Blog: Is it time for ‘knock-for-knock’ to be knocked out?

Laura Petrie

The face of UKCS contracting is changing, and rapidly so with the introduction of the Oil and Gas Authority in October 2016. Laura Petrie considers whether mutual indemnities remain beneficial to all parties.

To set the scene, the 2016 Court of Appeal decision in Transocean Drilling UK Ltd v Providence Resources PLC brought the consideration of allocation of consequential loss in offshore contracts to the attention of UKCS operators and supply chain managers.

In doing so, it also brought about significant discussion on the continuing relevance of the use of mutual indemnities in respect of such loss, and other losses, or ‘knock-for-knock’ provisions in North Sea contracting.

The case has been well reported, but essentially turned on the interpretation of both the mutual indemnities (covering third party losses) and the consequential loss carve outs within the contract.

The provisions in dispute were relatively typical of those which can be found in most UKCS contracts for the supply of services.

As is the intention of such clauses, certain claims that could otherwise have been recoverable at law can be deemed to be excluded by the parties, and responsibility for such claims reallocated as a result of the commercial agreement.

These provisions have been used in the UKCS offshore industry for well over 25 years and originally were used in recognition of the fact that the potential losses such as the destruction of an entire oil rig or platform could not be borne by a single contractor.

In addition, the manner in which offshore work has historically been carried out meant there has been significant overlapping of lines in respect of roles and responsibilities among groups of contractors working on the same project and between contractors and operators.

Round 1 – insurance

A key driver in mutual indemnity provisions originally being introduced was the availability of insurance and where such insurable risks lay.

The types of insurance available and the risks covered were narrow compared with the liability expected to be taken on by contractors, and traditional public liability, professional indemnity and general contractors’ all risk (CAR) insurance were not wholly appropriate.

Accordingly, it became common to contract on the basis that the operator would retain liability for all operator assets and the contractor for all contractor assets as these were items which could be readily insured under standard policies.

As the insurance market has developed a clearer understanding of the oil and gas industry, the available insurance products and coverage matured and developed.

Insurance brokers are now aware of the impact of changing technology, emerging territories and markets and the impact and effect of catastrophic events and the level of losses which can be incurred across single incidents.

This growing awareness has led to tailored insurance packages and products which then allow operators and contractors to combine the right products to protect their potential exposure to liability or loss.

The updated insurance products available include bespoke pollution clean-up coverage, more detailed storm damage packages, improved CAR insurance that acknowledges consortium or group working among contractors and project specific insurance for particular oil and gas projects (such as fracking, drilling operations or decommissioning).

These products have been prepared both for use by operators and by contractors so there is no longer a risk that one party or the other will not be able to obtain appropriate insurances. There is still a risk of costs being high in obtaining such insurances, but this can be accounted for across pricing mechanisms.

Ultimately, significant developments in the insurance market have considerably altered the scope of allocation of liability.

Round 2 – collaboration

While the Oil and Gas Authority-mandated requirement to collaborate only applies to operators, it is the service and supply chain sector where collaborative projects are increasingly being initiated.

Depending on the project in question, it can be difficult to apply mutual hold harmless regimes to a collaborative enterprise. By their very nature, collaborations are intended to bring together specific skill sets for specific work and, therefore, the risks and liability need to be apportioned against that division.

Moreover, the mutual hold harmless approach was predicated on a standard risk and reward mechanism. A contractor would accept responsibility for its own risks and, once work was completed, would be rewarded for completion of that work by payment of the agreed sum.

Collaborative enterprises tend to use different and varied approaches to the reward mechanisms, particularly in the oil and gas industry where returns linked to production can allow for a range of uplift and performance-related rewards above and beyond basic reimbursement.

It is not uncommon to hear of consortia of service and supply chain companies, or indeed a single provider, entering into arrangements with operators that see the payment for goods and services being deferred until production (with a handsome uplift percentage applied).

Beyond such delayed payment mechanisms there have also been instances of work being completed as an ‘investment ‘by the collaborating service and supply chain sector companies in return for a royalty or net profit interest payable from the resulting production.

With such differing reward profiles becoming commonplace, a varied approach to risk and liability allocation has to similarly apply.

Round 3 – changing roles

Over the last five years, there have been significant changes in the ownership of UKCS infrastructure with many key pipelines and terminals moving into independent ownership rather than being linked to the ownership of the main producing field using such infrastructure.

This, in turn, brings a change in the willingness to undertake certain risks that are normally inherent when the infrastructure is owned, operated and used by the same party or parties.

Infrastructure as a commercial venture requires as much risk as possible to be passed to the users rather than the owner, and would rarely be considered as ‘shared’ in the usual mutual sense.

Plus, there has been a shift in management of operations with a growing rise in the use of duty holder operators.

This has largely arisen as a result of an increase in new, less experienced entrants into the UKCS market. A new entrant requires to demonstrate technical capability to the Oil and Gas Authority for the purposes of being awarded operatorship.

In some cases, this comes from agreeing to appoint a third party with the requisite skills, experience and track record for running such operations. Similarly, many established operators see the use of duty holders as an opportunity to reduce costs and pass on liability and risk.

Part of appointing a duty operator will be to require them to hold and maintain insurances, and increasingly will not include any element of mutual hold harmless arrangements between the licence operator and the duty operator. From there, this feeds through the remaining services and supply chain contracting arrangements and the duty operator seeks to further limit its liability.

Final round – on the ropes?

Despite these changes, there are many UKCS companies continuing to automatically include mutual hold harmless.

As a contracting structure, it has weathered many storms (literal and contractual) and continues to be the initial negotiating position for many industry contracts.

Cases such as Transocean v Providence bring these clauses to the fore and, if nothing else, highlight the importance of ensuring the liability structure is right for the specific project rather than just relying on standardised wording.

It is fair to say that the industry is making more moves away from the mutual hold harmless regime, but it remains a case of down, but not out, for ‘knock-for-knock.’

Laura Petrie is a partner at Ledingham Chalmers