Arbitration Provisions For International Oil And Gas Agreements - Research Paper Example

Arbitration Provisions For International Oil And Gas Agreements Abstract The purpose of this essay is to concentrate on the making of mutual hold harmless provisions effective. For this, the paper focuses on the oil and gas agreements around the world, particularly in UK. Initially, the paper discusses conflicts of interests in the oil and gas agreements and relates them to the structure of the agreements and the duties of the operator. Next the paper analyzes certain cases and justifies the successes of some of them. Discussing the cases in detail, the paper attempts to relate them to the assessment of the topic. The first case that has been discussed is about the Piper Alpha disaster in 1988. The second is about the same incident but the approach of the case is different from the first one. The aim of discussing the two is to show how the mutual hold harmless provisions have been made effective by applying the indemnity clauses to various scenarios. The third that is the BHP Petroleum Ltd and Others v British Steel plc and Dalmine SpA aims to emphasize the importance of the distinguishing of direct and indirect losses. Introduction The oil and gas industry is complex, hazardous and capital intensive and all these features make it different from other industries1. There are various different technologies that are involved in the industry that may range from seismic shoot up to drilling and then to the refining of the final product. Since there are so many processes that have to take place, there are huge amounts of costs and profits involved. The different nature of the oil industry then entails an approach that is different from other industries. As mentioned before, the oil and gas industry has many risks involved in it. The higher levels of risk involved then requires the “adjustment of contractual risk allocation matrix where indemnity is the main key element2 ” This means that the contractual agreements that pertain to the oil and gas industry do not accept the standard notion of risk allocation i.e. they deviate from the view that the one who can hold the risks more effectively should be asked to pay for the expenses etc. In fact in oil and gas agreements, a settlement usually arises with the understanding that one party has to pay for the other’s expenses, costs and claims. This is what the hold harmless clause means. The phenomenon of ‘watching your own side’ is very common in the oil and gas industry because of the presence of the conflicts of interest. The oil and gas industry comprises of many contractors, operators and employees. There are numerous offshore scenarios and so the risk that may be associated to each party may be uneven. Also, the work processes are very labour intensive and there is a great chance of injury. Further, it is often very difficult to put the blame on the different parties because of the hazardous nature of the industry. As a result, owners and participants in the oil and gas sector industry are more likely to enter into agreements that are ‘hold harmless.’ There are many different structures that are followed in mutual hold harmless agreements yet one of the most important one is the structure followed in a Joint Operating Agreement. When more than one company owns interest in a particular area, an agreement like JOA works for all the parties involved. The JOA is responsible for the conducting of the operation hence leading to the stipulation of the decision making hierarchy. The JOA is usually designed in the manner that covers all the costs and productions and a clear statement of ownership of all property and materials. The Joint Operating Agreement basically has two principal functions. The first one is to document the proportion of shares and responsibilities that have to be fulfilled by the different contractors. This function of the JOA is there to determine the responsibilities that are relevant to the interests of the participants. The other function of the JOA is to specify the manner in which the operator will operate. This function involves the operation of the operator, the relevant duties regarding particular situations etc. Since there are many risks involved in the oil and gas industry, companies are usually more inclined to enter into agreements for risk allocation. These Joint Operating Agreements may concern the governing of the performance of activities that may include drilling and operating of well3. In such kind of agreements generally the participants chose an ‘operator’ who is to be responsible for the day to day monitoring of activities. Even if the operator is helped by an operating committee of representatives, he/she is solely responsible for either the performing of the work in the field or for making sure the works get done by the contractors. The sale of production, however, is something that might be controlled by the operator or the participants of the agreement. An operator generally collects money, for the operations, from the participants of the agreement. He/she also has at times the duty of distributing the proceeds from the production. Since there is a great deal of responsibility involved in all this, there usually arises a situation where the authority of the operator is questioned. To avoid this from happening regularly, there are certain duties that the operator should follow. The operator, under the agreement, has the duty to ‘conduct all joint operations in a diligent, safe and efficient manner in accordance with such good and cautious petroleum industry practices and field preservation principles as are usually followed by the international petroleum industry under alike situations4.’ To ensure that this is done, the operator’s acts, under Article 4.2, can be assessed in reference to the standard of care owed by the operator. There, however, is no other way by which the performance of the operator can be measured5. Also, the operator is not responsible for the payment of any liability resulting as a result of his negligence and wilful misconduct. Along with the setting of the JOA and the assigned duties of the operator, there are many other ways in which the oil and gas industry has prospered and has developed a mechanism for the avoidance of the fault based risk allocation. The allocation of the risk between two parties ensures that one party is willing to pay for the damages of the other one. This mutual hold harmless notion has worked out well in the past for certain contractors. Some of the similar cases are presented as examples as follows. Certain Case Studies Caledonia North Sea Limited v British Communications Plc The first case that is discussed is about the one that was between Caledonia North Sea Limited and British Communications Plc for the Piper Alpha incident. The Piper Alpha was a platform operated by Caledonian North Sea limited. In 1988 an oil leakage and resulting fires and explosion led to the loss of around 167 lives and totally destroyed the gas platform. Also, a loss of approximately US$3.304 billion was insured. The Piper Alpha disaster was a very crucial event because it eventually led to a series of proceedings as the party that was to be responsible for the damages was yet to be decided. The Lord Ordinary stated that the oil platform at Piper Alpha was a very dangerous one and the potentially dangerous nature of the operation was responsible for the decision f the providing of indemnities. In such a dangerous location, it was hard to deduce whose fault it was. Secondly the platform comprised of a huge number of contractors and subcontractors. The platform had twenty four different contractors and 134 of the people who had died were all employed by the contractors. These two were the weaknesses of the case. This was because it was very hard to prove which party was the one that had to be responsible for the providing of indemnities. It was not clear as to what the course of action would be in the case and the case continued for approximately fourteen years before arriving at a conclusion. A public enquiry was set up by Lord Cullen in 1988 to find out the causes for the disaster. The established committee had soon arrived at some conclusions. The leak of condensate had resulted from the restarting of a gas compressor, that was leaking, had been shut down for maintenance. The lack of awareness of the state of affairs arose because there had been a lack of the transfer of information as soon as the shifts had changed. Consequently there was a huge explosion that blew up the main supplies. The emergency systems at this time had failed to activate and so there was nothing that could be done to stop the damage. The situation was further aggravated by the ill-prepared personnel of the neighbouring Claymore and Tartan platforms who delayed the shut-in of the oil production at their own platforms, thereby fuelling the explosion with further oil production. In addition, there were only 62 people on night duty. The rest were in the accommodation section that was very soon engulfed in smoke and flames. So it was very difficult of the accommodation section to be evacuated by lifeboat or helicopters. There was no way these men could have escaped and all the people in the accommodation section had died. Further, the operator’s management had failed to help with emergency. There was nothing in particular that had been to help the people. The emergency systems that had been installed beforehand had also failed to work. The litigation that arose from the Piper Alpha disaster was divided into two stages. Firstly, the dependants of the victims who had died sued the operator claiming that he had exhibited negligence and had failed to work according to his relevant duties. However Lord Cullen’s enquiry showed that the operator was not the one who was responsible. In the second stage, the operator then raised actions against the contractors whose employers had been victims of the unfortunate accident. The London Bridge litigation consequently grouped together claims against seven of the twenty four contractors. A clause in the London Bridge case stated that the contractor was to ‘indemnify, hold harmless and defend the company and its parent, subsidiary and associate corporations and participants, and their respective officers, employees, agents and representatives from and against any claim, demand, cause of action, loss, expense or liability6.’ However this was to be done under the condition that the party that was to be indemnified was not responsible for any contributory negligence. Consequently the operator was found negligent but the negligence was not seen as the main reason for the loss. It was discovered that the negligence on the part of the contractor’s employees had also been a cause for the accident to occur, although the contractors themselves had not been liable in negligence. Thereby it was deduced that the contractors were not in any way responsible for the mishap. The contractors argued here that unless they themselves had been liable to the employees, they should not be liable to indemnify the operator. This matter of construction however was not accepted. The House of Lords argued that nowhere was it written that the contractors have to be liable to the employees in order for the indemnity clause to operate. It was also maintained that the approach of the contractors imposed a general liability with the exception of the case where the sole negligence or wilful misconduct of the operator was the prime reason. A lot of importance was also given to the phrase ‘irrespective of any contributory negligence’ that was present in one of the clause 15.1(c). The contractors argued that the meaning of the phrase was actually ‘contributory to negligence’ however the Lords disagreed. The phrase meant that the ‘negligence’ was that which in fact contributed to the loss as compared to the ‘sole negligence’ causing the loss. Hence the phrase was neutral as to what the other role of causing a loss may be. The operator’s negligence, therefore, was not the only cause of the accident and the clause 15.1(c) was enough to settle the issue of the indemnities. This case was important too because the House of Lords through the case affirmed the position regarding the relationship of the indemnities found in the contracts between operators and contractors and the indemnities found in the contracts of insurance. It was fortunate for the operator because it had taken out the insurance to cover up for the liabilities of the parties, especially the third parties, involved. This was a matter of concern for the contractors who believed that the operator, who had already been insured, did not have any authority and right to sue anymore. The Inner House, in this regard, had come to the conclusion that the operator’s insurers were free to be subrogated to the statements of the operator against the contractors under the contractual indemnities. This decision was based on the principle that the wrong doer’s liability to pay for the expenses and costs was not affected by the fact that the victim of the wrongdoing had been paid for his expenses or indemnified under an insurance policy. As far as the contractors were concerned these insurance agreements were res inter alios acta and so the contractors were not to be concerned about them. This was because the obligation of the contractors, under the clauses aforementioned, was a primary liability7. On the other hand, the operator’s insurer’s duty was a secondary one. Hence, in these particular circumstances, the contractors were the ones who were responsible for the damages, not the operator. The insurance policy was meant to benefit the operator, not the contractors. The Piper Alpha case was a very interesting one because there were various numbers of parties that were involved in the claims against other parties. The Piper Alpha disaster had affected many people and none of the parties was keen enough to pay for the enormous amount of damages. The case portrayed how in the oil and gas agreements it is often very hard to put the blame on different parties because of the great risks involved. The case had many good points, the most important of which was the interplay of the operator-contractor agreements and the operator-insurer agreements. The case made a clear distinction between the two and pointed out that the insurance agreements of the operator were not a matter of concern for the contractors. Rather they were something that were independent and hence were not to be considered for the indemnity decisions by the contractors. The case was successful to a greater degree because of the appropriate clauses that were present in the agreement. Although initially there was confusion between the parties as to who would pay for the damages, the problem was ultimately solved because of the set principles that were laid down in the agreement. Similarly the phrase ‘irrespective of any contributory negligence’ was responsible for controversy in the beginning, yet it was maintained that the phrase like all others (in different clauses) was very clear in its meaning. Hence the appropriate and well defined clauses were responsible for the consequential results. This case was in particular very important because it was one of the few first cases that used the ‘mutual hold harmless’ provisions. The case ensured that the affected party was duly compensated by the other party for any damage. It also made certain that the operator was not the only one responsible for everything. It was true that the operator had to look after the day to day activities and had to monitor the platform, still the contractors also had a role to play. The case proved that the operator was not the one solely responsible for any kind of accident and damage. EE Caledonia v English Orbit Valve The second case that the paper will look at it is the English Orbit Valve v EE Caledonia Ltd case that was tried by the Hobhouse J in the Commercial Court. This case was very similar in circumstances to the Piper Alpha one. The plaintiff EE Caledonia appealed against the dismissal of the claim that had been made by the Orbit Value Company8. The defendant firm was an engineering one and had entered in to an agreement with the plaintiff in which the defendant was to provide a service engineer to the Caledonia limited. However, unfortunately, the service engineer died in the Piper Alpha explosion of 1988. The defendants of the service were enraged and claimed for the damages from the Caledonia Limited. Their claim was that the service engineer had died due to the negligence and the breaches of statutory duties of the plaintiff and they needed to be penalized. The plaintiff then paid an amount to the dependents of the victim and claimed for reimbursement. The court was asked to look into the matter and deduce whether the decision had been in regard to the indemnity clause that had been specified in the agreement. According to the relevant indemnity clause, each party was to defend and hold harmless the other one provided that the other party had acted in good faith. The same indemnity rules also applied to the third parties involved. This meant that one party had to pay for the other’s expenses if the other had not deliberately been responsible for any consequence. The courts of appeal looked into the matter and followed the three-part test that had been used in other cases like the Canada Steamship Lines one9. According to the first part of the three part test, effect must be given to a provision where the clause uses language that exempts a person from all the favours if anything happens because of his own negligence. The second part states that if there is no direct mention of negligence, the court needs to scrutinize the language thoroughly and deduce whether the language that has been used in the agreement wide enough to cover the negligence of the person’s own negligence. The third and last part states that in the situation where the language is wide enough for the above mentioned cases, the court should also consider another head of damage that would not be solely based on negligence. The operator of the Caledonia Limited had claimed for the reimbursements of the damages that had been paid to the dependants of the victim however the claim was dismissed by the House of Lords. It was stated that the indemnity clause was to be interpreted according to well established principles of construction. It was clearly specified that the use of established principles of construction meant that a party was not to be relieved of the implications of its own negligence unless and until it were to use clear words thereby demonstrating explicitly that it was the parties’ intention. Secondly, it was true that the words that had been used in the operator-contractor contract were wide enough to cover for the liability arising from negligence. However there was no specific mention of such a provision and hence the indemnity clause could not be interpreted. The third conclusion was that the words that had been used in the agreement were also applicable to a breach of the duty that could arise without holding any party liable for negligence. The judge also held that whenever there was a series of causes that led to a particular event, each cause was the cause of a subsequent incident. This meant that since the service engineer’s death had been caused by the operator’s breach of statutory duty and the negligence of his employees both, the operator’s liability had not been just caused because of his breach of duty but also had been caused by the negligence of his own workers. Further Hobhouse J maintained that the operator’s negligence was one of those circumstances where the indemnity clause did not cover for different for a loss or liability. This case was initially weak because of the lack of properly defined clauses. However, the courts did arrive at a conclusion about the words of the agreements. The courts considered every scenario that could arise due to the use of the words in the agreement. The case was dismissed because the plaintiff was held responsible for the damages that had been caused after the thorough studying of the agreement. This case shows that the clauses that exclude or restrict the liability that may be considered a breach of statutory duty should be specified clearly and without any element of ambiguity. This is because these clauses are generally taken very seriously and the degree of strictness in the scrutiny of these clauses depends on the extent of the deviation from the clear mentioning of circumstances. BHP Petroleum Ltd and Others v British Steel plc and Dalmine SpA It is important that the affected parties are compensated with the damages however it is also important to concentrate on the difference between direct and indirect losses in order to be just. The direct losses that are associated with a breach of negligence are mainly financial and so may not be covered by the indemnities that concern property. Therefore, the contractors usually fall back into scrutinizing the exemption clauses that exclude the liability of consequential losses. In addition to the purporting of the excluding of liability, there are also other things that are covered by these clauses for example business interruption, loss of earnings etc. If these clauses are not specified carefully, then there may be unintended consequences. It is important now to consider the case of BHP Petroleum Ltd and Others v British Steel plc and Dalmine SpA. The case is basically about the interpretation of an exemption clause that was aimed to exclude the liability of indirect or consequential losses. The case concerned a contract between the BHP (plaintiff) and the British Steel (defendants). According to the agreement, steel was to be supplied for a gas reinjection pipe in Liverpool in UK. The pipe that linked the Douglas field to the Lennox field was to pump back the gas produced in the Douglas and Lennox field to the Lennox field so as to facilitate the oil production in the field. The steel piping was provided by both the British steel and the Dalmine company (the other defendants). Defects had appeared shortly after the first use of the pipeline and there were many problems that had been caused. The main issue was not that the defendants had breached from their statutory duty. Rather it was whether the defendant’s liability was excluded or limited. The plaintiffs pleaded for the costs for the fixing of the pipeline. Also they asked for other costs that were related. For example, the other costs included the ‘costs of investigation into the nature and cause of the pipeline’s failure,’ ‘costs involved in modifying the gas flaring process at the Douglas field’ and the cost of the ‘deferral of production of oil and gas from the development.’10 The plaintiffs also argued that they were ‘required… to defer the extraction of oil and gas from the development and to delay the attainment of maximum production levels, as a result of which the revenues expected from the Development have been and will be deferred.11’ This was something that was defeated by the defendants according to the 14.5 clause. The clause stated that no party would be held responsible for the loss of production or profits. The defendants argued that this case was indeed a loss of production and profits. Because of the debate between the two parties over the pipeline, Rix J was very keen to clarify the distinction between the direct and indirect losses. He came to the conclusion that the replacement cost of the pipeline was not actually an indirect loss and so clause 14.5 was not applicable to it. Also, the claim of the plaintiff that was associated with the deferred production was a claim for the loss of production and so according to clause 14.5 the defendants could not be asked to pay for the cost of deferred production. Further, the cost of dealing with Douglas gas was something that was a direct loss and so the defendants were to pay for the damage that was caused. In addition, the costs that were associated with the investigation of the nature of the damage caused were beyond the scope of the exclusion clause of 14.5. This meant that these costs could not be distinguished as direct or indirect. Overall, Rix J was unable to be definitive in terms of the losses that had been incurred really by the plaintiff. However he did mention that the loss of production, loss of profits, and the loss of business were some costs that had been excluded by the clause 14.5. However, he believed that the parties had been in error when they had agreed to the contract. This is because all three above mentioned costs, according to him, were direct losses. He also argued that the plaintiff would have easily had been compensated for these losses, had the clause not specifically mentioned them as excluded. This case thus shows that it may often be very hard to make a distinction between direct and indirect losses. Although the direct losses are usually financial in nature, a ‘loss in the profits’ that is often considered an indirect loss can be financial in nature too. It is important that a lot of importance is given to the distinguishing of the direct and the indirect losses. In the case, the plaintiff lost for most of the costs that it demanded because the defendant had an advantage in the specified indirect losses. Conclusion Mutual hold harmless provisions are important for the oil and gas industry because this is the only way the huge risk can be distributed among the concerned parties. However these agreements should be made more effective so that the party that has breached from its statutory duty is held responsible and the affected party is compensated. The cases discussed showed that the provisions can be made more effective if clear and specific terms of the agreement are specified. In case of unclear meanings, it is often very difficult to hold the right person responsible. Also, the specification of direct and indirect losses may also make it easier for both the parties to share a fair degree of losses. References David, M. (1996). Upstream oil and gas agreements: with precedents. UK. Sweet & Maxwell. Derman, A. Hallake, M. Golding, A. Katz, W. and Vermillion, P. (2006). Choice of Law Considerations when Drafting Arbitration Provisions for International Oil and Gas Agreements. UK. Thompson and Knight LLP. Hewitt, T. (2008).Who is to Blame? Allocating Liability in Upstream Project Contracts. UK. Journal of Energy & Natural Resources Law, Vol 26. Maccatram, G. (2008). How can the indemnity clause expand or limit the responsibility for liability of the parties in International Oil and Gas contracts? UK. Markov, T. (2008). Indemnity in the International Oil and Gas Contracts: Key features, drafting and interpretation. UK. University of Dundee. Read More