06/16/2010 05:40 pm ET | Updated May 25, 2011

Oil Spill Compensation -- Not So Fast: It's Not Just BP at Risk!

The proliferation of headlines pertaining to various demands from all levels of government on BP for payment of various costs resulting from the Gulf oil spill - e.g. lost sales and state income tax revenue and salaries for laid off oil service workers, and perhaps lost revenues for tourism dependent firms - has major implications for our economy and legal system. It is certainly viscerally appealing for all concerned to hold out their hands to BP, which has almost certainly done something giving rise to civil liability. At the least, everyone, even BP, agrees that it is liable for direct clean up costs. It is also making voluntary payments to many impacted persons.

However, the efforts which are being pursued at the federal and state levels are at best superfluous, and at worst, seriously detrimental to the economy. There already exists an elaborate body of tort (and perhaps contract) law governing the liability of one who has wrongfully caused harm to another. In general, this body of law limits recoverable damages to what should have reasonably been foreseeable to the wrongdoer at the time of their wrongful act. Those with legal training will recognize and recall the infamous Palsgraf case involving a chain reaction of events on a train - premature movement, people falling, fireworks erupting, objects falling, etc. - which guides us today, and makes clear that the rule of damages which is applied in tort law is not a simple 'but for" standard, but one which limits damages to a much greater extent by defining a "zone of exposure." A moment's reflection indicates that doing otherwise would inhibit economic activity by exposing actors in all fields to vast and unpredictable claims - out of proportion to potential benefits - if anything were to go wrong. While far from perfect, this system has served us reasonably well as our economy has developed.

Adding to the din are administration demands for the creation of an escrow fund to pay for claims against BP. We already have ample mechanisms for those who feel that they are aggrieved by BP to pursue such claims, and for courts to order the creation of security for claims ultimately found to be valid, if they feel that the defendant may not be able to satisfy such claims at that time. Many such claims - individual and class - are already pending. If claims which are currently being made are covered by existing law, the new initiatives are unnecessary. If they are not already covered, and I think many of them, such as claims for lost tax revenue, are not, cooler heads need to seriously consider the macroeconomic effect of the proposed legal changes. It is also essential to look at the constitutionality of the proposed efforts, as many of those which involve forcing BP to make payments without adjudication of liability involve Fifth Amendment Due Process issues.

Whatever the legalities, the last thing we should be doing now is discouraging business activity. Yet, if we expand exposure where a venture - in the oil industry or elsewhere - encounters problems, we will, by definition, discourage the formation, continuation or investment in such ventures, by decreasing the expected return. This will reduce employment. Policy makers need to seek a delicate balance between holding businesses responsible for the damage they genuinely cause and holding them responsible for everything remotely attributable to them. This is why we have a foreseeability standard.

Telling BP that it must make up for sales and income tax revenue which it is not paying because of its focus on clean up activity, seems appealing, but tells other firms, large and small, that even if they do not perform well, for whatever reason, they may be called upon to bolster a government fisc as if they had done so. Nothing would limit such demands to situations where the poor performance results from an environmental disaster. Similarly, requiring payments of lost wages and profits to those in the area following an environmental incident may be just a precursor to such a requirement following a strike, material shortage, fire or natural disaster. It is also an open invitation to fraud, as it will be difficult to determine who would have been fired or laid off or gone out of business in any case, and who would have done well absent the events complained of. While it is unclear whether any pending "suggestions" such as the escrow fund involve resolving claims outside the legal process, if this is the case, the potential for fraud grows exponentially.

Many people lose a good deal of money from the innocent and wrongful actions of other private actors, but as a society, we can not and do not seek to provide an all encompassing safety net through the private sector. The current experience of Europe, which has sought to do so, and undermined its economy to a greater extent than the US, as indicated by the growing sovereign default fears, should be instructive.

Many understandably see the $75 million cap on economic damages - not clean up costs - from oil spills which is contained in current federal law as the triumph of Big Oil and its lobbyists. This may be true, but it is also an important balancing mechanism between risk and reward which encourages the development and preservation of oil production which is critical to meeting our energy and employment needs. Perhaps such a cap should be raised or the definition of recoverable items broadened in light of today's circumstances, but it should not be eliminated to allow open ended recoveries of all conceivable losses.

It may be hard to believe in light of the catastrophic losses from the current oil spill, but there is considerably more at stake for our economy than for the Gulf Coast region. Treating BP as a guarantor of all Gulf Coast losses simply because this may be financially possible, will make clear to the rest of the business world that they may be next when it is politically expedient and will inhibit efforts to reduce unemployment. Our policy makers need to heed not only the sound of the mob clamoring for "justice," and "fairness," but also the more muted sound of reason.