UK: Drilling Contracts: The Danger Of Not Reviewing The Standard Forms

Last Updated: 14 April 2010
Article by Patric McGonigal

A termination clause in a charterparty which, when invoked, had severe consequences for one of the parties, was not deemed by the court to be commercially absurd, and was accordingly upheld.

BP sought a declaration that it was entitled to terminate, without liability for loss of profit, a drilling rig charter relating to the semi-submersible drilling rig "BYFORD DOLPHIN', owned and operated by Dolphin Drilling ("Dolphin').


The background

On 10 September 2008, the parties entered into Heads of Agreement which provided for a final three year agreement to be negotiated at a daily operating rate of US$410,000. Dolphin agreed that, pending the final agreement being signed, it would not seek any work which might conflict with the commitment to BP or be in competition with BP's planned operations. The charter was signed in March 2009 with a Commencement Date of no earlier than 1 January 2010 or later than 31 March 2010.

The charter contained a termination clause which gave BP the right "to terminate all or any part of the Work or the Contract at such time or times as [BP] may consider necessary for any or all of the following reasons: (a) to suit the convenience of [BP];...' The relevant section was taken almost word for word from the standard form LOGIC Conditions of Contract Edition 1, December 1997.

BP argued that it was permitted to terminate at any time prior to the Commencement Date without any liability for any loss of profit thereafter. Dolphin argued that such an outcome would be commercially absurd and irrational. It was Dolphin's case that something must have "gone wrong with the language and that a reasonable person would have understood the parties to mean that it was subject in effect to an implicit proviso that this entitlement could only be exercised after the Commencement Date."

The financial consequences for each side were significant. Termination after the Commencement Date would require BP to pay 90 per cent of the operating rate for the entire three year period (less any mitigation). Termination before the Commencement Date would require BP to pay various upgrade costs plus a termination fee which did not include any loss of profit. Dolphin also emphasised that, given the world financial crisis, alternative work in the event of termination was unlikely and submitted that BP's construction would essentially give it a "call option' over the rig right up until the drill was taken in tow, without payment of any premium.

The law

In construing the charter, Mr Justice Steel adopted the approach taken by the House of Lords in Chartbrook2, and reiterated the five principles to be considered:

(i)

 

The essential question is what a reasonable person having all the background knowledge would have understood.

(ii)

 

Something must have gone wrong with the language for the court to depart from the ordinary meaning of the language used. However, linguistic mistakes are not easily established in a formal document.

(iii)

 

It is not sufficient that a contract may appear to be unduly favourable to one party.

(iv)

 

A meaning which can be understood in a rational way is to be accepted instead of a meaning which makes no commercial sense or which appears arbitrary or irrational.

(v)

 

It should be clear that something has gone wrong with the language but also clear what a reasonable person would have understood the parties to mean.

The judgment

In applying these principles, the court recognised that the outcome sought by BP may have been highly unattractive from Dolphin's perspective but found that it arose from a standard term. The fact that the provision in question was virtually identical to that found in the standard form LOGIC Conditions of Contract greatly undermined the suggestion that an open ended liberty to terminate at the convenience of BP before the commencement of operations made no commercial sense. Representatives from across the industry (including BP) were on the drafting and review committees of the LOGIC Conditions and they had been in use for 12 years.

In addition, a number of other difficulties were identified, including the fact that, as there were other circumstances in which Dolphin accepted that the right to terminate before the commencement of operations existed (for example, in the case of Dolphin's bankruptcy or the total loss of the rig), Dolphin's interpretation would have required the termination provision to be construed in two different ways.

In short, while Dolphin may see it as severe, Dolphin fell a long way short of establishing that something had gone wrong with the language let alone that a reasonable person would have understood otherwise than as claimed by BP. Ultimately, the value of BP's option may not have been fully appreciated at the time of contract given the extreme nature of the business downturn but that did not mean that the consequences were commercially absurd.

Comment

The judgment serves as a useful reminder of the principles of construction of contract terms as set out in Chartbrook, but it also serves as a timely reminder of the inherent risks associated with the use of standard form contracts where over-familiarity can result in a less rigorous approach to drafting - indeed, a similar warning is given in the preamble to the LOGIC Conditions. The LOGIC Conditions are in widespread use throughout the drilling industry, but that does not mean that they will fit all arrangements all of the time. Each new contract, even if based on a well known standard form which has evolved over time (or perhaps especially when based upon such), should be considered in its entirety to ensure it is appropriate in the specific circumstances and meets the parties' ever may have been highly unattractive from changing requirements on each occasion.

Footnotes

1 BP Exploration Operating Co Ltd v Dolphin Drilling Ltd [2009] EWHC 3119 (Comm.)

2 Chartbrook v Persimmon Homes Ltd [2009] 3 WLR 267

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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