Wednesday, March 5, 2014 Houston, TX. 3:15 4:30 p.m. RISK ALLOCATION IN MASTER SERVICE AGREEMENTS AND DRILLING CONTRACTS

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1 Wednesday, March 5, 2014 Houston, TX 3:15 4:30 p.m. RISK ALLOCATION IN MASTER SERVICE AGREEMENTS AND DRILLING CONTRACTS Presented by William W. Pugh Shareholder Liskow & Lewis John G. Almy Shareholder Liskow & Lewis Drilling contracts and master service agreements (MSAs) are key contracts that allocate risk and insurance purchasing responsibilities in the oil patch. While drilling contracts have been standardized to a large extent, there is much variation in approaches to MSAs, which are increasingly used by operators to facilitate the rapid engagement of contractors. This session will explore the common approaches to risk allocation in these agreements, including the operation of anti-indemnity statutes and approaches to insurance provisions. Then, using mock negotiations of the different provisions, the session will outline best practices for contract and insurance provisions. 1

2 Notes This file is set up for duplexed printing. Therefore, there are pages that are intentionally left blank. If you print this file, we suggest that you set your printer to duplex. 2

3 William W. Pugh Shareholder, Houston Liskow & Lewis Mr. Pugh chairs Liskow & Lewis s Houston office and serves as a member of its Board of Directors. In his practice, he handles a wide variety of maritime and energy-related cases including contract disputes, products liability cases, insurance disputes, and casualties. He has extensive experience analyzing, drafting, and reviewing energy-related contracts and insurance, indemnity, and other contract issues. His practice background also includes master service agreements, onshore and offshore drilling contracts, charters, flight service agreements, and onshore and offshore construction contracts. Mr. Pugh works with companies, both domestically and internationally, to develop comprehensive contracts that maximize the company s risk allocation, including indemnity and insurance protection. Mr. Pugh maintains an active seminar and speaking schedule. He has given numerous presentations on issues related to insurance and risk allocation in the energy industry and speaks before leading professional and legal organizations. He has also helped clients, internationally and domestically, integrate their contracts, both internally and following mergers or assignment of contracts (such as drilling contracts). Mr. Pugh is currently serving as a member of the Council of the Oil, Gas and Energy Resources Law Section of the State Bar of Texas. In addition, Mr. Pugh previously participated in drafting the 2002 AIPN International Model Well Services and Seismic Agreements, and he is currently co-chair of the AIPN Model Contract Committee, which is drafting an international drilling contract and reviewing the 2002 Model Well Services and Seismic Agreements. Mr. Pugh received his undergraduate degree from the University of Virginia and his J.D. from Louisiana State University. At LSU, he was editor-in-chief of Louisiana Law Review. 3

4 John Almy Shareholder, Houston Liskow & Lewis Mr. Almy is a shareholder in the firm s Houston office and works with the firm s Maritime, Oilfield, and Insurance and Complex Business, Bankruptcy, and Utility Litigation sections. His practice focuses on the negotiation of oilfield operational contracts such as drilling contracts, master service agreements, and master time charters. He also deals with bankruptcy matters and has experience with Chapter 7 liquidations and Chapter 11 reorganizations. Mr. Almy also works on casualty, insurance, and indemnity litigation matters. He received his law degree in 2005 from the Washington and Lee University School of Law, where he was a member of the Washington and Lee Law Review. Prior to law school, Mr. Almy taught high school and coached lacrosse in the Houston Independent School District. 4

5 Risk Allocation in Master Service Agreements and Drilling Contracts: You Can t Always Get What You Want, But It s Good To Know How To Get What You Need Presented By: wwmi 1 William W. Pugh and John G. Almy Shareholders Liskow & Lewis IRMI.IR wwmi w. 1 Overview General principles Effect of indemnity structure Insurance protections Restrictions on indemnity and insurance Mock negotiation of indemnity and insurance provision in an MSA Discussion of potential scenarios IRMI wwmi 2 5

6 6 wwmi ww ww ww ww www. IR IR IR IRMI MI MI MI MI c.c om om om om IRMI General Principles 3 wwmi ww ww ww ww www. IR IR IR IRMI MI MI MI MI c.c om om om om IRMI Indemnity/Release π Principal Demand (Indemnity) Indemnitee Indemnitor Releasee Releasor Indemnity Release 4

7 Recovery of Fees/Costs Defense Costs Maritime and Texas: Duty to indemnify includes duty to defend Louisiana: Only if expressly provided for by contract Fees/Costs Incurred Pursuing Indemnification Only if expressly provided for by contract IRMI wwmi 5 Indemnity Must Haves Must have valid magic language to obtain indemnity for one s own negligence IRMI wwmi 6 7

8 Coverage for Your Own Negligence Maritime: Clear and unequivocal Louisiana: Unequivocal Texas: Express negligence Fair notice and conspicuousness IRMI wwmi 7 Randall v. Chevron (5th Cir.) (maritime law) Owner hereby agrees to defend, indemnify and hold harmless Company against all claims for damages, whether to person or property, and howsoever arising in any way directly or indirectly connected with the possession, navigation, management, and operation of the vessel. HELD: Provision did not adequately express parties intent to cover indemnitee s negligence. IRMI wwmi 8 8

9 Smith v. Shell (5th Cir.) (Louisiana law) Contractor shall defend and indemnify Company, its employees, and agents, against all losses, claims, suits, liability, and expense arising out of injury or death of persons or damage to property resulting from or in connection with performance of this order and not caused solely by Company s negligence. HELD: Sufficient to include concurrent negligence of indemnitee. IRMI wwmi 9 Singleton v. Crown Central (Tex. Sup. Ct.) (Texas law) indemnity for any and all claims, demands, of every kind and character whatsoever, excepting only claims arising out of accidents resulting from the sole negligence of Owner HELD: Did not satisfy Texas express negligence test; only specified what was not included and did not expressly say concurrent fault included. IRMI wwmi 10 9

10 Conspicuousness (Texas) Magic Language needs to be somehow set off from the rest of the contract All caps Bold font Bigger font Separate paragraph/separate heading But, showing of actual knowledge that indemnity includes indemnitee s own negligence is sufficient IRMI wwmi 11 Indemnity Must Haves Must have valid magic language to obtain indemnity for one s own negligence Indemnity wording should expressly address certain categories of fault other than negligence IRMI wwmi 12 10

11 Indemnity for Fault Other Than Ordinary Negligence Sole or concurrent negligence Strict liability Unseaworthiness Preexisting conditions Gross negligence IRMI wwmi 13 Gross Negligence/Punitive Damages Maritime law: Recent Deepwater Horizon ruling states indemnity for gross negligence (as opposed to release) is not against public policy under maritime law, but indemnity for punitive damages is. Louisiana law: Civil Code art precludes release of gross negligence; unclear for indemnity, especially after Deepwater Horizon ruling. Texas law: Not clear whether indemnity for gross negligence available. Insurance: Insurance for punitive damages allowed where not excluded by policy terms (maritime and La.; maybe in Tex.). IRMI wwmi 14 11

12 Indemnity Must Haves Must have valid magic language to obtain indemnity for one s own negligence Indemnity wording should expressly address certain categories of fault other than negligence Be aware of any issues relating to the scope of the indemnity or the scope of the MSA IRMI wwmi 15 Vessel Operations Present Special Issues If Maritime Law Applies Lanasse: indemnity for claims directly or indirectly connected with the possession, navigation, management and operation of the vessel Smith: indemnity for any claim that arises out of or is incident to the performance [of the charter] Platform owner wears two hats: 1. Vessel charterer 2. Platform owner IRMI wwmi 16 12

13 Lanasse and Smith Indemnitor (No Indemnity Owed) Indemnitee 100% IRMI wwmi 17 Remedy for Lanasse Issue Contract wording should expressly include indemnity for: loading and unloading of cargo ingress and egress IRMI wwmi 18 13

14 Sample Indemnity Contractor shall release, defend, indemnify and hold the Company Group harmless from and against any and all claims, damages, liabilities, and expenses (including attorneys fees and all costs of defense) for bodily injury to, illness or death, or any damage to or loss of property, of any member of Contractor Group to the extent such bodily injury, illness, death, damage or loss arises out of or is incident to the performance of the Services, including loading, unloading, ingress, and egress of personnel or cargo, regardless of the cause, even though caused in whole or in part by a preexisting condition, orthenegligence (sole or concurrent), strict liability, or the unseaworthiness, unairworthiness or defective condition of vessels, craft or premises owned, supplied, hired, chartered or borrowed under other agreements or otherwise of or by Company Group, excluding in each case to the extent that such injury, illness, death, damage, or loss was caused or contributed to by the gross negligence or willful misconduct of the party seeking defense, indemnity or release. IRMI wwmi 19 Indemnity Must Haves Must have valid magic language to obtain indemnity for one s own negligence Indemnity wording should expressly address certain categories of fault other than negligence Be aware of any issues relating to the scope of the indemnity or the scope of the MSA Indemnity must be broad enough to extend to all intended beneficiaries: pass-through indemnity IRMI wwmi 20 14

15 Indemnity Structures IRMI wwmi 21 Major Contract Is Key Driver Essential contract for operator Likely a broad reciprocal indemnity Drilling contractor will want indemnity for operator s people and property and people and property of operator s other contractors With broad reciprocal in drilling contract, operator will owe indemnity to drilling contractor every time there is an accident IRMI wwmi 22 15

16 Contractor s View COMPANY CONTRACTOR OTHER CONTRACTORS SUBCONTRACTOR IRMI wwmi 23 Operator s View Company Mud Logging Contractor Subs, if any Drilling Wireline Vessel Casing Helicopter IRMI wwmi 24 16

17 Drilling 16 2/3 % Wireline 16 2/3 % 16 2/3 % Mud Logging Company Helicopter 16 2/3 % 16 2/3 % Vessel 16 2/3 % Casing IRMI wwmi 25 Pugh Wheel (basic) Pass-Through Drilling 16 2/3 % Wireline 16 2/3 % 16 2/3 % Mud Logging Company Helicopter 16 2/3 % 16 2/3 % Vessel 16 2/3 % Casing IRMI wwmi 26 17

18 What Happens without a Pass-Through Provision? For every instance in which company owes a broad reciprocal indemnity, but the underlying contract has no pass-through provision, company has no recourse IRMI wwmi 27 Foreman v. Exxon: Contractual Situation Diamond M (Indemnity) Exxon Caterer Offshore Wireline Contractor Vessel (Charter) Employee IRMI wwmi 28 18

19 Foreman v. Exxon: Contractual Situation Diamond M (55%) (Indemnity) Exxon (10%) Caterer Offshore (35%) Wireline Contractor Vessel (Charter) Employee IRMI wwmi 29 Foreman v. Exxon: Result Diamond M (85%) (55%) (Indemnity) Exxon (15%) (10%) Caterer Offshore (35%) Wireline Contractor Vessel (Charter) Employee IRMI wwmi 30 19

20 Exxon (85%) (55%) Foreman v. Exxon: Result (Indemnity) Offshore (15%) (10%) Caterer Offshore (35%) Wireline Contractor Vessel (Charter) Employee IRMI wwmi 31 Options for Obtaining a Pass-Through Require indemnity for any contractual liability to third parties Specify that indemnity is owed to indemnitee and anyone to whom the indemnitee owes contractual liability Use company group definition to expand the indemnitee to include contractors, subcontractors, and others IRMI wwmi 32 20

21 Insurance Must Haves IRMI wwmi 33 Three Necessary Protections Waiver of subrogation Additional insured Additional assured coverage should be primary, at least for risks assumed Additional insured coverage should extend all protection to Company Group (or cover insurance pass-through in a different way) Insurance requirements should dovetail with indemnity provisions IRMI wwmi 34 21

22 Insurance as a Limit on Indemnity Dickerson case: Contract required the contractor to maintain insurance with limits of not less than $ to cover all obligations imposed by the indemnity. Held to limit indemnity to amount of insurance required. Easily resolved with sentence stating the minimum insurance limit requirements are not intended to limit the extent of contractor s indemnity. IRMI wwmi 35 Ogea and Tullier: Insurance First, Then Indemnity Where the indemnity portion of a contract required one party to indemnify the other, but the insurance section required that the indemnitor be named as an additional insured in the liability policies maintained by the indemnitee, Fifth Circuit held the insurance obligation primary and the indemnity obligation secondary. Avoid the potential problem by limiting the additional insured coverage to the extent of liabilities assumed under the contract. IRMI wwmi 36 22

23 Maritime Insurance Endorsements Protection and indemnity (P&I) policies typically provide coverage to an insured in its capacity as owner of one or more vessels. Where an oil company/platform owner is named as an additional insured in a vessel owner s P&I policy, the as owner language in the policy serves to limit the oil company s coverage to liability incurred in its capacity as charterer of the vessel (but not as platform owner). Must have endorsement to provide full coverage to group regardless of any as owner coverage limitation. Must have endorsement preventing reduction of limits available to group even if owner can limit liability. IRMI wwmi 37 23

24 Restrictions on Indemnity and Insurance IRMI wwmi 38 Texas Oilfield Anti-Indemnity Act (TOAIA) Applies to property damage and personal injury/death Exceptions for indemnity supported by insurance Unilateral indemnity ($500,000) Mutual indemnity (up to amount of insurance obtained for the benefit of the other party as indemnitee ): no longer required to specify equal amounts Unilateral and mutual indemnities have specific definitions. Unclear whether a failed mutual leaves nothing or possibly $500,000 under unilateral. IRMI wwmi 39 24

25 Getty Oil Co. v. Insurance Co. of N. Am. In the event an indemnity obligation fails, the insurance that supports it fails as well If there is a second, separate obligation to procure insurance, that obligation will be enforceable. IRMI wwmi 40 Longshore and Harbor Workers Compensation Act Maritime indemnities are generally enforceable except that 33 U.S.C. 905(b) prohibits an indemnity claim by a vessel against the employer of an injured longshoreman BUT, insurance is fully enforceable, and mutual indemnity on OCS is enforceable IRMI wwmi 41 25

26 Louisiana Oilfield Indemnity Act (LOIA) LOIA restricts indemnity and insurance LOIA only applies to contracts pertaining to a well Applies to personal injury/death, not property damage Additional insured endorsement invalid unless indemnitee pays the premium for the endorsement under Marcel v. Placid Oil Co. Compare Amoco v. Lexington (La. App.) with Rogers v. Samedan (5th Cir.) IRMI wwmi 42 Meloy and Actual Negligence LOIA prevents receiving indemnity for bodily injury arising out of the indemnitee s own negligence If the indemnitee can show it was not negligent, it can recover its defense costs Split between federal and state courts on settlement and litigating negligence later (Feds no, state yes) Immediately tender to maximize amount of recoverable attorneys fees IRMI wwmi 43 26

27 Marcel v. Placid Oil Judge made law, not statutory Not an exception, merely a workaround Party wishing to get insurance must pay all material costs of extending the insurance Cannot handle payment as a bookkeeping exercise; someone must pay the underwriter or broker Can turn into administrative nightmare IRMI wwmi 44 LOIA Personal Injury Property Damage Additional Insured LOIA v. TOAIA TOAIA Personal Injury Property Damage Additional Insured Supported by Insurance Supported by Insurance (Mutual/Unilateral) IRMI wwmi 45 27

28 Mock Negotiation of an MSA IRMI wwmi 46 Indemnity Structure Company wants a modified indemnity where contractor indemnifies company s broad group (including company s other contractors and subcontractors) for the people and property of contractor s broad group, but company wants to indemnify only for its own people and property Contractor would like a full broad reciprocal indemnity IRMI wwmi 47 28

29 Carve Outs Contractor requests the following carve outs Loss or damage to downhole tools Loss or damage to its equipment resulting from sound location issues or damage caused by company s helicopters or supply vessels Loss or damage arising out of pollution events Loss or damage arising out of catastrophic events like blowouts, fire, explosions, etc. Protection from consequential damages Contractor requests a cap on its overall liability IRMI wwmi 48 Insurance Issues Company wants contractor to comply with company s insurance requirements IRMI wwmi 49 29

30 Additional Insured Requirement... name Company Group as additional insured on all insurance policies of Contractor, whether or not required by the contract, on a broad form basis without restriction for the sole or concurrent negligence of the additional insureds and not being restricted (i) to ongoing operations, (ii) to coverage for vicarious liability, or (iii) to circumstances in which the named insured is partially negligent IRMI wwmi 50 Contractor s Concerns Scope of additional insured coverage? Also concerned re: Marcel requirement? Maritime endorsements Reciprocal coverage? IRMI wwmi 51 30

31 Some Examples IRMI wwmi 52 Factual Scenario Acme Oil hires Big Drill drilling contractor Big Drill jack-up is damaged by SS Minnow Rig is badly damaged ($15 million in repairs) and will take 90 days to repair SOS Wireline employee is injured Rig leg has damaged a nearby pipeline What are the issues? IRMI wwmi 53 31

32 Exploration Drilling Rig: Broad Reciprocal Fast Helicopter SuperDuper/ p SOS Big Drill (Damage to rig) Acme Oil Slow & Steady Cement Co. IRMI wwmi Slick Vesselsel 54 SOS employee SuperDuper (SOS) Big Drill Acme Oil SS Minnow, Inc. IRMI wwmi Pipeline Owner 55 32

33 SOS employee SuperDuper (SOS) Big Drill Acme Oil SS Minnow, Inc. IRMI wwmi Pipeline Owner 56 33

34 Conclusion IRMI wwmi 57 Conclusion Understand the basics Choose your indemnity structure wisely Anticipate potential exposures and problems Choose the best option under the circumstances If there is a problem, be creative and learn to cope IRMI wwmi 58 34