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HOW CAN THE INDEMNITY CLAUSE EXPAND OR LIMIT THE RESPONSIBILITY

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					       HOW CAN THE INDEMNITY CLAUSE EXPAND OR LIMIT THE
         RESPONSIBILITY FOR LIABILITY OF THE PARTIES IN
            INTERNATIONAL OIL AND GAS CONTRACTS?

                             GENEVIEVE MACATTRAM ∗
                              genmacattram@hotmail.com


ABSTRACT: From a legal perspective indemnity clauses are among the most
important clauses in any contract. This is especially relevant for contracts in the oil
and gas industry where potential liabilities are enormous. However it is ironic that
these clauses tend to be the least successfully negotiated and in the worst case
scenarios result in expensive and protracted litigation. This means it is also
subsequently an area where lawyers can add the most value. This paper will look at
the construction, interpretation and policy considerations under two systems of law
highly pertinent to the oil and gas sector - the Laws of England and Wales and the
Laws of the State of Texas. The aim of the paper is to serve as a road map to the legal
landscape when drafting an indemnity clause.

The two clauses examined have been chosen for specific reasons. The indemnity
provision within the International Operating Agreement provides a classic non-fault
based indemnity which excludes liability for gross negligence and wilful misconduct
– this leads to a consideration of public policy considerations and two seminal cases
EE Caledonia Ltd v . Orbit Valve Co and the Ethyl Corp v . Daniel Construction Co.
under English Law and the law of Texas respectively.




                              LIST OF ABBREVIATIONS

A.C.            Law Reports Appeal Cases

A.E.R.          All England Law Reports

AIPN            Association of International Petroleum Negotiators

All ER.         All England Law Reports

Build. L.R.     Building Law Reports

Co.             Company

Ex.             Exchequer Reports


*BA Hons Law & French, Middlesex University, LLM Public International Law, London School of
Economics (Merit); Candidate LLM Natural Resources Law and Policy, CEPMLP, University of
Dundee. Trained and qualified as a solicitor with Clifford Chance specialising in the practice of
derivatives and other specialised international financial instruments.
Inc.           Incorporated

JOA            International Operating Agreement

Lloyd’s Rep. Lloyd’s Law Reports

LLR            Licensing Law Reports

Ltd            Limited

SW. L. J.      Southwestern Law Journal

Tex.           Texas

Tulsa L. J.    Tulsa Law Journal

US             United States of America

USC            United States Code

WLR            Weekly Law Reports



1. INTRODUCTION


The indemnity provision numbers among one of the most important contractual
clauses requiring negotiation in the international oil and gas industry on account of its
role as a risk management tool.


In making a decision to utilise a contractual approach for risk allocation, the parties
will be concerned about the many extraneous factors, which impact on the intended
construction of a negotiated agreement. One determinant that is of especial interest in
this paper is the probability of the negotiated agreement not reflecting the parties’
precise intentions. This can occur because although the subject is important it is an
area which tends to be the least successfully negotiated due to uncertainty or lack of
clear understanding as to the legal consequences of certain provisions. This, in turn,
can lead to the type of expensive litigation the indemnity provisions were designed to
avoid.




                                           2
Risk is a byword for the energy sector and in particular the international oil and gas
industry 1 and therefore it is essential that in choosing the legal route to allocate such
risks, the apportionment be undertaken effectively.


There is significant synergy between insurance and indemnities as interchangeable
and concurrent methods of risk allocation. Due to limitations of space, insurance is
not a feature of this paper, save to say that following the events of 2001 within and
outside of the oil industry, insurance premiums have risen to such an extent that there
have been significant efforts to reallocate risks through other methods such as self-
insurance and contractual indemnity provisions.


The paper will look at the construction and interpretation as well as policy
considerations under the laws of England and Wales and the law of the state of Texas,
two important common law jurisdictions in the international oil and gas industry.


Commencing with a definition of the common law indemnity, the paper goes on to
analyse ways in which the contractual indemnity will seek to adapt the common law
version and the extent to which the courts will interfere to uphold or undermine the
parties’ intentions. The indemnity provision at Article 4.6 of the Association of
International Petroleum Negotiators (AIPN) International Joint Operating Agreement
provides an example of a classic non-fault indemnity excluding liability for gross
negligence and wilful misconduct and as such serves as a good illustration of the
public policy issues and affords a look at some of the seminal cases relevant to this
area of law.


A consideration of relevant indemnity provisions within the AIPN Well Services
Contract provide an opportunity to undertake an examination of broader issues
pertaining to indemnities and provide a further look, in a different context, at some of
the issues already considered in the earlier part of the paper.

1
  Two stark and recent examples of the massive liabilities that can be incurred include the recent fire of
27 July 2005 at the Bombay High Field, India's biggest oil field, accounting for some 260,000 barrels a
day. 10 Dead in Indian Oil Field Fire http://news.bbc.co.uk/1/hi/world/south_asia/4721933.stm (Last
visited 28 July 2005); In 2001 the destruction of the Petrobas P-36 oil platform, the world’s largest off-
shore oil rig after a series of explosions accounted for approximately 80% of the oil and gas casualty
premiums paid world-wide in 2001/2http://www.nfpa.org/assets/files/MbrSecurePDF/SAS.pdf (Last
visited 20 July 2005)


                                                    3
It is especially important that the parties to an indemnity be in a position to confirm
the extent of their liability otherwise they may face a large and unexpected exposure
that could undermine their ability to continue operations.


The purpose of the article is to provide a tool that can assist in the negotiation of
indemnities by highlighting the issues at stake and the areas where courts may seek to
redefine the scope and interpretation of a contractual indemnity and to avoid,
subsequently, such eventuality.


2.       GENERAL OVERVIEW OF INDEMNITY PROVISIONS 2


An indemnity is a contract between two parties in which one agrees to be liable for
loss or damage sustained by the other and or a third party from a specified act or
condition or damage which results from a claim or demand. 3


Indemnity provisions are a matter of contract negotiation and are designed to effect a
contractual apportionment of risk between parties to an agreement. The result will be
a function of the transaction type and the relative bargaining power of the parties. The
indemnitor assumes the burden of the indemnity. An indemnitee is the party that
receives the benefit of an indemnity and is paid or reimbursed.


Such indemnification provisions may appear in many forms. Provisions akin to the
indemnity include a survival provision 4 , release, 5 exculpation, disclaimer 6 , “hold




2
  Indemnity means the act of “making someone "whole" (give equal to what they have lost) or
protected from (insured against) any losses which have occurred or will occur”
http://dictionary.law.com/default2.asp?typed=disclaimer&type=1&submit1.x=35&submit1.y=10 (Last
visited on 14 July 2005).
3
  Parker, P. L., Slavich. J., Contractual Efforts to Allocate the Risk of Environmental Liability: Is there
a way to make indemnities worth more than the paper they are written on?, 44 SW. L. J. 1349 (1990-
1991) at p 1353
4
  Releases are a method of limiting the survival of representations, warranties and indemnities to an
agreed period of time from the execution of the contract, it may not override statutory limitation
periods.
5
  Releases such as of claims and liabilities contemplated under the agreement are homologous with
exculpatory provisions.
6
  A contractual release or waiver of an implied warranty


                                                     4
harmless” and “as is” 7 clauses. Hold harmless and exculpation provisions perform the
same technical function. 8 A contract of indemnity is often referred to as a hold
harmless agreement and the following illustration shows how the idea of both
indemnity and exculpation are usually manifest in an indemnity agreement. Where a
party acting as an indemnitor agrees to indemnify and hold indemnitee harmless … if
the indemnitee is sued or suffers a loss, the indemnity provisions will apply and the
indemnitee will seek recovery from the indemnitor. The hold harmless or exculpation
provisions will come into play if the indemnitor is sued or suffers the loss. The
indemnitor will not be in a position to recover from the indemnitee on account of the
exculpation. It is usually the general intent of the parties that any loss will be the
responsibility of the indemnitor regardless of which of the parties is sued first.
However courts may apply different rules to indemnities and exculpations which, in
turn, may lead to different results. 9


The common law principles governing the interpretation of indemnities and any
statutory limitations must be acknowledged and incorporated in order to ensure that
the parties’contractual intent is satisfied when negotiating and drafting indemnity
clauses.


2.1      COMMON LAW RULES


The purpose of a contractual indemnity is to amend the common law position.


2.1.1 BASIC COMMON LAW POSITION


Common law indemnity only allows recovery for damages related to the indemnitor
and only in instances where there is no participatory fault on the part of the
indemnitee. In contrast, contractual indemnity provisions modify the rights and
obligations of the parties where there is contributory fault or negligence and can allow
for indemnitee to recover for its own partial or full negligence.

7
  Usually present in property transactions and places the onus on the purchaser to satisfy themselves
that the property is free from defect.
8
  Effect is to release one party from financial responsibility to the other




                                                   5
Indemnity provisions can raise public policy concerns because of the prejudicial use
of relative bargaining power of parties negotiating such provisions coupled with
widespread misunderstanding of the legal consequences of certain aspects of such
provisions. These and other factors can lead, intentionally or inadvertently, to
oppressive and overly burdensome contractual indemnity clauses. For this reason the
law tends to step in to modify contractual provisions which are considered to show a
marked deviation from common law indemnity principles. As such, these factors
present a legal risk which accurate and informed drafting of indemnity provisions is
designed to address.


2.2      CHOICE OF LAW


The choice of law is a key decision to be made when negotiating international energy
agreements and can be a confusing one to make due to complex conflicts of laws
rules. 10 Parties tend to want to avoid subjection to an unknown legal system and may
seek to use a law with which they are familiar to govern their rights and duties under
the contract. The laws of England and Wales and the Laws of the state of Texas are
two important legal jurisdictions, which underpin the legal framework of contracts in
the international oil and gas industry.


3.       FUNCTION OF A JOINT OPERATING AGREEMENT (JOA) IN THE
INTERNATIONAL OIL AND GAS INDUSTRY 11


Where more than one company owns interests in a single contract area, an agreement
such as a JOA will commingle the rights of the parties. All such operating agreements
have certain clauses in common. The JOA will direct the conduct of the joint

9
  Parker, P. L., Slavich. J., Contractual Efforts to Allocate the Risk of Environmental Liability: Is there
a way to make indemnities worth more than the paper they are written on?, 44 SW. L. J. 1349 (1990-
1991) at pp 1349-1350
10
   Smith, E. E, et al., International Petroleum Transactions (2nd edition), (Denver, Colorado: Rocky
Mountain Mineral law Foundation, 2000) at p561.
11
   Mosburg, L. G., International Joint Operating Agreements at http://www.mosburgoil-
gas.com/html/body_mosburg_primer_ijoa1_11_96_2a.html (Last visited on 12 July 2005
http://www.mosburgoil-gas.com/html/body_mosburg_primer_ijoa1_11_96_2a.html (Last visited on 12
July 2005); Smith, E. E, et al., International Petroleum Transactions (2nd edition), (Denver,
Colorado: Rocky Mountain Mineral law Foundation, 2000) at p 561.


                                                     6
operation, stipulating the decision-making hierarchy. There must be a formula for
participation in costs and production and a clear statement of ownership of all
property and materials. Finally the agreement, for operational practicality, will
designate an "Operator" to control the day-to-day activities and will specify such
Operator's powers, duties, and compensation.


In essence the JOA has two principal functions, one is to document the proportions in
which the parties will share the rights and obligations of the venture. The most
common division is in accordance with the interests of the participants. The other is to
specify the way in which the operator will manage, subject to the direction of an
operating committee, in the event that such a committee has been constituted. 12


The AIPN has developed a Model Form International Operating Agreement, which
offers a large number of alternatives and options concerning how the operations may
be conducted, consequently, the agreement can be uniquely adapted for the parties to
the agreement. The AIPN model form is frequently used as a point of departure for
joint operations.


4.       CONSIDERATION OF THE INDEMNITY PROVISIONS OF THE
AIPN        2002         MODEL          FORM           INTERNATIONAL                  OPERATING
                    13
AGREEMENT


Article 4.6(A) and (B)
The general effect of Article 4.6 (A) and (B) is to indemnify the Operator and any
other Indemnitee (defined so as to include the Operator and its Affiliates, their
respective directors, officers and employees), from loss or liability for all damages,
losses, costs, expenses (including reasonable legal costs, expenses and attorneys’ fees)
and liabilities which may not be directly related but incident to any claims which arise
out of, result from Joint Operations, even where they are caused in whole or in part by
a pre-existing defect or the negligence (sole, joint or concurrent), gross negligence,



12
   Smith, E. E, et al., International Petroleum Transactions (2nd edition), (Denver, Colorado: Rocky
Mountain Mineral law Foundation, 2000) at p164.
13
   See Relevant Articles of the AIPN 2002 Model Form International Operating Agreement


                                                   7
wilful misconduct, strict liability or other legal fault of Operator or any other of the
Indemnitees.


The Operator seeks indemnification against any third party claims arising out of joint
operations, even for those acts caused by its own negligence including gross
negligence, wilful misconduct, strict liability or other legal fault, save to the extent of
its own participating interest share.


4.1     SCOPE
The scope of the provision is restricted to liability “which arise out of, result from
Joint Operations”


The rationale for such a one-sided provision is based on the fact that the role of
operator is a non-profit undertaking performed for the general benefit of the
participating interests to the JOA.


4.2     DUTIES OF THE OPERATOR 14

The Operator is under a duty “to conduct all joint operations in a diligent, safe and
efficient manner in accordance with such good and prudent petroleum industry
practices and field conservation principles as are generally followed by the
international petroleum industry under similar circumstances.” 15 Any assessment of
the acts of the Operator will be by reference to the standard of care owed by the
Operator under Article 4.2. The Non-Operators do not have a very stringent or
objective standard by which to measure the Operator’s performance. In addition the
standards by which the Operator is bound are accompanied by the exculpatory
provisions of Article 4.6 which provide that the Operator shall not bear any liability
resulting from a failure or even performance of its duties and functions as Operator in
the face of gross negligence or wilful misconduct.




14
   Article 4.2 (Rights and Duties of the Operator) of the AIPN 2002 Model Form International
Operating Agreement
15
   Article 4.2(B)(2) of the AIPN 2002 Model Form International Operating Agreement



                                                 8
Article 4.6 (A) and (B) allocates the majority of the risks of the Joint Operations onto
the Non-Operators absent the Gross Negligence/Wilful Misconduct of the Operator’s
Senior Supervisory Personnel. This indemnification extends to employees and
affiliates of the Operator.


Article 4.6 (A) and (B) is unilateral in effect in creating a contractual right in favour
of the Indemnitees (which in addition to the Operator may include independent
contractors and agents employed by the Operator) for them to be indemnified against
all liability arising from the performance or failure to perform the duties and functions
of operator subject to the extent of their Participating Interest shares.


Generally accepted petroleum industry practice has developed so as to avoid fault-
based allocation of risk, but instead to allocate risk to the party best able to manage it.
The goal is “efficient” risk allocation in proportion to relative rewards.


As stated above, the common law position is that the Indemnitor will indemnify loss
caused by its own negligence, strict liability or other fault. The issue that the oil and
gas industry has with this technique is that fault-based indemnities are often enforced
through expensive and time-consuming litigation to determine liability and
responsibility which, in turn, can lead to increased legal costs. In practice, it is
difficult to get the balance right and a particular type of loss or poor drafting can,
notwithstanding the imposition of non-fault based indemnities, lead to protracted
litigation coupled with the fact that it is virtually impossible to completely avoid a
fault-based system of risk allocation.


Efficient and fair contractual indemnities can only be drafted once the parties to the
agreement are fully conversant with the other company’s risk management scheme
and the risks associated with a particular project.


The key issue which leaps out for consideration in Article 4.6 is the indemnification
of the Operator and other Indemnitees for actions and subsequent claims arising out of
their own negligence, gross negligence, wilful misconduct, strict liability or other
legal fault.



                                             9
4.3    GENERAL RULE OF CONSTRUCTION


Courts in interpreting Article 4.6 will seek to deduce the parties’ objective at the time
the contract was negotiated as the subjective intent of the parties will not be reliable
depending as it will on whether a party is an Indemnitor or Indemnitee under the
agreement. In so doing the courts will assume that the parties want fault-based
indemnities. One reason for this presumption is manifest. The use of the term “wilful
misconduct” implies an intentional tort which is likely to be excluded from the
coverage of general liability insurance policies. Article 1 definitions provide for one
definition for the terms Wilful Misconduct and Gross Negligence as a combined
definition taking into account the more prevalent use of the term wilful misconduct, in
preference to gross misconduct, under English Law.


Negligent acts governed by the definitions of negligence and gross negligence are also
problematic as they necessarily include acts of personal negligence by the indemnitee.


The generally applicable rule therefore is that non-fault based indemnities must be
“clear and unequivocal” to address important public policy concerns surrounding inter
alia indemnification of an indemnitee against liability for death, injury or property
damage caused by its own gross negligence or wilful misconduct.


English Law

The judgment of Sellers LJ clearly states in Walters v. Whessoe Ltd and Shell
Refining Co. Ltd 16


“ It is well established that indemnity will not lie in respect of loss due to a person’s
own negligence or that of his servants unless adequate and clear words are used or
unless the indemnity could have no reasonable meaning or application unless so
applied…”


Further in support Devlin LJ comments on the construction of indemnity clauses.




                                           10
“ It is well established that if a person obtains an indemnity against the consequences
of certain acts, the indemnity is not to be construed so as to include the consequences
of his own negligence unless those consequences are covered either expressly or by
necessary implication. They are covered by necessary implication if there is no other
subject matter upon which the indemnity could operate. Like most rules of
construction, this one depends upon the presumed intention of the parties. It is thought
to be unlikely that one man would agree to indemnify another man for the
consequences of that other’s own negligence that he is presumed not to intend to do
so unless it is done by express words or by necessary implications.”


The classic three part test case dealing with the duty of a court in relation to indemnity
provisions is summarised by Lord Morton of Henryton whilst delivering the judgment
of the board of the Privy Council in the case Canada Steamship Lines Ltd v R, 17 :
(1) where a clause contains language which expressly exempts a person in whose
favour it is made (the “proferens”) from the consequence of the negligence of his own
servants, then effect must be given to such a provision;
(2) where there is no express reference to negligence a court must consider whether
the words in their ordinary meaning are wide enough to cover the negligence of his
own servants;
(3) where the words used are wide enough for the above purposes then the court must
consider whether there is another head of damage on which to base the claim other
than negligence. Though that ground must not be too remote such that the proferens
cannot have expected to gain protection from it.


The case, which addresses the enforcement of indemnification agreements in view of
public policy concerns under English Law, is EE Caledonia Ltd v. Orbit Valve Co. 18


The plaintiffs EE Occidental Ltd (formerly Occidental Petroleum (Caledonia) Ltd)
appealed against the dismissal of their claim for indemnity against the defendants
Orbit Valve Plc.



16
   [1960] CA (Civil Division) 6 Build LR 23
17
    [1952] 1 Llyod’s Rep 1 at p 8, col; [1952] AC 192 at p 208
18
   Court of Appeal [1995] 1 All ER 174, [1994] 1 WLR 1515, [1994] 2 Lloyd’s Rep. 239.


                                               11
The defendants (an engineering firm) entered into a written agreement, on the basis of
the plaintiff’s standard form, with the plaintiffs (joint owners and operators of an oil
platform) whereby the defendants agreed to provide the services of a service engineer
(the Agreement). The said service engineer unfortunately went on to perish in the
Piper Alpha explosion of July 1988.


The dependants of the service engineer claimed damages in tort against the plaintiffs
on the basis of the negligence of the plaintiff’s lead operator and by reason of various
breaches of statutory duties. An amount was paid to the dependants by the plaintiffs
and reimbursement claimed under an indemnity clause pursuant to the Agreement.


The court was asked to consider whether on the proper construction of the Agreement
the plaintiffs were entitled to the indemnity.


The courts followed very closely, the reasoning in Walters v. Whessoe Ltd and Shell
Refining Co. Ltd and came to the same conclusion using the three-part test from the
Canada Steamship Lines case. Essentially the courts will, look to the agreement and
provided it is clear and unequivocal,apply the indemnity provision.


Texas Law

Under Texas law any indemnity provision must be “clear and unequivocal” and
“conspicuous”, the “Express Negligence” doctrine as articulated in the Ethyl Corp. 19
case. The case states that “the express negligence doctrine provides that parties
seeking to indemnify the indemnitee from the consequences of its own negligence
must express that intent in specific terms.” 20 Further it is not sufficient to state that the
indemnity covers everything save for a party’s gross negligence and wilful
misconduct. The indemnity must actively refer to the inclusion of the party’s
negligence. 21 There has never been a direct examination by a Texas court of whether
a party may be expressly indemnified for their own gross negligence or wilful
misconduct though such provision has been expressly held to be against public policy

19
   Dresser Industries, Inc. v. Page Petroleum Inc., 853 S.W2d 505 (Tex, 1993); Ethyl Corp. v. Daniel
Construction Co., 725 S.W.2d 705 (Tex. 1987).
20
   Ethyl Corp. v. Daniel Construction Co., 725 S.W.2d at 707-08 (Tex. 1987)




                                                 12
in other US states, it is the view of certain commentators that it is likely that Texas
courts would come to the same determination on the basis of similar public policy
justifications. 22


As a general principle of law the failure of an indemnity provision to reflect the
express negligence rule can undermine the validity of the indemnity.


The dangers of drafting a statutorily defective indemnity 23


As a general rule the Texas Anti-Indemnity Act 24 (the “Texas Act”) proscribes
indemnification for one’s own negligence though with certain exceptions. The Texas
Act provides that an agreement which is “a covenant, promise, agreement or
understanding contained in, collateral to, or affecting an agreement pertaining to a
well for oil, gas or water or to mine for a mineral… [that] purports to indemnify a
person against certain loss or liability for damage that is caused by … sole or
concurrent negligence … is void and unenforceable.” 25 In particular where that loss or
liability resulting from personal injury or death or property damage is caused by the
negligence of the indemnitee the provision will be void. There is no requirement for
actual negligence to be present to render the entire indemnity invalid, subsequent to
which the indemnity would be considered unenforceable even as to non-negligent
matters if it purports to indemnify a party for that party's own negligence. 26


The Texas Act does not apply to indemnification against personal injury, death or
property damage resulting from pollution, reservoir or underground damage or for




21
   Adams v Spring Valley Constr. Co., 728 S. W. 2d 412 (Tex App. Dallas 1987) in which it was held
that wording within contract must say, “caused by indemnified party’s own negligence”.
22
    Parker, P. L., Slavich. J., Contractual Efforts to Allocate the Risk of Environmental Liability: Is
there a way to make indemnities worth more than the paper they are written on?, 44 SW. L. J. 1349
(1990-1991) at p 1353.
23
   It has been confirmed by O Anderson in e-mail correspondence dated 30 July 2005 that AIPN
contract is not designed to comply with the Texas Act.
24
   Tex. Civ Prac & REM. CODE ANN. §§127.001 –127.008 (Vernon 1986 & Supp. 1991).
25
   Id. §127.003(a)(1).
26
    Parker, P. L., Slavich. J., Contractual Efforts to Allocate the Risk of Environmental Liablility: Is
there a way to make indemnities worth more than the paper they are written on?, 44 SW. L. J. 1349
(1990-1991) at p 1358.


                                                  13
personal injury death or property damage as a result of attempts to control a wild
well. 27


There have been several court decisions concentrating on the construction of the
Texas Act and whether it is possible to provide for an indemnity against an
indemnitee’s own negligence. Up until the Ethyl Corp case the test was the provision
must be expressed in “clear and unequivocal” language. The Texas Supreme Court
affirmed the “express negligence” test. The parties to a contract must assert their
intention to provide for an indemnification against an indemnitee’s negligence within
the four corners of the instrument. The Texas Supreme Court have ruled that a
contract which provides for an indemnity “against all liability arising from work
performed “including but not limited to any negligent act or omission of” the
indemnitee passes the express negligence test. 28 However the matter does not end
there because the same court has also ruled that similar language is not sufficient. The
matter is thus open-ended and appropriate care is required when drafting an indemnity
provision under Texas law. 29


In drafting, where indemnification is sought notwithstanding the negligence of the
indemnitee, such indemnity should be limited “to the extent authorised by law” to
prevent the invalidation of the entire indemnity provision.


4.4        WAIVER OF CONSEQUENTIAL DAMAGES


Article 4.6(C), is an optional provision which states that “Under no circumstances
shall the Operator (except as a party to the extent of its participating interest) or any
other Indemnitee bear any Consequential Loss or Environmental Loss.”


The consequence is that the Operator will not be liable for any Environmental Loss
except to the extent of its participating interest. The Non-Operators will need to bear



27
   Anderson, O. L., The Anatomy of an Oil and Gas Drilling Contract, 25 Tulsa L. J. 359-522 (1990) at
p 426.
28
   Atlantic Richfield Co. v. Petroleum Personnel Inc., 768 S.W. 2d 724, 726 (Tex. 1989).
29
   Anderson, O. L., The Anatomy of an Oil and Gas Drilling Contract, 25 Tulsa L. J. 359-522 (1990) at
p 431.


                                                 14
such loss. Prudent Non-Operators would be advised to seek prior protection from such
potential liability. 30


This provision is typical to the extent that it is usual for service contracts to contain
waivers for consequential damages and exemplary punitive damages including
without limitation loss of profits. However, there is no provision providing that the
Parties providing an indemnity to the Operator and the Indemnitees for any claims
arising out of the Joint Operations whether or not caused by the gross negligence,
wilful misconduct etc. of Operator or any Indemnitee shall be exempt from
Consequential Loss. The following case law gives an indication of the sort of
unfettered liability an indemnitor could seek to limit.


English Law
The cases which inform the drafting of a consequential damages clause indicate what
damage the Courts are likely to consider as direct and consequential to the event from
which a claim arises.


The seminal English law case on this issue is Hadley v. Baxendale 31 and its two-prong
test. The “objective test” direct damage is said to arise from “imputed” knowledge,
defined as knowledge that a reasonable businessman would or ought to have foreseen
as the likely consequence of events. The “subjective test” relates to knowledge of
special circumstances or particular consequences that are not ordinarily foreseeable,
but which are recoverable because there are within the “reasonable contemplation” of
the parties.


This was the view upheld in the case Investors Compensation Scheme Ltd v. West
                                      32
Bromich Building Society (No.1)            the test for direct as opposed to consequential
damage is what a reasonable businessman would understand from the contract.




30
   Highlights of key revisions – 2002 AIPN Model Form International Operating Agreement
http://www.kslaw.com/library/pdf/2002_JOA.pdf Philip Weems & Michael Bolton (Last visited on 10
July 2005) at p 8.
31
   (1854) 9 Ex. 341
32
   [1998] WLR 896 (HL)


                                              15
More recently in British Sugar plc v. NEI Power Projects Limited and Another, 33 and
BHP v. British Steel. 34 , held lost profits, production and business are direct losses.


Texas Law

In the case of Wil-Roye Invest Co.II v. Alleder, Inc., 35 it was held that damage to
reservoir, decreased production, increased production costs are direct damages.


The optional provision (C) carves out any claims which may arise due to the Gross
Negligence / Wilful Misconduct of any Senior Supervisory Personnel of the Operator
or its Affiliates. In that case, the Operator will bear responsibility to the extent of one
of three alternative options. Alternative No. 3 institutes a cap. Where such a cap is
utilised, care must be taken so as not to exclude payment for punitive damages on the
basis of Gross Negligence / Wilful Misconduct or regulatory fines such as pursuant to
the US Foreign Corrupt Practices Act which may far exceed the monetary ceiling of a
cap.


5.      FUNCTION OF A WELL SERVICES CONTRACT


The service contract is a ubiquitous agreement in the international oil and gas industry
in, which there is agreement to perform services in exchange for payment. Once a
successful and commercially viable find is made, a company must be hired to operate
the well and will enter into the following type of agreement.


5.1. CONSIDERATION OF THE INDEMNITY PROVISIONS 36 OF THE
AIPN 2002 INTERNATIONAL MODEL WELL SERVICES CONTRACT

Article 13. 1 General
Is an express statement of intent from the outset the agreement stipulating that the
indemnities are drafted as non-fault based in order “to avoid the time and expense of
protracted litigation between the Parties and to allow each Party to arrange for
insurance or self insurance”


33
   87 Build LR 42
34
   (CA 2000) 2 LLR 277.
35
   (2001))WL903179 Tex.App. – El Paso Aug 2001)
36
   See Relevant Articles of the AIPN 2002 International Model Well Services Contract


                                                16
The following articles are classic examples of risk management through the allocation
of potential liability amongst the parties on a non-fault basis.


Article 13.1.1 Contractor’s indemnity of Company Group
Regardless of cause, the Contractor shall be liable and shall indemnify the Company
Group from Claims which arise out of personal injury, death, or property loss or
damage suffered by any member of the Contractor Group.


The Indemnitee is the Company Group and the Contractor is assuming liability for
any loss amounting to personal injury, death… by a member of its own group or
property regardless of any negligence on the part of any member of the Company
Group. This is known as a “care, custody and control” indemnity because the
Contractor is likely to have control of its entities within its group. Such liability is
considered best managed by the controlling party because they are responsible for the
proper care, maintenance, training and safety practices of their own personnel and
subcontractors. They are also in a good position to assess the level of risk and
organise appropriate levels of workers’ compensation and employers’ liability
insurance.


Notwithstanding, such personnel indemnities can be hard to negotiate as the relative
risk will depend on the likelihood of serious injury (the practical reality is that the
determinants will often be affected by factors outside the control of the indemnitee)
and on the relative numbers of personnel each party has working at the site.


For the parties negotiating this provision, factors that will impact on the ability to
provide a general release from liability for the Indemnitee from performing or failing
to perform it’s duties will include the likelihood of risk of personal injury, or loss, or
damage of property occurring and the magnitude of such harm if it were to occur.


On the basis that there is an assumption for liability resulting form personal injury,
death or property damage caused by the negligence of the indemnitee, care needs to
be taken with the provisions of the Texas Act. The 1989 Amendments to the Act
provide that the Act does not apply to an indemnification supported by liability


                                            17
insurance (provided by the indemnitor) 37 . If the parties agree to mutual
indemnification as per Articles 13.1.1- 13.1.3 such indemnification will be valid to the
extent of the coverage. 38


5.2     CLAIM
As the provisions of Article 13.1.1-13.1.4 are fairly reciprocal, the Claim as a defined
term encompasses a broad definition of the obligations. This is useful for the
indemnitee, which happens to be both parties at different points throughout the
agreement.


It is interesting to note that the definition of “Claim” specifically excludes punitive
and exemplary damages unless a specific election is made to include them. Similarly,
again, to include Gross Negligence a similar type of election must be made. The
parties would have to make an express amendment to the definition of Claim should
they choose to include Gross Negligence.


The trigger for the indemnity can be elicited from the definition of the Claim. The
Claim in this case also defines the scope of the indemnity. The obligation of the
indemnitor is in the form of “all claims, damages…liabilities, losses, demands, liens,
encumbrances, causes of action of any kind, obligations, costs, judgments, interest
and awards (including legal counsel fees and costs of litigation) arising out of the
contract or the performance of the Work.” , and is stated so broadly so as to include
indemnity for liability and damage, loss and expenses. In this way there is no
requirement to distinguish between the indemnity against liability, indemnity against
loss and the implied “hold harmless” agreement or where included the agreement to
defend the claim.


As a matter of general law, legal fees will not normally be held to be included within
the contract unless specifically provided for by the parties. There is specific provision
in this agreement and it is worth noting that legal counsel fees have not been qualified
by any requirement of necessity or reasonableness.


37
  1989 Tex. Sess. Law Serv. 1102, § 3 (Vernon).
38
  Anderson, O. L., The Anatomy of an Oil and Gas Drilling Contract, 25 Tulsa L. J. 359-522 (1990) at
p 428


                                                18
5.3        SCOPE OF THE CLAIM


The interpretation of the scope and terms of an indemnity agreement is a question of
“law” not of “fact” 39 and reflect the negotiated allocation of risks between the parties.
Matters of fact arise in relation to reasonableness of the parties’ actions and
sufficiency of notice given in the event that there is a notice requirement.


The Scope of the claim has been limited to “Claims arising out of personal injury,
illness, death or property loss or damage suffered…”




5.4        REGARDLESS OF CAUSE; NEGLIGENCE; GROSS NEGLIGENCE
The Claim will survive notwithstanding the occurrence of Negligence in whole or
contributory negligence if there is express provision as such. It has not been made
clear whether the “negligent acts” of either party would include negligent personal
acts whilst performing their role under the agreement.


Article 13.1.3 Company’s indemnity of Contractor Group

Alternatives 1 and 2

The obligation of the indemnitor acting where it is the Company is much broader in
Alternative 2 than in Alternative 1. In Alternative 1 the Company shall indemnify the
Claims arising out of personal injury, illness, death or property loss or damage
suffered by (i) Company itself, (ii) Company’s Affiliates, (iii) Joint Interest Owners,
(iv) Company’s Invitees and (v) the shareholders, officers, directors, employees,
agents, consultants, servants and insurers of each of the parties set out in (i)-(iv).
Whereas Alternative 2 provides that the Company shall indemnify the Claims arising
out of the same loss and damage as in Alternative 1 suffered, in addition, by
Company’s contractors and their Subcontractors as well as their shareholders, officers
… (other than the Contractor as defined in the agreement).



39
     Kemp v Gulf Oil Corp. 745 F.2d 921,924 (5th Cir. 1984)


                                                   19
Optional

Article 13.1.4 Third Parties

Indemnities in favour of third parties may be “fault-based” for the reasons given
above. An example is found in Articles 13.1.4.1 and 13.1.4.2 where the Contractor
and the Company provide reciprocal indemnities for injury to Third Parties’ personnel
and property, provided such loss is caused by their Negligence or Gross Negligence of
any member of the Contractor or Company Groups.


5.5    DEFENCE OF CLAIMS

Generally the indemnitor will want to control any litigation and make a response to a
third party claim. Defend as a defined term in this agreement is extremely limited and
unless otherwise provided includes the obligation to pay reasonable legal fees and
costs to party as a result of defending against a Claim pursuant to the agreement. The
indemnitor does not reserve the right to select counsel, control any litigation or
participate in settlement negotiations.


It is usual for the indemnitee to want the indemnitor to defend against any claim, not
just pay out on any settlement as the claim may be without merit, or the Indemnitee
may want the opportunity to approve or perhaps reject what it considers to be a
completely unreasonable settlement by Indemnitor. Where there is a possibility that
settlement could impose criminal liability, the indemnitee would want to participate in
such negotiations. It would not be uncommon to see a provision prohibiting either
party from settling a claim without the consent of the other.


Articles 13.1.4.1 and 13.1.4.2, however, provide that the Indemnitor shall not be
obligated to defend against any claim.




                                           20
5.6  CONTRACTUAL                      ALLOCATION                 OF        ENVIRONMENTAL
LIABILITIES

The lack of judicial predictability in the interpretation of contractual environmental
provisions is more marked than for the other indemnity provisions requiring accurate
drafting to ensure the desired result.

Article 13.2.10 Pollution

Pollution or contamination is a common feature of oil and gas drilling. Article 13.2.10
is a typical “care, custody and control” indemnity, subsequently fault-based, placing
the responsibility for any Claims of pollution from equipment or material delivered to
the location (once on site) firmly on the entity having care, custody and control.


In recognition that a blowout may result in an enormous liability for resultant
pollution and contamination, Article 13.2.10.5 provides flexibility with three options
for election. Alternatives 2 and 3 allow the indemnitor to cap its liability. In the case
of Alternative 2, liability will only kick in above a de-minimis level to be agreed
between the parties. Alternative 3 places a straightforward financial limit on liability.


Texas Law

The Comprehensive Environmental Response, Compensation and Liability Act
(CERCLA) 40 imposes liability for the cost of clean up and other response actions
resulting from the release of substances hazardous to the environment. The courts
generally have endorsed contractual indemnification provisions and the CERCLA
provisions have been interpreted as providing that the parties can indemnify or release
one another with respect to CERCLA liability, but that the federal government or
other third parties will, notwithstanding, remain free to pursue CERCLA claims
against the indemnified party. What is clear from recent case law is that where parties
are responsible under the Act, the statute prohibits any contractual transfer of liability
between them. 41

40
   42 U.S.C. ##9601-9675 (1988), as amended by the Superfund Amendments and Reauthorisation Act
of 1986 Pub L. No. 99-499, 100 Stat. 1613 (SARA)
41
    Parker, P. L., Slavich. J., Contractual Efforts to Allocate the Risk of Environmental Liability: Is
there a way to make indemnities worth more than the paper they are written on?, 44 SW. L. J. 1349
(1990-1991) at p 1362.


                                                  21
CERCLA provides for liability solely on the basis of status. Subsequently under the
law liability may attach irrespective of fault to an owner or operator of a facility or
vessel. 42


6.      CONCLUSION


There exist many ways in which a court re-interpretation of an indemnity clause can
limit or expand the liability of the parties, the most important of which relates to
indemnification in spite of an indemnified party’s negligence. This paper has sought
to spotlight the areas where both an unwary indemnitor and indemnitee may acquire
greater or less protection under an indemnity than was the intention during
negotiations. In so doing, it has addressed what tend to be the problematic areas in the
interpretation of an indemnity provision, namely whether the liability is within the
scope of the indemnity and the intention of the parties has been satisfied.


It is clear from case law in the two assigned jurisdictions that the courts have laid
emphasis on different matters and that the relevant Texan legislature has become
more heavily involved in the regulation and enforceability of indemnity provisions
(clearly illustrated with two statutory acts – the Texas Act and CERCLA which
directly regulate indemnities). By contrast the English jurisprudence has developed
with a view to respecting commercial autonomy and at the same time emphasising the
legal position with respect to indemnities when a suitable case arises to do so. To
conclude the two jurisdictions both indicate that they will support the enforcement of
indemnity provisions that clearly and without ambiguity assign the appropriate risks
between                                          the                                         parties.




42
   Parker, P. L., Slavich. J., Contractual Efforts to Allocate the Risk of Environmental Liability: Is
there a way to make indemnities worth more than the paper they are written on?, 44 SW. L. J. 1349
(1990-1991) at p 1371.



                                                 22
/

                              BIBLIOGRAPHY

1.   PRIMARY SOURCES

     1.1   Judicial Decisions
     BHP v. British Steel (CA 2000) 2LLR 277

     British Sugar plc v. NEI Power Projects Limited and Another, 87 Build LR 42

     Canada Steamship Lines Ltd v. R [1952] 1Lloyds Rep


     EE Caledonia Ltd v. Orbit Valve Co. [1995] CA, 1 ER 174, [1994] 1WLR
     1515, [1994] 2 Llyod’s Rep 239.

     Hadley v. Baxendale (1854) 9 Ex. 341
     Investors Compensation Scheme Ltd v. West Bromich Building Society (No.
     1) [1998] WLR 896 (HL)

     Walters v. Whessoe Ltd and Shell Refining Co. Ltd [1960] CA (Civil
     Division) 6 Build LR 23




     Adams v. Spring Valley Constr. Co., 728 S.W.2d 412 (Tex App. Dallas 1987)

     Atlantic Richfield Co. v. Petroleum Personnel Inc., 768 S.W. 2d 724, 726
     (Tex. 1989)

     Ethyl Corp. v. Daniel Construction Co., 725 S.W.2d 705 (Tex, 1987)

     Dresser Industries, Inc. v. Page Petroleum Inc. 853 S. W2d 505 (Tex, 1993)

     Wil-Roye Invest Co.II v. Alleder, Inc., (2001) WL903179 Tex. App. El Paso
     Aug 2001



     1.2    National Legislation
     Comprehensive Environmental Response, Compensation and Liability Act 42
     U.S.C. §§ 9601-9675 (1988) as amended by the Superfund Amendments and
     Reauthorisation Act of 1986 Pub L. No. 99-499, 100 Stat. 1613.

     The Texas Anti-Indemnity Act TEX. CIV. PRAC. & REM. CODE ANN §§
     127.001 – 127.008 (Vernon 1986 & Supp.)




                                      23
2.   SECONDARY SOURCES

     2.1    Books

     Smith, E. E, et al., International Petroleum Transactions (2nd edition), (Denver,
     Colorado: Rocky Mountain Mineral law Foundation, 2000)


     2.2    Articles

     Anderson, O. L., The Anatomy of an Oil and Gas Drilling Contract, 25 Tulsa
     L. J. 359-522 (1990)

     Parker, P. L., Slavich. J., Contractual Efforts to Allocate the Risk of
     Environmental Liability: Is there a way to make indemnities worth more than
     the paper they are written on?, 44 SW. L. J. 1349 (1990-1991).


     2.3    Other

     Highlights of key revisions – 2002 AIPN Model Form International Operating
     Agreement http://www.kslaw.com/library/pdf/2002_JOA.pdf Philip Weems &
     Michael Bolton (Last visited on 10 July 2005)

     An analysis of health & safety & environment provisions in the 2002 AIPN
     Model form International Operating Agreement – Does the HSE provision go
     too far? Andrew B. Derman & Scott Deatherage
     http://www.tklaw.com/website.nsf/webnewx/766446829128495F8625700D00
     709106/$File/Final%20article%20on%20AIPN%20JOA%20provisions.pdf
     (Last visited on 10 July 2005)

     Mosburg, L. G., International Joint Operating Agreements
     http://www.mosburgoil-
     gas.com/html/body_mosburg_primer_ijoa1_11_96_2a.html (Last visited on 12
     July 2005)

     http://dictionary.law.com/default2.asp?searched=hold+harmless&type=1&sub
     mit1.x=44&submit1.y=21 (Last visited 14 July 2005)

     Daniels, R. G., Contractual Indemnities: To what extent are they legally
     enforceable and insurable?
     https://www.schinnerer.com/risk_mgmt/design_firms/amia/indem.pdf (Last
     visited 14 July 2005)




                                        24
10 Dead in Indian Oil Field Fire
http://news.bbc.co.uk/1/hi/world/south_asia/4721933.stm (Last visited 28 July
2005)

http://www.nfpa.org/assets/files/MbrSecurePDF/SAS.pdf (Last visited 20 July
2005)




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