lawyers working for "the firm," or the people at the top of the firm (who hire the lawyers) who have the most to gain from reckless behavior that assures massive short-term profits? Why do we pretend that there is some "firm" interest represented, when in fact in real life the lawyers are interested in continuing to get business allocated to them by a "control group" whose interests diverge from that of the firm as a going concern? It's "i'll be gone, you'll be gone," over and over again.

The best way to prevent accidents like BP is to make firm leaders feel some "pain" for skimping on safety. But that won't happen, so extensive regulation is needed.