Liabilities and Indemnities in Oil & Gas contract law.
Background: At law if you cause injury to someone or damage their property you will be liable to them to the extent it was caused by your negligence or breach of a statutory duty (“Legal Position”) e.g. if you bump into your neighbour’s car whilst parking due to not paying attention then you will be liable for the damage caused to their car. The Legal Position is fair in that the party pays for their own mistakes.
Industry Position: Typically, in the oil industry the parties to a contract agree a reciprocal arrangement to apportion liability for specific losses (e.g. injury to personnel, damage to property), with each absorbing their own (and their groups) losses regardless of the Legal Position. This arrangement is commonly referred to as “knock for knock”, which consists of a (i) hold harmless and an (ii) indemnity.
Here is a simplified example to illustrate the purpose of the (i) indemnity and (ii) hold harmless mechanisms to give effect to the knock for knock:
Example: A service company (“Contractor”) has a contract with oil company (“Client”) to provide offshore platform cleaning services (“Contract”). An employee of Contractor accidentally injures one of Client’s employees (“Injured Person”) and causes damage to the platform whilst performing cleaning services under the Contract.
The purpose of the indemnity in the Example:
The Injured Person is not bound by the knock for knock arrangement as he is a third party. The Legal Position rights of the Injured Person allows him to sue the Contractor for damages in respect of his injury.
The indemnity, however is the mechanism between the Client and the Contractor to ensure the knock for knock will apply. This is played out as follows: (i) the Injured Person sues Contractor, (ii) the court finds Contractor at fault and orders Contractor to pay damages to the Injured Person, (iii) Contractor pays the damages, (iv) Contractor then requests Client under the Contract to honour its indemnity by reimbursing Contractor an amount equal to the damages it had to pay to the Injured Person.
The purpose of the hold harmless in the Example:
The hold harmless mechanism is effectively a contractual undertaking by one contracting party to the other party to waive their Legal Position rights. In the example given the Client is the only party who could sue in respect of damage to their platform. The hold harmless agreement is their undertaking not to sue Contractor in respect of that damage. The hold harmless ensures there is no court action taken by Client against the Contractor
Reasons for the Industry Position: There are good reasons for adopting this approach:
- The industry is conducted in a dangerous environment amplifying the risk of incidents occurring hence it was seen as necessary to ensure contractors would agree to work in such an environment;
- Each contracting party knows the value of its own assets and is therefore best placed to determine (in light of the knock for knock arrangements) the type and level of insurance coverage it needs (and prevents “double-insuring”, reducing overall costs of the industry);
- It avoids disputes between the contracting parties (to establish and enforce the Legal Position) thereby avoiding lengthy and costly adversarial proceedings; and
- It provides the parties to the contract with some certainty around financial risk exposure.
- Despite the industry’s adoption of the knock for knock regime there are many clients who deviate from this and seek to pass on unrealistic and unacceptable liabilities to their contractors/subcontractors.
- There have been many cases challenging indemnity wording on the basis of drafting ambiguities. As these are complex contractual provisions with unique and particular wording requirements, it is imperative that you have an experienced contracts advisor/ oil & gas lawyer review and draft them.
- Determine whether the indemnities are relevant to and sufficient for the scope of work you are performing e.g. if your client requires you to work on his drilling contractor’s rig ensure you have an indemnity from your client to cover this (unless you know the Industry Mutual Hold Harmless would apply and which is only applicable to offshore UK).
- Ensure you have identified any gaps in the knock for knock arrangements which give you exposure and consider how best you can manage that risk including whether you carry any insurance to cover that exposure.
- Try to follow the LOGIC industry standards where possible (i.e. UK specific) as these have been drafted and vetted by relevant professionals.
- Involve your insurance broker where necessary to ensure you have appropriate insurances in place including your ability to comply with the contractual requirements regarding the L&I and insurance provisions (which are closely linked).