Contractual Risk Management in the Oil and Gas Industry: Issues in the Enforcement of Mutual Indemnity

Clauses
Raphael Bahati Tweve Mgaya*

1. Introduction

High risks associated with upstream oil and gas exploration and production require efficient and cost-effective
means for allocation of risk and liabilities between various participants. 1 Accordingly, the oil and gas industry
has developed standard contracts used to facilitate allocation of such risk and liabilities.2 Given the complexity
of operations and the huge risks involved in the oil and gas sector 3, parties to a contract must identify probable
risks and commit themselves to addressing them throughout the life of a contract.”4

This article discusses the significance of contractual risk management in the oil and gas industry by looking at
how risks allocation through indemnity and other liability clauses of contracts have been enforced in practice.
The article is divided into four parts. In the first part, the author conceptualizes indemnity in the context of the
oil and gas industry. While the rationale of indemnity is examined under part Two, the enforceability of
indemnity and the limitations thereto are discussed under parts Three and Four respectively. In the last part,
the author concludes the article.

2. Indemnity Clauses in the Oil and Gas Contracts

In oil and gas contracts such as production sharing agreements, joint operating agreements and drilling
contracts, risks are allocated through contractual clauses such as indemnity clauses, party obligations and
insurance clauses. This article discusses indemnity as an important contractual clause through which risks are
allocated, albeit briefly. By definition, an indemnity is a contract between two parties in which one party agrees

*The author is a Senior Legal Officer for the Tanzania Petroleum Development Corporation (TPDC), and Advocate of the High Court of
Tanzania and subordinate courts thereto. He holds a Bachelor of Laws (Hons) degree from the University of Dar es Salaam, Master of
Laws degree from the University of Warwick and Master of Business Administration from Mzumbe University. He also hold an MSc in
Oil and Gas law from the University of Robert Gordon, Aberdeen. He can be reached through , raphael.mgaya@gmail.com, cell: +255
788 523 649.
1
Taverne, B.G., Petroleum, Industry and Governments: A study of the Involvement of Industry and Government with the Production
nd
and use of Petroleum, 2 Edition, Bedford: Kluwer Law International, 2008, p. 380.
2
Carolin Schramn and others, “Contracting Strategies in the Oil and Gas Industry”
< www.ilf.com/fileadmin/user_upload/publikationen/3R_Schramn_Nov09.pdf > accessed 22 March 2014.
3
Frank Jahn and others, Hydrocarbon Exploration and Production, 2nd edition, Oxford: Elsevier, 2008, p. 332.
4
R. Scott Agar, “Contractual Risk Management Part I: Definition”
<http://www.pennprime.com/index.asp?Type=B_BASIC&SEC=%7B79B0BCE7-2674-4FA5-AF1D-10C03B7712D5%7D > accessed 20
March 2014.
1
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. 5 A typical indemnity clause provides:

“Contractor agrees to defend, indemnify and hold harmless company, its officers and employees,
from and against any and all claims and causes of action and all losses on account of any
personal injury or death or property damage arising out of or in any way related to the
performance of the Contractor or any sub-contractor of the Contractor of services hereunder.”6

Indemnities are of two main types namely simple indemnities and mutual indemnities.7 On the one hand, a
simple indemnity clause is a provision in a contract whereby the indemnitor agrees to be financially responsible
for payment to the indemnitee in the event that the latter suffers loss in specified circumstances.8 On the other
hand, mutual indemnity is a contract agreement where each party agrees to be financially responsible for, and
indemnify the other against resulting injury or death to its own personnel or damage to its own property,
regardless of the fault 9. From the foregoing, one can say that the difference between the two is that whereas
simple indemnities are one-sided or unilateral, mutual indemnities are bilateral.

The extent of coverage of indemnity is a matter of negotiation and thus parties may virtually agree on any
matter including (in some jurisdictions) those matters that are outside the principles of the law. 10 Of the two
types, mutual indemnity clauses are particularly significant in the oil and gas sector, and the next section
discusses the rationale for the same.

3. Significance of mutual Indemnity Clauses in the oil and gas sector

11
Mutual indemnity clauses are specially developed to cater for peculiarities of the oil and gas industry.12 This
is because; alternative contractual clauses that are based on the ‘guilty party pays’ principle, applicable
statutory duties, or the law of negligence are impractical and inefficient in the context of the oil and gas
industry. In the absence of indemnity clauses, a court on the basis of equity principles can only apportion the

5
Parker, P.L. and 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?” Vol. 44, SWLJ p. 1353.
6
Pisano, Charles M., “Judicial Interpretation of Indemnity Clauses” (1987), Vol. 48 Issue 1 Louisiana Law Review.
7
Makarov, T., “Indemnity in the International Oil and Gas Contracts: Key Features, Drafting and Interpretation” p.1
<http://www.google.co.tz/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&ved=0CC8QFjAB&url=http%3A%2F%2Fwww.dundee.ac.uk
%2Fcepmlp%2Fgateway%2Ffiles.php%3Ffile%3DCAR-
12_5_757771054.pdf&ei=xn5jU8nRI8S47QaCu4HYDg&usg=AFQjCNGF0HjHpaHF_AuFl9Y71SDvkmr-wQ > accessed 2 May 2014.
8
Gordon, G. “Risk Allocation in the Oil and Gas Contracts” in Gordon G., and Paterson (eds.), Oil and Gas law: Current Practice and
Emerging Trends, 2011, Dundee: Dundee University Press, Chapter 14.
9
Mutual indemnity clauses are also known as “mutual hold harmless”, or “knock for knock” or “bury your dead” indemnity clauses.
10
Ibid.
11
The oil and gas industry is peculiar in the sense that it involves huge investment costs, long project life cycles, and fluctuation in
prices of crude, high political risks especially in developing countries and informational inadequacy which prevents accurate estimate
of available resources.
12
Bicknell, A., “Examining the Role of Indemnities in Contracts and their Enforceabilities (Presentation)” Vol.2 No.3 OGEL, 2004, p.3.
2
risk arising under a particular contract, years later.13 Apportioning risks and liabilities under the contract allows
parties to anticipate the scope of their obligation and plan accordingly, including by obtaining relevant
insurance covers.14 Without mutual indemnity clauses, companies would be forced to take several insurance
covers, which would lead to multiple overlapping layers of insurances and high insurance premiums. In turn,
this would raise the overall costs of the project.15

In view of the above, mutual indemnities are particularly preferred in the oil and gas contracts because in
addition to reducing costs in terms of avoiding layers of insurance with high premiums, they simplify and
shorten the period for contractual negotiations and facilitate the administration of contracts.16 Extensive
incorporation of indemnity clauses into model contracts developed by renowned institutions and associations in
the oil and gas industry attest to their wide application and preference. 17 The renowned Associations that have
developed model contracts featuring Indemnity clauses include the International Association of Drilling
Contractors (IADC)18, the Leading Oil and Gas Industry Competitiveness (LOGIC)19 and Association of
International Petroleum Negotiators (AIPN).20 At this juncture, a discussion on the enforceability of indemnity
clauses is in order, and the next section focuses on it.

4. Enforceability of Indemnity Clauses

Clarity of indemnity clauses in terms of the wording is a crucial element in their enforceability. This is because,
unclear or ambiguous wording may affect both its interpretation and enforceability. Another important feature

13
Pisano, Charles M., Op. Cit., p. 169.
14
Ibid.
15
Egbochue, C., “Reviewing ‘Knock for Knock’ Indemnities following the Macondo Well blowout” Vol.7 No. 4, Construction Law
international, 2013, p.8
<http://www.herbertsmithfreehills.com//media/Files/PDFs/2013/Reviewing%20knock%20for%20knock%20indemnities%20following
%20the%20Macondo%20Well%20blowout.pdf > accessed 13 April 2014.
16
M.M. Andrade (n 2) 3.
17
The purpose of the reciprocal indemnity agreement in the contract is to divide the responsibility for personal injury/death among
the many employers and contractors according to the identity of the injured employee rather than according to which party’s f ault or
negligence caused the injury. In effect, each party assumes the risk of the other’s negligence and agrees to be responsible for injuries
to its own employees no matter how, or by whom, caused.
18
The International Association for Drilling Contractors (IADC) provide model oil and gas contracts for members which can be
accessed through its website <http://www.iadc.org/>. Accessed 23 April 2014.
19
LOGIC is a not-for-profit wholly owned subsidiary of Oil & Gas UK that operates as the custodian for cross-industry projects that aim
to increase the efficiency of working practice in the United Kingdom Continental Shelf (known as the UKCS). It provides standard
contracts in the oil industry which can be freely accessed in its website < http://www.logic-oil.com/> 12 May 2014.
20
The Association of International Petroleum Negotiators (AIPN) is a non-profit organization founded in 1981 to enhance the
professionalism of cross-border energy negotiators throughout the world. AIPN is now comprised of approximately 4,500 members in
90 countries, representing numerous international oil and gas companies, host governments, law firms and academic institutions.
AIPN also provides various model contracts in oil and gas industry for its members which are available through its website <
http://www.aipn.org/about_AIPN.aspx > accessed 22 May 2014.
3
is consistency with the law. Accordingly, indemnity clauses that are contrary to the law cannot be enforced.
Such indemnity clauses include those that contravene with statutory duties and public policy. 21

In addition to the above elements, disasters that have happened in the oil and gas industry have tested and in
some cases challenged the risk allocation legal framework between the parties in the oil and gas industry,
particularly between the contractor and the operator. Monumental incidents in this regard include the Macondo
and the Piper Alpha.. Discussed in details below, each of these incidents shed light on the contractual risk
allocation architecture through indemnities and liabilities.

4.1 The Macondo Disaster

This disaster involved the “Macondo well” which was being drilled by the Deep-water Horizon, an Oil and Gas
drilling company which was contracted by Transocean (contractor) to BP (the operator). On 20 April 2010 the
well exploded and killed 11 out of the 126 personnel who were onboard the platform on the fateful day. 22 A
floodgate of lawsuits, whereby more than 7,000 suits were instituted in the United States, followed the
disaster.23 For example, the US Government instituted claims under the Clean Water Act for damages against
both the operators and contractors. In addition, other criminal charges were laid under the Clean Air Act and
federal false statement laws respectively. 24 Relevant claims touched on damage to property and the
environment, tort, insurance coverage, personal injury and contract..25

Specifically, the case of BP PLC and others v. Transocean Offshore Deepwater Drilling and others26 is one of
the numerous cases that were instituted as result of the Macondo accident. In this case, BP sued Transocean
Offshore Deepwater Drilling and others (Transocean) seeking USD 40billion in damages and other costs in the

21
A. Bicknell, Op. Cit., pp. 6-11.
22
Deepwater Horizon Study Group, ‘Final Report on the Investigation of the Macondo Well Blowout’<
http://ccrm.berkeley.edu/pdfs_papers/bea_pdfs/dhsgfinalreport-march2011-tag.pdf > accessed 24 April, 2014. The Macondo well
blow out took place at approximately 9:47 p.m. (Central Standard Time) on the evening of April 20, 2010, following an uncontrolled
flow of water, oil mud, oil, gas, and other materials out of the drilling riser of the drilling vessel, Deepwater Horizon. The vessel was
owned by Transocean and contracted by BP to drill the Mississippi Canyon 252 #1 Macondo well in approximately 5,000 ft of water in
the northern Gulf of Mexico offshore the coast of Louisiana. A series of two or more explosions and a huge fire followed shortly after
the uncontrolled flow commenced. The fire continued unabated for about two days fueled by hydrocarbons coming from the
Macondo well. The Deepwater Horizon was abandoned shortly after the fire started, but 11 of 126 persons aboard perished. The
vessel sank about 36 hours later and the fire was extinguished. The riser and drill pipe inside bent at the top of the subsea Blowout
Preventer (BOP) and dropped crumpled and broken on the seafloor, spewing gas and oil. During the next 83 days oil from the well
flew continuously into the Gulf of Mexico.
23
These lawsuits were later consolidated into Multi-District Litigation (MDL) before the US District Court for the Eastern District of
Louisiana in New Orleans.
24
Thibault, R.P., and others, “The Post Macondo World of Litigation, Regulation and Transactions: No Longer Business as Usual” Vol.
11 No. 2, OGEL, 2013.
25
Ibid 6.
26
BP v. Transocean, Case 2: 10-md-02179-CJB-SS Document 5446 Filed 01/26/12.
4
federal court in New Orleans for negligence. 27 BP also sued Cameron International Corporation (Cameron) for
negligence arguing that the Blowout Preventer that was made by Cameron failed to prevent the catastrophe. BP
asked U.S. District Judge Carl Barbier, to order Cameron to reimburse it for "all or a part" of its damages. 28
Under the Drilling Contract29 between BP and Transocean the two parties had agreed or promised to indemnify
each other “without limit and without regard to cause or causes” of incident including negligence “whether such
negligence be sole, joint or concurrent, active or gross.”

In particular, the contract provided mutual indemnities in favour of the Operator and the Contractor respectively
in respect of pollution. Article 24.1 of the Drilling Contract between the operator and the contractors read as
follows:

“Contractor shall assume full responsibility for and shall protect, release, defend,
indemnify, and hold Company and its joint owners harmless from and against any loss,
damage, expense, claim, 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, paints, solvents, ballast, air emissions, bilge sludge, garbage, or any
other liquid or solid whatsoever in possession and control of contractor 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 company, its contractors, (other than contractor) partners, joint venturers, employees,
or agents. In addition to the above, contractor to a limit of fifteen million dollars (us$
15,000,000.00) per occurrence, shall release indemnify and defend company for claims
for loss or damage to third parties arising from pollution in any way caused by the
drilling unit while it is off the drilling location, while underway or during drive off or
drift off from the drilling location.”

Under Article 24.2 the Drilling Contract stated that:

“Company shall assume full responsibility for and shall protect, release, defend,
indemnify, and hold Contractor harmless from and against any loss, damage, expense,
claim, fine, penalty, demand, or liability for pollution or contamination, including control

27
Jonathan Stempel and Paritosh Bansal, ‘BP sues Transocean for $40 billion over oil spill’ Reuters, Thu Apr 21, 2011 <
http://www.reuters.com/article/2011/04/21/us-bp-cameron-lawsuit-idUSTRE73J7NR20110421 > accessed 2 May 2014.
28
Jonathan Stempel, ‘BP sues blowout preventer maker over Gulf spill’ Reuters, Wed Apr 20, 2011.
29
The Drilling Contract is publicly available at:
< http://www.sec.gov/Archives/edgar/data/1451505/000145150510000069/exhibit10_1.pdf > accessed 3 May 2014. It was originally
concluded between Vastar and Reading & Bates, predecessors to BP and Transocean respectively. It is 409 pages, reflecting many
changes made over its life.
5
 and removal thereof, arising out of or connected with operations under this contract
hereunder and not assumed by Contractor 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
Contractor.”

These two mutual indemnity clauses were the epicenter of the arguments between the parties, as each tried to
convince the federal courts in Louisiana to decide in its favour. BP argued that its contractual indemnities did
not stand and thus some of its liabilities should be shared with the contractors, namely Transocean and
Halliburton.30 On its part, Transocean refuted BP’s claims on the ground that terms of the contract were very
clear on the indemnification of contractors regardless of gross negligence and was very common standard in the
international petroleum industry.

The indemnity clauses of the contracts were upheld by Justice Barbier in the Federal US Court in New Orleans
where it was held inter alia, that BP must indemnify Transocean for some of the compensatory damage claims
over the Macondo oil spills and that Transocean was not responsible for compensatory damage claims raised by
third parties for oil spilled below the ocean surface even if attributed to negligence, gross negligence or strict
liability. The court held that Article 24.1 quoted hereinabove on indemnity in favour of the operator (BP)
covered only cases of pollution originating “on or above the surface of the land or water” and that it did not
cover oil spill below the surface. Judge Barbier later used the reasoning of the Court in the BP v. Transocean in
delivering a similar judgment in favour of Halliburton.

Another case related to the Macondo incident is Ranger Insurance Limited v. Transocean 31, which involved
insurance claims in respect of the Drilling Contract. In this case, the court, among other things, considered the
issue whether an umbrella insurance policy or the indemnity clauses controlled insurance coverage of BP under
the drilling contract. Under Article 20 32 of the Drilling Contract, the Contractor (Transocean) was obliged to
maintain insurance covering its operations as per Exhibit C to the contract, which obligated Transocean to name
BP and its affiliated companies "as additional insured in each of [Transocean's] policies, except Worker's
Compensation for liabilities assumed by [Transocean] under the terms of [the] Contract."33.

30
Prior to Macondo Disaster, BP and Halliburton, via its subsidiary, Sperry Sun had executed a Contract for Well Cementing Services.
The Contract had similar indemnity clauses between the Operator (BP) and Contractor (Halliburton).
31
Ranger Insurance, Limited v. Transocean Offshore Deepwater Drilling, Inc.), 710 F.3d 338 (5th Cir. 2013).
32
Article 20 of the Drilling Contract read:
“Without limiting the indemnity obligation or liabilities of CONTRACTOR or its insurer, at all times during the term of this CONTRACT,
CONTRACTOR (Transocean) shall maintain insurance covering the operations to be performed under this CONTRACT as set forth in
Exhibit C.”
33
Pursuant to the Drilling Contract, Transocean held insurance policies with a primary liability insurer,
Ranger Insurance Ltd (“Ranger”), as well as several excess liability insurers led by London market syndicates (“Excess Insurers;”
together with Ranger, “Insurers”). Transocean’s insurance policy with Ranger provided at least $50 million of general liability
coverage, and its policies with the Excess Insurers
Formed four layers of excess coverage directly above the Ranger Policy that provided at least $700 million of additional general
liability coverage. The Ranger and Excess Policies contained materially identical provisions. See at the details and decision of the US
6
Under Exhibit C34 of the Drilling Contract, Transocean was required to maintain a certain level of insurance
coverage at its own costs and without recourse against BP for payment of premiums. In this case, BP argued
that it was the “additional insured” under the insured policies at issue and that insurance policies alone (and not
the indemnities in the Drilling Contract) governed the scope of BP’s coverage rights as “additional insured”.

The insurers argued that their additional insured obligation was limited to liabilities assumed by Transocean
under the Drilling Contract's terms. The district court read the clause of the Exhibit C as if there was a comma
following the phrase “except the Workers’ Compensation”. This reading rendered the three words their own
discrete carve out from liability. The lower court, inter alia reasoned that the interpretation required Transocean
to name BP as insured only for liabilities Transocean has expressly assumed under the contract. The district
court further considered Article 24 of the Drilling Contract and concluded that BP was not covered under the
Transocean’s policy for the pollution related liabilities deriving from the Deep-water Horizon incident since the
“spill originated below the surface of water”(emphasis added).

However, at the appellate court, the Fifth Circuit found that the phraseology in the highlighted language above
only applied to the Workers Compensation policy because no comma followed the word "Compensation." The
Fifth Circuit held that the umbrella insurance policy, and not the indemnity provisions in the Drilling Contract,
controlled the extent to which BP was covered for operations under the Drilling Contract. In reaching this
decision, the Fifth Circuit applied the Laws of Texas and also relied on the mutual indemnities contained in the
Drilling Contract. Further, the court held in Evanston Insurance Company v. ATOFINA Petrochemicals Inc35
that so long as the indemnity agreement and insurance provisions are separate and independent, the court looks
to the applicable insurance policy, not the underlying service contract, to ascertain whether additional insurance
coverage exists.36

In the same vein, the Fifth Circuit also considered its earlier decision in Aubris Resources LP v. St. Paul Fire &
Marine Ins. Co. in which while relying upon the decision in the case of ATOFINA, the Court held that a
separate indemnity clause does not apply to limit the scope of insurance coverage. In the final analysis, the Fifth
Circuit held that it does not matter how the indemnity provision reads, for it is the language in the policy itself
that dictates the extent of additional insured coverage. The Court further stated that since the policy did not
exclude pollution related liabilities from such coverage, BP was entitled to that coverage under Transocean's
policies.

appellate Court for the Fifth Circuit at < http://www.ca5.uscourts.gov/opinions%5Cpub%5C12/12-30230-CV1.wpd.pdf > accessed 21
April 2014.
34
The relevant clauses of Exhibit C provided that:
“[BP], its subsidiaries and affiliated companies, co-owners, and joint venturers, if any, and their employees, officers and agents shall be
named as additional insureds in each of [Transocean’s] policies, except Workers’ Compensation for liabilities assumed by [Transocean]
under the terms of this Contract.”
35
Evanston Ins. Co. v. ATOFINA Petrochems., Inc., 256 S.W.3d 660 (Tex. 2008)
36
Keith B. Letourneau, ‘United States: The 750,000,000 Missing Comma?’ <
http://www.mondaq.com/unitedstates/x/269290/Insurance/The+750000000+Missing+Comma > accessed 25 April 2014.
7
 4.2 The Piper Alpha Disaster

The Piper Alpha was operated by Occidental Petroleum (Caledonia) Ltd, a wholly owned subsidiary of
Occidental Petroleum Corporation when the explosion happened on 6 July 1988 37. Most of the dead and
survivors were employed by the contractor against whom the operator brought claims, Caledonia North Sea
Limited v. London Bridge Engineering Limited and Others 38 (London Bridge case) for indemnity in respect of
payments made to settle the resulting death and personal injury claims. The disasters lead to the insurance loss
of 1.4billion. 39 Further investigations showed that the initial explosion was caused by the negligence of two
people - an employee of a specialist valve contractor and an employee of the operator. 40

Under sub-clause 15(1) of the contracts, the contractors agreed to indemnify the operator against claims and
liabilities, including, the personal injury or death of the contractors’ employees, irrespective of any contributory
negligence, unless the injury or death was caused by the sole negligence or wilful misconduct of the operator.
Clause 21 excluded any liability for indirect or consequential losses, including loss of use, loss of profits, loss
of production or business interruption. In disputing the claims of the operators, the contractors put forward three
arguments: i) that they (Contractors) could not be liable to indemnify the operator unless they were themselves
liable to their employees in negligence or breach of statutory duty; ii) that their liability to the operator had been
discharged by the payments made by the operator’s insurers; and iii) that the damages over and above what
would normally have been awarded in Scotland were consequential losses and so fell within clause 21 and were
not recoverable.

The court did not accept the contractors’ reasoning on the basis of the ratio from the Mason v Sainsbury,41
where it was held inter alia that an insurance policy does not relieve a third party against liability of a situation
where the insured has a claim in contract or tort. It was held further that there were no grounds for suggesting
the contractors' liability under the contract depended on whether or not insurers had paid up the insurance
claims and that there was no provision in the contracts requiring the operator to obtain insurance cover. In
particular, Lord Bingham referred to mutual indemnities that covered employees as a “market practice” that has
developed to take account of particular features of offshore oil and gas operations”. His Lordship further held
that mutual indemnity properly construed entitle the operator to indemnity from the contractors even where
they were not liable at common law, or liable for breach of statutory duty in respect of fatalities and injuries.
Apart from shedding light on contractual risk allocation through indemnities and liabilities, court decisions in
various jurisdictions have shown that certain limitations apply in enforcements of indemnities. Relevant
limitations are discussed below.
37
Oil and Gas UK, Piper Alpha: Lessons Learnt, 2008 < http://www.oilandgasuk.co.uk/cmsfiles/modules/publications/pdfs/HS048.pdf
> accessed 4 May 2014. On 6 July 1988 a series of explosions and fires aboard the Piper Alpha oil and gas production platform in the
North Sea claimed the lives of one hundred and sixty-five (165) of the two hundred and twenty-six (226) persons on the installation
and two of the crew of a rescue craft. The death toll was the highest of any accident in the history of offshore operations.
38
Caledonia North Sea Limited v London Bridge Engineering Limited and Others (2002) UKHL 4.
39
Chidi Egbochue (n 9) 8.
40
For Brief facts of the Case see < http://archive.onlinedmc.co.uk/caledonia_v__ldn_bridge.htm > accessed 4 May 2014.
41
Mason v Sainsbury (1782) 3 Douglas 61.
8
 5. Limitations on the Enforcement of Mutual Indemnities

5.1 Liability for a breach of contract

In respect of whether an indemnity claimed by a party who causes damage to another party by breaching an
express contractual provision can stand, English courts have shown varied views. In the case of Smedvig Ltd v.
Elf Exploration UK Plc42 (Super Scorpio II) for example, a drilling contractor damaged a remotely operated
vehicle which was a “Company Item” covered by a mutual indemnity clause in favour of the contractor. The
operator argued that since the contractor contravened an express contractual obligation consequently causing
damage, therefore the contractor could not rely on indemnity clause. The High Court held that there was no
reason for limiting the scope of the indemnity provision under the contract between the operator and the
contractor since the indemnity clause was very clear in its wording such that not enforcing it would undermine
the parties’ allocation of risks. In effect the court decision in the Super Scopio II meant that the fact that even if
the contractor was in breach of contractual provision, such breach cannot be invalidate contractor’s claim under
indemnity clause.

A similar decision was made in another English case of A Turtle Offshore SA & Anor v Superior Trading Inc43
where while considering the indemnity clause of the contract the court held that loss and damage was for the
sole account of the rig owner and that the tug owners were exempt from liability in respect thereof. Clause 18
of the contract provided that:

“The following shall be for the sole account of the Hirer without any recourse to the Tug owner, his
servants or agents, whether or not the same is due to breach of contract, negligence or any fault
on the part of the Tug owner, his servants or agents: (i) loss or damage of whatsoever nature
caused or sustained by the Tow (ii) loss or damage of whatsoever nature caused to or suffered by
third parties or their property by reason of contact with the Tow or obstruction created by the
presence of the Tow (iii) loss or damage of whatsoever nature suffered by the Hirer or by third
parties in consequence of the loss or damage referred to in (i) and (ii) above. (iv) any liability in
respect of wreck removal or in respect of the expense of moving or lighting or buoying the Tow or
in respect of preventing or abating pollution originating from the Tow.”

In this case, Claimants owners of rig A Turtle claimed damages from defendant, Superior Trading Inc., the tug
owners of the Mighty Deliverer for loss of the rig and associated wreck removal expenses. A Turtle was a semi-

42
Smedvig Ltd v. Elf Exploration UK Plc [1998]2 Lloyd’s Rep 659(QBD Com Ct). In this case, Smedvig Ltd (the Contractor) and Elf
Exploration Company UK Plc (the Project Operator) entered into a contract whereby the contractor agreed to furnish and operate a
drilling unit for the project operator in an offshore well. The project operator had previously hired the Super Scorpio II a vehicle
owned by Submersible Television Ltd to employ it in the well operations. When the super scorpion II was being lifted and loaded on a
vessel, it was struck by the crane of the drilling unit operated by the contractor and consequently damaged. Submersible Television
then started proceedings against the contractor to recover the losses resulting from the collision on the ground that a contractor’s
employee negligent operation of the crane had caused damage to the Super Scorpio II.
43
A Turtle Offshore SA & Anor v. Superior Trading Inc [2008] EWHC 3034 (Admlty).
9
submersible drilling platform which the Mighty Deliverer was a “pusher” tug contracted to tow a Turtle from
Macae, in Brazil to Singapore via Cape Town in accordance with the towage contract. The tug ran out of fuel
en route in the South Atlantic and towage connection was released and the Turtle drifted away from the tug. It
was later found and then dumped at sea. The rig owner sued the tug owner for the loss of a rig. The judge
rejected the argument that the tug owners’ breach was of such a nature that the exemption at Clause 18 could
not cover it.

However, the Court of Appeal in Deepak Fertilizers and Petrochemicals Corporation v. ICI Chemicals &
Polymers made a different decision44. In this case, Deepak brought an action against both ICI Chemicals and
Davy McKee alleging that plant explosions was due to defendant’s negligent misrepresentations and also to
Davy McKee’s breach of contract. The Court of Appeal held Davy McKee liable for costs of reconstruction of
the plant. In respect of indemnity, the court held that indemnity given by Deepak did not purport to protect
Davy McKee from liabilities arising from its own breach of express terms of the contract. However, the court
did not give any reasoning as to why damage from a party’s breach of contract should be excluded from the
scope of mutual hold harmless indemnity provided by the other party.

Further, the interplay between the breach of contract by a party and its right under indemnity clauses in contract
were examined by Mr. Justice Flaux of the Commercial Court in London in Seadrill v. OAO Gazprom.45 In this
case, Gazprom (the Operator) entered into a drilling contract with Seadrill (the Contractor) for drilling of an
exploration well in the Bay of Bengal. During preloading operations the rig was damaged necessitating its
removal from the site for repairs. The bone of contention was over who was the cause of the incident and would
shoulder the liability for consequences. The operators argued that the accident was caused by the negligent
operation of the rig by the contractor and that the same was a breach of contract. The contractor admitted
negligence but contented inter alia that Article IX of contract, particularly paragraph 910 and 911 and 501
excluded contractor’s liability for negligence.

Applying the English law of contract construction, Mr. Justice Flaux found that the contractor was liable for
negligence and that it was this negligence that was the only cause of the accident and that the contract did not
exclude liability for such negligence. In particular, the judge relied on the principle laid down by Lord Diplock
in Gilbert-Ash v. Modern Engineering 46 that clear words are necessary before the court can hold that a contract
has taken away rights or remedies which one of the parties to it would have been entitled to at common law,

44
Deepak Fertilizers and Petrochemicals Corporation v. ICI Chemicals & Polymers [1999] Lloyd’s Rep. 387 (CA). In this case, the
defendant (Davy McKee London Ltd) agreed to furnish technology and knowhow for the construction of the claimant’s methanol
plant in India. This technology and knowhow was in turn had been supplied to it by the first defendant (ICI Chemicals). The Plant was
built and later on, Deepak and Davy McKee signed a letter of acceptance of plant in which Deepak noted that the malfunctionin g of
certain areas was affecting the plant’s performance. In spite of this acceptance, the methanol converters designed using the
technology supplied by the defendants exploded causing severe damage to the plant and the cessation of all methanol production.
Deepak brought action against both ICI Chemicals and Davy McKee alleging that explosion was due to defendant’s negligent
misrepresentations that the process technology was reliable and had been successful in previous occasions and also to Davy Mc Kee’s
breach of contract.
45
Seadrill Management Services Ltd v. OAO Gazprom [2009] EWHC 1530 (Comm); 126 (2009) Con.L.R.130130 (QBD Com Ct)
46
Gilbert-Ash v. Modern Engineering [1974] AC 689.
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which in this case lacked. Thus, the contractor was held liable to the operator for losses suffered as a result of
aborted drilling operation.

5.2 Public policy

Generally, mutual indemnity clauses may be invalidated on the grounds of public policy. 47 For instance, in the
Illinois law in the US, certain statutes effectively void indemnification against one's own negligence or strict
liability on public policy grounds. 48In BP v. Transocean, the Louisiana District court held that where the
objective of civil penalties are to punish and deter rather than compensate then public policy prohibits
contractual indemnification of such penalties. In the case of BP v. Halliburton 49 where BP’s alleged that
Halliburton had committed fraud by making fraudulent statements Court agreed that fraud would invalidate an
indemnity clause on public policy grounds.

6. Conclusion

Allocation of contractual risks in the oil and gas contracts is an area of law with particular significance due to
the huge risks and complexity of the oil and gas industry generally. Accordingly, mutual indemnity clauses
have been developed particularly to cater for allocation of risks in the oil and gas industry due to their ability to
efficiently allocate contractual risks between parties. Without mutual indemnities in contracts, transactional
costs would raise tremendously as parties would be required to take various insurance coverage. Despite mutual
indemnities being accepted by the industry as excellent tools of contractual risks management, Courts on
several occasions have tended to limit their scope.

Nonetheless, mutual indemnities are likely to continue to be used to allocate risk even in the post Macondo era,
albeit with some modifications. It is more likely that, considering new developments which have been actuated
by the Macondo disaster where contractor have had to bear responsibilities which had been born by operators, a
shift in the contractual risk allocation is likely to happen. In particular, operators will prefer to carve out
negligence, gross negligence or wilful misconduct from the scope of mutual indemnities.

Needless to say, mutual indemnities will continue to be used in the oil industry since the alternatives are
impractical and costly. In the context of the lessons learned from the past incidents, it is important for parties to
exercise due diligence during negotiation and drafting of mutual indemnity clauses to avoid them being
rendered unenforceable. In particular, parties must use clear and unambiguous languages in drafting indemnity
clauses and make sure that the same do not violate public policy or statutory requirements.

47
R.P. Thibault and others (n 14) 6.
48
Washburn, J.A, ‘Indemnity for One's Own Negligence or Strict Liabilities’
<http://www.gouldratner.com/Assets/News/Indemnity%20for%20One.pdf > These statutes
involve construction contracts, real property leases, bailment agreements and contracts regarding health
Care.
49
BP V. Halliburton, Case 2:10-md-021179-CJB-SS Document 5493 Filed 01/31/12.
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