Reciprocal indemnification agreements in the oil industry: the good, the bad and the ugly.

• Author: Evans, Christopher L.

RECIPROCAL or mutual indenmity agreements, (1) often referred to as "knock for knock" agreements, are frequently used in the oil industry to allocate risk by contract, rather than through the vagaries of the legal system. Under these agreements, "each party (as 'indemnitor') agrees to indemnify the other party ('indemnitee') and the indemnitee's contractors for claims arising from injuries to the indenmitor's employees, regardless of fault." (2) In other words, each party agrees to take full responsibility for all bodily injury or property damage claims made by its own employees, regardless of which party may actually be responsible for the injury.

While a contractual allocation of risk based on who makes the claim, rather than who is at fault, is contrary to the traditional risk allocation method under our legal system, such agreements can be very beneficial to both parties. The fact that mutual indemnity agreements have been and remain so popular in the oil industry attests to the beneficial aspects of such agreements. Unfortunately, as in the movies, good things often bring with them bad and sometimes ugly consequences. Accordingly, this article discusses some of the pros and cons of reciprocal indemnity agreements and finishes by briefly reviewing recent cases where courts in Texas have interpreted indemnity arrangements in interesting ways.

1. The Good--Benefits of Reciprocal Indemnity Agreements

   Reciprocal indemnity agreements offer several significant benefits to contracting parties. The specific benefits enjoyed by contracting parties will often depend on the circumstances applicable to the object of the agreement. However, as a general rule, such agreements can reduce costs to both parties, help to strengthen the relationship between contracting parties and allow parties to work together against a common enemy, rather than against each other.

   1. Reduced Costs

      Even without complications, the search for oil and gas is expensive and always involves risk. Litigation inevitably increases the cost of the effort. Accordingly, one of the primary benefits of reciprocal indemnity agreements can be a reduction in cost to both parties.

      When parties enter into a knock for knock agreement, potential liability is established at the time of contract for both parties through the contract. If an accident occurs causing an injury to the employee of either party to the agreement, the parties can avoid disputes between themselves regarding their relative responsibility for the accident. As between the two parties to the contract, the reciprocal agreement will have already established liability--Company A will be responsible for all claims made by its employees, and Company B will be responsible for all claims made by its employees--regardless of who is at fault. The parties can, therefore, avoid costs that might otherwise be incurred to establish their respective responsibility.

      Furthermore, a reciprocal indemnity agreement allows one party to take over responsibility for both contracting parties and retain one lawyer to defend both parties. For instance, if an employee of a contractor for Company A is injured as a result of an accident caused by both Company A and Company B, the third party contractor employee would generally bring suit against both companies to determine liability. In maritime cases, where the employer is not protected by workers' compensation laws, suit is often filed directly against both companies by their own employees. In either case, without a reciprocal agreement, both companies would have to hire their own attorneys and incur the cost of separate defenses. However, if the parties had in place a reciprocal indemnity agreement, one attorney would be able to defend both parties. Thus, mutual indemnity agreements not only diminish the need for litigation between the contracting parties, but can also reduce overall litigation costs, should suit arise.

   2. Intangible Benefits

      Along with reducing costs, there are a number of important intangible benefits that come with reciprocal indemnity agreements. Knock for knock agreements help decrease friction between the contracting parties, not only by establishing liability of both parties at the time of contract, but also by establishing a level of certainty to both parties with regard to their liability exposure. (3) Furthermore, such agreements allow parties to work together to create a safer workplace for all employees.

      When two parties enter into a reciprocal indemnity agreement, they promise to hold each other harmless for their own employees' claims. In return, each party is freed from the burden of liability for claims by the other party's employees. This practice of pre-setting liability reduces friction between parties by decreasing the likelihood of future litigation between the contracting parties. The parties are freed up to concentrate more on their business relationship without worrying about having a dispute if something goes wrong and an employee of either party is injured.

      Moreover, a reciprocal indemnity agreement "provides a level of certainty to all of the parties regarding liability exposure" that is not otherwise available. (4) An oil rig is often times a common workplace for employees of several different companies and, without a reciprocal indemnity agreement, each party is potentially liable for claims by any of the other companies' employees. Accordingly, while each company can help protect itself from liability by properly training and managing its own workers, there is often little it can do with regard to the employees of other companies. Uncertainty about liability exposure can translate into higher costs for all involved.

      By establishing in advance their relative exposure to liability for worksite accidents, the parties to a reciprocal indemnity agreement can better manage their costs. For example, each party can better determine the amount and cost of the insurance they will need for the job by simply knowing how many people will be at the work site that fall under the contracting party's scope of liability. A contracting party with fewer workers at the site for whom the party is legally responsible will have a relatively smaller exposure than a company that has many workers at the site who might be injured if an accident occurs.

      Finally, concerns about potential legal responsibility for safety issues are reduced when parties enter into a reciprocal indemnity agreement. When the liability of the parties involved is determined not by relative fault, but by the more random chance of who the person is that is injured, the parties are in a better position to work together on safety matters. Both parties have an equal incentive to make the work place safe for all, because either party can be responsible for an accident, even if it was not their fault. Further, the parties can work together to institute safety policies without concern that the party responsible for a particular safety policy will increase their relative responsibility for any potential liability that might arise if the safety policy they were responsible for is violated and someone is injured.

   3. A United Front

      When two parties contract with each other, they hope to form an amicable working relationship based on common interests and goals. Such a relationship facilitates all future agreements, meetings, and joint operations between the parties. However, when an accident occurs at a job site where the parties have not agreed in advance on their respective liability, an amicable working relationship can come undone in a hurry. Two parties that once worked side by side to accomplish the same goal will often be forced to point fingers at each other. Trying to establish another party's responsibility for an accident is not at all...