I have often written in this column about the importance of the mutual hold harmless indemnities which are found in many oil&gas agreements and which protect a party to a contract against the risks of damaging the other party’s property or injuring its people.
A recent decision of the Scottish Supreme Court shows that these indemnities can affect not only the parties who have them, but also parties who don’t.
The court considered the wording of an indemnity clause of the sort typically found in North Sea oil&gas contracts and found that the clause in question actually served as an exclusion of liability as well as an indemnity, overturning the Inner Court’s decision on this point.
The decision has a particular impact on parties in the supply chain which are not protected by indemnities, for the reasons explained below.
Farstad was the owner of an oil supply vessel, which was chartered to Asco. The vessel was berthed in Peterhead harbour and was undergoing works to remove residue from the holding tanks, which were carried out by Enviroco.
On Asco’s instructions, the master of the vessel started the engines to move to another berth. However, an Enviroco employee had left a valve open, releasing oil on to the engine-room floor. The oil ignited and the resulting fire resulted in the death of an Enviroco employee and damaged the vessel.
Farstad sued Enviroco in negligence. Enviroco, in turn, sought to bring Asco into the proceedings, contending that Asco’s negligence in instructing the master of the vessel to start the engines before cleaning had finished amounted to contributory negligence. Enviroco argued that Asco should pick up a share of the damages.
Section 3(2) of the Law Reform (Miscellaneous Provisions) Act 1940 allows the court to apportion liability among parties who are jointly liable in a way that it views as just, allowing a party that has been found liable (for instance, Enviroco) to seek a contribution from another party who “if sued, might also have been held liable in respect of the same loss or damage”.
This would have been straightforward, except that the charter agreement between Farstad and Asco contained an indemnity under which Farstad agreed that, even if Asco had been negligent, Farstad would “defend, indemnify and hold harmless (Asco) … from and against any and all claims, demands, liabilities, proceedings and causes of action resulting from loss or damage in relation to the vessel”.
The issue before the court, therefore, was how the operation of this clause affected the interpretation of the act.
Farstad argued that the clause went beyond that of a mere indemnity and was, in fact, an exclusion of liability. As a result, the argument went, Enviroco could not recover from Asco under the act as it was not a “person who, if sued, might also have been held liable”.
This argument was upheld by the Outer House of the Court of Session, but later overturned on appeal by the Inner House in May 2009. The Supreme Court has now restored the decision of the Outer House.
The court considered the words “defend, indemnify and hold harmless” in the charter agreement. The court held that these words, in the context, went beyond that of an indemnity and, in fact, amounted to an exclusion of liability. In particular, the obligation to hold harmless went “further than the obligation to reimburse because they are words of exception”.
Because the effect of the clause in question was to exclude Asco’s liability for damage to the vessel arising out of its own negligence, Asco would have had a defence against an action brought by Farstad to recover any losses arising from such damage. As a result, Enviroco was not able to seek a contribution from it under the act.
The court went on to consider the result in the event that the clause operated as a simple indemnity and concluded that the result would have been the same.
Even if liability had not been excluded and Asco had been found liable to pay money to Farstad under the act, Asco could immediately have claimed that money back under the indemnity, and the court would not award damages in such a situation.
This decision does illustrate the risks to parties operating on the UK Continental Shelf who are not indemnified in the typical manner. In a situation where two parties are jointly liable for a particular negligent act, but one of them is indemnified by the claimant, the other may find itself bearing 100% of the loss.
Therefore, parties should give careful consideration to their potential liabilities within the overall contractual regime in operation. In this instance, Enviroco’s contract was with Asco. However, it would seem (although the terms of that contract were not before the court) that Asco’s contract with Enviroco did not indemnify Enviroco against damage caused by Enviroco to Asco’s other contractors (such as Farstad).
There often may be gaps in the contractual pyramid which may or may not have been overlooked. While the Industry Mutual Hold Harmless scheme (of which Enviroco is a member) provides some cover against the risk of damage to other contractors operating offshore, it does not currently extend to supply vessels.
The new deed, to come into force from 2012, will potentially cover supply vessels, but it remains to be seen whether operators such as Farstad will sign up to it.
Penelope Warne is a partner and practice group manager for energy projects and construction at international law firm CMS Cameron McKenna LLP
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