April 6, 2011
Are Lawyers to Blame for Poor Risk Management?
In the past year, we have seen some significant and tragic environmental disasters in the oil industry. The question I pose here: are lawyers to blame?
As for the disasters, first, of course, was the Deepwater Horizon disaster in the Gulf of Mexico, which released 4.9 million barrels (205.8 million gallons) of oil into the Gulf. In addition to some $20+ billion in cleanup and spill-related claims, BP lost (by my estimate), $531,797,000.00 @ today's price of $108.53/bbl. A second, smaller spill occurred last year when Enbridge Inc.'s oil pipeline dumped 800,000 gallons of oil into Michigan's Kalamazoo River. That's about 19,047 gallons of oil, a loss of $2,067,238.10 at today's price per barrel. Enbridge today announced that the cleanup would cost about $550 million.
I know some people feel differently, but I think it is pretty clear no one at these companies wanted anything like this to happen. The economic incentives are clearly there to try to avoid such spills, even before you take into account the necessary (and far more expensive) costs of remediation. I do think, however, this highlights that people are often very bad risk managers, even when they are highly educated and highly sophisticated.
This is true well beyond the oil industry. As the flood waters have begun to rise again in the Northern Plains, we again see the risk that returns annually when significant and permanent flood-avoidance measures are delayed or avoided. Fargo, North Dakota, and the rest of the area are once again working diligently to prepare for potentially disastrous flooding.
In years past, as I have argued elsewhere, we have seen the dangers of such floods when a city lacks adequate protection. In 1997 in Grand Forks, ND, flooding and a related fire led to $4 billion in losses and a $400 million dike system to protect the city from similar future events. The impact of Hurricane Katrina, and the resulting flooding, on New Orleans was even larger: $100 billion lost ($40B private). The present value cost (at least arguably) of flood protection is about $1.5 billion. Thus, in both circumstances, the cost of prevention was far cheaper than the cost of repair. And in both cases, the cost of prevention was also incurred (or needs to be).
We see this problem with corporate managers every day. Managers, of course, must deal with risks in a variety of ways. As Robert Eli Rosen explained in his dissertation, Lawyers in Corporate Decision-Making: a manager’s job is "balancing risks, developing a risk-portfolio, [and] securing support from others to minimize risks." And it may be that lawyers are failing their client managers.
Again, as Rosen explains: "The lesson to be learned in the risk analysis approach is that the lawyer must approach managers in a constructive fashion to effectively serve the corporation. The lawyer must approach the manager from the position of helping the manager realize his objectives. If the lawyer doesn't adopt this stance, the client will not consult him and will find ways to circumvent him."
Lawyers, especially in the non-litigation context, need to help their clients assess risk and help them solve problems. That can’t mean saying no all the time. It means learning their clients’ business, and understanding what their clients need, then providing options and solutions. Of course, some things are simply illegal. But, for the most part, it’s a not question of whether the clients can do something. It’s whether it’s worth it.
Risk management, obviously, can be done well. For example, in Winnipeg (Canada), a floodway was completed in 1968 to protect the city from flooding of the Red River, which is the same (north running) river that flooded Grand Forks and threatens Fargo today. Known as Duff's Ditch and Duff’s Folly (after its chief proponent, Manitoba premier Duff Roblin), it cost $63 million (about $300-$900m today, depending on how you do the calculation). In the years since its construction, "Duff's Folly" has saved billions of dollars, not to mention the human and social costs related to traumatic events.
I’d like to think Premier Roblin had very good legal advice.