UK: Indemnity Versus Exclusion - Supreme Court Decision

Last Updated: 17 May 2010
Article by Judith Aldersey-Williams and Eleanor Layton

The Supreme Court recently overturned the decision of the Inner House of the Court of Session in the case of Farstad Supply AS v Enviroco Limited and another [2010] UKSC 18. The case concerns the interpretation of section 3(2) of the Law Reform (Miscellaneous Provisions) (Scotland) Act 1940 ("the 1940 Act"), and how it relates to contractual indemnities.

The court considered the wording of an indemnity clause of the sort typically found in North Sea oil and gas contracts, and found that the clause in question actually served as an exclusion of liability as well as an indemnity, overturning the Inner House decision that the clause was an indemnity clause and not an exclusion clause. The decision has a particular impact on parties in the supply chain which are not protected by indemnities, for the reasons explained below.

Background

Farstad Supply AS ("Farstad") was the owner of the MV Far Supply, an oil supply vessel, which was chartered to ASCO UK Limited ("ASCO"). The Far Supply was berthed in Peterhead harbour, and was undergoing works to remove residue from the holding tanks, which were carried out by Enviroco Limited ("Enviroco"). On ASCO's instructions, the master of the vessel started the engines to move to another berth. However, an Enviroco employee had left a valve open, releasing oil onto the engine room floor. The oil ignited and the resulting fire killed an Enviroco employee and damaged the vessel.

Farstad sued Enviroco in negligence. Enviroco in turn sought to bring ASCO in as a third party, contending that the fire was materially contributed to by ASCO's negligence in instructing the master of the vessel to start the engines before cleaning had finished. Enviroco sought to recover sums for contributory negligence under section 3(2) of the 1940 Act, which reads:

Where any person has paid any damages or expenses in which he has been found liable in any such action as aforesaid, he shall be entitled to recover from any other person who, if sued, might also have been held liable in respect of the loss or damage on which the action was founded, such contribution, if any, as the court may deem just.

This would have been straightforward, but for the following clause included in the charter agreement between Farstad and ASCO:

... the Owner shall defend, indemnify and hold harmless the Charterer... from and against any and all claims, demands, liabilities, proceedings and causes of action resulting from loss or damage in relation to the Vessel... irrespective of the cause of loss or damage, including where such loss or damage is caused by, or contributed to, by the negligence of the Charterer...

The issue before the court therefore was how the operation of the clause affected the interpretation of the section 3 of the 1940 Act. Farstad argued that the clause went beyond that of a mere indemnity, and was in fact an exclusion of liability. As a result, the argument went, Enviroco could not recover from ASCO under the 1940 Act, as they were not a "person who, if sued, might also have been held liable".

This argument was upheld by the Outer House of the Court of Session, but later overturned on appeal by the Inner House in May 2009. The Supreme Court has now restored the decision of the Outer House.

The 1940 Act

Section 3(2) of the 1940 Act allows the court to apportion liability among parties who are jointly liable in a way that it views as just, allowing a party that has been found liable (for instance, Enviroco) to seek a contribution from another party who would have also been found liable for the same loss (in this case ASCO). By reading sub-section (2) together with sub-section (1), the court held that the words "if sued" in sub-section (2) meant if sued by the same party as the original wrongdoer was sued by (in other words, sued by Farstad).

As a result, the question of whether ASCO was subject to section 3(2) of the 1940 Act depended on whether it would have had a defence in an action brought by Farstad. This was the opposite conclusion reached by the Inner House, and meant that the case rested on the interpretation of the provisions in the charterparty.

The Charterparty

The court considered the words "defend, indemnify and hold harmless" in the sub-clause relating to damage to the vessel. In agreeing with the Lord Ordinary in the Outer House, the court held that these words, in the context, went beyond that of an indemnity and in fact amounted to an exclusion of liability. In particular, the obligation to hold harmless went "further than the obligation to reimburse because they are words of exception".

It was acknowledged that the words, used either together or individually, could have different meanings, but the court made the point that the sub-clause in question was to be interpreted in relation to the clause, and the contract, as a whole. The court noted, for instance, that the clause was titled "exceptions/indemnities"; that elsewhere in the clause there were references to "the exceptions and indemnities set out in this Clause 33"; and that other sub-clauses with the same wording were clearly intended to operate as exclusions. Furthermore, the court argued that to interpret the particular sub-clause as a simple indemnity did not fit with the overall purpose which the contract was meant to achieve. To the extent that the individual words could have different meanings, the true interpretation was to be found in the context of the wider clause and the contract as a whole.

Because the effect of the clause in question was to exclude ASCO's liability for damage to the vessel arising out of its own negligence, ASCO would have had a defence against an action brought by Farstad to recover any losses arising from such damage. As a result Enviroco was not able to seek a contribution from them under section 3 of the 1940 Act.

The court went on to consider the result in the event that the clause operated as a simple indemnity and concluded that the result would have been the same. Even if liability had not been excluded, the claim would have been met with the defence of circuity of action (under English law, which governed the charterparty, as well as under a similar principle in Scots law).

Impact of the Decision

In our Law Now following the Inner House appeal, we suggested that the standard North Sea oil and gas indemnities, if properly drafted, would be upheld by the Scottish courts in the manner intended.

The latest ruling by the Supreme Court confirms this. However, the decision does illustrate the risks to parties operating in the UKCS who are not indemnified in the typical manner. In a situation where two parties are jointly liable for a particular negligent act, but one of them is indemnified by the claimant, the other may find itself bearing 100% of the loss.

Therefore, parties should give careful consideration to their potential liabilities within the overall contractual regime in operation in the UKCS. In this instance Enviroco's contract was with ASCO, however it would seem (although the terms of that contract were not before the court) that ASCO's contract with Enviroco did not indemnify Enviroco against damage caused by Enviroco to ASCO's other contractors (such as Farstad). These kinds of gaps in the contractual pyramid are often overlooked, and while the Industry Mutual Hold Harmless scheme (of which Enviroco is a member) provides some cover it does not currently extend to supply vessels. The new Deed, to come into force from 2012, will potentially cover supply vessels but it remains to be seen whether operators such as Farstad will sign up to it.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 13/05/2010.

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