Liability Regimes in offshore contracts (Skuld)

Model Knock For Knock (KFK) contracts in the offshore energy sector are becoming somewhat less common, with parties at all tiers of the contractual chain trying to pass on liability to those below them. Lewis McDonald of Skuld Offshore has observed in a Skuld article that this had led to a significant increase in the number of liability sections “which have a KFK at their heart, but numerous carve-outs from that, each of which pass on additional risk and exposure”.

McDonald covered the main types of liability regimes frequently seen by Skuld Offshore and provided some guidance on how to identify which type you might have in your contract, as well offering some advice in relation potentially to improving your contractual position.

Since the early days of North Sea exploration. liability regimes in offshore contracts have incorporated the KFK principle, which, broadly speaking, set out that each party is liable for loss of or damage to their property and personnel, regardless of any fault or negligence of any other party.

McDonald noted that this meant exposures were quantifiable, insurance was not duplicated, and extensive and costly litigation on liability  was avoided.

However, McDonald said that over the years, and in particular in recent years, this position had been encroached upon, with alternatives to and less clear-cut versions of the KFK principle emerging. They could be designed to look like a full indemnity regime but, in the cold light of day following a significant incident, may potentially be found wanting.

Fault Based Regimes

Although most offshore contracts included some sort of KFK regime, it was not a universal principle. Some countries did not recognise KFK regimes, and some were reluctant to apply them when they have been set out in a standard form contract which showed no sign of having been negotiated and specifically agreed by the contract parties.

In those circumstances, liability would typically be dealt with in the traditional,  way, with the party at fault for the incident bearing their liability and, where there was fault by a number of parties, each bearing liability in line with their degree of fault.

McDonald observed that, while fault based liability regimes had the benefit of ease of comprehension – a criticism frequently levelled at KFK regimes was that it made no sense to ask an innocent party to pay for the fault of another – that simplicity often resulted in lawyers becoming involved to resolve the issue and the apportionment of fault.

McDonald said that in almost every offshore incident there was a degree of fault from a number of parties, which meant that the apportionment of liability had either to be either agreed by parties or assigned by a court or tribunal. This was at best a time-consuming process and at worst an extremely lengthy and costly one.

A further problem was that in an offshore field there would often be a large number of vessels, units and expensive infrastructure in place. Insuring against potential liabilities could be a costly exercise, and one which would also be carried out by other contractors, leading to significant duplication of insurance.

Released Contractors Clauses

Another full liability regime Skuld commonly encountered was best described as a “released contractors” clause. These provisions would be designed to look like a full liability regime and, on a casual reading, they could come across as such, but on closer examination it would quickly become apparent that the clauses were not nearly as robust as they might initially have appeared.

Typically, a “released contractors” clause would be built around the premise that the company at the top of the contractual chain indemnifies the contractor but does not give any indemnity in respect of its other contractors. However, as those other contractors have entered into contracts with the company which include identical regimes, then if contractor and all the other contractors agree that the indemnity regime they have signed up to also applies to incidents between themselves, an indemnity regime would be established.

As McDonald observed, the issue with such an arrangement was that there was no contractual connection between contractor and any of the other contractors. This mean that, should there be an incident involving any of these parties, there would be no direct contract between them which could be pointed to with a view to enforcing.

Some contracts attempt to enhance this regime by incorporating third party rights legislation such the English Contracts (Rights of Third Parties) Act of 1999. However, this would rely on such a law being applicable in the relevant jurisdiction, the indemnity provisions being sufficiently similar that the wording of the ‘released contractor’ clause could apply, and the court or tribunal finding that it did apply.

Thus, while it was possible that such clauses could operate effectively, they did not give the contractor or the insurer the same level of certainty as would be given under full KFK.

Mutual Hold Harmless Regimes

MHHs were in some ways similar to ‘released contractor’ clauses, but what they offered was more robust and certain. While the company at the top of the chain does not provide an indemnity in respect of their other contractors, they put in place a contractual indemnity annex, to which all other contractors are required to formally sign. The effect of this was that a clear contractual nexus for enforcement is created.

However, an additional administrative burden is created. For MHHs to be effective, each party operating in the project or field has to sign up to them. For a contractor, this means ensuring that a similar annex applies to their subcontracts, and their subcontractors pass it on to their subcontractors, and so on. Ideally, all these documents would be collated by the company at the top of the chain, which tries to ensure that all other parties have signed up to it too.

Model KFKs

A true KFK regime sees each party accept liability for its own property and personnel, regardless of any fault or negligence.

Each Party releases and indemnifies the other Party Group from and against all Claims arising out of this Contract in relation to personal injury and the loss of or damage to any of their Group Property, regardless of the fault or negligence of the other Party Group.

McDonald said that when a KFK is styled in this way it was very important to pay attention to the party definitions.

Modified KFKs

As McDonald observed model KFKs were becoming somewhat less common, with a significant increase in the number of liability sections being inserted , thus diluting the degree of true KFK and increasing the potential for legal costs and duplication of insurance cover. One typical KFK exclusion clause might cover negligence or wilful misconduct for up to a certain amount.

The writer said that because these clauses would be framed around a KFK agreement, they did have the benefit of certainty. However, as they deviated from pure KFK terms, they fell outside the scope of poolable cover, and would therefore require an additional cover to be purchased to respond – if it was possible for the risk to be covered by the P&I suite of covers at all.