Hazardous Storage, Judgment-Proofness, and Bilateral Care
A warehouse stores 40,000 litres of industrial solvent 300 metres from a river. With low care, the annual probability of a spill is 8%; with high care it is 2%. High care costs €90,000 per year. A spill would cause €2.5 million in damage to downstream residents and fishermen. The warehouse has assets of €100,000 and is a single-purpose subsidiary; its parent is not liable under current law. Residents can sue in tort, but litigation costs each side €40,000. The regulator is choosing between a negligence rule with a statutory high-care standard, strict liability, and a property rule allowing residents to seek an injunction. The warehouse argues that the residents should insure. The residents argue that the warehouse is judgment-proof. The ministry wants to know which rule minimizes expected social costs, including administrative costs.
1. Apply the Hand formula and determine whether high care is efficient.
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Hand formula: B = 90,000; p(low) = 0.08; L = 2.5m; expected harm low = 200,000. High care: p = 0.02, expected harm = 50,000; total expected cost = 90,000 + 50,000 = 140,000. Low care total expected cost = 200,000. Because 90,000 < (0.08 − 0.02) × 2.5m = 150,000, high care is efficient. The statutory high-care standard is therefore justified if it is set at the efficient level and can be applied without excessive error.
2. Compare negligence and strict liability when the warehouse is judgment-proof.
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Under negligence with a high-care standard, the warehouse avoids liability by taking high care; if it takes low care, expected liability is 200,000, so high care is cheaper by 110,000 (200,000 − 90,000). Under strict liability, it also faces expected harm and chooses high care. But judgment-proofness changes this. With assets of 100,000, expected liability under low care is 0.08 × 100,000 = 8,000; under high care it is 0.02 × 100,000 = 2,000 plus 90,000 = 92,000. The warehouse chooses low care. Negligence does not solve the problem if the liability cap is the same and the standard is not backed by criminal or administrative penalties. Mandatory insurance, a parent guarantee, or a bonding requirement can restore the incentive.
3. Assess the property rule versus liability rule choice, taking account of insurance and activity-level effects.
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A property rule lets residents seek an injunction; if they are numerous, holdout and coordination costs may prevent an efficient bargain. A liability rule with damages equal to expected harm compensates and lets the warehouse decide whether to take care or pay, but capped damages under judgment-proofness under-deter. If the residents can insure, insurance may cover losses but does not internalize the warehouse's activity level; moral hazard and correlated risk remain. The best mix is a high-care standard plus mandatory financial responsibility (insurance or bond) and, for catastrophic risk, a strict liability rule with minimum capital requirements. The ministry should compare expected harm, care cost, administrative cost, and insolvency risk, not just who bears the loss.