1/3LY Oil & Gas Disputes: Recent Cases On The Interpretation Of Contracts

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As a result of acute financial pressures caused by the sustained low oil price, disputes in the oil & gas industry are on the rise.
UK Energy and Natural Resources
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In terms of disputes, the conclusions of the recent survey of the oil & gas industry carried out by Clyde & Co are entirely consistent with our own experiences in the sector, throughout the Clyde & Co offices globally. As a result of acute financial pressures caused by the sustained low oil price, disputes in the oil & gas industry are on the rise.

This represents a considerable change in attitude for an industry which, historically, has been relatively reluctant to trigger contractual dispute resolution provisions, due to the close, inter-connecting relationships which exist, often globally, throughout the supply chain.

The main pressure points for disputes include attempted renegotiation of contracts, early termination of contracts, and non-payment. When times were good, many companies may have written off unpaid invoices or sought a commercial compromise, but in today's climate a harder edged, more bullish approach is increasingly prevalent. Many of the disputes are resolved by either mediation or by negotiation, often with the close involvement of the senior management of the respective companies in dispute. Such top level intervention can be highly effective in reaching a pragmatic compromise which avoids the need to engage in costly and time consuming legal proceedings.

Contractual interpretation

For those cases which cannot be resolved amicably, the contractual dispute resolution process, which will stipulate either arbitration or litigation, can in some cases be the only way to reach a conclusion. This, in turn, brings the precise wording of contracts, and how such terminology will be interpreted by the courts/tribunals, under the microscope. From the litigation following the Piper Alpha disaster in 1988, which finally concluded in the House of Lords in 2002, through to the more recent Macondo litigation in Louisiana, there have been many examples of how the courts interpret oil & gas contracts, and in particular, any exclusions in the contracts. What is crystal clear from the decisions is that clear, unambiguous and express wording must be used when drafting exclusion clauses. For example, where parties wish to agree that indemnities shall apply irrespective of negligence, then the language of the clause must specifically address negligence.

Recent Supreme Court cases

Different approaches to interpretation

One of the most controversial debates in the English courts is the tension between the strict "literal" approach to contractual interpretation and the more expansive "commercial common sense" approach; in particular the extent to which the courts should "read in" provisions to contracts which the parties have not expressly included. Two recent decisions of the Supreme Court in England have provided an invaluable insight into the current thinking of our most senior judges. The dissenting judgment of Lord Carnwarth in the Arnold v Britton case demonstrates that this is, by no means, a straightforward area of law.

The facts in the case of Arnold v Britton and others [2015] UKSC 36 is of little relevance to the oil & gas industry. What is important is the leading judgment by Lord Neuberger, where he stated that when interpreting a written contract, the court is concerned to identify the intention of the parties by reference to "what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean" – Lord Hoffmann in Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38, [2009] 1 AC 1101, para 14. He went on to state:

"This the court does by focussing on the meaning of the relevant words, in their documentary, factual and commercial context. That meaning has to be assessed in the light of (i) the natural and ordinary meaning of the clause, (ii) any other relevant provisions of the lease, (iii) the overall purpose of the clause and the lease, (iv) the facts and circumstances known or assumed by the parties at the time that the document was executed, and (v) commercial common sense, but (vi) disregarding subjective evidence of any party's intentions.".

Lord Neuberger then dealt with the issue of common sense. Whilst it is a factor, it should not be used to undermine the importance of the language actually used in the contract. Where a clause is badly drafted, the court will more readily depart from its natural meaning. However, the court should not seek out problems with the drafting of a contract solely to justify departing from its natural meaning. Commercial common sense must be assessed as at the date the contract was entered into, and should not be invoked retrospectively only once it has become clear that the bargain "has worked out badly, or even disastrously, for one of the parties". The court should be slow to reject the natural meaning of a term merely because it appears to have been an imprudent term to have agreed, even at the time of entering the contract. Surrounding factual circumstances may only be taken into account to the extent that they were known or reasonably available to both parties. In language that will resonate with anyone drafting oil & gas contracts, Lord Neuberger stated:

"[T]he parties have control over the language they use in a contract. And, again save perhaps in a very unusual case, the parties must have been specifically focussing on the issue covered by the provision when agreeing the wording of that provision . . . it is not the function of a court when interpreting an agreement to relieve a party from the consequences of his imprudence or poor advice. Accordingly, when interpreting a contract a judge should avoid re-writing it in an attempt to assist an unwise party or to penalise an astute party. ".

Implied Terms

In the case of Marks and Spencer v BNP Paribas [2015] UKSC 72, the Supreme Court considered the test for implying terms into a contract. Lord Neuberger held that the judgment in the earlier Privy Council case of Attorney General of Belize v Belize Telecom Ltd [2009] UKPC 10 should not be read as having watered down the traditional, highly restrictive, tests for implying a term. The court held, instead, that in assessing whether it is appropriate to include an implied term into a contract, the court should first construe the express words used, and then decide whether a term should be implied. Furthermore:

  • A term will only be implied where it is strictly necessary for business efficacy;
  • It is not enough that the parties would have agreed to it had it been suggested to them. That is a necessary but insufficient ground for implying a term;
  • The test is not one of absolute necessity but whether, without the term, the contract would lack commercial or practical coherence; and
  • A term will not be implied where it 'lies uneasily' with the express terms in the contract.

Indirect and Consequential Damages

Finally, no overview of recent case law would be complete without mentioning the Court of Appeal's decision a few months ago in Transocean v Providence [2016] EWCA Civ 372.

Providence had contracted with Transocean for the supply of a semi-submersible drilling rig for a drilling contract in the Irish Sea. A dispute arose between the parties and Providence claimed, among other things, that it was entitled to recover its wasted spread costs as a result of Transocean's alleged breaches of contract. The spread costs involved were significant, and consisted of the costs of personnel, equipment, and services contracted from third parties which were wasted as a result of the delay. These included well logging; well testing and cementing; and mud engineers.

Following a trial at the High Court in London in 2014, Mr Justice Popplewell made a ruling in relation to the interpretation of the consequential loss provision which had far reaching consequences for the industry. In a nutshell, and to the surprise of most, he ruled that "spread costs" were not excluded by the consequential loss provision. As a result of this initial decision, the industry saw a significant increase in claims for spread costs.

Transocean appealed, and the Court of Appeal reversed the decision of Mr Justice Popplewell in relation to consequential loss. The clause in question was the standard LOGIC Form, with a few relatively minor changes. The key part of the consequential loss provision in section 20 of the Contract was:

" . . . 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...".

The decision of the Court of Appeal was that the spread costs claimed by Providence were included in the definition of "loss of use" and that, therefore, Transocean had no liability to Providence for spread costs – the words, highlighted in bold, were clear and demonstrated the clear intention of the parties to exclude liability for wasted spread costs.

A number of important principles in contract interpretation under English law are clear from this decision of the Court of Appeal:

  • Freedom of contract remains a fundamental principle of English law;
  • Where parties of equal bargaining power agree to a sophisticated apportionment of liability under knock-for-knock provisions, this will be enforced by the courts, provided the language is clear and unambiguous;
  • In particular, where parties agree mutual undertakings to accept the risk of consequential loss flowing from each other's breaches of contract, such undertakings are enforceable;
  • A consequential loss clause must be interpreted as part of a broader scheme for allocating losses between parties. The entire liability and indemnity scheme must be read together. It is not, therefore, a simple exclusion clause of a kind which at one time the courts were willing to construe restrictively in order to avoid commercial oppression;
  • The words used by the parties must be given their ordinary and natural meaning. Artificial approaches to the construction of commercial contracts are to be avoided;
  • The court should give the language used by the parties the meaning which it would be given by a reasonable person in their position furnished with the knowledge of the background to the transaction common to them both; and
  • The judge was wrong to invoke the contra proferentem principle. This should only be invoked when the language chosen by the parties is one-sided and genuinely ambiguous. In such cases the application of the principle may enable the court to choose the meaning that is less favourable to the party who introduced the clause or in whose favour it operates. It has no part to play, however, when the meaning of the words is clear; nor does it have a role to play in relation to a clause which favours both parties equally, especially where they are of equal bargaining power. In the case of a mutual clause, it is impossible to say who is the proferens and who the proferee.

First published in the International Arbitration 1/3LY, Issue 7

1/3LY Oil & Gas Disputes: Recent Cases On The Interpretation Of Contracts

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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