Risk Allocation in Offshore Construction Contracts 0

Transcription

1 0 24 October 2013

2 Allocation of Risk Issues in Offshore Construction Contracts Asia Offshore Energy Conference 2013 Mark Errington 24 October 2013

3 Risk Allocation - General Standard approach to risk allocation in offshore construction contracts Consideration of the scope and effect of exclusions for consequential loss 2 24 October 2013

4 Contract wordings Most common form of (head) contract is the Engineering, Procurement and Construction (EPC) contract (between the oil company / operator and principal contractor) Variants include EPIC (including installation) and EPCC (including commissioning) Oil companies have their own preferred / standard forms of contract wording (and there can be significant variations between wordings) The key characteristic of the risk regime is that (with the exception of the permanent works) parties typically agree to bear liability for their own property and personnel as well as for their own consequential losses 3 24 October 2013

5 Risk of loss or damage to contract works Typically risk of loss or damage to the permanent works (before handover) lies with Contractor LOGIC s Standard Conditions for the UK Offshore Oil and Gas Industry, General Conditions of Contract (Edition 2, October 2004) provide: Subject to the provisions of Clause 24.2 [damage by war risks; force majeure; negligent act or omission by Company Group]... the Contractor shall be responsible for the Permanent Work from [Commencement] until the Completion Date of the relevant part of the Permanent Work... Before the Completion Date in the event of loss or damage to the relevant part of the Permanent Work, the Contractor shall, if instructed by the Company, reconstruct, repair or replace the same... Typically this allocation of risk of loss also applies to Company provided items in the possession/control of the Contractor 4 24 October 2013

6 Risk of loss or damage to contract works However Contractor s liability for damage to the permanent works often capped in the contract Cap will often be at the level of the CAR policy deductible (with the policy effected for all parties and naming the Contractor as an additional insured) Such liability caps are not however universal and contracts may provide for example that: Neither the cover nor any limits of the cover... shall be construed as exemptions or limitations of the Contractor s liabilities under the Contract. The Contractor shall... be liable for the full amount of the loss including but not limited to the amount in excess of the Contractor s or Owner s insurance cover and including the amount of any deductible specified in Contractor s or Owner s insurance cover October 2013

7 Risk of Damage to other property; personal injury; third party risks; and consequential loss Knock for knock regime. There is typically a scheme of mutual indemnities in respect of other risks, namely: damage to property (non-permanent works); Injury/death to employees; third party risks; and consequential loss Principal and Contractor each typically assumes liability for damage to its own property or injury to its own personnel and for its own consequential losses regardless of fault, negligence or breach of duty 6 24 October 2013

8 Risk of Damage to other property; personal injury; third party risk; consequential loss LOGIC s General Conditions reflect this providing that The Company shall be responsible for and shall save, indemnify, defend and hold harmless the Contractor Group from and against all claims, losses, damages, costs (including legal costs) expenses and liabilities in respect of: (a) (b) (c) loss of or damage to property of the Company Group... at the Worksite in connection with the performance or non-performance of the Contract, but excluding the Permanent Work; and personal injury including death to any person employed by the Company Group... and personal injury including death or loss of or damage to the property of any third party to the extent... caused by the negligence or breach of duty... of the Company Group... A similarly worded indemnity is provided by the Contractor to the Company Group 7 24 October 2013

9 Damage to Existing Property Damage to the oil company s own property will tend to include its existing installed operational properties at/near the worksite (particularly relevant for example with regard to tie-in arrangements and crossing of existing pipelines) Existing operational assets will almost certainly be insured under owner s operational insurance (albeit perhaps with significant deductibles) Also common now to include risk of damage to existing property through a Damage to Existing Property (DTEP) extension/buy-back within the Third Party Liability (TPL) section of the CAR cover 8 24 October 2013

10 Consequential Loss indemnities and exclusions The same mutual indemnity principle typically extends to consequential (i.e. business interruption and other financial) losses The rational for the mutual indemnities is particularly obvious as far as consequential loss is concerned given that: Oil company s potential loss of revenue following any incident causing interruption to its business could be vast; Could be very expensive for the contractor to purchase cover if left with responsibility for the oil company s consequential losses due to his breach However the distinction between direct loss and indirect or consequential loss can be confusing Consequential loss exclusions do not always offer the protection which the parties (and particularly contractors) might think they do 9 24 October 2013

11 Consequential Loss indemnities and exclusions For this reason consequential loss exclusions and mutual indemnities are common in a range of contracts encountered in the offshore sector, for example: the TOWCON (International Ocean Towage Agreement) 2008 provides at clause 18(3) ( Liabilities ) of Part II of that (subject to certain provisions): neither the Tug owner nor the Hirer shall be liable to the other party for loss of profit, loss of use, loss of production or any other indirect or consequential damage for any reason whatsoever the SUPPLYTIME 89 and SUPPLYTIME 2005 provide mutual indemnities for any consequential damages whatsoever arising out of or in connection with the performance or non-performance which include (but are not limited to) loss of use, loss of profits, shut-in or loss of production and cost of insurance, whether or not foreseeable at the date of [the] Charter Party October 2013

12 Consequential Loss indemnities and exclusions With regard to EPC contracts, Clause 25 of the LOGIC General Terms provides Notwithstanding any provision to the contrary elsewhere in the Contract and except to the extent of any agreed liquidated damages... the Company shall save, indemnify, defend and hold harmless the Contractor Group from the Company Group s own Consequential Loss and the Contractor shall save, indemnify, defend and hold harmless the Company Group from the Contractor Group s own Consequential Loss, arising from, relating to or in connection with the performance or non-performance of the Contract. Other contracts may, for example, simply provide: Unless expressly stipulated in the Contract neither Owner nor the Contractor shall be liable for any claims, loss or liability arising out of or in connection with the Contract for indirect or consequential loss October 2013

13 What is consequential loss? Some contracts define consequential loss in fairly clear terms. For example the LOGIC General Terms provide: Consequential Loss shall mean: (i) (ii) consequential or indirect loss under English law; and loss and/or deferral of production, loss of product, loss of use, loss of revenue, profit or anticipated profit (if any), in each case whether direct or indirect to the extent that these are not included in (i), and whether or not foreseeable at the effective date of commencement of the Contact. Very carefully worded - may avoid some of the pitfalls encountered with consequential loss exclusions However other contracts provide no definition and this can have significant and possibly unintended consequences Parties will in many cases be wrong to assume that claims for loss or revenue / profit will be excluded by many commonly worded exclusions for consequential loss October 2013

14 Meaning of Consequential Loss (English law) Hadley v Baxendale It is now clear that consequential (or indirect ) losses are those which fall within the second of two types of recoverable damages discussed in the 1854 case Hadley v Baxendale H's mill was shut down due to a broken crank shaft. It was necessary to send the broken shaft to the makers so a new one could be made. B undertook to deliver the crankshaft to the makers but due to carelessness, negligence and improper conduct on the part of B the shaft was not delivered for a long and unreasonable time. In consequence the mill could not be restarted until sometime after it otherwise could have been. H lost profits he would have otherwise made. B argued that H could not recover the lost profits as such damages were too remote October 2013

15 Meaning of Consequential Loss (English law) Hadley v Baxendale The Court distinguished between two types of recoverable damages (direct and indirect). It determined that damages are recoverable when they are: (1) "such as may fairly and reasonably be considered arising naturally, i.e. according to the usual course of things" from the breach, or (2) "such as may reasonably be supposed to have been in the contemplation of both parties at the time they made the contract", provided in both cases that they are the probable cause of the breach. Loss or damage in the usual course of things, falling under the first limb is considered direct Loss or damage which arises only by reason of special circumstances falls within the second limb and is considered indirect loss Subsequent authorities make clear that the degree of knowledge assumed under the first limb will to some extent depend on the nature of the business relationship between the parties October 2013

16 Meaning of Consequential Loss (English law) Hadley v Baxendale So an exclusion of consequential loss under English law will not in itself exclude those types of loss that a reasonable person would have foreseen in the normal course of things and without knowledge of specific facts or special circumstances As the cases show, losses (including e.g. loss of revenue) which can be foreseen on the basis of ordinary knowledge are considered direct (as opposed to indirect ) and will, in principle, not fall within the ambit of a simple exclusion for consequential loss October 2013

17 Meaning of Consequential Loss (English law) Victoria Laundry v Newman (1949) V wished to expand its business and for this purpose entered into a contract with N to purchase from it a new boiler. It was agreed that the boiler was to be delivered on 5 June, but when V went to collect the boiler on that day it was told that it was not ready. The boiler was not delivered until November. V lost the profits which it would have earned during this period, including certain particularly lucrative dyeing contracts and sued for recovery of itslosses. The Court of Appeal held that certain loss of profits were recoverable by V as: N knew at the time of contracting that V was a launderer and dyer and required the boiler for immediate use; and N must have presumed that V would suffer some loss of profits by reason of the delay. However, absence any special knowledge of the lucrative dyeing contracts N could not reasonably foresee the additional losses suffered by V's inability to accept the highly lucrative contracts October 2013

18 Meaning of Consequential Loss (English law) Victoria Laundry v Newman (1949) Based upon this decision it is clear that Following a breach of contract, the aggrieved party is only entitled to recover that loss which was reasonably foreseeable (to result from the breach) at the time the contract was formed. What was reasonably so foreseeable depends on the knowledge of the party who subsequently commits the breach: everyone is taken to know the ordinary course of things and therefore what loss is liable to result from a breach of contract. where the defaulting party has knowledge of special circumstances, whereby a breach is liable to cause more loss, further losses may be recovered. It is clear that loss of profits may fall into either the first or second limb of Hadley, they may be either direct or indirect October 2013

19 consequential v indirect loss It now appears to be clearly established that consequential loss is considered to be indirect loss in the context of exclusion clauses It therefore equates to the second tier of recoverable losses referred to in Hadley Authority goes back at least to Millar s Machinery Co v David Way (1935) where the Court of Appeal considered that the word consequential had come to mean not direct (although the basis for this might be questioned) However this has been followed in subsequent cases: Saint Line v Richardson's Westgarth [1940] Croudace v Cawoods [1978] McCain Foods v Eco-Tec [2011] October 2013

20 Consequential Loss Saint Line v Richardson's Westgarth [1940] involved the supply of defective ship's engines. The contract provided that the parties respective liabilities would not ever or in any case extend to any indirect or consequential damages or claims whatsoever." S asserted claims for (amongst other things) loss of profits. The court stated: the words "indirect or consequential" do not exclude liability for damages which are the direct and natural result of the breaches complained of What the clause does do is protect the respondents from claims for special damages which would be recoverable only on proof of special circumstances If one takes loss of profit, it is quite clear that such a claim may very well arise directly and naturally from the breach based on delay October 2013

21 Consequential Loss In Croudace v Cawoods [1978] a contract for the supply of building materials excused any consequential loss or damage. Plaintiff successfully claimed an indemnity in respect of claims by sub-contractors in respect of delay in the sub-contractors' work caused by the late delivery of the material. The Court of Appeal considered it was bound by the decision in Millar s Machinery It held that: consequential does not cover any loss which directly and naturally results in the ordinary course of events from late delivery October 2013

22 Consequential Loss In McCain Foods v Eco-Tec M had purchased a system for removing hydrogen sulphide from the biogas produced by its waste water system, so that the biogas could be used to generate heat and electricity. The system was defective and M claimed damages from E, which included claims for loss of revenue (from selling certificates of renewable energy) The Court held that E had breached its obligation to provide a system that was fit for the intended purpose. Contract stated that in no event will the Seller be responsible for indirect, special, incidental and consequential damages. The Court held that all the losses claimed, including the loss of revenue, were direct losses in the circumdstaces and therefore recoverable System would have resulted in revenue had it operated correctly and the loss of such revenue was the natural (and therefore direct) loss caused by the inability to commission the system October 2013

23 Consequential Loss Importance of context / wording as a whole In Leicester Circuits Ltd v Coates, C had supplied ink for the manufacture of circuit boards. Held that terms such as operating loss when placed within the exclusion clause did not give a wider meaning to the exclusion for consequential or incidental damages than would otherwise have been the case The Court of Appeal decided that the claims for loss of profit were not excluded as: such claims would have been within the reasonable contemplation of the parties if the ink supplied had been unsuitable for its purpose and thus within the first limb of Hadley October 2013

24 Consequential Loss Importance of context / wording as a whole In Pegler Limited v Wang (UK) Limited the contract provided that W would not be liable for any indirect, special or consequential loss (including but not limited to loss of anticipated profits) even if advised of the possibility of such potential loss. The Court held that the reference in brackets to loss of anticipated profits did not mean the exclusion related to all loo of profits The context meant that only those lost profits which were of an indirect, special or consequential nature were excluded (ie those within Hadley s first limb would not be) The loss of profits as excluded were governed by the immediately preceding words Similarly in The Herdentor (considering a TOWCON exclusion) the extent of the exclusion for loss of profit, loss of use, loss of production was dictated by the subsequent wording or any other indirect or consequential damage October 2013

25 Consequential Loss Importance of context / wording as a whole However there has been some inconsistency of approach BHP Petroleum v British Steel [1999] Court considered a mutual exclusion of liability for loss of production, loss of profits or any other indirect losses or consequential damage Court construed the clause disjunctively as excluding: (i) loss of production and loss of profits and also (ii) indirect / consequential loss October 2013

26 Consequential Loss Ferryways NV v Associated British Ports F brought a claim against ABP (an English port operator) in respect of the death of an officer on board a vessel. Clause 9(c) of the stevedoring agreement identified specific types of loss which were excluded but the manner of the drafting meant these were to be read as being examples of indirect loss: "Where the Company is in breach it shall have no liability for any loss, damage, costs or expenses of any nature whatsoever incurred or suffered by the Customer which is of an indirect or consequential nature including without limitation (i) loss or deferment of profit (ii) loss or deferment of revenue; (iii) loss of goodwill; (iv) loss of business; (v) loss or deferment of production or increased costs of production " October 2013

27 Consequential Loss The Court of Appeal noted that the words "consequential" and "indirect or consequential" had a well-recognised meaning. The Court stressed that very clear words would be required to exclude losses which fall outside of that well-recognised meaning. This is particularly the case when "indirect" is used which draws an implicit distinction with direct losses. It determined that the words were not sufficient October 2013

28 Consequential Loss Importance of context / wording as a whole To avoid any uncertainty on this issue, better to use clear language. In Deepak v ICI the parties had agreed that: in no event shall D by reason of its performance or obligation under this contract be liable for loss of anticipated profits or for indirect and consequential damage Drafted disjunctively / with two limbs This has the benefit of (hopefully) avoiding a finding that the exclusion relates only to losses within the second limb of Hadley October 2013

29 So to return to Logic Consequential Loss shall mean: (i) (ii) consequential or indirect loss under English law; and loss and/or deferral of production, loss of product, loss of use, loss of revenue, profit or anticipated profit (if any), in each case whether direct or indirect to the extent that these are not included in (i), and whether or not foreseeable at the effective date of commencement of the Contact October 2013

30 Different governing laws different approaches Most common law systems typically follow a similar approach to Hadley However certain civil law systems (including in Asia) do not recognize the concept of indirect or consequential loss or damage. Some simply provide for compensation for all damage as would usually arise from non-performance. Some also provide for compensation for damage arising from special circumstances where the party concerned foresaw or ought to have foreseen such circumstances. In the latter scenario there may be some parallels with the English law concepts set out in Hadley. Therefore possible that loss of profits may similarly be determined to be damages that usually arise from non-performance (in the absence of clear contractual wording providing otherwise) October 2013

31 Consequential Loss concluding comments There is a common misconception that loss of profits and other financial losses will be consequential losses The parties intentions to exclude all liability for financial loss may not be given effect by the wordings frequently being incorporated into their contracts Claims for loss of profit (etc) as may fairly and reasonably be considered arising naturally may well be recoverable Clearly very significant potential impact given the potential for considerable losses/claims October 2013

32 Consequential Loss concluding comments Careful drafting is required to ensure the exclusion clause has the effect that the parties intend This is particularly the case given that an exclusion clause will typically be construed against the party seeking to rely upon it to limit its liability Law and jurisdictional risk the governing law will significantly impact on how the terms in a contract will be applied October 2013

33 Q&A October 2013

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