UK: The Hidden Dangers Of "Knock for Knock" Indemnities

Last Updated: 27 July 2009
Article by David Gardner

Basic Scheme of Knock for Knock

The underlying principles of a "knock for knock" scheme are well established. Each of the Company and the Contractor agrees to save, indemnify and hold harmless the other, their affiliates and other group members against any claims or liabilities arising in respect of: (i) damage to property owned, hired or leased by it; and (ii) injury to any of its personnel. Although this is not usually expressly stated, the effect will be to exclude any liability on the part of the Contractor for damage or injury caused to Company Group property and personnel and vice versa.

In the absence of such indemnities, the rights and obligations of the parties will be determined by the terms of their contract or by the general principles of tort (negligence) liability applicable in the country where the damage occurs. The effect therefore of an indemnity expressed to apply irrespective of negligence is to reverse the legal position applicable in most jurisdictions that the party at fault in causing the damage or injury is liable. Under a "knock for knock" scheme, each party is obliged to meet any claims arising from damage to its property and personnel even if the damage is caused by fault on the part of others.

Such indemnities in common with exclusion and limitation clauses are interpreted restrictively under English law and, in the case of ambiguity, will be construed in the manner least favourable to the party seeking its protection. In particular an English court or arbitration tribunal will be reluctant to conclude that one party intended to indemnify the other against the consequences of its own negligence, unless the indemnity clearly states that this is to be the case.

The Extent of the Groups

One of the principal purposes of such indemnities is to limit the substantial risks involved in any significant off shore project to a level acceptable to most contractors and to avoid the need for multiple and overlapping layers of insurance by permitting the Company and the various contractors to carry insurance covering their own equipment and personnel rather than the damage this equipment and personnel can cause. Any significant off shore development will however involve numerous contractors and subcontractors and the "knock for knock" scheme will usually be extended to all members of each party's group. Thus the Contractor and the Company indemnify each other against any claims arising in connection with damage to property or injury to personnel of any member of their respective groups, including if they fall within the group any subcontractors and agents.

Thus, if the Contractor is held liable for damage caused to property belonging to a member of the Company's Group, the Company will be obliged to indemnify the Contractor against this liability. The Company Group member may be entitled to bring its claim against the Contractor but will, where it is operating under a parallel indemnity scheme with the Company, be obliged to indemnify the Company against its liability to the Contractor, thereby rendering the process circular.

The ambit of the Company and Contractor groups will however often be the subject of considerable disagreement with the larger oil companies in particular being reluctant to extend their indemnities to cover damage and injury caused to all of their contractors and their property. This reluctance reflects the administration required, the extent of the risk involved in obtaining "back to back" indemnities from these contractors and in some cases the complexity of field ownership structures.

Breach of Contract

Although the principle that the mutual "knock for knock" indemnities apply irrespective of negligence is well established, much less consideration is often given at the drafting stage to the extent to which the indemnities should also apply where the damage is caused by breach of contract.

In the Super Scorpio II (1998), the Contractor and the Company exchanged "knock for knock" indemnities with the Company (Elf Exploration) agreeing to indemnify the Contractor against all claims in respect of or in connection with damage to Company's Items. In addition the drilling contractor, Smedvig, undertook to "take all necessary care of Company's Items as required by good oil and gas industry practices and to return them to the Company in their original condition" and "to ensure the storage, safekeeping, protection and the general maintenance by its personnel of Company's Items." During offshore operations, a Company Item, the Super Scorpio II, a remote operate vehicle, was damaged by the negligence of one of Smedvig's employees. The owners of the Super Scorpio II obtained damages from Smedvig for the cost of repairing the ROV, and Smedvig in turn sought an indemnity from the Company against this liability.

Elf accepted that the ROV was a Company Item, but contended that the Company's obligation to indemnify the Contractor in respect of any damage done to a Company Item did not apply where the act which gave rise to the claim was itself a breach by the Contractor of its obligation under the contract to take all necessary care of the Company's Item. The Court held that the allocation of risk in the contractual indemnities was clear. The Contractor remained obliged to take care of any Company Item entrusted to it but the financial consequences of any damage to property caused by lack of care was nonetheless dealt with under the "knock for knock" indemnity regime.

A different conclusion was reached in Deepak v ICI (1998). In that case Deepak claimed that an explosion at its methanol plant in India was caused by errors in the defendant's design of the plant. These errors were said to amount to breaches both of express terms of the contract and of collateral warranties given by Davy in favour of Deepak. Throughout the construction phase and thereafter the plant was the property of Deepak, and under the indemnity provisions Deepak was obliged to indemnify Davy and its employees against any liabilities for death or injury to employees of Deepak or loss of or damage to its property.

In defending claims brought by Deepak for the cost of repairing the damage caused by the explosion and for the loss of use of the plant, Davy contended that the indemnity given by Deepak covered all such claims. The Judge regarded it as surprising that if liability for breach of an express contractual provision was not excluded by a specific exemption clause, it should effectively be excluded by an indemnity clause "whose effect is simply to stand the contract on its head, so far at any rate as liabilities for personal injury or damage to property are concerned." In the Judge's view an indemnity clause should not, in the absence of strict wording or where the logic of the clause or contract so requires, be interpreted to protect a party against liability where this is due to breach of his own contractual obligations "whether or not these obligations lie in negligence or are strict obligations."

Plainly the result in both the Super Scorpio II and Deepak cases was correct but it is still far from easy to indentify the principle that will determine whether an indemnity should cover liability arising where there is breach of contract. The Judge in Deepak suggested a distinction between "strict" contractual obligations and those that mirror duties assumed in negligence. This however was doubted by the Court of Appeal and may in any event give rise to difficulties where for example the breach is of a strict statutory obligation.

A particular issue may also arise where the Contractor's scope of work involves the transfer of title to the "Permanent Work" to the Company. The Contractor will typically be obliged to warrant aspects of the performance of the Permanent Work, to repair any defects or damage to it prior to delivery, and to guarantee that it will be free from defects during at least the warranty period. Where the Contractor is required to assume responsibility for the Permanent Work until completion, it will usually be expressly excluded from the Company's property indemnity. Often however it will be more efficient for the Company to insure the Permanent Work, and to indemnify the Contractor against any loss or damage to this. In such circumstances the Contractor may be required to assume a limited liability for each occurrence of loss or damage but the extent to which the Contractor can be liable under other provisions of the contract beyond this "duty of care" amount will frequently be unclear.

Limitations and Exclusions of Liability

Offshore contracts often include limitations and restrictions on the liability of both Contractor and Company, particularly as regards consequential loss. In WesternGeco Ltd v ATP Oil & Gas (UK) Ltd (1996), a vessel engaged by the contractor undertaking seismic survey operations caused damage to a wellhead installation belonging to a third party, Total E&P. Under Clause 19.1(c) of the contract, which was based on LOGIC terms (though with significant amendments) the Contractor was obliged to indemnify the Company against any liabilities arising in respect of damage to the property of a third party, caused by the Contractor's negligence.

The parties also agreed "that Contractor Group's liability under this Contract shall not exceed the aggregate amount of payments received by Contractor for the Work and Company shall save, indemnify and hold harmless the Contractor for any amounts in excess thereof". In response to proceedings by Total E&P as owner of the wellhead installation, the Contractor sought an indemnity from the Company to the extent that this liability exceeded the aggregate amount of payments it had received for the Work.

Faced with a potential inconsistency between the indemnity given by the Contractor in respect of damage done to the property of third parties, and that given by the Company in respect of liability in excess of the contract cap, the Judge considered that the Contractor's liability under its indemnity in respect of damage done to third party property, did not constitute a "liability under the Contract". Although liable in negligence to Total for the damage caused to the wellhead, the Contractor had no liability under the Contract to pay any money to the Company, and there was therefore no legal liability that could be subject to the limitation of liability. The Judge accepted that the position would have been different if Total had brought a claim against the Company rather than the Contractor. This rather technical approach clearly leaves open the possibility that an aggregate limitation of liability may "cap" the Contractor's liability under its indemnity obligations. It is also notable that the unamended LOGIC terms clearly provide that the limitation of liability does not apply to obligations assumed under the knock for knock indemnities.

In addition to an overall limit on the Contractor's liability most offshore contracts will also exclude any liability of either party for consequential loss. The term "consequential loss" will usually be broadly defined so as to include any loss of use, production, product, revenue or profit, and the parties will usually also agree to indemnify each other and the members of their respective groups against such loss. This clause is moreover frequently expressed to apply "notwithstanding any other provision of this contract."

In Caledonia v BT (2002) which was part of the litigation arising out of the Piper Alpha tragedy in the North Sea, the operators' insurers having settled claims brought by the relatives of the dead and injured sought reimbursement of the amounts paid under the indemnities given by the Contractor. In order to avoid litigation in the USA the Company's insurers had settled the claims at levels above those which would have been awarded by a Scottish court. The Contractor contended that this part of the damages was consequential and excluded by an express term of the contract excluding both parties from liability to the other for any consequential loss. Although the House of Lords held that the indemnity did cover all of the settlement, Lord Hoffman took the view that the consequential loss provision excluded liability for such loss where it arose from a breach of contract and therefore had no application to a claim to an indemnity for liability incurred by the operator outside the contract.

In the Caledonia case, the contract contained an exclusion of consequential loss but not an indemnity and the extent to which the indemnity in respect of consequential loss reduces the obligations under the other "knock for knock" indemnities is potentially of great importance. Where the indemnities given in respect of property and personal injury do not extend to consequential loss, then both Company and Contractor are potentially exposed to liabilities to group members for which they may have no contractual recourse under the indemnity scheme.

There remains a tendency to treat indemnities as "tucked away" at the back of the contract, and an issue to be agreed largely between insurance advisors. In fact the breadth of the property indemnity in particular and its relationship with express warranties given by the Contractor needs to be clearly identified, defined and addressed. What may appear from to be a standard knock for knock indemnity may on closer analysis prove inadequate to cover the potential liabilities that may arise on a complex offshore project. These hidden dangers may only become apparent after the liability has arisen and a time when the ability of the party liable to limit or exclude a loss has passed.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
David Gardner
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert
Email Address
Company Name
Password
Confirm Password
Mondaq Topics -- Select your Interests
Accounting and Audit
Anti-trust/Competition Law
Consumer Protection
Corporate/Commercial Law
Criminal Law
Employment and HR
Energy and Natural Resources
Environment
Family and Matrimonial
Finance and Banking
Food, Drugs, Healthcare, Life Sciences
Government, Public Sector
Immigration
Insolvency/Bankruptcy, Re-structuring
Insurance
Intellectual Property
International Law
Law Practice Management
Litigation, Mediation & Arbitration
Media, Telecoms, IT, Entertainment
Privacy
Real Estate and Construction
Strategy
Tax
Transport
Wealth Management
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.