Oil and Gas Contract Law.docx

Contractual Risk in Upstream Oil and Gas Projects – An assessment of its concern to operators and contractors as demonstrated during catastrophic offshore incidents where issues of liabilities and indemnities may give rise to disputes

BSM578 – Oil and Gas Contract Law – Dr Leon Moller
Student: Kylie Sullivan (Robert Gordon 1217187) (CGSB 15645933)
Word Count: 2,776













Executive Summary
The purpose of this report is to explore the definition of and concerns relating to contractual risk within the Oil and Gas industry – an industry uniquely exposed to a number of inherent operational risks such as: blowouts, oil spills, employee and contractor safety, environmental damage and loss of large capital investments.
Extensive and complex litigation can follow, subsequent to a catastrophic event in the Oil and Gas industry, as demonstrated with reference to the Piper Alpha and Deepwater Horizon incidents in the United Kingdom and United States respectively.
Contractual mechanisms are available to help manage and allocate risk appropriately amongst contracting parties, to help limit potential litigation, but also to reduce duplicate administrative and insurance costs.
Examples of contractual mechanisms include: simple indemnification, mutual indemnification (or 'knock for knock') and limitation of liability.
Mutual indemnification clauses have largely been incorporated into standard industry contracts.
Contractual risk can prevail, however, if these clauses are not worded clearly and as intended to be interpreted by the courts.
When worded specifically, such clauses have been found to be largely effective, when tested in litigation following catastrophic events, such as the Piper Alpha and Deepwater Horizon incidents as well as smaller cases such as Lanasse v. Travelers Insurance Company California and A Turtle & Others v. Superior Trading Inc.
Such clauses were, however, found to be ineffective in shielding contractors Transocean and Halliburton with regard to fines imposed under Clean Water Act (CWA), subsequent to the Deepwater Horizon Incident.

Table of Contents

1.0 Introduction

2.0 Contractual Risk in Upstream Oil and Gas Projects

3.0 Effectiveness of Contractual Mechanisms for Management of
Contractual Risk

4.0 Conclusion

5.0 References










Introduction
Contractual risk in upstream oil and gas projects is a major concern to operators and contractors as demonstrated subsequent to catastrophic offshore incidents where issues of liabilities and indemnities often give rise to disputes. [1]
Contractual Risk in Upstream Oil and Gas Projects
Contractual risk relates to the possibility of loss from a party rescinding on a contract and/or from failure of performance agreed within a contract. [2]
Catastrophe is defined as 'a sudden and widespread disaster; misfortune, mishap or failure.' [3]
Within the Oil and Gas industry, contractual risk is of particular concern because consequences of default and/or non-performance can directly or indirectly lead to increased operational risks already inherent within the industry, such as; the risk of spills and blowouts, destruction of ecosystems, displacement of local communities, loss of life amongst employees and/or contractors and the loss of large capital investments, to name a few - all of which could be considered a catastrophic event to various stakeholders.
Additional risks such as geological challenges, political instability and price volatility, further exacerbate the complex environment operators and contractors alike navigate in order to operate effectively and efficiently in the oil and gas industry. [4]
It is largely recognized that a key challenge and risk unique to the oil and gas industry is the number of contractors from different service companies, operating and interacting with one another on offshore platforms.
The interconnectedness between operational risk and contractual risk becomes even more apparent when the relationship amongst contractors is analyzed and often found to be non-contractual, while they work together in this uniquely high risk environment.
This observation was echoed by the House of Lords with regard to the Piper Alpha incident, where in 1988 on the United Kingdom Continental Shelf (UKCS), an offshore platform gas leak resulted in an explosion and toxic fumes which killed 167 workers, injured many more and destroyed the platform. [5]

Concluding comments to appeals brought before the House of Lords for determination of liability between the operator and contractor highlighted the inherent risk within the oil and gas industry, drawing specific attention the number of contractors working on the offshore platform at the time of the Piper Alpha incident.
Lord McKay conveyed in Caledonia Northsea vs London Bridge:
"it is plain beyond doubt that an Oil Platform is a dangerous place unless careful and proper safety precautions are taken. The platform holds contained under pressure large quantities of gas and liquid hydrocarbon material which is explosive, very flammable and most dangerous if control of it is lost. [The president and managing director of the operator] described the operations as being 'potentially hazardous'. This was well recognised before the accident." [6]
Lord Bingham highlighted in Caledonia Northsea vs British Communication Plc & Others:
"…the Piper Alpha disaster led to claims against 24 different contractors. Of those on board the platform who were killed, 134 were employed by contractors and 31 by the operator. Of those who survived, 55 were employed by contractors and 6 by the operator." [7]
The Piper Alpha incident illustrates how contractual risk increases in conjunction with the number of contractors working on an offshore platform.
Contrastingly Lanasse v. Travelers Insurance Company California involved only one contractor, yet also amounted to extensive litigation after an employee of an offshore contractor was pinned and almost crushed to death as a result of negligence on the part of the Operator's crane hand.
Chief Judge John R. Brown commented:
"This is another one of those seagoing donnybrooks in which all generously claim that someone else must bear the burden of amounts paid to a seaman for injuries sustained during a typical offshore drilling operation in Louisiana shelf waters." [8]
There is therefore a need, particularly within the Oil and Gas industry, to effectively manage and allocate risk appropriately amongst all parties, to help avoid extensive litigation in the event of a catastrophe, but also to help reduce duplicate administration and insurance costs. In knowing upfront and agreeing to their potential exposure to liability, a party can then make a determination as to its own appetite for either assuming the risk or choosing to insure against it.
Effectiveness of Contractual Mechanisms for Management of Contractual Risk
Within a common law jurisdiction, consideration as to the allocation of risk and liability would generally include breach of care and steps taken by the non-breaching party to mitigate its loss and compensatory damages. Largely, it would be held that the party in breach of contract or duty of care is under obligation to make good any losses suffered by the non-breaching party. [9]
Contractual mechanisms are, however, available to redirect this line of consideration and conclusion and in effect dictate an alternate allocation of risk and liability, agreed upfront amongst contracting parties.
Indemnity clauses are an example of such a contractual mechanism, available to facilitate the management of contractual risk.
A simple indemnification clause is where one party (i.e. the operator) undertakes responsibility to indemnify another party (i.e. the contractor) should a loss be suffered during their contractual relationship. The Operator effectively agrees to absorb the loss (or might choose to insure against it) [10], for breach of contract or care, even if the contractor is at fault. [11]
Given this diversion from common law practices and assumptions, it could be argued that contractual risk in upstream oil and gas projects can often be embedded in the actual wording of contract clauses and provisions intended to mitigate it, because unless an indemnity clause is clearly worded and without capacity for misinterpretation, the courts could revert to common law and lay liability on the breaching party.

It is therefore important at the time of drafting agreements that operators and contractors alike not only consider how they intend indemnity provisions, but also consider how they might ultimately be interpreted by the courts.
This notion was also evidenced in Lanasse v. Travelers Insurance Company California Company in comments made by Chief Judge John R. Brown:
"Aside from the usual complexities arising from impleaders, cross-claims, direct actions against underwriters and demands for indemnity, [this] is also a case in which the party that wrote the contract claims it does not mean what it says and means what it does not say." [8]
With regard to the latter point, the operator had argued an indemnity provision within a time charter insulated it from liability claims:
"directly or indirectly connected with the possession, management, navigation, and operation of the vessel". [8]
This wording was found to be too vague and the indemnity provision was ultimately ineffective in insulating the operator from its liability in relation to the incident.
The importance of clarity and specificity when constructing up front, contractual mechanisms such as indemnities and limitations for dealing with the distribution of liability, was also emphasized in Batson-Cook Company v. Industrial Steel Erectors, where Judge R. Brown commented:
"…the purpose to impose this extraordinary liability….must be spelled out in unmistakable terms. It cannot come from reading into the general words used the fullest meaning which lexicography would permit." [12]
Judge Brown further explained in Lanasse v. Travelers Insurance Company California Company that the interpreted purpose of such clauses cannot be based on inferences of what a party claims it originally intended to mean after the fact, but effectively did not relay in express terms at the time of constructing the contract. [8]
Commonly used across the oil and gas industry are mutual indemnifications, also known as 'mutual hold harmless' (MHH) or 'knock for knock' indemnity clauses, where both parties indemnify each other. The broad aim of these clauses is to achieve an allocation of liability acceptable to all contracting parties in addition to achieving efficiencies through reduced legal, administrative and overlapping insurances costs. [13]
The evolving and wide use of mutual indemnification clauses within the oil and gas industry is evidenced by their adoption and incorporation into standard industry contracts such as United Kingdom's Leading Oil and Gas Competitive (LOGIC) model contracts [14] and US International Association of Drilling (IADC) standard contracts. [15]
LOGIC, a not-for-profit subsidiary of Oil & Gas UK, promotes efficient working practices in the UKCS by providing 10 Standard Contracts for use. It was originally established in the 1990's under Cost Reduction in New Era (CRINE) with the objectives of simplifying procedures and reducing costs by 30% within the industry. [14]
A model contract, however, is just that – a model and a starting point. It is not necessary fit for all purposes and should be tailored to the specific intentions of each party with recognition given to the uniqueness of each arrangement. As previously mentioned contractual risk can extend to the actual wording of contractual provisions intended to mitigate it and care should be taken by all parties to fully consider how such clauses might be interpreted, especially in the event of a catastrophic incident. [16]
This was illustrated in A Turtle & Others v. Superior Trading Inc. where a tugboat contractor was towing a rig and ran out of fuel, resulting in the loss of the rig which was of catastrophic consequence to the rig owner.

Despite obvious negligence, the contractor was not held liable for the loss on account of clause 18.2 of their contract, which indemnified the tugboat contractor:
"…whether or not…due to breach of contract, negligence or any fault on the part of the Tugowner.." [17]
Limitation of liability or a 'liability cap' is another contractual mechanism commonly used in the Oil and Gas industry. Unlike indemnities which look to shift liability, a liability cap looks to limitation of a party by reference to a total sum of money payable, rather than by reference to a particular species of loss. [1]
Limitation of liability also exists within legal frameworks, for example, In the United States the Oil Pollution Act of 1990 (OPA) seeks damages in response to oil spills with a liability cap of $75 million plus removal costs. The damages sought under this Act are intended to cover loss of natural resources, property damage, removal and clean-up costs, loss of profits/ earning capacity, loss of government revenue and/or increased public services. [13]
In addition to the OPA, also existent in the United States is the Clean Water Act (CWA) as amended in 1972 under which fines can be apportioned in line with the degree of negligence exhibited by offenders, calculated as a function of the number of barrels of oil spilled. [18]
Prior to the Macondo incident, allocation of liability under standard industry contracts including standard indemnification provisions had largely been un-contested and held to be enforceable by the courts across a number of jurisdictions in which oil and gas operations are prevalent. [13]
This was the challenge British Petroleum (BP) faced in litigation with a number of its contractors, following the Deepwater Horizon 2010 incident in the Gulf of Mexico where an uncontrollable blow out and subsequent explosion in the Gulf of Mexico killed 11 workers, injured many more, destroyed the rig and led to the largest oil spill in U.S. history with nearly 5 million barrels of oil released into the Gulf of Mexico. [19]
BP's stock price dropped by 55% within the two months following the incident. [20]
At the time of the blowout, BP was the operator on the Macondo Project. Transocean provided the drilling rig (Deepwater Horizon) and Halliburton the cement & mud logging services.
In BP's contracts with Transocean and Halliburton, standard industry reciprocal indemnity language - common across the international petroleum industry - was used and the contracts were 'reflective of a global template'. [13]

The standard contract language used by BP and Transocean gave rise to agreement to effectively indemnify each other:
"…without limit and without regard to the cause or causes" [including negligence] whether such negligence be sole, joint or concurrent, active, passive or gross." [21]
Given the extremity of the Deepwater Horizon catastrophe and in an effort to mitigate its own liability to subsequent damages and penalties, BP argued that the agreed contractual indemnities in this situation should not hold and instead, liability should be shared between itself as Operator and Transocean and Halliburton as Contractors.
The effectiveness of the standard indemnity clauses utilized by BP and Transocean was ultimately tested in the Federal US Court in New Orleans in January 2012.

In BP PLC and others v. Transocean Offshore Deepwater Drilling and others Judge Barbier held that Transocean was not responsible for compensatory damage claims raised by third parties, irrespective of any negligence on behalf of Transocean and that BP in turn must indemnify Transocean for some claims relating to the oil spill. [22]
Judge Barbier did find, however, that the indemnity clause did not extend to punitive damages nor civil penalties imposed by the US Government under the Clean Water Act [23] because in doing so would circumvent the intended purpose of such repercussions: to punish and deter similar behaviour in the future. [13]
A similar conclusion was reached with respect to Halliburton with Judge Barbier again firmly rejecting the notion that in the event of a catastrophic an agreed indemnification clause should be overlooked.

Judge Barbier found no ambiguity in the wording or interpretation of the clause and as part of his reasoning pointed out that BP was of size and experience to know and understand case law and was therefore positioned to have argued for the exclusion of gross negligence from any of its indemnity provisions, should it have wished to do so. [13]
In the case of BP v Deepwater Horizon, the Drilling Contract clearly articulated mutual hold harmless indemnification clauses with respect to both personal injury and death (Articles 21.1 and 21.2) as well as pollution (articles 24.1 and 24.2) without regard to negligence.
It could be argued that these indemnification clauses were effective in protecting contractors Transocean and Halliburton from compensatory damage claims, ultimately borne by BP.
Alternatively, it could be argued that the indemnification clauses were ineffective in protecting contractors Transocean and Halliburton against punitive and civil penalties. Prior to Macondo, it had largely been accepted that regulators would target the Operator for such damages. [13]
From the perspective of BP, it could be argued that the indemnification clauses were ineffective in limiting its exposure to compensatory damage claims, given that it was held solely responsible on account of the finding of 'gross negligence'.
Somewhat similar to Lanasse v. Travelers Insurance Company California Company, in arguing for shared liability after the fact, BP demonstrated somewhat of a position shift. At the time of constructing the contract BP could have negotiated for exclusion of reference to gross negligence within the indemnification clause, yet they did not pursue it.

With regard to the Piper Alpha catastrophic incident, Operator Caledonia North Sea Ltd, its co-venturers and insurers settled fatal accident and personal injury claims within a number of months following the catastrophic incident.
Caledonia subsequently went on to spend the next three and a half years in proceedings against the 24 contractors concerned who had employed 189 of the workers killed or injured.
The contract in this case was not standard and the indemnity clause required the contractor to indemnity the operator in respect of:
"Injury to or death of persons employed by…the contractor…irrespective of any contributory negligence, whether active or passive, of the party to be indemnified, unless such injury, death, damage, loss or destruction was caused by the sole negligence or willful misconduct of the party which would otherwise be indemnified".
A key focus of the contractors' arguments was that they were not liable to their employees and that their liability to the operator was discharged at the time the operator's insurers settled fatal accident and personal injury claims.
In their judgment, the Law Lords stated the indemnity provisions mentioned nothing about the contractors having to be liable to their employees nor about the contractor having to have insurance and the contractors were held primarily liable. [6]
The indemnification clause in this instance, was effective in indemnifying the operator with respect to the injury and death of contractor employees.
Conclusion
Contractual risk emerges in the absence of, or insufficiently worded indemnity or limited liability clauses within agreements and is of particular concern to operators and contractors within the oil and gas industry, given its unique exposure to catastrophic offshore incidents.
When worded succinctly, such clauses have been found to be largely effective, as evidenced in litigation following the Piper Alpha and Deepwater Horizon incidents.
However, with respect to Government legislation such as the Clean Water Act such clauses have been found to be ineffective in shielding contractors from punitive damages and civil penalties, as evidenced in litigation following the Deepwater Horizon incident.



References
1. Moller, L., Contractual Risk Management, in Robert Gordon University. 2016.

2. Black's Law Dictionary 2nd Edition. Available from: http://thelawdictionary.org/contract-risk/.

3. Dictionary.com. 2016; Available from: http://www.dictionary.com/browse/catastrophe.

4. Revenue Watch; "Covering Oil: a Reporter's Guide to Energy and Development". OEGL 3, 2005.

5. Piper Alpha oil rig ablaze. BBC News 6 April 1988; Available from: http://news.bbc.co.uk/onthisday/hi/dates/stories/july/6/newsid_3017000/3017294.stm.

6. in Caledonia North Sea Limited v London Bridge Engineering Limited and Others February 2002, UK House of Lords: Lords Bingham, Mackay, Nicholls, Hoffmann and Scott.

7. Caledonia North Sea Limited v. British Telecommunications Plc (Scotland) and Others, in 2002 UKHL 4 2002.

8. Lanasse v. Travelers Insurance Company California Company 450 F.2d 580. 1971, United States Court of Appeals, Fifth Circuit.

9. Gordon, G., "Risk Allocation in the Oil and Gas Contracts" in Gordon and Paterson (ed): "Oil and Gas Law: Current Practice and Emerging Trends". Vol. Chapter 14. 2011.

10. Hewitt, T., Who is to Blame? Allocating Liablity in Upstream Project Contracts. Journal of Energy & Natural Resources Law, 2008. 26 No 2: p. 177.

11. Wang, A. Indemnity Clauses: Understanding the Basics. 2016; Available from: http://www.shakelaw.com/blog/indemnity-clauses-understanding-basics/.

12. Batson-Cook Company v. Industrial Steel Erectors 257 F. 2d 410. 1958.

13. Cameron, P.D., Liability for Catastrophic Risk in the Oil and Gas industry. OEGL, 2013. 2.

14. LOGIC - Governance for Standard Industry Solutions. 2016; Available from: http://www.logic-oil.com/.
15. IADC International Daywork Drilling Contract - Offshore. 2016; Available from: https://iadc.ebiz.uapps.net/personifyebusiness/OnlineStore/ProductListing/tabid/56/Category/CONTRACTS/Default.aspx.

16. Abbagnara, F.V. A critical overview on the CRINE/LOGIC contracts within the UK oil and gas industry. Globe Business Media Group, 2014.

17. A Turtle Offshore SA Assuranceforeningen Gard-Gjensidig v Superior Trading Inc, in [2008] EWHC 3034 (Admlty). 2008, Queen's Bench Division.

18. Deepwater Horizon litigation. 2016; Available from: https://en.wikipedia.org/wiki/Deepwater_Horizon_litigation.

19. Spill, U.S.N.C.o.t.B.D.H.O., O. Drilling, and N.C.B.P.D.H.O. Spill, Deep Water: The Gulf Oil Disaster and the Future of Offshore Drilling. 2011, Perseus Distribution Digital.

20. Zolkos, R. Definition of catastrophe key to risk management: RIMS Canada speaker. 2011.

21. Drilling Contract No. 980249 between Vastar Resources Inc., predecessor in interest to BP America Production Company ("BP") and R&B Falcon Drilling Company ("R&B") for RBS-8D (now known as the Deepwater Horizon). December 1998; Available from: https://www.sec.gov/Archives/edgar/data/1451505/000145150510000069/exhibit10_1.pdf.

22. in BP v. Transocean, Case 2: 10-md-02179-CJB-SS Document 5446 Filed 01/26/12.

23. Clean Water Act. 1972; Available from: https://www.epa.gov/laws-regulations/history-clean-water-act.