Precautions to be taken in drafting Oil & Gas Industry Contracts - Essay Example

? Precautions to be taken in drafting Oil & Gas Industry Contracts Oil & Gas industry is a unique industry as it involves a high risk aspect of exploitation and exploration , high capital –intensive character of the industry , geographic ambit of operations and assets , environmental issues , up-date technology needs , safeguard issues , downstream brand advertising, size and range of employee base , political predispositions,etc. Oil & Gas industry engrosses the granting many contracts like project feasibility study, construction, supplies, civil and offshore contracts, mainly through subcontracts. If the turnkey contract is implemented, then the contract has the responsibility of defining in a strict, complete and definite manner the works to be covered and risk to be borne in the contract itself. (1). In the oil and gas sector, the definitive goal of any operator is to exploit maximum revenues by efficient and rapid discovery of petroleum and gas resources with no or minimal disruption. Contractual process in Oil and Gas ( hereinafter will be referred as O&G) industry is a lengthy and time-consuming process , fixing the accountability and granting damages to the affected parties is normally considered to be a hectic task given the nature of the industry which is symbolised by subcontracting. (4). To achieve their business goal, operators in O&G industry is well aware that risks in the industry can be administered and controlled when the same has been unequivocally distributed to one or more parties. It is to be noted that risks can be covered by taking appropriate insurance policies, but this involves an additional financial burden to the operators. The easy way to shift the risk in O&G industry is to employ contractors to alter common law approach as a risk management process. (4). LOGIC of UK has published a standard contract (boilerplate contract) through its 2nd Edition, October 2004 for the oil & gas industry in UK. This is a standard contract, and the contract employs English law .However, now, all references to UK needs’ have been withdrawn, and it can be employed on a global basis. For drafting contracts for oil and gas industry , the lawyers will use boilerplate contract like the one designed by Logic .It connotes to any interchangeable ,” one size fits all” provision. While drafting the contract, more significance has to be given to the areas like the notice clauses, the choice of law clauses, the force majeure clauses, the delegation and the assignment provision. These clauses are significant as it will give a road map, informing the parties concerned their relationships and how to administer the contract. (2) Some of the main advantages of the boilerplate contracts are that it contains many clauses either override or restates the common law provisions and is being in use by the relevant companies for long time. It is having drafting efficiency and to costs fewer pounds and takes less time to input the standard clauses into the contract. By incorporating the conditions available in the boilerplate contracts will help to avoid errors. Further, a standard clause is well known to business and legal community, thereby minimising the costs of reassessing and negotiating the provisions, as well as fostering a analogues interpretation. (2) Some critics allege that the poorly outlined boilerplate clauses may result in issues instead of finding a solution while execution of a contract. A poorly drafted contract will no doubt will result in the litigation which is not only time-consuming and also expensive. Thus, there is a need to give more careful attention to each and every boilerplate clauses, including how it is going to be interpreted in the case of future litigation. (2) For the risk allocation, common law provision is followed in O&G contracts and, where there is no specific contract and the general law pertaining to tort, contract/delict will be applicable. With the operative word being ‘negligence”, the liability stems from the fault or infringement of duty in such cases. Mitigation of loss is carried out by awarding a compensation which is dependent on the frustration of contract or remoteness of damage. (5). Now, O&G industry follows the risk allocation through inserting indemnity clauses in contracts. An indemnity is a contract where in the event of any loss, damage, injury or harm, one party promises the other to indemnify the losses in case of any damage or harm to the sufferer with certain exceptions. (6). O&G industry faces both predictable and unpredictable risks immediately following their realisation of hydrocarbons. Nonetheless, investments in O& G industries are capital intensive thereby making these perils more than just transitory of interest. Indemnity clause plays a pivotal role in mitigating the risk in O& G industry contracts as several parties are associated with it, and it make judicial sense to share the risk to those party who can better handle the same instead of fault based sharing of risk.(11). In Canada Steamship Lines Ltd v R case, Lord Morton laid down the typical three- part check about the indemnity clause in a contract. In case , if a clause consists wording, which obviously exempts a person in whose errand ,it is drafted from the outcome of the negligence due to acts of his employees , then proper effect should be accorded to such a provision. Where there is no obvious suggestion to negligence, a court should interpret whether the phrases in their ordinary meaning are wide adequate to cover the negligence of his own employees. Where the phrases employed are broad enough for the above mentioned objectives , then , the court should regard whether there is availability of another head of damage on which to foot the claim apart from a claim under negligence.(7). The recent case WesternGeco Ltd v. ATP Oil and Gas (UK) Ltd has corroborated the necessitate for drafting as regards to indemnity clauses in oil and gas industry as to evaluate the objectives of the parties when construing the contract, the courts would look at the materials and facts before them. In this case, the Contractor was made accountable for any kind of harm caused to third parties due to the negligence of the contractor vide clause 19. In a separately negotiated clause 19.8, there was a stipulation that the company should indemnify the contractor in the event any accountability under the contract that surpassed the total amount of payments that the contractor would receive under the contract. During the execution of the work, the contractor had spoiled the property of another contractor namely Total E & P UK Plc. However, the damage claimed by the Total surpassed what the contractor would receive from the company. Hence, the contractor cited the clause 19.8 and demanded that the company should indemnify him as the amount claimed by Total was in excess what it would receive from the company. The court interpreted at the construction of the contract as a whole in establishing the real meaning of the term. Aikens J, by looking at the contract, held that there was an obvious differentiation in the contract between the accountability between the parties to the contract and with that of third parties. Aikens J interpreted the meaning of “accountability under this contract “to connote only liability as between the parties to the contract and not to the liability to the third party namely “Total” and hence, the excess over the contract payments from the company cannot be claimed by the contract by accessing the clause 19.8. This case law ingeminates the necessity, while drafting a contract, irrespective of the fact whether it is a boilerplate or not, to interpret the contract as a whole. (3). It is to be noted the same view was also expressed in the Bank of Credit and Commerce International SA (in liq) v. Ali by Lord Bingham.(12). The Caledonia North Sea Ltd v London Bridge Engineering Ltd relates to fire and later explosion in the Piper Alpha oil platform. Many employees on the board were killed and there was far-reaching damage. As per terms of the contract, in case of the death of the employees, the compensation paid by the claimants to the defendant’s employee’s legal heirs would be indemnified by the defendants. The indemnity clause also specifies the following: the payment of damages by the contractor to the defendant would be notwithstanding the fact that the contractors were not proved to be negligent by themselves; the damages were already paid to the operator by their insurers ; the damages so paid might have surpassed the quantum of damages normally allowable under Scots law. After paying the compensation, the insurers exercised their privilege under the subrogation that facilitated them to recover any indemnities that their insured had been authorised to either under the tort or contract law. The insurer was succeeded to claim the amount from the defendant under the indemnity clause of the contract. In this case, the careful wording of indemnity clause has helped the claimant to recover the damages paid by the insurer to the injured from the defendants. (8). In “EE Caledonia Ltd v. Orbit Valve Co”, an engineer of the defendant was killed while he was at duty in the oil rig. The family members of the Engineer who was dead made a claim against the claimant, and their claim was settled out of court by the defendant as it consented that defendant was responsible both under the infringement of safety and health rules and also under negligence. Then, the Caledonia filed a claim against the defendant under one of the contract clauses which was reproduced as follows: “Each party to the contract shall hereby undertake to indemnify against the other against and from any liability happening by the reason of the death of an employee while on his duty.” However, Caledonia was not successful in banking upon the indemnity clause though it had covered negligence in the contract to be indemnified, but it not covered its obligation under safety and health rules. Had the contract included the wording both negligence and under health and safety regulations, Caledonia would have succeeded to make a claim against the subcontractor. This shows how one should be meticulous to draft indemnity clause covering all kinds of risk in O&G industry. (9). Knock-for-Knock Schemes in O&G contracts Knock-for-Knock schemes are usually found in O& G contracts where the offshore industry has acknowledged the liabilities on “knock-for-Knock” basis. The above scheme is designed to protect the interest of each party in the O&G contract from damage or injury happening to its assets and own employees. This is normally accomplished by a mixture of both the indemnity clauses and exclusion clauses. The perceptive underlying the distribution of risk is that each party to the contract will obtain insurance to recoup the losses that the party may incur. This is mainly intended to shun legal clashes to establish which party was accountable for the loss creating incident. (10). Allocation of Risk by Employing UK LOGIC By employing the UK LOGIC General form, one can allocate the risk between various stakeholders in an O&G Contract. The drafting shall include the provision for damage or loss to the contract works preceding to devolve the works to the owner which shall have to be assumed by the contractor However, the contractor will be exempted from the damages or harm if the loss is caused due to omission or any negligent act by the operator or due to nuclear risk or due to war risks. (13). Through reciprocal or mutual indemnity clauses, the accountability for any damage to its own property or to any harm to their employees will be borne by each party, and this is mainly achieved through inserting Knock-for-Knock clauses. [14] As regards to liability to third parties , the contract should have a provision for mutual indemnity thereby each party holds the other party safe from claims from third party for either damage to property or for personal injury, which has occurred due to that party’s own infringement of duty or own negligence. This indemnity will establish a commitment on the appropriate party to cover up the residual risk with insurance. By making an appropriate provision in the contract, the company can restrict the third-party liability claim. It can be stated that if the damage or loss has arisen with in 500 metre radius of any vessel or barge, then operator can be held liable else not. Likewise, a knock-for-knock provision shall have to be inserted in the contract for any harm or damage arising due to pollution. Appropriate provision in the contract shall have to be made as regards to removal of wreckage. Usually, the contractor will borne the risk of removal of any debris arising from the performance of the contract work. It is better to draft suitable provision about who will be held responsible for removal of debris either the contractor or the operator by explaining the situations unambiguously in the contract. (15). There may be understanding between the operator and the contractor to limit or cap the overall liability of the contractor for damage to any permanent work. By inserting an appropriate clause in the contract , such capping of contractor’s liability can be made but there should be wording in the contract to exclude the limit on the indemnity liability agreed to be borne by the contractor or as regards to the insurance obligations to be borne by the contractor. Proper clause in the contract should be incorporated as regards to insurance coverage by the operator through the “Construction All Risks (CAR)” policy and this would also cover the contractors, affiliates, subcontractors as supplementary insured. The insurance policy should be endorsed to necessitate the insurers to relinquish any privileges of recourse, which includes any subrogation against same persons. There should be clear provision in the contract that any third-party liability and employee] s liability that may happen during the operations shall be covered by the contractor himself. (15). There should be a provision in the contract thereby excluding from the “knock-for-knock” losses engendered due to wilful misconduct or gross negligence. However, in Tradigrain S.A v Intertek, it was held by the Court of Appeals that there exists no difference between simple and gross negligence. In Armitage v Nurse, it was held that there seems to be no vast difference between simple and gross negligence, and the parties can keep out the accountability for gross negligence. (15). As regards to wilful misconduct, the offshore contract may contain a provision that the particular wilful misconduct can happen at the top management level. Proper definition in the contract about the wilful misconduct should be given by covering what is misconduct –viz. conscious, intentional or reckless in spite of any contractual clauses of prudent and good O&G industry management practice. (15). To sum-up, while drafting the contract, more significance has to be given to the areas like the notice clauses, the choice of law clauses, the force majeure clauses, the delegation and the assignment provision. It is advised to use LOGIC standard contract form as it is having drafting efficiency and to costs fewer pounds and takes less time to input the standard clauses into the contract. By incorporating the conditions available in the boilerplate contracts will help to avoid errors. Further, a standard clause is well known to business and legal community, thereby minimising the costs of reassessing and negotiating the provisions, as well as fostering an analogues’ interpretation. The easy way to shift the risk in O&G industry is to employ contractors to alter common law approach as a risk management process. This can be done through insertion of indemnity clause, which plays a pivotal role in mitigating the risk in O& G industry contracts as several parties are associated with it and it make judicial sense to share the risk to those parties who can better handle the same instead of fault based sharing of risk. The recent case WesternGeco Ltd v. ATP Oil and Gas (UK) Ltd has corroborated the necessitate for drafting as regards to indemnity clauses in oil and gas industry . The above case law ingeminates the necessity, while drafting a contract, irrespective of the fact, whether it is a boilerplate or not, to interpret the contract as a whole. In the Caledonia North Sea Ltd v London Bridge Engineering Ltd, the careful wording of indemnity clause has helped the claimant to recover the damages paid by the insurer to the injured from the defendants. In “EE Caledonia Ltd v. Orbit Valve Co”, no adequate care was shown to add the liability under the health and safety regulations. Had it been added, Caledonia would have succeeded to make a claim against the subcontractor. This shows how one should be meticulous to draft indemnity clause covering all kinds of risk in O&G industry. It is advisable to add knock-for-knock clauses in O&G contracts, and this can be carried out normally through the mixture of both the indemnity clauses and exclusion clauses. Further, provisions like gross negligence, wilful misconduct, damages due to non-adherence of pollution norms have to be incorporated so that it remains a foolproof contract without any loopholes. References 1 Dennis Babusiaux. Oil and gas exploration and production: reserves, costs, contracts. Paris: Technip; 2004. 2. Tina L. Stark. Negotiating and Drafting Contract Boilerplate. New York: ALM; 2003.p. 6 3. Robert Palmer. United Kingdom: Liability and Indemnity Clauses: The Need for Careful Drafting. [Internet] 2006 [updated 2006 December 18; cited 2012 March 27]. Available from: http://www.mondaq.com/article.asp?articleid=45070 4. Securing Oil and Natural Gas Infrastructures in the New Economy. New York: Diane Publishing Company; 2001. p.63. 5. Victor P Goldberg. Readings in the Economics of Contract Law. Cambridge: Cambridge University Press; 1989. p.86. 6. Frank Adoranti. The Manager’s Guide to Understanding Indemnity Clauses. New York: Global Publishing; 2006. p.5. 7. By H.G.Beale, W.D Bishop, M.P.Furmston. Contract: Cases and Materials. 5th edition, Oxford: Oxford University Press; 2008. p.1016. 8. Julia Graham and David Kaye. A Risk Management Approach to Business Continuity. Connecticut: Rothstein Association Inc; 2006. p.259. 9. Gruditta Cordero-Moss. Boiler Plate Clauses, international commercial contracts and the Applicable law. Cambridge: Cambridge University Press; 2011. p.168. 10. Peter Roberts. Gas Sales and Gas Transportation Agreements. London: Sweet& Maxwell; 2008. p.xxxi. 11. Joseph A.Huse. Understanding and Negotiating Turnkey and EPC Contracts. London: Sweet& Maxwell; 2002. P.489. 12. Catherine Mitchell. Interpretation of Contracts.Abingdon: Routledge; 2007. p.21. 13. Philip Loots & Donald Charrett. Practical Guide to Engineering and Construction Contracts. Sydney: CCH Publications; 2009.p.43. 14. Sean O’ Sullivan, Exclusion Clauses in Offshore Contracts. [Internet] 2010. [updated 2010 January 10; cited 2012 March 28]. Available from :< www.shippinglbc.com/content/uploads/.../offshore_contracts_1.pdf>. 15. Elizabeth Blackburn QC. Allocation of Risk and Exclusion in Offshore Marine Construction Contracts. . [Internet] 2010. [updated 2010 January 10; cited 2012 March 28]. Available from :< www.shippinglbc.com/content/uploads/.../offshore_contracts_1.pdf>. Read More