In this month’s article, we are at the letter “K” and will look at a kind of provision that is somewhat unique to offshore oil & gas construction and operation contracts – the ‘knock-for-knock’ indemnity clause. This knock-for-knock indemnity is peculiarly a creature of offshore oil & gas construction contracts and one rarely sees it in other construction contracts.
In fact, this clause also finds its way into contracts between the oil field owner and the operator post-construction.
A knock-for-knock clause provides that in a contract between two companies (say A and B), Company A indemnifies Company B for any claims brought by Company A’s employees against Company B, or for any damage to the property of Company B, regardless of whether Company A has any liability in law for the claim. In return, Company B provides the same indemnity to Company A. This kind of provision, also called a ‘mutual hold harmless’ clause, effectively makes both contracting parties liable for losses caused to their own employees or property regardless of who caused the loss and regardless of whether or not they were negligent.
This is indeed a strange provision. It reverses the basic principle in law that a party is liable to another if he has caused harm to the other party (through his negligence, or strict liability etc). So why has this provision come about?
The historical development of this clause is usually understood to be for three reasons: first, given the scale of potential losses from an incident on an offshore oil & gas platform (think, Piper Alpha or Horizon Deepwater), for each party to carry potential liability means that each party must also carry insurance for that liability. This means a number of premiums and potentially a lot of overlapping coverage, all of which results in added cost and inefficiency in the operations. A knock-for-knock indemnity reduces the scope of insurance required, particularly for subcontractors who can come under the coverage of the main contractor’s knock-for-knock indemnity (similar to a Contractors All Risk – CAR – insurance policy in construction contracts). Secondly, if liability is fault based, upon an incident occurring, positions could be entrenched as to who is liable and who should pay – to the detriment of ongoing construction and operations. Usually, oil & gas construction and operation contracts are an order of magnitude greater than onshore construction contracts, so any delay or disruption to progress can be very expensive.
Thirdly, and related to the second, such knock-for-knock indemnities avoid protracted litigation on the share of liability or contribution to be borne by any parties that are made co-defendants to a claim as each party bears the loss caused to its own property or employees regardless of who is at fault. Given this background, there are three issues that one must bear in mind when drafting and construing knock-for-knock indemnity clauses.
First, check if the clause is wide enough to include liability arising from gross negligence or wilful default (in addition to just negligence). Sometimes, knock-for-knock provisions cover only liability arising from negligence; if a party wants to avoid indemnifying the other, one can expect a defence that the other party was not simply negligent, he was grossly negligent or the default was wilful.
To avoid such scenarios, the clause should cover liability arising from gross negligence or wilful default – though the draftsman should check whether there is anything in the law governing the contract that affects the enforceability of clauses limiting or excluding liability for gross negligence or wilful default.
Secondly, knock-for-knock indemnities do not cover damage to third parties – they relate only to damage to property and person of the contracting party (or their employees). So each party remains liable in law for any damage caused by their actions to third parties, and cannot seek indemnity from the other contracting party (unless that party is also at fault).
Thirdly, knock-for-knock indemnities usually cover not only the other contracting party, but also companies in their ‘group’. Very often, the definition of the ‘group’ is a hotly negotiated clause. To deal with the insurance issue mentioned earlier, often the ‘group’ includes not just companies related to the contracting party, but also the contracting party’s subcontractors.
Knock-for-knock provisions are quite specialized and you may not come across them often (or at all) in your construction career. But when you see one, or have to draft one, you would be well advised to consider the true ambit of the clause in the assessment of your potential liabilities (and, if an indemnifying incident has not yet occurred, you should seriously consider taking out insurance to cover your liability to indemnify).
Shourav Lahiri is the principal at Lahiri LLC, a Singapore-based law firm specialising in construction and engineering law and arbitration. He can be reached at email@example.com.