CHAPTER 8 CONTRACTING FOR GOODS AND SERVICES IN THE OIL AND GAS AND MINING INDUSTRIES
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CONTRACTING FOR GOODS AND SERVICES IN THE OIL AND GAS AND MINING INDUSTRIES
Liskow & Lewis
Houston, Texas
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JOHN ALMY, is a partner in the Houston office of Liskow & Lewis. He is a business lawyer who focuses on the creation, drafting and negotiation of oilfield operational contracts with experience in both domestic and international work. John has extensive experience helping clients design and implement risk allocation programs using indemnity and insurance concepts for work in Texas, Louisiana and the Gulf Coast, and has assisted clients with their endeavors in locations stretching from Colorado to Israel and North Dakota to Venezuela.
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Contractual risk allocation can be a very tricky, nuanced endeavor with pitfalls that every drafter should be aware of. Used effectively, contractual risk allocation can allow parties to plan ahead for potential liabilities, allowing each party to effectively and efficiently guard against future liability by placing certain risks with the parties best suited to address those risks and allowing each to better manage its own insurance program to address the risks it has assumed.
The purpose of this paper is to provide a brief look at the mechanics of regardless-of-fault indemnities, specifically how to draft an indemnity that will be enforceable and then how to strengthen those protections through the use of additional insurance coverage. This paper will also briefly discuss various state statues that can impact the effectiveness of such indemnity agreement and discuss potential work-arounds, if they exist.
Just about every lawyer, contract administrator, or anyone else that deals with drafting contracts on a regular basis has encountered an indemnity provision of some form or fashion. Whether an oilfield "knock for knock" indemnity or a promise to assume all liabilities arising after the closing of a sale of real property, indemnity or "hold harmless" clauses abound in the transactional world. As we press forward, this paper will discuss the sorts of indemnities that are often encountered, but will focus primarily on so-called "status based" indemnities that allocate the liability regardless of the negligence of the party seeking protection, or the lack of negligence on the part of the person or entity providing protection.
I. WHAT IS INDEMNITY?
At its core, an indemnity is a promise by one person (the "indemnitor") to protect a second person (the "indemnitee") from claims by a third person. Put in more practical terms, an indemnity is a promise by Andy to Betty that he will protect her from liability for some or all of the loss or damage Charlie might suffer. Note that while the term "indemnity" is often also used to describe a promise of protection for loss or damage to the person or property of the promisor (Andy agrees to protect Betty from loss or damage that Betty might inflict upon Andy) that promise is technically a release. The difference between indemnities and releases is generally subsumed in the indemnity promises as the intent of the parties is often to protect each other from loss or damage to their own people and property as well as the people and property of certain others. However, it is important to realize that the two are fundamentally separate concepts and can be treated differently in various contexts. The biggest difference to recognize is that a release essentially destroys the claim where an indemnity merely shifts primary responsibility.
For example, if Betty runs a stop sign and destroys Charlie's brand new Bugatti Chiron (retail price $3 million), the law would hold her liable for those damages. Andy, having agreed to protect her from such claims, would be bound to pay. However, if Andy only promised to provide up to $1 million, or if Andy only has $1 million to his name, Charlie is not limited to just Andy's money; Betty is still liable for whatever damages she caused in excess of the protection that Andy was required, or was able, to provide. The critical lesson is that an obligation to indemnify is only as valuable as the money available to provide the protection.
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II. TYPES OF INDEMNITIES
When taking on an indemnity obligation, it is critical to determine whether the indemnitor intends to protect the indemnitee from the consequences of his or her own negligence. Either the indemnity will be "fault based" or "regardless of fault."
Fault Based – Fault based indemnities are exactly what they sound like – an agreement to indemnify another to the extent the liability arises out of the negligence of the party providing such protection. Essentially, the indemnitor (the person or entity providing the indemnity) is telling the indemnitee (the recipient of the protection) that the indemnitor will be responsible for whatever liability the indemnitor causes. Often phrased like "Andy shall release, defend, indemnify, and hold harmless Betty from and against any claims, losses, damages, and causes of action of any kind or character, arising directly or indirectly out of any loss or damage to Charlie, to the extent such claims, losses, or causes of action arise out of the negligence of Andy."
This is a very simple indemnity and, in many respects, is of little value to Betty. All Andy has promised is that he will be responsible for, and will protect her from, liability arising out of Andy's own negligence - essentially what the law would do anyway. Andy is going to pay for the damage he caused and Betty won't have to. Fault based indemnities aren't very strong simply because if Andy were the real cause of the loss or damage, Betty shouldn't be liable anyway. That being said, it should not be overlooked that a fault based indemnity may provide valuable defense costs to the indemnitee.
Regardless of Fault – An indemnity that is provided regardless of fault is a much more substantial promise. In this instance, the indemnitor is agreeing to protect the indemnitee even if the indemnitee is the cause of the loss or damage. Here, Andy agrees to release, defend, indemnify, and hold harmless Betty from and against any claims, losses or causes of action of any kind or character, arising directly or indirectly out of any loss or damage to Charlie, regardless of the cause or causes thereof, including the sole, joint, or concurrent negligence, strict liability, or other legal fault of Betty. Now Andy is on the hook for, and Betty is effectively protected from, loss or damage she might cause Charlie. If Charlie sues Betty because she ran a red light and caused a car wreck that destroyed his new car, Andy will be compelled to pay any damages.
There are many different ways to construct an indemnity once the threshold question of whether or not the indemnity will cover the fault of the indemnitee has been answered. Most allocate risk on the basis of ownership or employment status (i.e. Andy is responsible for all of the property he owns and all of the people he has brought to the work), or time (Andy will protect Betty from all claims arising before the closing of the transaction, Betty will protect Andy from all claims arising after the transaction); but all will have some rubric for allocating the risk, and it is critical that the contracting parties understand the allocation, what it includes, and what it does not.
Why allocate risks regardless of fault? The most common reasons state that by allocating risk on the basis of ownership or employment status, time, or some other objective factual criteria, rather than fault, the parties seek to bypass any ambiguity as to who is responsible and place any liability with the party or parties that are most efficiently able to handle the situation. For example, in an indemnity that allocates risk of loss to the owner of the property, the assumption is that the owner knows exactly what the value of his exposure is, and consequently is in the best position possible to insure against those risks.
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As and added consideration, since the question of fault is not being litigated, there is less chance of knowledgeable parties pointing fingers at each other, discussing all the possible mistakes and driving up the value of any adverse judgment. Typically, the trade-off for accepting responsibility for loss of his property to the negligence of another is that he himself is protected from that same kind of liability if he negligently causes damage to another person or entity.
III. INDEMNITY STRUCTURES
When indemnifying regardless of fault, there are three questions that must be answered, and great pains should be taken to ensure that they are answered clearly and completely.
"What obligations are being assumed?"
This is perhaps the most important question. Defining the scope of the indemnity allows the parties to understand exactly what sort of liability they are taking on, and exactly what liability they are sending away. Bodily injury or death claims? Property damage? Government fines and penalties?1
"Whose claims and losses are being assumed?"
The second major question determines the breadth of the promises being made. Is the indemnitor only promising to protect its indemnitee(s) from its own losses? How about the losses of its employees or other contractors or subcontractors? Its customers? Its customer's other contractors and subcontractors? What about claims by true third parties? The indemnitor must be extremely vigilant about the promises it makes with respect to the claims it is picking up. If the indemnitor cannot effectively insure the risks it assumes, how can it expect to pay for those liabilities if they materialize?
"To whom is protection owed?"
The third and last structural question of any individual indemnity is how far does the obligation go? Who are the indemnitees? Generally speaking, each additional indemnitee expands the risk the indemnitor is assuming as each additional indemnitee is...
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