Avoiding Liability But Not Tort

Gideon Parchomovsky and Endre Stavang, Contracting Around Tort Defaults: The K4K Principle and Accident Costs (working paper, 2013), available at Docstoc.

When two sophisticated parties jointly decide that, in the case of accident, each will bear its own costs and insure against its own losses, why should anyone care? The Restatement Third of Torts, for one, does not. Restatement Third of Torts: Apportionment of Liability §2 (1999) (“When permitted by contract law, substantive law governing the claim, and applicable rules of construction, a contract between the plaintiff and another person absolving the person from liability for future harm bars the plaintiff’s recovery from that person for the harm.”). In their article, Contracting Around Tort Defaults, Gideon Parchomovsky and Endre Stavang, however, sound a cautionary note about potential social costs of private contractual agreements to opt out of tort liability. If potential tort liability prods actors to adopt socially optimal levels of precaution, when parties disclaim that liability through contract, will actors “under-invest in precaution and fall short of the optimal level of care,” with deleterious impacts not on the contracting parties themselves but on third parties? In short, will we have less tort liability but more tort?

The backdrop for Parchomovsky and Stavang’s question is an important one—oil and gas industry contracts that pervasively opt out of the tort system through a broad system of exculpatory agreements, sometimes referred to as “knock for knock” clauses. Courts determining the applicability of these agreements often focus their inquiries on the intent of the contracting parties to waive liability for negligence. Reeder v. Wood Cnty. Energy, LLC, 395 S.W.3d 789 (Tex. 2012), opinion supplemented on reh’g (Mar. 29, 2013) (“In construing a written contract, the primary concern of the court is to ascertain the true intentions of the parties as expressed in the instrument.”) Parchomovsky and Stavang’s critique suggests that  the effects of waivers on nonparty potential victims should also be taken into account. Could the industry’s pervasive system of exculpatory clauses, which ensures that liability falls short of even the cost of physical harms from negligently caused accidents, have caused insufficient industry precautions and led to major accidents like the Deepwater Horizon spill? While the authors don’t offer a definitive answer, they do identify the potential for industry contracts to result in moral hazard problems and suboptimal precautions  which increase hazards to third persons.

Parchomovsky and Stavang also identify four important mechanisms that may ameliorate the problems of moral hazard: 1) contract provisions that permit liability in the case of intentional and some other harms; 2) deductibles and precaution requirements; 3) regulation; and 4) continuing relationships between the parties. The authors do not blithely assume that these mechanisms are adequate to solve the moral hazard problem or the threat to third parties. Nor do they believe that the pervasive knock for knock clauses reflect the superiority of private over public ordering. Indeed, although scholars extoll the virtues of private ordering in other contexts, the authors distinguish oil and gas contracts here on the basis that parties’ negligence can have far reaching and potentially deleterious effects on others. According to the authors, in only a few situations would knock for knock clauses be welfare enhancing.

Stavang’s and Parchomovosky’s work thus asks a critical and underexplored  question in a context in which the answer is essential—when do private waivers of negligence liability jeopardize third parties so that intervention is necessary to protect not the sophisticated parties themselves but the safety of the public at large? The oil and gas cases put this question in sharp relief because the parties themselves are sophisticated, repeat players. They are capable of taking care of their own interests, but in so doing they may be exposing third persons to significant physical and environmental harm as well as economic loss. The extent to which these kinds of hazards justify imposing “public policy” limitations on express assumptions of risk is understudied in the academy and has received little attention from courts and legislatures.

This article is significant for the theoretical question it poses and the real-world context it exposes to scrutiny. We should hope that it is just the beginning of a conversation—that these authors and others will continue to study the issue. As recent accidents in the oil and gas setting suggest, the safety, property, and prosperity of many people may depend on reaching and implementing the right answers.