CHAPTER 11 DON'T LOSE SIGHT OF THE BIG PICTURE -- MAKING SURE THE INDEMNITY AND INSURANCE PROVISIONS IN YOUR VARIOUS CONTRACTS FIT TOGETHER

• Jurisdiction: United States

Oil and Gas Agreements: The Exploration Phase
(May 2004)
CHAPTER 11
DON'T LOSE SIGHT OF THE BIG PICTURE -- MAKING SURE THE INDEMNITY AND INSURANCE PROVISIONS IN YOUR VARIOUS CONTRACTS FIT TOGETHER
William W. Pugh
Liskow & Lewis
New Orleans, Louisiana

William W. Pugh is a shareholder in the admiralty section of Liskow & Lewis in New Orleans, Louisiana. He has practiced maritime, tort, and insurance law with Liskow & Lewis since 1980, and his practice has involved a wide variety of matters, including litigation and drafting, revising, and negotiating numerous energy and offshore related contracts such as drilling contracts, offshore construction contracts, master service agreements, charters, and various other contracts.

He graduated from the University of Virginia in 1976, received his J.D. degree from Louisiana State University Law Center in 1979, and served as Editor-in-Chief of the Louisiana Law Review from 1978-79.

Mr. Pugh has authored several articles for the Rocky Mountain Mineral Law Foundation, including "The IADC Offshore Drilling Contract" Third Special Institute on Oil and Gas Development on the OCS (1998); "You Can't Always Get What You Want, But You Can Avoid Costly Mistakes: Insurance Issues for Oil and Gas Operators" 45 Rocky Mtn. Mn. L. Inst. (1999); and "Master Service Agreements and Risk Allocation--In Whose Good Hands Are You?" 48 Rocky Mtn. Mn. L. Inst. (2002).

He also participated in drafting a form international well services agreement through AIPN and other industry groups. He is a member of the Council of the Louisiana Law Institute, the Louisiana Association of Defense Counsel, and the Maritime Law Association of the United States and speaks frequently on indemnity and contract subjects.

TABLE OF CONTENTS

I. INTRODUCTION

II. GENERAL RISK ALLOCATION ISSUES

A. Typical Risk Allocation Scheme in Drilling Contracts

B. Effect of Broad Reciprocal Insurance and Indemnity Provisions

C. "Pass-Through" Indemnity Protection

1. Why is "pass-through" protection necessary?

2. Obtaining Pass-Through Protection

D. Implementing the Risk Allocation Program With Master Service Agreements

E. Making Sure Other Contracts Fit with the Risk Allocation Program

III. SPECIFIC INDEMNITY CONSIDERATIONS

A. Basic Requirements for Obtaining Indemnity for the Indemnitee's Negligence

1. There must be a clear intent to indemnify for the indemnitee's fault

2. The indemnity obligation must be "conspicuous"

B. The Scope of the Indemnity

IV. MAXIMIZING INSURANCE PROTECTION

A. Summary of Important Insurance Requirements

B. Insurance and Indemnity Interplay

1. Insurance provisions may prime indemnity provisions

2. Important vessel coverage endorsements

V. RESTRICTIONS ON INDEMNITY AND INSURANCE

A. The Louisiana Oilfield Indemnity Act

B. The Texas Anti-Indemnity Act

C. The Wyoming Anti-Indemnity Act

D. The New Mexico Anti-Indemnity Act

E. Section 905(b) of the LHWCA

VI. APPLICABLE LAW: STATE LAW, MARITIME LAW, AND THE OCSLA

A. Applicable Law in General

B. Application of State Law Under OCSLA

1. OCSLA situs

2. Federal law applying of its own force

3. State law inconsistent with federal law

4. Effect of choice of law provisions

5. How is the "adjacent" state determined under the OCSLA?

VII. CONCLUSION

I. INTRODUCTION

Risk management for an oil and gas company starts with identifying and evaluating particular risks. Once needs and risks have been evaluated, it is imperative that the company allocate risk in accordance with its underlying contracts and insurance program. Contractual risk allocation through indemnity and insurance provisions is an important part of a company's approach to managing risk. In addition, it is critical that the risk allocation provisions in different contracts fit together; this is often most effectively accomplished through the use of a "pass-through" provision (whereby indemnity protection is passed through the contracting party to other beneficiaries). However, enforceability always remains a potential pitfall, which requires that the company constantly scrutinize the scope of the risk assumed. Moreover, insurance protections should dovetail with indemnity provisions, and in some cases, insurance may provide more protection than indemnity. Ultimately, an oil and gas company will have many contracts in place at the same time, and this paper will examine the most effective ways to integrate these various contracts to maximize protection and minimize the risk of a "bad fit."

II. GENERAL RISK ALLOCATION ISSUES

One of the threshold issues for developing a contractual risk allocation program is for the company to understand that it will be entering into various different types of contracts and that the risk allocation provisions in each will need to fit together. The most common operational contracts entered into by an oil and gas company are drilling contracts and master service agreements. Of these two types of contracts, the most critical is the drilling contract, and the operator cannot effectively develop a master service agreement program without understanding the critical role that the drilling contract will play.

A. Typical Risk Allocation Scheme in Drilling Contracts

The typical drilling contract ¹ will allocate a variety of risks on a reciprocal basis, particularly liability for bodily injury/death claims and damage to property, and these indemnity obligations will apply regardless of fault. ² Understanding the scope and effect of these reciprocal indemnities is a critical first step in developing a cohesive risk allocation program.

B. Effect of Broad Reciprocal Insurance and Indemnity Provisions

The drilling contract will generally require the operator to assume liability for all personal injury claims asserted by, or property damage sustained by, the operator and the operator's other contractors. ³ This is often referred to as a "knock for knock" indemnity and is referred to in this paper as a broad reciprocal indemnity. The effect of this type of broad reciprocal indemnity is that the operator will owe indemnity to the drilling contractor every time there is a casualty involving anyone other than the drilling contractor (or its subcontractors, if any). ⁴ Consequently, the broad reciprocal indemnity imposes significant risk on the operator, and to the maximum extent possible, the operator should either refuse to accept such risks (which is difficult) or make certain that it has obtained back-up or pass-through indemnity and insurance protection from its other contractors in the applicable master service agreement or other underlying contract. ⁵ Otherwise, the operator may be entitled to insurance or indemnity protection from its other contractors, but not be able to extend such protection to the drilling contractor. ⁶ In other words, the amount of risk that should be assumed by an operator in a drilling contract depends on the indemnity and insurance protections that the operator has obtained, or will obtain, in its underlying contracts.

Another critical issue in the drilling contract is the extent to which the drilling contractor's indemnity (and insurance) obligations ⁷ are owed to the operator's intended beneficiaries. These beneficiaries should include the operator's economic family (i.e., affiliated companies), its non-operators, and any partners, joint venturers, or other parties that operator may want to benefit from the indemnity protections. In addition, the operator will often want to be sure that its other contractors are beneficiaries of the indemnity protections as well (to obtain pass-through protection as discussed below). The former protection is generally easy to obtain; the latter can be significantly more difficult to obtain, ⁸ but may nevertheless be critically important. ⁹

C. "Pass-Through" Indemnity Protection

1. Why is "pass-through" protection necessary?

Absent express language, an indemnity provision will not be held to cover the indemnitee's contractual liability to a third party. The presence or absence of pass-through protection can be critical. The drilling contractor will always want the operator to indemnify for any claims by the operator's other contractors, and given this broad indemnity obligation, the operator will have no back up indemnity from its other contractor unless there is a pass-through indemnity provision in the underlying contract. Without a pass-through provision, the operator may end up with more liability exposure than it would have had in the absence of any indemnity provision. For example, in Foreman v. Exxon Corp., ¹⁰ an employee of an oil company's contractor was injured, and sued the oil company and the drilling contractor. The oil company owed indemnity to the drilling contractor for injuries to contractor's employees, such as the plaintiff. While the contractor/employer owed indemnity to the oil company, the indemnity did not cover the oil company's obligation to the drilling contractor. At trial, the contractor/employer defended the oil company, but the oil company had to defend the drilling contractor. Both were found negligent, but because of the indemnity, the oil company had to pay the proportionate fault attributed to the drilling contractor, which was more than five times greater than the fault attributed to the oil company. In other words, an indemnity provision that protects the operator from all claims for or on account of personal injury to a contractor's employee provides the operator with indemnity protection if it is sued by the contractor's employee, but if the operator has itself agreed to indemnify another party (i.e., the drilling contractor) for such personal injury claims (to the operator's other contractors' employees), the indemnity from the employer/contractor will not cover the operator's contractual obligation to the drilling contractor. ¹¹ Under both Louisiana law ¹² and maritime law, ¹³ the operator's contractual obligation to...