In the recent case of Transocean Drilling U.K. Ltd v Providence Resources Plc  EWCA 372 the Court of Appeal has provided a timely lesson for lawyers and professionals alike on avoiding some common pitfalls in the interpretation of exclusion clauses in a contract negotiated between two commercial parties at arm's length.
While ostensibly concerning the construction of a few clauses in a contract for the hire of a semi-submersible drilling rig, it raises some interesting questions about the freedom of commercial parties to determine the terms on which they wish to do business.
In addition, the first instance judgment contains some suspect reasoning on the nature of the Contractor's maintenance obligations under a modified 'LOGIC' form contract.
On 15 April 2011 the owner of the rig, Transocean Drilling U.K. Ltd. ("Transocean"), entered into a contract with Providence Resources Plc ("Providence"), to drill an appraisal well in an area of the Barryroe field off the Southern coast of the Republic of Ireland. The contract was based on a 'LOGIC' form contract, which the parties had adapted to meet their particular needs.
On 18th December 2011 drilling operations were suspended as a result of the misalignment of part of the blow-out preventer ("BOP"), the safety device used to prevent the uncontrolled flow of liquids and gases during well drilling operations. They resumed on 2nd February 2012, when the rig was able to continue work from the point at which it had been interrupted.
The delay gave rise to various disputes between the parties. Transocean claimed for the remuneration due to it for completing the work but which Providence had failed to pay. Providence's main claim was for the additional overheads it had incurred during the extended period of work, known as 'spread costs', such as the costs of personnel, equipment and services contracted from third parties, which it said were wasted as a result of the delay.
The judge at first instance, Popplewell J, found that Transocean had breached the contract by failing to maintain the BOP in accordance with the contractual requirements. He then turned his attention to the question of whether Providence could recover damages for the loss caused by that breach, which could then be set off against the monies due to Transocean.
Interpretation of the exclusion clause
The contract contained a detailed mutual hold harmless regime, often referred to as "knock for knock" agreement. In summary, this is an agreement that loss or damage should stay where it contractually falls, regardless of who was 'to blame'. Of particular relevance to the parties' dispute was clause 20, which contained mutual undertakings by Transocean and Providence to indemnify each other against their own consequential loss. If the spread costs in issue fell under the definition of 'Consequential Loss' in clause 20, Providence would have to hold Transocean harmless in respect of those costs, and most of its claim would fall away. Clause 20 read as follows:
"20. Consequential Loss
For the purposes of this Clause 20 the expression "Consequential Loss" shall mean:
(i) any indirect or consequential loss or damages under English law, and/or
(ii) to the extent not covered by (i) above, loss or deferment of production, loss of product, loss of use (including, without limitation, loss of use or the cost of use of property, equipment, materials and services including without limitation, those provided by contractors or subcontractors of every tier or by third parties), loss of business and business interruption, loss of revenue (which for the avoidance of doubt shall not include payments due to CONTRACTOR by way of remuneration under this CONTRACT), loss of profit or anticipated profit, loss and/or deferral of drilling rights and/or loss, restriction or forfeiture of licence, concession or field interests whether or not such losses were foreseeable at the time of entering into the CONTRACT and, in respect of paragraph (ii) only, whether the same are direct or indirect. The expression "Consequential Loss" shall not include CONTRACTOR'S losses arising in connection with (1) failure by COMPANY to provide the letter of credit as required by Clause 3.13 of Section III or resulting termination of this CONTRACT or (2) any termination of this CONTRACT by reason of COMPANY'S repudiatory breach.
Subject to and without affecting the provisions of this CONTRACT regarding (a) the payment rights and obligations of the parties or (b) the risk of loss, or (c) release and indemnity rights and obligations of the parties but notwithstanding any other provision of the CONTRACT to the contrary the COMPANY shall save, indemnify, defend and hold harmless the CONTRACTOR GROUP from the COMPANY GROUP'S own consequential loss and the CONTRACTOR shall save, indemnify, defend and hold harmless the COMPANY GROUP from the CONTRACTOR GROUP'S own consequential loss."
Popplewell J began his analysis by stating that the clause must be interpreted contra proferentum, and therefore against Transocean, because "a party relying on an exclusion clause must establish that the words show a clear intention to deprive the other party of a remedy to which he would otherwise be entitled." In support of this principle he relied on the well-known observation of Lord Diplock in Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd  AC 689 that there is a presumption that neither party to a contract intends to abandon any remedies for its breach. If the parties wish to rebut that presumption they must spell it out in clear words.
A restrictive interpretation was also justified because clause 20(ii) was an incursion into the territory of the first limb of Hadley & Baxendale (losses arising naturally from a breach of contract). Popplewell J thought that the courts should be slow to interpret such clauses as a widespread redefinition of excluded loss.
The judge was reinforced in his view by the application of the eiusdem generis principle (Latin for "of the same kind"), which applies to a general term followed by specific examples, as in clause 20(ii). If the specific examples are all of the same kind, the principle applies to limit the interpretation of the general term to cover only those examples. The judge used the principle to explain that the words "cost of use" were intended only to refer to the cost of hiring in equipment or services, the benefit of which has been lost, in order to mitigate the loss of the benefit. The clause had no application to the spread costs where the costs were for equipment and services actually provided.
Finally, Popplewell J found that giving Clause 20 the interpretation put forward by Transocean would render the primary performance obligations in the contract effectively devoid of contractual content, because there would be no sanction for non-performance. It would be a mere 'declaration of intent'. That result was a strong indication that the parties did not intend the clause to have that meaning.
This reasoning led Popplewell J to the conclusion that the spread costs Providence had incurred were not covered by the language of clause 20, and could be set off against the amounts due to Transocean. Transocean appealed to the Court of Appeal on this one issue of construction, arguing that the judge had failed to apply the correct principles of contractual interpretation.
Court of Appeal's decision
Moore-Bick LJ, who gave the sole judgment in the Court of Appeal, agreed with Transocean. In as judicious language as he could muster, he found that Popplewell J failed to apply the correct principles at each stage of his analysis.
Moore-Bick LJ pointed out that the first instance judge had failed to ask himself the most important question: what is the natural meaning of the language the parties had used? The words "loss of use" naturally refer to the loss of the ability to make use of some kind of property or equipment owned or under the control of either party. However, in Moore-Bick LJ's view, it was clear that the parties had intended to widen the scope of those words in the remainder of clause 20(ii).
As an illustration of this, Moor-Bick LJ pointed out that the clause extended to the loss of use or the cost of use of property, equipment and materials provided by contractors, sub-contractors and third parties. Further, the repeated use of the words "without limitation" in clause 20(ii) were a strong indication of the parties' intention to give the words a broad meaning.
Fundamentally, the basis of Providence's claim to recover spread costs was that they represented costs of goods and services obtained and paid for by Providence, but which were wasted as a result of the delay caused by Transocean's breach of contract. That was exactly the type of loss that was naturally covered by the words "loss of use or the cost of use of property, equipment, materials and services ... provided by contractors or subcontractors of every tier". This rather straightforward approach was sufficient to dispose of the appeal, but Moore-Bick LJ continued in his judgment to explain why the analysis undertaken by Popplewell J was wrong.
First, the court gave a reminder that the principle of contra proferentem is only applicable in circumstances where the clause is one-sided and genuinely ambiguous, i.e. equally capable of bearing two distinct meanings. Only in those cases will it be appropriate to construe ambiguity in the words of a clause against the party attempting to rely on them. It was therefore inappropriate to apply it to clause 20, which had a clear natural meaning and was negotiated between two parties of equal bargaining power.
Moore-Bick LJ lamented that the principle of contra proferentem now seems to be used synonymously with the principle in Gilbert Ash. The latter principle was often given undue importance, and parties should remember that it is readily rebuttable by clear words in a contract. In any event, the question here was not whether the parties had intended to give up a contractual right - that was the whole purpose of clause 20 - the only question was to what extent the parties intended to give up those rights.
Neither was there any authority for Popplewell J's proposition that the clause should be defined narrowly because it was an incursion into the first limb of Hadley v Baxendale. Such an approach would be tantamount to re-shaping the contract instead of giving effect to the intention of the parties. If the parties wished to exclude recovery of losses naturally flowing from a breach of contract, it was open to them to use clear words to do so.
Moore-Bick LJ was equally dismissive of Popplewell J's use of the eiusdem generis principle. The natural reading of the sub-clause was that those words were intended to expand, not restrict, the words "loss of use". This was clear from the repeated use of "without limitation" within clause 20(ii). The purpose of the clause was to catch consequential losses of all kinds, and the words were wide enough to cover the spread costs in dispute.
Finally, the Court of Appeal dealt with the argument that, if clause 20 was given the meaning Transocean contended, it would effectively denude the contract of any meaningful obligations and become "a mere declaration of intent". Moore-Bick LJ began by recognising that such an argument could succeed if it was supported by the facts of the case. The principle was, however, to be used as a last resort. It applies to the very small number of cases where the effect of a clause is to relieve one party from all liability for breach of any of the obligations which he purports to undertake. Only in such a case could it be said that the contract amounted to nothing more than a mere declaration of intent.
On the facts, the contract between Transocean and Providence contained many obligations relating to the performance of the work and important mutual undertakings relating to the manner in which any loss or damage should be borne. The contract was not devoid of legal content just because the parties had agreed that neither should be entitled to recover consequential, as opposed to direct, loss. That suggested to Moore-Bick LJ that the court below had made an agreement for the parties which they had not chosen to make. He concluded:
"I can see no reason in principle why commercial parties should not be free to embark on a venture of this kind on the basis of an agreement that losses arising in the course of the work will be borne in a certain way and that neither should be liable to the other for consequential losses, however they choose to define them. In my view the language of clause 20 is clear and is apt to exclude liability for wasted costs in the form of the spread costs which Providence seeks to recover in this case."
The Court of Appeal's straightforward approach to the construction of clause 20 is to be welcomed. It is commendable that the court's starting position was the ascertainment of the natural meaning of the words used by the parties. This gives parties some confidence that the use of clear words in a contract will be the most important factor to a court in discerning that contract's meaning.
By contrast, Popplewell J was heavily influenced in his judgment by the apparent injustice he saw in the consequences of the various mutual indemnities the parties had included in their contract. This led him to rely on a vague and generalized application of several principles normally used to interpret exclusion clauses restrictively. His judgment should serve as a warning to lawyers, who often fall into the trap of applying the same restrictive principles to an exclusion clause before attempting to ascertain the natural meaning of the words.
The nature of a contractor's maintenance obligations
Although not subject to appeal, Popplewell J's judgment contains another piece of suspect reasoning that deserves close scrutiny. It concerns Transocean's maintenance obligations under the contract, which were as follows:
"4.1. On the COMMENCEMENT DATE ... [Transocean] shall provide the DRILLING UNIT fully equipped as set out in section IV(b) – Rig Specification. Subject to its design limitations, the DRILLING UNIT shall be adequate to conduct the WORK at the location(s) specified by [Providence] and contemplated by this CONTRACT. The DRILLING UNIT and all other equipment, materials and supplies hereinafter specified as being provided by [Transocean] shall be in good working condition and together with the personnel, shall be provided and maintained by [Transocean].
4.2. [Transocean] shall carry out all of its obligations under the CONTRACT and shall execute the WORK with all due care and diligence and with the skill to be expected of a reputable contractor experienced in the types of work to be carried out under the CONTRACT.
4.3 [Transocean] shall take full responsibility for the adequacy, stability and safety of all its operations and methods necessary for the performance of the WORK ...
5.10 [Transocean] shall install, operate, test, repair and maintain its well control equipment, in good condition at all times and shall use all reasonable means to control and prevent fires and blowouts and to protect the hole."
Providence contended that the effect of these terms was that Transocean had an absolute duty to maintain the rig in a good working condition. Transocean argued that the terms imported a duty to act with reasonable skill and care, and that there would be no breach unless Providence established that there had been a failure to implement a proper maintenance plan.
Popplewell J agreed with Providence that the duty was an absolute one. His starting point was that the natural meaning of clause 4.1 was that the rig and equipment must be maintained as "adequate to conduct the WORK", a continuing objective that must be met, and was not simply an obligation to "maintain" in the general and undefined sense.
The judge thought it was "clear" from clauses 4.1, 4.3 and 5.10 that this obligation took the form of a continuing warranty and not a due diligence obligation. His view was that the words in clauses 4.1 and 4.3 were the language of achieving a stated result, not of following a process of due diligence in order to achieve it. Transocean were responsible for ensuring that the WORK was adequate at all times.
Popplewell J found further support for this interpretation in Clause 5.10. The obligation to maintain the well control equipment was expressed in absolute terms, in contrast to the "reasonable means" standards to prevent fires and blowouts and to protect the hole. He expressed the view that:
"Where the parties wished to identify a due diligence obligation, they did so in terms. By contrast the obligation to maintain in clause 5.10 is not so qualified."
An unconvincing analysis
The obvious response to the above quoted remark is clause 4.2, which the judge inexplicably failed to refer to in his analysis. Clause 4.2 provides that all Transocean's obligations under the contract are subject to the standard of due care and diligence. Those express words must be the starting point for any analysis of whether a particular obligation under the contract is subject to an absolute or qualified duty. The inferences Popplewell J drew from clauses 4.1, 4.3 and 5.10 do not justify a departure from the clear words contained in clause 4.2. The natural reading of the contract is that Transocean's obligation to maintain the rig were subject to the standard of due care and diligence.
The 'due diligence' interpretation is supported by a consideration of the operation of the contract as a whole. In particular, the contract provided for a standard remuneration regime in rig hire contracts, whereby a different rate would be paid depending on whether the rig was operational, on stand-by, under repair etc. The 'Repair Rate' provided as follows:
"Except as otherwise provided, the Repair Rate will apply in the event of any failure of [Transocean's] equipment (including without limitation, non-routine inspection, repair and replacement which results in shutdown of operations under this CONTRACT including the time up to recommencement of [Providence's] operations at the same point (including any trip time, e.g. "drill to drill") as when the failure occurred excluding any period when the failure has been remedied but operations cannot proceed due to adverse weather or sea conditions ..."
The Repair Rate applies in the event of "any failure" of Transocean's equipment, including where that failure is caused during repair or maintenance. The normal understanding of these words would be that the rate will apply in the event of any equipment failure except where that failure was caused by Transocean's negligence or by any of the exceptions specified in the clause. Negligence as an exception is read into such clauses because it is assumed that commercial parties are unlikely to agree that the contractor should be paid in the event of his negligence or default. This presumption can be rebutted but clear words are needed to do so (Sonat Offshore v Amerada Hess  1 Lloyd's Rep 145).
The effect of Popplewell J's interpretation of Transocean's maintenance obligations transformed this normal understanding. Any failure of Transocean's equipment would be a breach of contract, because Transocean had an absolute duty to ensure that the equipment was adequate for the work. In circumstances where Transocean had acted with all due care and diligence but the operation of the rig was stopped, it would no longer be able to claim the Repair Rate, or any rate, because that would be construed as paying the contractor for his own default.
The default position of the Repair Rate was reversed. It was now only payable when the exceptions specified in the clause applied, such as a failure of the equipment caused by adverse weather or sea conditions. If the equipment failed for any other reason, including the non-negligent acts or omissions of Transocean, no remuneration would be payable to Transocean for the duration of the shutdown.
This represented a significant shift in the balance of risk provided for in the contract, no doubt one which the parties did not intend. In the event, the issue was not argued before the Court of Appeal because Popplewell J made the additional finding that, if he was wrong on the interpretation of Transocean's maintenance obligations, Transocean had failed to exercise due care and diligence in implementing an adequate maintenance programme for the rig. Transocean would not be entitled to the Repair Rate in any event because the shutdown of the rig had been caused by their negligence.
On the facts of this case Popplewell J's view of the nature of the contractor's maintenance obligations was of no consequence. It is not difficult, however, to imagine a scenario where the distinction could be vital. It cannot be rare that some piece of equipment on a rig will break down as a result of a non-negligent act or omission of the contractor.
While it is impossible to predict how the courts will interpret such obligations in future, and bearing in mind that the construction of a contract will depend on its exact terms, it is to be hoped that the courts' attention will be drawn to the shortcomings in Popplewell J's analysis, in particular his failure to account for the effect of clause 4.2 on Transocean's maintenance obligations or to fully consider the consequences of his interpretation on the availability of the Repair Rate.
To avoid such uncertainty, it may be necessary for parties to spell out expressly in their contract exactly what standard is expected by a contractor in the performance of its maintenance obligations. A general catch-all due diligence term such as clause 4.2 may now be insufficient.
There is currently an encouraging trend in the decisions of the courts at the highest level. Increasing emphasis is being given to the principle that one should hold the natural meaning of the words used in a contract as paramount to its construction. Perhaps the most prominent recent examples are Chartbrook Ltd v Persimmon Homes Ltd  UKHL 38 and Arnold v Britton  UKSC 36. Parties to contracts with novel or unorthodox clauses should be reassured that the courts will strive to give effect to their intentions if clear words are used. On the flip-side, the pitfalls of not clearly defining the parties' obligations are aptly demonstrated by Popplewell J's misinterpretation of Transocean's maintenance obligations, with its potentially far-reaching, unintended consequences.
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.