Halliburton Could Be Derailed By Gulf Oil Spill

| About: Halliburton Company (HAL)
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Halliburton is trading at a valuation nearly in-line with its peers, even though it may have to pay tens of billions of dollars of fines for the Gulf oil spill.

A presidential commission indicated that Halliburton could well have been guilty of gross negligence that led to the Gulf oil spill.

If a judge agrees that the company was guilty of gross negligence, he could easily rule that the company must pay tens of billions in punitive damages.

The judge has already shown that he is very eager to ensure that victims of the Gulf oil spill get a great deal of compensation.

Investors seem to believe that Halliburton's (NYSE:HAL) liability for the 2011 Gulf oil spill will be limited to $1 billion or $2 billion at most, as the stock is trading at a multiple that is only slightly below the level of its peers. Doubtlessly, the company has contributed to this optimism by taking a reserve of only about $1.3 billion to cover its liability for the oil spill.

But Halliburton itself has admitted that it cannot be sure what its ultimate liability for the tragedy will be, and there are indications that its final bill could be much, much higher. There are several reasons why investors should be more worried about Halliburton's liability for the Gulf oil spill and should avoid the stock until the company's legal situation becomes clearer. Risk tolerant investors may want to consider shorting the name.

Halliburton could be held liable for punitive damages stemming from lawsuits filed against it over the oil spill. Total punitive damages against the remaining defendants in the case could be at least equal to the amount of compensatory damages awarded. In the 2008 Exxon Valdez case, the Supreme Court ruled that punitive damages could not exceed compensatory damages, according to Reuters. The news service, however, did not indicate that the court's decision limited punitive damages in any other manner.

Moreover, a legal expert with whom I spoke said that the total amount of punitive damages could potentially be several times the compensatory damages. The amount of punitive damages for each defendant is determined based on the extent of their misconduct, said the source, who did not want to be identified because he has not been following the trial.

Although it's difficult to find sources that describe the amount of compensatory damages that the defendants are seeking in the case, BP has said that Louisiana and Alabama are seeking a total of at least $34 billion in damages, Bloomberg reported in February 2013. In addition to those two states, the federal government and private parties, including financial institutions, casinos, other businesses and residents, are also plaintiffs in the case, according to Bloomberg.

Hypothetically and conservatively speaking, if $60 billion in total compensatory damages are awarded, at least $60 billion in punitive damages could also be assessed. If Halliburton is found liable for just one-third of those punitive damages, the company would be on the hook for $20 billion. As of March 31, the company had just $2.12 billion in cash and equivalents, it reported last week.

Moreover, there are some indications that Halliburton could indeed be hit with punitive damages. A defendant can be assessed punitive damages if it is found to have been guilty of gross negligence. According to Law.com, gross negligence is "carelessness which is in reckless disregard for the safety or lives of others, and is so great it appears to be a conscious violation of other people's rights to safety."

A presidential commission that investigated the oil spill found that Halliburton, BP, and Transocean had "ignored critical warning signs and failed to take precautions that…might have averted the environmental disaster," The Washington Post reported. More specifically, the commission stated that the cement Halliburton had used to seal the well was shown to be unstable by tests the company performed before the disaster.

Although I'm not a lawyer, if a company uses cement it knows to be unstable, and the cement directly contributes to a huge disaster, it seems to me that the company did exhibit carelessness which involved reckless disregard for the safety or lives of others and violated people's rights to safety.

Additionally, Halliburton pleaded guilty to destroying important evidence last year. The plea could indicate that the company's case in the civil trial is weak, Reuters quoted a Tulane University law professor as saying last year.

And Carl Barbier, the judge who will decide the key civil case in which Halliburton is a defendant, has been very eager to ensure that victims of the Gulf oil spill get a great deal of compensation. Barbier decided that BP must pay hundreds of millions of dollars in compensation to businesses that do not have proof that their losses were directly caused by the Gulf oil spill. Also ominously for Halliburton, a three judge panel of the Fifth Federal Circuit Court of Appeals earlier this year upheld Barbier's decision. The Fifth Circuit would likely hear any appeal by Halliburton of Judge Barbier's assessment of punitive damages against it.

In addition, investors (and analysts) should wonder why, despite trying for years, Halliburton has been unable to settle the civil lawsuits against it.

Another ominous sign for Halliburton is the wave of insider selling that has hit the stock this year. In the six months ended April 25, insiders have sold over 400,000 shares, equivalent to nearly 15% of their total holdings, according to Yahoo Finance.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.