Abstract

Oil and gas services by their inherent nature are a very risky industry. The parties involved need to be careful while contracting and undertaking obligations. Through these obligations arise risks. It is important for parties to understand such risks and take appropriate measures to mitigate the same.

Knock-for-Knock indemnity is one such measure through which operators and contractors allocate risk and plan risk mitigation measures. Knock-for-knock indemnity is a reciprocal indemnity given by parties wherein each party is responsible for any losses that are caused to its own personnel and any damages that are caused to its own property.

The prime benefit of Knock-for Knock Indemnity is the reduced insurance cost wherein each party is ensuring its own personnel and property.  Additionally, parties save time and money as they are not required to establish fault to claim indemnity.  This principle of Knock-for-Knock Indemnity is the exact opposite of a Fault-based regime. 

While drafting Knock-for Knock Indemnity, one must appropriately define the “indemnified party” as the same would determine the scope of coverage. A few additional points to be kept in mind are the exclusions to such scope. Parties should beforehand decide whether they would like to include/exclude losses arising from gross negligence, wilful misconduct, material breach of contract and/or statutory obligations, consequential losses, etc. While knock-for-knock is a prevalent practice in the Oil and Gas sector, the concept itself is untested in many jurisdictions. Hence, it is very important to draft such clauses with great precision.

Introduction

Meaning:

The term indemnity is a concept where one party undertakes to make good for the losses that are caused to the other party.

Under theIndian Law, the Contract of Indemnity is defined as a contract by which one party guarantees to save the other person from loss caused to him by the action of the guarantor himself, or by the action of any other person.

The indemnity clause, therefore, determines which party shall bear risk under what circumstances. The clause also covers the nature of claims.

A Knock-for-Knock indemnity is a subset of indemnity wherein one party undertakes to indemnify the other party against any claims that arise from death or injury to its personnel, damage to its own property irrespective of the fact that by whose fault the damage or injury has resulted from.

This concept is prevalent in the oil and gas industry where operators of the oil platforms and their contractors’ performing services on such platforms undertake Knock-for-Knock obligations. More than the concept of “make good”, the principle behind this concept is the identification and allocation of risk associated with the contract. The logic behind this concept is that the magnitude of risk involved in oil and gas sector contracts is very high. Considering the performance capabilities, financial strength, scope of work, and profits margins of the small contractors, it is unfair to impose an indemnity on a contractor wherein he is liable for anything that goes wrong in the whole operations. Hence, the parties opt for Knock-for-Knock indemnity wherein each party is responsible for claims arising from its personnel and property irrespective of the fault.

Ingredients

1) It is a mutual indemnity where each party indemnifies the other one and is reciprocal in nature.

2) Parties shall compensate each other for the losses that arise from:

a. Damage to its own property

b. Death or injury of its own personnel 

Each party is responsible for any other third-party claims and the same shall be determined based on negligence or breach from such party.

3) This concept is the exact opposite of a fault-based regime wherein a party at fault is required to indemnify the other party. Under Knock-for-Knock indemnity, a party is required to indemnify for claims arising from its personnel and property irrespective of the fault.

4) The injured party is compensated. Only the party compensating for such losses change.

5) The definition of the indemnified party would usually include each party’s contractors and affiliates (usually defined as “Indemnified Group”). This plays a factor in determining the scope of Knock-for-Knock indemnity.

6) Upon risk allocation, the Parties will either mitigate such risk by insurance or could self-insure themselves.

Benefits of Knock-for-Knock vis-à-vis Fault-based Indemnity

Advantages of Knock-for-Knock regime:

1) This system helps in risk identification and allocation to a definitive party. This is beneficial both for the indemnifying party and the claimant. Indemnifying can do a better risk assessment and accordingly take steps toward risk mitigation through third-party insurance or self-insurance. For the injured party/claimant, receipt of an expeditious payment is useful.

2) Parties do not waste resources (time and money in litigation) to establish fault since the indemnity is determined by who is being indemnified rather than whose fault is it.

3) Avoidance of double insurance by both parties, for the same subject matter, is one of the biggest benefits of this regime. Considering that the cost of insurance would ultimately be built in the project cost, results in eventual cost reduction in the project.

Disadvantages of Knock-for-Knock regime:

1) The flaw with the Knock-for-Knock arrangement is the very principle that a party is being liable for damage that has not resulted from its fault or non-performance. In this no-fault regime, a party is liable to indemnify the other party even if such indemnified party could have been grossly or contributorily negligent.

2) The Knock-for-Knock has certain industry recognised exceptions (detailed down in the section below). If such exceptions form a part of the clause, either party could be held liable for losses; hence, both the parties are forced to take insurance. This would also result in increased litigation in order to establish which party is at fault. This could generate additional costs and be time-consuming.

Fault-based vs Knock-for-Knock:

Subject matter

Knock-for-Knock

Fault-based

Concept

Each party is responsible for the losses its personnel has sustained or damages that have been caused to its own property.

The party responsible for causing losses is required to indemnify the losses.

Who shall be the indemnified

Injured party i.e., the party that

suffered the loss.

Who shall be the indemnifier

Based on the identity of the injured person, each party is responsible for its own personnel even if such damage has resulted due to default on part of another party.

Party at fault or in breach of duty or who has been negligent.

Liability under law

Knock-for-Knock indemnities often reverse the background law, protecting an otherwise responsible party from liability.

Fault-based regime more closely mirrors what a party would be typically liable for as per the law.

Drafting Considerations

While drafting a Knock-for-Knock indemnity following considerations should be kept in mind by the drafter:

1) Definition of “Indemnified Parties”

This definition would determine the scope of the indemnity. Would only the contracting party be entitled to indemnification or would it include the contracting party’s directors, employees, its affiliates, its other contractors working on-site, and their employees and directors? Usually while drafting such a clause, parties define a contractor and client as “Group”. These definitions of “Group/s” determine the scope for indemnities provided.

Primary parties and their employees and sub-contractors constitute a “Group” for the purposes of risk allocation. Group members have the same protection as the primary parties; damage and loss suffered by a member of the primary party’s group is borne by that primary party, regardless of fault;

The primary party agrees to indemnify other primary parties and their groups against any liability for claims by the indemnifying party’s group, irrespective of fault; and primary parties should have insurance to protect them and their group against losses and to underwrite their obligation to indemnify other primary parties and their groups.

Additionally, parties need to clearly lay down in the contract if the Knock-for-Knock Indemnity should cover losses arising from the third party i.e., parties other than defined as “Group”.

2) Type of losses covered under Knock-for-Knock Indemnity:

Parties need to expressly define and limit the Knock-for-Knock indemnity to certain specific kinds of losses. A few of the commonly accepted losses for this indemnity are:

  • death/personal injury to party’s personnel
  • damage to property
  • losses resulting from environmental harm
  • indirect or consequential losses resulting from acts of other parties

3) Exclusions:

The courts in almost all the jurisdictions interpret Knock-for-Knock indemnity objectively wherein the words of the contract are considered as the intention of the parties. This would imply that the other side would not be held liable in an absolute sense even if such party has been negligent or has breached its obligations or has contributed to the accident that has resulted in losses.  Hence, it becomes important to lay down exceptions to the said Knock-for-Knock indemnity clause. Few of the common exceptions which party should consider while drafting this clause are:

a) Gross negligence/negligence/Wilful misconduct:

While the term “Gross Negligence” is not defined under many jurisdictions including India, England, Australia, US courts have recognised it as conduct, that is so careless as to show a complete disregard for the rights and safety of others or conduct that is ‘truly culpable or harmful conduct’.

Gross negligence is basically a higher degree of negligence. Whereas to understand the concept of negligence an ordinary man’s prudence in a particular situation is looked upon, in case of gross negligence that bar is further lowered to more serious disregard to one’s duty or obligations.

Wilful misconduct as the word suggests, involves intent to conduct a wrong act.

These are traditionally considered as exceptions for Knock-for-Knock indemnity and are required to be expressly stated in the agreement amongst the contracting parties.  

b) Material breach of contract:

The term material breach of the contract would imply a breach that is serious in the widest sense of having a serious effect on the benefit which the other party would, absence of such a breach, derive from the contract.

The issue at hand is, would a material breach make the contract voidable at the option of the other party hence, releasing such other party of its obligation to indemnify. Courts in different jurisdictions have taken different stand on the subject matter and hence, if the intent of the parties is to carve it out as an exception, it is best to expressly state the same.

c) Statutory or strict liability:

Statutory liabilities are the liabilities that are arising as a result of non-compliance with the laws of the land. The primary objective for the imposition of statutory liability is to encourage parties to comply with the obligations and fulfil the compliances as are required under applicable law. If parties are allowed to get indemnified for such losses based on no fault of the other party, this would frustrate the whole purpose behind the law. Hence, civil and criminal penalties arising out of breach of law or statutory obligations should be treated as an unwritten exception to the Knock-for-Knock clause.

Additionally, courts will not generally allow indemnities to extend to criminal penalties if they offend public policy even if the same is expressly not carved out in the agreement. The Deepwater horizon case is one such example where public liability was given preference over what was specified in the agreement between the parties.

d) Consequential losses:

Consequential damages are indirect claims and are not a result of the breach but as a consequence of the breach.

Exclusion of consequential losses is usually done through a catch-all provision, where a party states that it shall not be liable for consequential losses caused to the other party.

Courts across have given varied interpretations of such exclusion of consequential losses from Knock-for-Knock indemnity, particularly, when it is mentioned as a catch-all clause and not as an exception for the Knock-for-Knock clause. Additionally, excluding consequential losses frustrates the whole benefits and reasoning behind Knock-for-Knock provisions i.e., allocation of risk, reduction of multiple insurances, and avoidance of litigation.Industry experts have advised against the insertion of this exclusion in order to keep things uncomplicated and easy to interpret.

Incidents

1)Piper Alpha

Piper Alpha was Britain’s biggest single oil and gas producing platform, producing 10% of the country’s total crude oil production. The platform was owned by a consortium including Texaco and was operated by Occidental. On 6 July 1988, 167 workers were killed on the Piper Alpha. Occidental settled claims by victims totalling £66m.

Subsequently, Occidental instituted proceedings against contractors seeking to enforce indemnities.  The contract between Occidental and contractor had a Knock-for-Knock indemnity clause whereby each party was liable for death and injury of its own personnel except for in a case where such damages have resulted solely from sole negligence or wilful misconduct of indemnified party. The contractor had put forth that contractor should only be liable to indemnify the Operator only in case of breach of its statutory duty or negligence on part of the contractor. The court upheld the Knock-for-Knock clause and held that irrespective of fault on part of the contractor, the contractor shall be responsible for claims arising from the contractor’s personnel.

2)DEEPWATER Horizon

The Deepwater Horizon, a mobile offshore drilling unit (“MODU”), was owned and operated by the Transocean entities as vessel owner-contractor and leased by BP as client-operator. From February 2010 until April 2010, the Deepwater Horizon was engaged in drilling activities on the Macondo Well.

On April 20, 2010, while the Deepwater Horizon was preparing to temporarily abandon the well, a blowout of the Macondo Well occurred, resulting in explosions and fire on Deepwater Horizon. MODU sank into the Gulf of Mexico, breaking the riser pipe that connected the MODU to the Macondo Well in the process. Oil flowed from the Macondo Well, up the wellbore, through the blowout preventer and remaining segment of the riser pipe, and into the Gulf of Mexico, and continued to do so until July 15, 2010. This resulted in the loss of life of 11 personnel and hugeenvironmental damages.

In addition to multiple legal issues that surfaced in this case, the primary liability of each party was determined in accordance with the Knock-for-Knock clause wherein each party was responsible for its own personnel and property.

BP had raised a contention that the Knock-for-Knock indemnity is void since Transocean was in material breach of its obligations and hence, BP is not obligated to indemnify Transocean. While the court agreed that there has been a material breach on part of Transocean, this cannot absolve BP of their indemnity obligation in this particular case due to various other factors that have contributed to the incident.

Additionally, the contract clearly stated and identified the party that shall be liable for sub-surface pollution. Transocean agreed to indemnify BP for above-surface pollution regardless of fault, and BP agreed to indemnify Transocean for all pollution risk Transocean did not assume, i.e., subsurface pollution.

Conclusion

Having a Knock-for-Knock clause is an accepted industry standard for oil sector services contracts. These are common features of standard terms and conditions issued by the Indian Public sector undertaking operating in oil sector services. 

The parties covered under the indemnity/definition of “group” should be clearly defined.

The purpose of this regime is to provide certainty to the claimant as well as the risk bearer. This definitely helps an organisation to plan and mitigate its risk and avoid resource-consuming litigations.

While Knock-for-Knock indemnity has been tested and clearly accepted by English and Australian courts, this concept is in a very immature stage in some jurisdictions. Some jurisdictions are moving towards accepting this principle like Canada, it might go unrecognised and unenforceable in some jurisdictions because of its nature being opposite of the principle of fault-based liability. Hence, it is important to understand and define the scope of such indemnities, carve out exceptions and state them clearly in the contracts.

About the Authors 

Ms. Medha Chhabra is Asst. General Manager – Legal at Godrej & Boyce Mfg. Co. Ltd.

Editorial Team 

Managing Editor: Naman Anand 

Editors-in-Chief: Jhalak Srivastav and Aakaansha Arya 

Senior Editor: Gaurang Mandavkar 

Associate Editor: Naman Jain

Junior Editor: Harshita Tyagi

Preferred Method of Citation  

Medha Chhabra, “Knock-for-Knock Indemnity in Oil and Gas Sector” (IJPIEL, 16 February 2022) 

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