Read In the offshore industry it is common for risk to be allocated by means of knock-for-knock contracts text version

At last year's Standard Offshore Forum there was a lively discussion about the recent introduction of clauses excepting gross negligence from the liability and indemnity regimes in "knock-for-knock" contracts. Such clauses mean less certainty and higher costs for the offshore industry, say Barbara Jennings and Vivian Frew. The following article was first published in Lloyd's List. In the offshore industry risk is commonly allocated by means of knock-for-knock contracts. These are contracts under which the parties take responsibility for loss of or damage to their own property or injury or death of their personnel, regardless of fault. Knock-for-knock is the basis of several industry standard contracts such as Heavycon and Towcon - it has the benefit of certainty and avoids costly and time-consuming litigation following accidents. This is particularly important in the offshore industry, where losses resulting from an accident can run into billions of dollars, making insurance hugely costly for the operators involved. Knock-for-knock contracts limit the risk and minimise insurance costs by avoiding duplication in the cover needed, as each party's insurance should only be called upon to respond to losses in respect of his own property and personnel. Unfortunately, the English courts were not as quick as the industry to recognise the benefits of knock-for-knock, or to appreciate that the parties genuinely intended to allow each other to contract out of liability for negligence. It is an established principle of English law that, if a party wishes to avoid the consequences of its own negligence, clear language to this effect must be used in the relevant contract. In E.E. Caledonia Ltd (formerly Occidental Petroleum (Caledonia) Ltd) v Orbit Valve Co. PLC 1994 2 LLR 239 (The "Piper Alpha"), the plaintiff claimed an indemnity in respect of monies paid to an employee of the defendant who had died in a fire on board the plaintiff's offshore platform. The contract contained a straightforward mutual indemnity clause in respect of each party's employees. The clause did not, however, contain any provision that the indemnity would apply even if the loss in question were caused by negligence. The claim failed on the grounds that the death had been caused by E.E. Caledonia's own negligence. The Court of Appeal judgment held that it was "prima facie implausible that the parties

would wish to release one another from the consequences of the other's negligence and agree to indemnify the other in respect of such consequences". In 2001 a similar question came before the Commercial Court in Smit International (Deutschland) GMBH v Josef Mobius, Bau-Gesellschaft GMBH & Co (unreported). The contract in question was BIMCO's Towhire form, in which Clause 18 contains knockfor-knock provisions making each party liable for damage to its own property and related third party claims. Importantly, the clause states that each party is to be liable regardless of the other's negligence or breach of contract. The defendant barge-owner argued that Clause 18 should not apply in respect of damage to its own barge and a third party vessel, since the tug-master was drunk at the time of the incident. This made the tug unseaworthy, in breach of Clause 13 of the contract. However, Morison, J., was not persuaded by this argument, referring to the knock-for-knock agreement contained in Towhire as "a crude but workable allocation of risk and responsibility", whose effectiveness would be reduced by arguments about seaworthiness. He continued that the intention behind the contract was not to permit seaworthiness arguments to intrude into the allocation of risk, a statement that seems to be wholly in line with the industry understanding of the reasoning behind knock-for-knock. Unfortunately, just as the English courts seem to have become more sophisticated in their approach to knock-for-knock contracts, the benefits of this method of pre-allocating risk are being eroded by the industry itself. More and more offshore contracts now include provisions that purport to exclude from the liability and indemnity regime losses caused by "gross negligence". The parties may well have a clear idea in their own minds just what this term covers, but in the experience of the authors it is very difficult to ascertain the exact meaning that the courts will assign to the words "gross negligence". What is "ordinarily" negligent is fairly settled law. A defendant is negligent if his conduct falls below the standard of care owed to the claimant, which will normally be the degree of care, competence and skill to be expected from a reasonable person engaged in the particular function or activity. Common law does not historically recognise different

degrees of negligence ­ either there is a breach of duty of care amounting to negligence, or there is not. Similarly, in commercial disputes, the courts have traditionally been reluctant to define "gross negligence". The term has been usefully considered in one English High Court case, in 1997 before Mance, J., in Red Sea Tankers Ltd v Papachristidis 1997 2 LLR 547 ("The Hellespont Ardent"). The plaintiffs alleged that the defendants had been "grossly negligent" in the performance of services rendered under a contract containing an indemnity given by the plaintiff to the defendant, except where the defendant's performance was grossly negligent or constituted wilful misconduct. Mance, J.'s, view was that the term "gross" negligence is clearly intended to represent something more fundamental than the failure to exercise proper skill and care. He concluded that, according to English law principles of construction of contractual terms, "gross" negligence would constitute "conduct which a reasonable person would perceive to entail a high degree of risk of injury to others, coupled with heedlessness or indifference to or disregard of the consequences...". The test should be an objective one, applying the standard of the reasonable man possessing the knowledge that the party in question has or should have. Mance, J., furthermore commented that there is no one single determinative factor, and that all circumstances must be weighed in the balance to ascertain whether an act or omission merits the description "gross". It seems, therefore, that if the parties choose to exclude from the knock-for-knock regime losses caused by "gross" negligence, they are effectively leaving it to the court to decide exactly what degree of carelessness or recklessness they intend to encompass by the provision. Even when the contract includes a definition of "gross negligence", the court will still take into account the circumstances and context of the individual act or omission. This opens the door to an uncertainty of meaning that is particularly problematic given the large losses resulting from accidents offshore. Parties are much more likely to seek a defence to high-value claims and in doing so to allege "gross negligence" on the part of their contractual partner. Because of the circumstantial

approach taken by the English courts to "gross negligence" provisions, such cases are likely to end in costly litigation, jeopardising the very certainty that is one of the great benefits of knock-for-knock. The problems are exacerbated when claims are decided in less sophisticated jurisdictions, which may fail to distinguish between "ordinary" and "gross" negligence, or worse, may use "gross negligence" provisions as an excuse to favour local litigants. When contracts are drawn up the parties may include such a provision in the belief that it will apply only in the most extreme or unusual cases. Unfortunately in the aftermath of a serious incident they are likely to discover that they have contracted for uncertainty, finding themselves embroiled in the very type of costly and time-consuming dispute that the knock-forknock contract was originally intended to avoid. Shipowners can buy additional cover for claims arising under "gross negligence" provisions, but these covers are expensive and have lower limits than normal P&I cover. Furthermore, it is not possible to insure against all expenses connected with such claims, notably the loss of goodwill and the cost of management time of being embroiled for long periods in high-value litigation. It is preferable, and cheaper for all parties, to contract as far as possible on knock-for-knock terms. The Standard Club works with its members to achieve this by reviewing contracts and providing advice and support during contractual negotiations.

Barbara Jennings is Director, Offshore Claims and Vivian Frew is a solicitor at the Standard P&I Club ...... words

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In the offshore industry it is common for risk to be allocated by means of knock-for-knock contracts