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Of BP, Caps, and Chapter 11

posted by Stephen Lubben

As BP moves through plans B through G in its attempts to stop the oil flow, and some analysts are suggesting BP faces liability of $40 billion or more, Congress has been looking at raising the current $75 million cap on BP's liability under federal law.

The disconnect between $75 million and $40 billion is striking -- and we should be clear that every dollar of cap below the actual damages caused by this event represents a subsidy to BP. On the other hand, some Senators have argued that exposing oil companies to uncapped damages will result in greater cost in terms of lost jobs in the energy sector.

But this argument ignores the role of chapter 11. In every other industry that has faced massive, escalating liabilities (e.g., asbestos), chapter 11 imposed a de facto liability cap. The cost of the tort liability is then shouldered by the shareholders, and in extreme cases the junior bondholders, rather than the employees.

Let me be clear, I don't think BP is near a chapter 11 filing, although the risk has clearly increased, as BP 5-Year CDS Prices shown by the spike in CDS prices. According to Bloomberg, at the end of 2009 BP reported assets of $236 billion and debts of $134 billion, so it can easily absorb several billion of new debt onto its balance sheet, assuming its banks and trade creditors don't panic.

But we should also be careful about suggesting that seemingly infinite liabilities will destroy employers. Shareholders will suffer, but the company will continue -- especially if it does not intend to make a habit out of creating massive environmental destruction.


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Didn't we learn in CorpFin that markets, even CDS markets, may overreact? Or are we now assuming some form of efficient market hypothesis?

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