Allocation_of_contractual_liabilities_through_standard_contract-libre.pdf

8/11/2019 Allocation_of_contractual_liabilities_through_standard_contract-libre.pdf

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Allocation of contractual liabilities through standard contracts

by Luca Lattanzio

Introduction .................................................................................................................................................. 2

The indemnity and the allocation of liabilities ........................................................................................ 3

Standard contracts and clauses............................................................................................................... 6

LOGIC .......................................................................................................................................................... 8

AIPN ........................................................................................................................................................... 10

Conclusion ................................................................................................................................................. 11

Bibliography .............................................................................................................................................. 12

Websites ................................................................................................................................................ 14

Cases ..................................................................................................................................................... 14


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Introduction

Although everybody hopes for an industry free from accidents and risks for the

environment and, in particular, for the people involved, unfortunately accidents can and do

happen1. The oil and gas industry is a hazardous, capital-intensive business. Although every

possible measure is taken to mitigate and minimize the risks, hazards cannot be totally

eradicated and accidents can occur, as history already showed us with the two most (in)famous

disasters of the recent years: Piper Alpha in the North Sea (1988), which caused 167 victims in

only 22 minutes2; and Deepwater Horizons in the Gulf of Mexico (2010), which caused the death

of 11 people and the injury of many more, left a fire burning for over 36 hours before the rig

sank, and hydrocarbons leaked into the Gulf of Mexico before the well was closed and sealed3.

Each stage of the oil and gas production, from the seismic to the drilling, from the extraction to

the refining, involves a huge number of different technologies and/or the handling of dangerous

substances, making the oil and gas industry a risky business, and creating the necessity for

managing the risks with effective risk management strategies and liability allocation models

(Makarov 2009).

The allocation of liabilities is, in fact, an important part of the contract the drafters have to

carefully take care of (Hewitt 2008). Traditionally, the operator has dealt with the risks via

insurances4; today it can be stated that the creation of indemnity provisions is probably the most

important part of a contract, in particular in the oil and gas industries, where the responsibilitiescan be enormous5. That is why the oil and gas industry developed a very sophisticated standard

1Hewitt T., Who is to blame? Allocating liability in upstream project contracts (2008) 26 J. Energy Nat. Resources L.

177.

2See Oil&Gas UK The voice of offshore industry, Piper Alpha: Lessons Learnt, 2008, available at

3See BP Deepwater Horizon accident and response, available at

4Cameron P., Liability for catastrophic risk in the oil and gas industry (2012), Issue 6 IELR.

5 Macattram G., How can the indemnity clause expand or limit the responsibility for liability of the parties in

international oil and gas contracts? (20 February 2007), CAR (CEPMLP Annual Review), University of Dundee.


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model to deal with the liabilities and risks, which includes indemnity clauses, exemption clauses

and limitation of liability provisions6.

The indemnity and the allocation of liabilities

An indemnity clause is a contractual provision whereby the indemnifying party agrees to

make payment to the party having the benefit of the indemnity in the event that the indemnified

party suffers loss as a result of the occurrence of a specific event7. It is the result of the

negotiation between two parties, commonly known as the indemnitor (the party who assumes

the burden of the indemnity) and the indemnitee (the party who benefits from the indemnity and

receives reparations for the damage occurred). In general terms, an indemnity is a transfer of

the risks from one party to the other, shifting the ultimate responsibility for payment to the party

who caused the injury8. However, it is not limited to a reimbursement for personal injuries or

property damages, but it extends and applies also to the contractual obligations of the parties or

fiscal liabilities. That is also why the language of the indemnity provision is extremely important

and needs to be clarified through unambiguous terms9, in particular because the dispute might

end up in courts, under different jurisdictions or in different countries (Makarov 2009).

As Wilson (2008) suggests, the liability regime might include: 1) the so-called gross

negligence and wilful misconduct10

, which usually needs to be accurately defined in the JointOperating Agreement itself; 2) unauthorized, negligent or unlawful acts; 3) consequential loss or

6Bullock K.W.II, A brief overview of indemnity provisions and allocation of risk in energy agreements (17 May 2012),

Texas Lawyers In-House Counsel Summit, Chamberlain Hrdlicka Attorneys at Law, available at

7Gordon G., Paterson J., Oil and Gas law. Current practices and emerging trends (2007), Dundee University Press.

8Perten J.H., Indemnity: A Clause Worth Reading (25 October 2007), Sheehan Phinney Bass and Green or the

Sheehan Phinney Capitol Group, informative paper, available at

9See the case EE Caledonia Ltd v Orbit Valve Co(Court of Appeal) [1995] 1 All ER 174; [1994] 1 WLR 1515; [1994]

2 Lloyds Rep. 239, where it has been stated that the judge will be focusing on the language used, and not on the

intentions of the parties who drafted the clause.

10In general terms, gross negligence refers to a serious carelessness of one of the parties which led to a mistake,

while wilful misconduct refers to the intentional disregard for the rules of conduct. However, both the terms must me

clearly defined in the contract. The standardized forms of contract, e.g. AIPN, offer examples of definition the parties

can adopt.


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personnel and property and its own consequential losses15. This particular form of indemnity is

usually referred to as mutual hold harmless16(MHH) or knock-for-knock indemnity, and it has

been integrated into the provisions of the majority of the international standard contract

models17.

There are two main advantages which led to the adoption of the MHH in the industry:

firstly, this clause does not require an investigation into which party was at fault18 (usually,

investigations on liability in case of a loss are lengthy and articulated); secondly, this clause

spares each contractor the need for stipulating innumerable insurances against all the possible

accidents which can occur, with very high premiums and incurring in many duplications of

insurances (Hewitt 2008). In simple terms, MHH clauses fills in the gap in the allocation of risks

for different companies working together on the same installation, but not being, in fact,

contractually linked.

Together with the indemnity clauses, effective risk management strategies might include

also two other important forms of provisions: the consequential loss provisionand the limitation

of liability. Consequential loss19 is defined as the indirect result of a specific breach in the

contract, and can refer to the deferral or loss of production, use, revenue or profit20. As for every

contractual provision, also a consequential loss clause must be prudently drafted, paying

attention to the language used and the definition offered. Lastly, the limitation of liability refers to

the creation of a so-called liability cap, which limits the liability to a specific maximum amount

of money payable21. Obviously, this cap must be the result of intense negotiations amongst the

parties involved. However, standard contract models often offer some figures the parties can

adopt to determine the cap.

15Hewitt (above n.1) p.182

16See the case Caledonia North Sea Ltd v London Bridge Engineering Ltd[2002] UKHL 4; [2002] 1 Lloyd's Rep 553,

HL.

17Cameron (above n.4) p.208


19See the case Hadley v Baxendale(1854) 9 Ex 341 for a detailed determination on the rules of consequential loss,

and BHP Petroleum Ltd and Others v British Steel plc and Dalmine SpA[1999] 2 Lloyd's Rep 583.

20LOGIC 2012 Mutual Indemnity and Hold Harmless Deed, 1.1. Definitions and interpretation.

21An example of claim for a limited liability (pursuant to 1976 Limitation) can be seen in the case A Turtle Offshore

S.A. v Superior Trading Inc [2008] EWHC 3034. See also WesternGeco Ltd v ATP Oil & Gas (UK) Ltd [2006] 2

Lloyd's Rep 535, concerning the problems in drafting effective liability caps against third party losses.


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Standard contracts and clauses

Due to the implications and the costs connected to the oil and gas industry, the risks and

liabilities involved, and the need for a huge number of clauses which have to be perfectly written

and defined, the oil and gas industry has started developing standardized forms of agreement

which can be adopted by the companies. This is meant to avoid the extenuating effort of

creating ad hoccontracts for each operation, as the repeated negotiation of contract terms ()

inevitably promote(s) delay and inefficiency and increases operational costs22. This shift toward

standardization resulted to be a natural step in an industry which is somehow unique in the

way competition is dealt with, and that had always strongly relied on negotiations in the view of

creating mutual benefits (Martin, Park 2010).

Model contracts present advantages and disadvantages. However, it can be shared the

opinion that the advantages far outweigh the disadvantages and that most of the disadvantages

() can be avoided through proper use of the model contract () and the weaknesses can

generally be avoided by skilled, knowledgeable users of model contracts23. The advantages

can be summarized as follows (Martin, Park 2010):

1. Cost efficiency: standard contracts save money and time to the parties, as well as

reduce costs of litigation and insurance24

.2. Speed: the negotiation times (previously indispensable) can now be cut. Martin and

Park (2010) refer a reduction of up to 90% of the negotiation times.

3. Avoidance of risks: the tight deadlines and the immediate need for starting the

operations rushed the drafters to leave unfinished, incomplete clauses. It also

happened that operations started before the execution of the contracts25.

22Roberts P., Standard terms for Asia oilfield service contracts (September 2003), PetroMin publication, Jones Day,

Hong Kong.

23 Martin T.J., Park J.J., Global petroleum industry model contracts revisited: higher, faster, stronger (2010) 3(1)

Journal of World Energy Law & Business, p.12.


25Martin, Park (above n.23) p.9


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4. Higher quality contracts: as standard contracts are drafted by expert, they are likely

to offer a quality model the companies can refer to. However, this might not apply for

every single contract, as it largely depends on the team who drafted and proofread it.

5. Wide industry understanding: well-prepared model contracts generate a better

understanding on the way a specific aspect of the industry can be treated, reducing

thereof the ground for disputes.

6. Improved relationships: model contracts avoid intensive negotiations which might

turn contentious. It helps maintaining good and friendly relationships.

7. Association development: the associations promoting the standardization process

improved their reputation, the quality of the contracts and the educational/training

programmes offered.

Roberts (2003) points out as well that the adoption of standard contracts generate the

perception of a high degree of fairness in the conditions, as the contracts have been drafted by

experts time beforehand, with no connection to any of the companies involved in the current

negotiation. The principle of standard conditions of contract is undeniably attractive, and that

certain industry bodies have devoted considerable effort to settling such standard conditions is

to be applauded26.

Amongst the disadvantages, Martin and Park (2010) list:

1. Relative bargaining power: standard models offer equal bargaining powers to the

parties. This often resulted in the stronger party trying to modify the contract so to

maintain its bargaining power.

2. Under-qualified users: the use of standard contracts requires the parties to fully

review and agree the terms, and not simply to fill in the blanks in the form. Model

contracts must be properly used.

3. Model paralysis: it can happen when the parties do not agree on a modification of the

standard contract. Nonetheless, reasonable and cooperative behaviours can avoid

an impasse.

26Roberts (above n.22) p.3


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4. Inappropriate use: a standard contract must be used exclusively for the purpose it

has been created for. Over-modifications of the contracts will enhance the risks and

will frustrate the idea behind the standardization process itself27.

5. Flawed models: the models must be maintained and revised, as flaws can be

present.

There are many associations offering standard contracts, depending on the field of

expertize and also on the geographic and juridical area the contracts will be implemented into.

Amongst them, we can mention the Leading Oil and Gas Industry Competitiveness (LOGIC),

the Association of Independent Petroleum Negotiators (AIPN), the American Petroleum Institute

(API), the International Association of Drilling Contractors (IADC), the International Association

of Geophysical Contractors (IAGC), the Petroleum Equipment Suppliers Association (PESA),

the International Federation of Consulting Engineers (IFCE), and many others. Due to space

limitations and requirements, I will focus only on two of them: LOGIC and AIPN.

LOGIC

The United Kingdom has widely recognized the importance of the standardization

process and has made concrete efforts to improve the efficiency of the operations in the North

Sea, which can be taken into account as a valuable model also for many other countries. TheCRINE initiative (Cost Reduction in New Era) was founded in 1992 with the goal of reducing the

costs of developing oil and gas fields by 30%, generating a network of companies adhering to

this initiative. In 1999, LOGIC28was created by the Oil & Gas Industry Task Force, becoming

fully operational in 2000. LOGIC is responsible for the issue of standardized contracts for use

within the industry29. There are different types of contracts available for download on the LOGIC

website30.

27Roberts (above n.22) p.4

28Not-for-profit wholly owned subsidiary of Oil & Gas UK that operates as the custodian for cross-industry projects

that aim to increase the efficiency of working practice in the United Kingdom Continental Shelf (known as the UKCS),

from the homepage of the official website

29See website

30For the entire list, please visit the website


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Amongst the number of key industry projects LOGIC manages and administrates (as the

standard contracts framework), fundamental is the Industry Mutual Hold Harmless (IMHH) deed

(which incorporates MHH in almost all the LOGIC standard contracts31). The IMHH is a scheme

the companies can join in order to address and mitigate risks in the offshore petroleum

operations. The numerous advantages of this scheme are well-known; therefore it is worthy to

try to focus briefly on the limitations32:

1. As the IMHH has been originated in the context of the North Sea development, it does

not apply to the onshore operations. Indeed, in case of operations which are partly

onshore and partly offshore, the IMHH will apply only to those offshore elements

involved.

2. The IMHH applies to personal injuries, property damages and consequential losses, but

does not apply to the pollution risk (as it resulted to be less quantifiable than the other

risks, and thereof would have paralyzed the correct functioning of the scheme).

3. The IMHH scheme is open to all the offshore contractors, and although there is no

limitation for the operators to sign it, the deed is not intended for execution by operators.

In order to make the deed suitable for the operators as well, a re-drafting would be

necessary.

Although these few limits, it is undeniable that the IMHH scheme creates an interesting

model the other States can inspire to, as Roberts (2003) suggests with reference to the oil and

gas operations in Asia, which could learn from the UKCS experience. However, the LOGIC

example of standardization relies very much upon the creditworthiness of the parties, as a

catastrophic incident can break the relationships. This applies perfectly in the North Sea, where

there are many small to medium sized companies with concrete interests in addressing and

anticipating the creditworthiness of the other parties33. It is not surprising, indeed, as the

success in the industry has always required cooperation with other parties, whether they be

contractors, governments or competitors34.


32See website




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AIPN

AIPN is a non-for-profit professional membership association created in 1982 with the

goal of supporting negotiators all around the world35. AIPN makes available a huge number of

model contracts which can be used as reference, e.g. Confidentiality Agreements, Farmout

Agreements, Gas Sales Agreements, Joint Operating Agreements, etc.

As far as the indemnity and liability issue is concerned, Macattram (2007) in her paper

goes in detail through the articles of the AIPN 2002 model form International Operating

Agreement, in particular Article 46 (A) and (B)36. This provision seems to entails all the elements

Young (2002) identifies (as previously discussed). Indeed, the clause gives a clear definition of

who the indemnitee is, what he is indemnified from, what the liabilities are, etc. It is important to

notice, though, that this clause poses also an apparent limitation, restricting the provision toliabilities which arise out of, result from Joint Operations. As Macattran (2007) underlines, the

rationale of this provision is based on the fact that the role of operator is a non-profit

undertaking performed for the general benefit of the participating interests to the JOA 37.

Although the standardization of the contracts involves mainly companies and not

governments (as standardized government contracts are usually created unilaterally by the

single governments to meet their own needs38), the standardization wave supported by AIPN

has been directed also towards the creation of a global model of host government contract.

Unfortunately, this project never received enough support from the international companies and

from the governments (Martin, Park 2010)39.

35For more information, please visit the website

36Article 46(A) and (B) deals with the indemnification of the Operator and any other Indemnitee (defined so as to

include the Operator and its Affiliates, their respective directors, officers and employees), from loss or liability for all

damages, losses, costs, expenses (including reasonable legal costs, expenses and attorneys fees) and liabilities

which may not be directly related but incident to any claims which arise out of, result from Joint Operations, even

where they are caused in whole or in part by a pre-existing defect or the negligence (sole, joint or concurrent), gross

negligence wilful misconduct, strict liability or other legal fault of Operator or any other of the Indemnitees.

37Macattram (above n.5) p.8


39For an in-depth review on the project, please refer to the Host Government Handbook that the AIPN created,

which represents a very interesting starting point.


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Conclusion

The standardization process gained, in the last years, an increasingly relevant role,

because of the fact that model contracts can lead the parties to more effective risk management

strategies, avoiding mistakes in the clauses, long-lasting negotiations and poor quality

contracts. Nonetheless, it remains critical to draft indemnities and exemption clauses precisely

and with due regard to the particular circumstances of each project40, avoiding inappropriate

use of contracts or their over-modification. Efficient and fair indemnity clauses can be drafted

only when the parties are fully conversant on the risk management schemes and risks

associated41.

However, it is worth mentioning that the standardization framework has suffered from a

severe challenge after the Deepwater Horizon accident, where the operator (BP) attempted toargue that its contractual indemnities did not stand, and that some of the liability should

therefore be shared with the drilling company, (Transocean) and its cementing and mud logging

contractor (Halliburton)42. The clause adopted was a standard clause/global template, awarding

a reciprocal indemnity without limits and without regard to the causes, including for negligence

(sole, joint, active, passive or gross) and without regard for whether the pollution or

contamination is caused in whole or in part by the negligence or fault of Transocean (owner of

Deepwater Horizon)43. BP argued that the wording negligence and fault did not refer to a gross

negligence or strict liability, and that public policy prohibits indemnities for gross negligence andpunitive damages. Judge Carl Barbier accepted BP argument about punitive damages, although

refused the argument about the gross negligence, sentencing that the language of the clause

was not intended to limit such conduct to ordinary negligence44.


41Macattram (above n.5) p.9


43Mouledoux A., Deepwater Horizon: Contractual Indemnity for Gross Negligence or Punitive Damages? (15

February 2012), in re Oil Spill by the Oil Rig Deepwater Horizon, MDL No. 2179 (E.D. La. Jan. 26, 2012), available at

44Ibid.


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As we can see from this example, the wording of indemnity clauses is notoriously

uncertain with respect to their enforceability45and it might sometimes not exclude the risk of a

substantial residual liability with the contractor (Cameron 2012). In the aftermath of Macondo,

contractors and operators have been pushed to review the contractual terms, the indemnity

regime/liabilities and the risk allocation46. It has been witnessed an increase number of proposal

by the operators trying to exclude the gross negligence from the indemnity, with the obvious

resistance of the contractors on the other side47.

Bibliography

Bullock K.W.II, A brief overview of indemnity provisions and allocation of risk in energy

agreements (17 May 2012), Texas Lawyers In-House Counsel Summit, Chamberlain Hrdlicka Attorneys at Law, available at http://www.chamberlainlaw.com/assets/

attachments/Indemnity%20Provisions%20in%20Energy%20Agreements.pdf

Cameron P., Liability for catastrophic risk in the oil and gas industry (2012), Issue 6 IELR.

Gordon G., Paterson J., Oil and Gas law. Current practices and emerging trends (2007),

Dundee University Press.

Hewitt T., Who is to blame? Allocating liability in upstream project contracts (2008), 26 J.

Energy Nat. Resources L. 177.

Macattram G., How can the indemnity clause expand or limit the responsibility for liability of the

parties in international oil and gas contracts? (20 February 2007), CAR (CEPMLP Annual

Review), University of Dundee.

Makarov T., Indemnity in the international oil and gas contracts: key features, drafting and

interpretation (04 June 2009), CAR (CEPMLP Annual Review), University of Dundee.

Martin T.J., Park J.J., Global petroleum industry model contracts revisited: higher, faster,

stronger (2010) 3(1) Journal of World Energy Law & Business.


46Moomjian C.A., Drilling contract historical development and future trends post-Macondo: reflection on a 35 year

industry career (7 March 2012), paper presented at the IADC/SPE Drilling Conference in San Diego, California,

available at

47See Moomjians paper (op. cit. n.46) for an interesting and detailed analysis of the post-Macondo.


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Moomjian C.A., Drilling contract historical development and future trends post-Macondo:

reflection on a 35 year industry career (7 March 2012), paper presented at the IADC/SPE

Drilling Conference in San Diego, California, available at http://www.drillingcontractor.org/wp-

content/uploads/2012/04/Drilling-Contract-Historical-Development-and-Future-Trends-Post-

Macondo.pdf

Mouledoux A., Deepwater Horizon: Contractual Indemnity for Gross Negligence or Punitive

Damages? (15 February 2012), in re Oil Spill by the Oil Rig Deepwater Horizon, MDL No. 2179

(E.D. La. Jan. 26, 2012), available at http://navwaters.com/2012/02/15/deepwater-horizon-

contractual-indemnity-for-gross-negligence-or-punitive-damages/

Perten J.H., Indemnity: A Clause Worth Reading (25 October 2007), Sheehan Phinney Bass

and Green or the Sheehan Phinney Capitol Group, informative paper, available at

http://www.sheehan.com/publications/good-company-newsletter/Indemnity--A-Clause-Worth-

Reading.aspx

Picton-Turbervill G., Jaun R., Efficacy of a contractor's liability cap against third party losses

(January 2007), Commercial Contracts Update, Ref:DTP/4355 Ashurst.

Roberts P., Standard terms for Asia oilfield service contracts (September 2003), PetroMin

publication, Jones Day, Hong Kong.

Sabey D.O., Fingarson J.L., Indemnity and insurance clauses in joint venture, farmout and joint

operating agreements (1970) 8 Alta. L. Rev. 210.

Yeats J.L., Tade J.B., Drafting enforceable indemnification provisions for the oil field (April1997), Second Contract Risk Management Symposium, Strategic Research Insitute, available

at http://www.gordonarata.com/720DE/assets/files/lawarticles/ LANIER3.pdf

Young J., Indemnification clauses in multiple contract transactions (2002), 30 Int'l Bus. Law.

115.

Williams R.J.III, Indemnity agreements in oil and gas operations in Texas (1975-1976) 17 S.

Tex. L.J. 452.

Wilson S., Contractual allocation of risk in upstream oil and gas projects (Spring 2008), Issue

3, Energy Source.


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Websites

Oil&Gas UK The voice of offshore industry, Piper Alpha: Lessons Learnt, 2008, available at

http://www.oilandgasuk.co.uk/cmsfiles/modules/publications/pdfs/HS048.pdf

(visited on 6 April 2013)

BP Deepwater Horizon accident and response, available at

http://www.bp.com/sectiongenericarticle800.do?categoryId=9048918&contentId=7082603

LOGIC http://www.logic-oil.com(visited on 26 March 2013)

LOGIC http://www.logic-oil.com/standard-contracts (visited on 26 March 2013)

LOGIC http://www.logic-oil.com/imhh/general-guidance (visited on 26 March 2013)

LOGIC http://www.logic-oil.com/standard-contracts/documents (visited on 26 March 2013)

AIPN https://www.aipn.org/Profile.aspx (visited on 26 March 2013)

Cases

A Turtle Offshore S.A. v Superior Trading Inc [2008] EWHC 3034

BHP Petroleum Ltd and Others v British Steel plc and Dalmine SpA [1999] 2 Lloyd's Rep 583.

Caledonia North Sea Ltd v London Bridge Engineering Ltd [2002] UKHL 4; [2002] 1 Lloyd's Rep553, HL.

EE Caledonia Ltd v Orbit Valve Co (Court of Appeal) [1995] 1 All ER 174; [1994] 1 WLR 1515;

[1994] 2 Lloyds Rep. 239

Hadley v Baxendale (1854) 9 Ex 341

WesternGeco Ltd v ATP Oil & Gas (UK) Ltd [2006] 2 Lloyd's Rep 535

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