House of Lords upholds North Sea indemnity
Großbritannien · 05.03.2002
Caledonia North Sea Limited against British Telecommunications Plc and linked appeals
The House of Lords delivered its decision in the long-running Piper Alpha litigation on 7th February 2002.
This judgment is not as straightforward as it first appears: it raises a number of interesting points on the drafting
and interpretation of indemnities, that are of particular relevance to the oil and gas industry as it moves towards
more widespread mutual hold harmless schemes.
The facts
All of those involved in the North Sea oil and gas industry are familiar with the facts. On 6th July 1988 an explosion
destroyed the Piper Alpha oil platform, killing 165 of the 226 persons employed on the platform. 134 of those killed
were employed by contractors.
The court found that the explosion was caused by the combined negligence of a contractor and the operator. It held
that an employee of the contractor company, Score (UK) Ltd., failed to fit a blind flange securely to pipework in
Module 6, and an employee of the operator allowed hydrocarbons to enter the pipework while it was in that
condition. The hydrocarbons escaped and ignited, causing the explosion, although the source of the ignition is
unknown. Both men were in breach of their statutory duties not to endanger the health or safety of persons on the
platform, and the operator was also in breach of its particular statutory duty to ensure that the relevant health and
safety regulations were complied with. In the earlier court hearings the court had been wary of apportioning blame,
but the general consensus had been that the incident had been caused by the contractor.
The operator settled claims made in respect of the contractors' employees and then sought recovery under its
contractual indemnities with the various contractors. The contractors declined to indemnify the operator. Seven
test actions commenced in the Scottish courts on 1st March 1993 with a total value of over £82 million. Each of the
relevant contracts was expressly governed by Scots law (English law contracts were the subject of separate
litigation in the English courts, see below). The Inner House judgment of Caledonia North Sea Limited v London
Bridge Engineering and others was delivered in favour of the operator on 22nd December 1999. The contractors
appealed to the House of Lords: six of the test actions were resolved prior to this hearing leaving one action,
involving Norton (No. 2) Ltd., (in liquidation), which resulted in this recent decision.
Before the operator settled the original claims, it was clear that there was a real possibility that the claimants would
raise actions in Texas in the absence of a settlement. It was likely that the damages awarded by a Texas court would
be significantly higher than that awarded by a Scottish court. Therefore an uplift was made to the amounts agreed
so that it was greater than that which would have been awarded by a Scottish court (a "mid-Atlantic settlement").
The judgment
The House of Lords upheld the contractual indemnities in favour of the operator and dismissed the appeal on each
of the contractor's points.
This Scottish decision is important for all those drafting offshore contracts in the UKCS, whether they are governed
by Scots or English law, for several reasons:
Firstly, the House of Lords gave explicit recognition to the industry practice of mutual offshore indemnities.
Their Lordships quoted from Sharp (Offshore Oil and Gas Insurance) and Daintith and Willoughby (Manual on
United Kingdom Oil and Gas Law) and came to the conclusion that there were good reasons for having an
indemnity regime in place and that the parties' intentions on the allocation of liability were clear. This
approach is likely to be adopted by English courts in subsequent cases – one of the members of the panel in
this case was the distinguished English judge, Lord Hoffman.
Nevertheless the court maintained the rule of strict interpretation and considered the actual drafting of the
indemnity provisions in some detail and this is the second important aspect of the case as it confirms the need
for clear and careful drafting.
Interestingly, however, on one issue the Scottish courts appeared to take a less rigorous approach than the
English courts. In the English case of E.E. Caledonia Ltd v Orbit Valve Co. Europe ("Orbit Valve") (which also
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arose out of the Piper Alpha incident but related to interpretation of different contracts which the parties
decided were governed by English law) a distinction was drawn between negligence and breach of statutory
duty as separate causes of the incident. The Court of Appeal, applying a strict interpretation of the indemnity
provisions in question (which were different from those considered by the Scottish courts), held that the
operator was not entitled to the benefit of the indemnities because they mentioned neither negligence nor
breach of statutory duty and they could not be interpreted to cover the operator in circumstances where it
was guilty of either of those unless it expressly so provided. By contrast, in this case their Lordships did not
make any issue of the fact that the indemnity provisions did not expressly refer to breach of statutory duty,
despite being clear that there had been a breach of statutory duty by the operator.
Their Lordships also confirmed that, at least where the indemnified party was under no obligation to take out
insurance, indemnities in oil and gas contracts will be treated as primary and will therefore apply
notwithstanding recovery under any insurance policy.
The court confirmed the Inner House finding that consequential loss did not include mid-Atlantic settlements.
Read together with Orbit Valve and the earlier Inner House decision, we now have clearer guidance on
drafting indemnity clauses both under Scots and English law. However, this case shows potential differences
between the interpretation of indemnity provisions under the two jurisdictions. Until this issue is clarified, it
therefore remains advisable not to "mix" governing laws in any set of contractual arrangements, as an
element of unforeseen exposure may result.
Issues
The issues considered by the House of Lords were:
1. Whether, on the construction of the particular indemnities in this case, the contractor was correct to argue
that it was not liable because it had not been responsible in any way for causing the incident which gave rise to
the death or injury in question;
2. Whether the operator was entitled to an indemnity under the contract between the parties in respect of the
claims arising from the death or injury of the contractors' employees in regard to the payments made by their
insurers. Furthermore, in Scotland, can insurers sue for relief in the name of the insured?
3. Whether, on a proper construction of the contract between the parties, recovery of the excess above the
Scots Law value of the claims was prevented by the consequential loss exclusion in Clause 21. In answering this
question, the House of Lords assumed that the claims could have been raised in Texas and that the parties had
agreed the level of damages which would have been awarded by a Scottish court.
The House of Lords unanimously upheld the 1999 decision of the Inner House of the Court of Session in favour of
the operator, i.e., that it was entitled to an indemnity for sums paid out in respect of those contractors' employees
killed and injured in the Piper Alpha explosion. This indemnity extended to mid-Atlantic settlements.
The leading judgments were given by Lord Mackay of Clashfern, Lord Hoffman and Lord Bingham of Cornhill - all
highly respected judges, making this decision extremely authoritative.
The Contract
The operator entered into similar contracts with each of the contractors. The indemnity provisions were contained
in Clause 15 and included the following:
"15 (1) Contractor's Indemnities
Contractor shall indemnify, hold harmless and defend the company and its parent, subsidiary and affiliate
corporations and Participants, and their respective officers, employees, agents and representatives from and
against and all suits, actions, legal or administrative proceedings, claims, demands, damages, liabilities, interest,
costs (including but not limited to the cost of litigation) and expenses of whatsoever kind or nature whether
arising before or after completion of the work hereunder and in any manner directly or indirectly caused,
occasioned or contributed to in whole or in part, by reason of omission or negligence whether active or passive
of contractor, or of anyone acting under contractor's direction, control or on contractor's behalf in connection
with or incidental to the work. Provided always that the contractor's total liability arising pursuant to this
indemnity shall not exceed one million pounds sterling (£1,000,000) per occurrence.
Without prejudice to the foregoing generality, the contractor shall indemnify, hold harmless and defend the
company and its parent, subsidiary and affiliate corporations and participants, and their respective officers,
employees, agents and representatives from and against any claim, demand, cause of action, loss, expense or
liability (including but not limited to the cost of litigation) arising (whether before or after completion of the
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work hereunder) by reason of:
.........
(c) Injury to employees and damage to property of contractor
Injury to or death of persons employed by or damage to or loss or destruction of property of the
contractor or its parent, subsidiary or affiliate corporations, or the contractor's agents, sub-contractors or
suppliers, irrespective of any contributory negligence, whether active or passive, of the party to be
indemnified, unless such injury, death, damage, loss or destruction was caused by the sole negligence or
wilful misconduct of the party which would otherwise be indemnified;
.................
Clause 15(2) contained similar indemnities from the operator in favour of the contractor.
Clause 16 contained the insurance provisions.
Clause 21 contained a consequential loss exclusion in the following terms:
"Notwithstanding any other provision of this contract, in no event shall either the contractor or the company be
liable to the other for any indirect or consequential losses suffered, including but not limited to, loss of use, loss
of profits, loss of production or business interruption."
Construction of the Contract
Their Lordships were all of the opinion that the drafting in Clause 15(1)(c) was clear and showed the parties'
intention that the contractor should bear the risk of injury to or death of its own employees in all circumstances,
except as the contract specified in this particular case, for the limited exception (if applicable) where the death or
injury was caused by the sole negligence or wilful misconduct of the operator. Their Lordships also recognised and
accepted the general principle of mutual offshore indemnities, and, as mentioned, even referred to standard
textbooks on the subject in making their judgments.
They also accepted the principle of North Sea indemnities and the reasons for such indemnities, which they
identified as a reduction in insurance costs (as a party to a contract will only need insurance to the extent of the risk
it agrees to take under the indemnities) and a reduction in litigation (as the parties' liabilities are clear from the
contract and do not require complex assessments of fault).
The contractor's argument was that Clause 15(1)(c) should have implied into it a provision that the indemnities are
not to apply unless the contractor is liable at common law or for breach of statutory duty in respect of the death or
the injury in question. Various arguments were put forward by the contractor to support this proposition, none of
which were successful.
Firstly, the contractor argued that the wording following "without prejudice to the foregoing generality" in Clause
15(1) showed that the later subsequent sub-clauses (including 15(1)(c)) were simply examples of what the
contractor was liable for under the first paragraph. Under that paragraph, the contractor would only be liable if it
was negligent. Their Lordships completely disagreed with this argument and emphasised that the words "without
prejudice to the foregoing generality" instead meant that provisions in the clause following the phrase are not
meant to cut down or exclude any claim falling under the first paragraph.
The contractor also argued that the fact that the contractor was not required to carry insurance in respect of the
indemnity given under Clause 15(1)(c) showed that it was not intended to bear this risk. Their Lordships agreed with
the operator's argument that the inclusion of the particular insurance requirements in Clause 16(2) (Employer's
Liability and Worker's Compensation insurance; public liability insurance; and professional negligence cover)
resulted from statutory obligations on the operator, and it was open for the contractor to take out other insurance
if it wished. Lord Hoffman felt that the risk of liability under the indemnity should in itself be a sufficient incentive to
take out insurance.
The contractor then tried to argue that, since Clause 15(1)(c) referred to "contributory negligence" (being the
contributory negligence of a party seeking indemnification), there would have to be negligence or breach of
statutory duty on the part of the contractor in order for the drafting to make sense. Generally, contributory
negligence is used in attributing liability between two negligent parties, but their Lordships were clear that this does
not prevent it being used, as in this case, to refer to negligence contributing to the cause of the accident, as
opposed to negligence which was the sole cause of the accident.
Perhaps the most interesting argument was the contractor's contention that Clause 15(1)(c) did not reflect general
North Sea practice as there was a carve out for the operators' sole negligence or wilful misconduct and therefore,
presumably, the usual assumption that the rest of the indemnity would apply regardless of negligence was also not
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appropriate.
Their Lordships accepted that it is the practice in the North Sea to have a full indemnity in terms of death or injury
of employees - but decided that the indemnity should not fail simply because it was different from the norm. Lord
Mackay of Clashfern: "In my view, although this is not an example of that practice fully carried out, it is not
altogether surprising that there should be an exception in respect of sole negligence or wilful misconduct,
recognising that this would be an extreme situation in which to pass liability to the contractor".
Lord Mackay emphasised the well known principle that ambiguous drafting would be construed against the party
seeking to rely on it and therefore had there been ambiguities in Clause 15(1) these would have been construed
against the operator. However, this did not appear to have been crucial to the decision.
Is the operator entitled to a indemnity?
Under this head of appeal, the contractor's argument was that, since the operator's insurers had settled the various
claims of the contractors' employees, the operator had suffered no loss for which it could to sue the contractors.
Furthermore, the operators' insurers had no right of subrogation since they were co-indemnitees alongside the
contractors. Lord Hoffman clearly set out the law as follows:
"It is certainly a general principle...that a person who has more than one claim to indemnity is not entitled to be
paid more than once. But there are different ways of giving effect to this principle. One is to say that the person
who has paid is entitled to be subrogated to the rights against the other person liable. The other is to say that one
payment discharges the liability. The authorities show that the law ordinarily adopts the first solution when the
liability of the person who paid is secondary to the liability of the other party liable. It adopts the second solution
when the liability of the party who paid was primary or the liabilities are equal and co-ordinate."
Therefore:
A person cannot be compensated twice for the same claim under different indemnities;
Where there are two indemnities, either both are equal or one is primary and the other secondary;
If both are equal, both are liable to pay a percentage of the sum claimed and an indemnitor who pays the full
sum has a right of relief for part of the amount against the other indemnitor;
If one is primary and one is secondary, the primary indemnitor is fully liable;
If the secondary indemnitor pays out then he has a right to claim the full amount paid from the primary
indemnitor.
The question for the court, therefore, was who was first, or primarily, liable - the insurer or the contractor - or were
they equally liable?
The court held that the contractual indemnity was primary to the indemnity under the contract of insurance.
In coming to its decision, the court took into account the fact that the operator was not contractually obliged to
insure for this risk (as might happen where, for example, an operator agrees to take out a Construction All Risks
insurance policy to cover work being done under a particular contract).
Had the insurers and the contractors been held to be co-indemnitees under co-ordinate indemnities then arguably
the insurers would have been entitled to a right of relief (known as contribution in English law) against the
contractors. However, their Lordships decided that it was clear that a contractual indemnity is primary where the
other indemnity is given under a contract of insurance where there is no contractual obligation on the insured party
to make any insurance arrangements. The court could find no reason why the operator and the insurer should have
intended that the insurer should put himself on an equal footing with the contractor in respect of the indemnity
which the contractor gave under the contract. The court relied on industry practice and the fact that the rates which
contractors quote in respect of work include an allowance in respect of the indemnity.
Therefore, the contractor's argument, that it was liable to indemnify the operator only if and to the extent that the
operator's insurer failed to do so, was not successful.
A note of caution from the judgment: their Lordships did not expressly address the question of whether, had there
been a contractual obligation on the operator to maintain insurance, the contractors' indemnities would still have
been primary.
Consequential Loss
The final head of appeal related to the uplift paid out as mid-Atlantic settlements.
The contractors argued that this uplift was a "consequential loss" i.e., a loss which does not follow from breach of
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the contract, but which might reasonably have been supposed to have been within the contemplation of the
parties. It claimed that there were special circumstances (i.e. the links with Texas) which, if the contractors had
known about them, would have made these damages recoverable under common law as consequential losses.
However, the effect of Clause 21 was to exclude recovery of consequential losses irrespective of the contractors'
knowledge of these losses.
The Lord Ordinary, at first instance, had held that the size of the settlement amounts was reasonable because
there was a real possibility that the claimants might have been able to sue in Texas. However, he had decided that
the uplift element of a mid-Atlantic settlement was a consequential loss, and therefore the operator was not
entitled to claim under the indemnity for the uplift, due to the exclusion in Clause 21. The Inner House reversed
this decision.
Their Lordships were again unanimous in holding that the mid-Atlantic settlements and the uplift which formed part
of such settlements fell squarely within the indemnity in Clause 15(1)(c) because they were a loss arising out of
liability for death or injury in respect of the contractors' employees. The court could not find that the uplift was a
different kind of loss from the rest of the compensation awarded for death or injury and Lord Hoffman, in
particular, found it irrelevant that the loss turned out to be greater than the contractor might have expected.
Although Clause 21 reflected typical industry drafting at the time of the contract, more recent consequential loss
exclusion clauses tend to reflect the fact that the examples normally contained within these clauses (such as loss of
production) may actually be direct rather than consequential losses. This point has been discussed in other oil and
gas industry cases (such as BHP Petroleum v British Steel, a 1999 Queen's Bench decision). Interestingly, however,
Lord Hoffman expressly reserved the question of whether this definition of consequential loss is correct, which
suggests that this issue may not yet be finally resolved. In the meantime, it is advisable to define consequential loss
along the following lines:
"(i) consequential loss under applicable law; and
(ii) loss and/or deferral of production, loss of product, loss of use and loss of revenue, profit or anticipated
profit (if any) whether direct or indirect, to the extent that these are not included in (i),
whether or not foreseeable at the date of execution of this agreement."
This reflects the usual intention of parties to offshore service contracts, in that the larger risks (such as loss or
deferral or production) are usually borne by the operators, as contractors are unlikely to be able to insure against
these risks.
Conclusion
This House of Lords decision is extremely important as it provides clear guidance on the operation of indemnities in
offshore contracts.
There are six main points brought out in the judgment:The industry practice of mutual offshore indemnities has been recognised and upheld, and was an important
factor in the court's decision;
It is nevertheless important to draft indemnity and exclusion clauses carefully. If they are clear and
unambiguous, they will be upheld by the courts;
The Scottish courts did not consider whether the indemnities needed to state that they were effective
irrespective of each separate head of negligence, breach of duty and breach of statutory duty. It is not clear
whether this issue was raised in argument. Until it is clarified whether the Scottish courts have a different view
on this issue, it must therefore continue to be good practice in Scots law contracts (and essential in English law
contracts in light of the Orbit Valve decision) to make it clear that offshore indemnities apply "irrespective of
negligence and/or breach of duty (whether statutory or otherwise)";
The judgments in this case and in Orbit Valve show that, although Scots and English contract law are aligned on
many points, there are potential differences when interpreting indemnity provisions. This House of Lords
decision will be highly persuasive in English law, but it is important to take care when choosing the governing
law of a contract to ensure that the indemnity provisions are effective.
Where there is no contractual obligation to take out insurance, the indemnities in the contract will be primary.
However, unlike the Inner House, the court did not provide an authoritative statement on the relationship
between contractual indemnities and indemnities under insurance where there is a contractual obligation to
provide that insurance. Generally the contractual indemnities will be primary, but best practice must be to
specify in the drafting that indemnities are "full and primary";
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To avoid uncertainty, the contractual definition of consequential losses should be approached with care.
However, Lord Hoffman's comments suggest that debates over the correct interpretation of "consequential
loss" may not be over.
For further information please contact Penelope Warne at penelope.warne@cms-cmck.com or Lorna Ingram at
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