Oil Spill: Need for liability, indemnification clauses in contracts

Felix E. Ayanruoh

06 November 2012, Sweetcrude, LAGOS – THE Deepwater Horizon oil spill in the Gulf of Mexico, one of the world’s worst petroleum disasters in recent history, will be remembered for a long to come. This disaster was caused by explosions at a Mobile Offshore Drilling Unit in the Macondo Prospect; a seabed located about 41miles off the southeast coast of Louisiana in the United States.

The rig was owned and operated by Transocean, the world’s largest offshore drilling contractor. Flagged in the Marshall Island, and leased to British Petroleum, BP, one of the world’s largest energy operator and majority interest holder in the Macondo prospect well located in the Mississippi Canyon Block 252 in the Gulf of Mexico, BP employed several service contractors to help in the development of block 252.

This spill like several spills across the globe called to questions the issues of liabilities and indemnification among others. One of the most interesting and challenging aspects negotiating and drafting International Petroleum Service Contracts revolves around the relationship between the operating oil company and service contractors on the one hand and liability/Indemnification issues on the other.

Whilst these two, often conflicting, principles are generally understood within the international petroleum industry, the question arises as to whether indemnification clause in service contract in favor of the company for tortuous acts committed by the contractors is permissible by law.

Service contractors are the engine that drives petroleum exploration and development around the world, and it is also a high risk activity. Major international petroleum companies depend on oilfield service contractors to provide specialized services and technology, which supports petroleum production both onshore and offshore, and includes drilling and related services. In practice, service contractors or individuals work as independent contractors.

This means that although they are engaged by the operating companies, they do not work under their control. Within the context of BP’s contractual relationship with its service contractors lies an independent contractor’s relationship

The freedom to enter into a contractual relationship in hydrocarbon development is both moral and profound. It can be effectively argued that the uniformity of terms of contract usually recurring in a service contract is an important factor in calculating risks.

Unforeseeable factors causing tortuous acts and liability issues such as the alleged actions of Transocean, and other service contractors can be effectively taken care of. However, the Machondo service contract did not provide for, the senior supervisory personnel in operators limitation of liability is. This omission was one of the major contentious issues before the courts.

The principle of indemnity under common law doctrine allows liabilities to be transferred from one party to another. This clause makes the party giving the indemnity liable to pay compensation for loss or damage that arises from a specific event. It is a means of shifting the financial consequences of an event to another party.

The allocating of risk and liability is generally addressed in the liability and indemnity clause of service contracts. A balanced risk, liability and management clause should not be one sided. The liability and indemnity clause includes a list of those liabilities which will be assumed, an undertaking of liability by one party to the contract, and the limits on any liability assumed. As a general rule, an operator is not liable for injury to the employees of an independent contractor.

Responsibility is resolved by looking into the express term in the contract and identifying the assuming party under the circumstance. Suffice it to state; however, that fault based indemnity cannot be completely avoided. Furthermore, it can be negotiated with other terms in the contract.

Indemnity provision in service agreement may also take the form of either held harmless and defend or exculpatory or release from liability clause which limits or exclude a party from liability of its own tortuous act. Exculpatory clause in contracts cannot and should not shield a party contractually from liability for gross negligence.

The courts have consistently held that indemnity provisions that are contrary to public policy are unenforceable. Consequently, parties relying on indemnification clauses have the burden of proving that they are not at fault. That is, the contracts are enforceable before the court of law. While a party may not be primarily liable in a culpable sense, he is liable by contract if the parties have bargained for the terms of indemnity and there is no disparity in bargain power or undue influence.

A body of jurisprudence relating to liability/indemnity clauses is of the view that agreements that impose liability different from that provided by the law should be strictly construed against the drafting party.

Negotiation of enforceable contractual indemnities is a significant part of risk management in petroleum development and also a difficult task. Understanding the contractual relationship between an operating oil company and a service contractor is seminal in negotiating and drafting service contracts with enforceable indemnity provisions.

One has to look whether or not if the service contractor is an independent contractor or agent to the operating oil company. Once it is determine that the relationship is one of independent contractor with no imputed responsibility, the next issue will be transfer of liability from one party to the other.

Furthermore, it is also valid to determine the relevant public interest, the conflict between the interest and the contract in question. In deciding public interest, the courts have consistently looked to anti-indemnity provisions as well as acts that injure the public welfare or interest, or are contrary to public decency, sound policy, and good morals.

Proper negotiation and drafting of indemnity clause can be beneficial to both operating companies and service contractors. Operating companies like BP should be vigilant of model contracts that hold operators solely responsible and assume liability for all consequences relating to oil development and exploitation.

About the Author

  • We want to believe that similar clauses already exists in existing contracts. However, owing to the peculiar structure of the mining contracts in countries like Nigeria where the government is a partner, the oil companies cannot assume full liability. In the case of Ogoniland where the oil spill volume and impact is greater than that of the Deepwater Horizon in the Gulf of Mexico, it goes to reason that since the Nigerian government through the NNPC owns a greater percentage of the equity (57%) in the Shell operated joint venture, the government has to put up more money to clean up the spill. From what we have gathered, Shell is not averse to contributing its own quota to clean up the spill. Rather, it is the Nigerian government that has failed to live up to its responsibility. We just wonder how re wording the liability and indemnification clauses in any mining contract will get any government with the character and complexity of the Nigerian to act.