AIDC|20 September 2018 Olga Labai Director

CONTRACTUAL RISK ALLOCATION IN

POST-MACONDO WORLD

INTRODUCTION

Oil and Gas Consultants is a training consultancy comprising professionals experienced in various sectors of international oil and gas.

We provide a wide spectrum of training programs, business consultancy and contract management services to our clients. www.ogc.works

• Contract Negotiations, Drafting and Management

• Claims Management and Dispute Resolution

• In-house training programs

• Tender Support and Bid Review Services

• Open training

• Liquified Natural Gas

SERVICES PORTFOLIO

Sakhalin-2 Project

• “Sakhalin Energy Investment Company Ltd.” (Gazprom, Shell, Mitsui, Mitsubishi)

• 182,4 million tons of oil

• 633,6 billion cubic meters of gas

• First specialised port in Russia

• 3 offshore platforms

• Onshore Processing Facility

• 800 km pipelines – oil and gas

• 30 thousand people involved

EXPERIENCE - OPERATOR

• Weatherford Iraq/Turkmenistan operations;

• Broad range of oilfield services, including drilling;

• Focused on improvement of processes related to revenue-generating contracts;

• Major clients of Weatherford included biggest oil and gas businesses conducting operations in Iraq.

EXPERIENCE – MAJOR

CONTRACTOR

• Risk to be covered by contracts

• Major industry risks

• Major disasters and their contribution to industry contractual practices

• Summary of Macondo incident

• Court conclusions on indemnity clauses

• Macondo effect on indemnities

• Practical recommendations for drafting risk allocation provisions

AGENDA – CONTRACT RISK

Category Risk Description

Economic Commodity Price Volatility and decreases in oil or natural gas prices leading to worsened operating results and future prospects. Regulatory and legislative changes and increased cost of compliance.

Environmental Natural Disaster Natural catastrophe leading to interrupted or reduced production or industrial accident. Resultant environmental or health restrictions and regulations.

Operational Industrial Accident

Major accident or oil spill resulting in loss of life, environmental damage, regulatory fines, civil liability, loss of license to operate and reputational damage.

Political Political Instability Disruption of supply due to war, civil war, guerrilla attack, terrorism or other political instability.

Resources Resource Availability

Material change in estimates regarding oil and gas reserves or development potential. Inability to expand reserves or find replacement reserves.

OIL AND GAS - INDUSTRY RISKS

of not being paid or under-payment (Contractor’s risk)

CONTRACTUAL RISK ALLOCATION

related to work performed – drilling, oilfield services, dredging

RISK of non-performance by Contractors

related to the insufficient levels of quality

of factors frustrating contract (economic, regulatory etc.)

of not being compensated for the losses (both parties)

related to increased dependency on Contractor

(technical approvals process, integrated operations)

of catastrophic events and natural disasters

WHICH RISK

SHOULD BE ADDRESSED

BY THE CONTRACT?

On April 20, 2010, the Deepwater Horizon mobile offshore drilling unit exploded, killing 11 people, injuring dozens, and discharging millions of gallons of oil into the Gulf of Mexico over the course of 87 days.

MACONDO CASE

MACONDO CASE

Deepwater Horizon Mobile Offshore Drilling Unit

MACONDO CASE

Approximately 3,000 cases with over 100,000 named claimants have been filed in U.S. courts (both state and federal):

(a) claims including wrongful death and personal injury due to the explosion and fire;

(b) post-incident injury resulting from exposure to oil and/or chemical dispersants used during the oil spill response;

(c) damage to property or natural resources;

and (d) economic losses resulting from the oil spill.

On August 10, 2010, most of these actions were transferred/consolidated to the United States District Court for the Eastern District of Louisiana.

MACONDO CASE

• BP admits that the Drilling Contract requires it to indemnify Transocean in some circumstances, but disputes the scope of the indemnity;

• BP denies that BP must indemnify Transocean for government claims under Oil Pollution Act and Clean Water Act and for claims based on Transocean’s gross negligence;

• BP also argues that public policy prohibits a broad indemnity clause.

To what extent does the 1998 Drilling Contract between BP and Transocean require BP to indemnify Transocean for the civil claims and the government claims?

• Actions for personal injury, wrongful death, economic loss, property damage, etc. brought against Transocean

• Transocean impleaded BP under Federal Rules of Civil Procedure

• BP and Transocean crossclaimed against one another, seeking contribution, indemnity, and affirmative defenses from the other for liabilities resulting from the incident

• United States asserted claims for civil penalties under Section 311(b)(7) of the Clean Water Act (“CWA”), 33 U.S.C. § 1321(b)(7)

• United States sought declaration of liability for removal costs and damages under the Oil Pollution Act of 1990 (“OPA”), 33 U.S.C. § 2701

• Named BP and Transocean as defendants, who crossclaimed against each other (similar to what happened in the civil actions)

CIVIL ACTIONS GOVERNMENT ACTIONS

MACONDO CASE

“Transocean shall assume full responsibility for and shall protect, release, defend, indemnify, and hold [BP] . . . harmless from and against any loss, damage, expense, claim,

24.1 Section

MACONDO CASE – TRANSOCEAN

RESPONSIBILITY

fine, penalty, demand, or liability for pollution or contamination, including control and removal thereof, originating on or above the surface of the land or water, from spills, leaks, or discharges of fuels, lubricants, motor oils, pipe dope, solvents, ballast, air emissions, bilge sludge, garbage, or any other liquid or solid whatsoever in possession and control of [Transocean] and without regard to negligence of any party or parties and specifically without regard to whether the spill, leak, or discharge is caused in whole or in part by the negligence or other fault of [BP], its contractors, (other than [Transocean]) Partners, joint venturers, employees, or agents.”

“BP shall assume full responsibility for and shall protect, release, defend, indemnify, and hold [Transocean] harmless from and against any loss, damage, expense,

24.2 Section

MACONDO CASE – BP

RESPONSIBILITY

claim, fine, penalty, demand, or liability for pollution or contamination, including control and removal thereof, arising out of or connected with operations under this contract hereunder and not assumed by [Transocean] in Article 24.1 above, without regard for negligence of any party or parties and specifically without regard for whether the pollution or contamination is caused in whole or in part by the negligence or fault of [Transocean].”

“Except to the extent any such obligation is specifically limited to certain clauses elsewhere in this contract, the parties intend and agree that the phrase ‘shall protect, release, defend, indemnify and hold harmless’ means that the indemnifying party shall protect, release, defend, indemnify, and hold harmless the indemnified

25.1 Section

MACONDO CASE – INDEMNITY

OBLIGATION

party or parties from and against any and all claims, demands, causes of action, damages, costs, expenses (including reasonable attorneys fees), judgments and awards of any kind or character, without limit and without regard to the cause or causes thereof, including preexisting conditions, whether such conditions be patent or latent, the unseaworthiness of any vessel or vessels (including the drilling unit), breach of representation or warranty, expressed or implied, breach of contract, strict liability, tort, or the negligence of any person or persons, including that of the indemnified party, whether such negligence be sole, joint or concurrent, active, passive or gross or any other theory of legal liability and without regard to whether the claim against the indemnitee is the result of an indemnification agreement with a third party.”

• Last clause of Article 24.2 (“specifically without regard for whether the pollution or contamination is caused in whole or in part by the negligence or fault of [Transocean]”) limited its indemnity obligation to instances where subsurface pollution is cause by Transocean’s “negligence or fault”—i.e., Transocean’s ordinary negligence;

• Inclusion of “negligence or fault” in Article 24.2 excludes from the indemnity losses resulting from other causes, such as gross negligence and strict liability;

• indemnification for Transocean’s gross negligence is against public policy;

• indemnity for punitive damages and civil fines/penalties under CWA is also against public policy;

• Transocean’s breach of drilling contract invalidates indemnity.

MACONDO CASE

BP’s Argument

• Argued that Article 25.1’s broad indemnity coverage applies to Article 24.2 because Article 24.2 did not “specifically limit” indemnity coverage to certain causes after it used the phrase “shall protect, . . .”

• Contends that the Drilling Contract made it clear when the indemnity obligation was specifically limited to certain clauses, such as in Articles 22.3 and 23.1

MACONDO CASE

Transocean’s Argument

• Article 25.1 establishes a rule for interpreting the other indemnity Articles

• Court found that “Article 24.2 does not specifically limit the application of Article 25.1”

• Indemnity, by its express language includes gross negligence, strict liability, or other causes or damages listed in Article 25.1

• “Article 25.1 is itself a clear and unequivocal agreement to provide broad indemnity coverage whenever the triggering phrase ‘shall protect, . . .’ appears. Moreover, if the triggering phrase appears, the ‘except . . . specifically limited . . .’ clause establishes that equally clear language is required to restrict Article 25.1’s broad indemnity coverage. . . . Article 24.2 contains the phrase triggering Article 25.1, but does not contain language that ‘specifically limit[s]’ Article 25.1’s application.”

MACONDO CASE

Trial Court Decision

Courts will not enforce a provision if the indemnitor did not have sufficient notice that the indemnity obligations would extend to the indemnitee’s own negligence.

INDEMNITY – EVOLUTION

CONSPICUOUSNESS REQUIREMENT

For example, in Dresser Industries, Inc. v. Page Petroleum, Inc., 1993), the Texas Supreme Court held that indemnity provisions and releases must be “conspicuous,” and adopted the standard provided in the Texas Uniform Commercial Code.

DRESSER INDUSTRIES, INC. V. PAGE

PETROLEUM, INC., 1993

50% 40% 10%

Operators challenge the traditional risk allocation

Regulators attempt to shift from long-held position that major

responsibility sits with operator/licensee

Significant, adverse implications for contractors; Effect on long term competitiveness and sustainability of the industry.

INDEMNITY – TRENDS

Subject of indemnity Traditional Reflects Macondo

PERSONAL INJURY OR PROPERTY DAMAGE SUFFERED BY CONTRACTOR GROUP

✓

PERSONAL INJURY OR PROPERTY DAMAGE SUFFERED BY COMPANY GROUP

✓

LOSS, DAMAGE, INJURY OR DEATH SUFFERED BY THIRD PARTIES ✓

CONTRACTOR RESPONSIBILITY FOR POLLUTION ✓

COMPANY RESPONSIBILITY FOR POLLUTION ✓

CONSEQUENTIAL LOSS LIABILITY EXCLUSION ✓

SCOPE AND EXCLUSIONS ✓

SUNKEN PROPERTY AND WRECK REMOVAL ✓

INDEMNITY – TRENDS

INDEMNITY – TRENDS

CONTRACTOR TO COVER

POLLUTION THAT

ORIGINATES

1. From spills of fuels, lubricants, motor oils, pipe dope, paints, solvents, ballast, bilge and garbage, sewerage and other materials in possession and control of CONTRACTOR GROUP or from the property of CONTRACTOR GROUP

2. from spills, leaks or dumping of oil emulsion, oil base or chemically treated drilling fluids, produced

fluids, contaminated cuttings and cavings, lost circulation materials and fluids, when said

materials are in possession and control of CONTRACTOR GROUP

4. from leakage, or other uncontrolled flow of oil, gas or water from pipelines,

on or in submerged lands, within any location arising out of or relating to the performance of the CONTRACT, when

resulting from negligence or breach of duty (whether statutory, contractual or otherwise) of CONTRACTOR GROUP but only up to and not in excess of CONTRACTOR limit of liability of Twenty Million U.S. Dollars (US$20,000,000) per occurrence.

3. from fire, blowout, cratering, seepage, or any other uncontrolled flow of oil, gas wastes or other substance from any well arising out of or relating to the performance of the CONTRACT, when resulting from negligence or breach of duty (whether statutory, contractual or otherwise) of CONTRACTOR GROUP but only up to and not in excess of CONTRACTOR limit of liability of Twenty Million U.S. Dollars (US$20,000,000) per occurrence

INDEMNITY - TRENDS

Subject to [CONTRACTOR’s POLLUTION INDEMNITY],

Company shall be responsible for and shall save, indemnify,

defend and hold harmless Contractor Group, from and against all

claims, losses, damages, costs (including legal costs), expenses

and liabilities arising from pollution and/or contamination

including without limitation such pollution or contamination

emanating from the reservoir and/or from any property of

Company Group arising from or related to the performance of

the Contract.

“We don’t negotiate – these are our standards T&C, other suppliers accepted them without ANY comments!”

NON-NEGOTIATIABLE TERMS

• T&C: imposed by Legal teams, available for use only in PDF;

• Procurement professionals are not authorised to negotiate any T&C;

• Legal team drafts T&C templates which are value-driven:

TERMS AND CONDITIONS

Middle East – trends

below $250k

goods or services

above $250k

low risk or high risk

THERE IS

NO CONSIDERATION

OF

TERMS AND CONDITIONS

Specific types of services

Experience with a specific supplier

Stages of a project

Supplier relationship strategy

Length of a future contract

Fairness of T&C at a given point in time

Effect on the total cost of purchasing

To achieve efficiency with contract drafting, management and close out processes:

1. Contracting Procedure (Policy) – 2 separate documents for procurement and revenue generating;

2. Clear accountability allocation;

3. Improved interface between contributing functions;

4. Approvals structure for each key clause in contract lifecycle.

CONTRACTUAL RISK ALLOCATION

BP sued Transocean and Transocean’s insurers for a declaratory judgment that as an additional insured, BP was entitled to the full reach of Transocean’s liability insurance, some $750 million dollars, to pay for pollution clean-up claims.

BP told the Texas Supreme Court it should be covered by Transocean Ltd.’s $750 million insurance, arguing that to rule otherwise would create great uncertainty about oil and gas insurance contracts statewide.

INSURANCE

“Because liabilities BP faces for pollution emanating from BP's well are from below the surface and from BP's well, those liabilities are not within the scope of the additional insured protection”

INSURANCE

Lloyds’s position

On Friday February 13th, 2015, the Texas Supreme Court rejected BP's claim for $750 million worth of coverage under Transocean Ltd.’s insurance policies to help pay the billions of dollars in damages and other costs associated with the ill-fated Deepwater Horizon oil rig in the Gulf of Mexico.

• Choice of law: what law applies to the contract is immensely important to the ultimate question of whether an indemnity agreement will be enforceable.

• Include an express reference to the negligence of the indemnified party, as well as an express reference to other forms of fault such as the “sole or concurrent” fault of the indemnified party, strict liability, unseaworthiness, and pre-existing conditions.

• If there is an intent that agreement covers the indemnified party’s contractual liability to a third party, expressly provide for this in the agreement as well.

PRACTICAL DRAFTING TIPS

MACONDO CASE

Section 24.1

Section 24.2

Section 25.1

• Limit carve‐outs and add‐ons to the actual risk intended (such as well control or wreck removal costs) as opposed to “all claims arising out of . . . [a blowout]”.

• Given the uncertainty of the meaning of gross negligence, use the term only on the basis that it is defined. This will also allow each party to propose a definition which is more appropriate to the particular contract than the manner in which the term is likely to be defined at common law.

• Note: U.S. court might well disregard such a contractual definition of gross negligence. It might instead apply whatever definition the court deemed to be required by applicable law.

PRACTICAL DRAFTING TIPS

• Indemnitor needs to make sure the effect of “pass-through” is achieved (through well-defined groups of multiple indemnitees and underlying contracts).

• Exercise cross-indemnity for the multiple-indemnitee scenario.

• In combining indemnity and insurance obligations, it is important to craft the insurance coverage to support the indemnity without hindering or limiting the coverage provided by either.

PRACTICAL DRAFTING TIPS

“SOLUTIONS EMPOWERIN

G YOUR BUSINESS”

QUESTIONS