The Knock-for-Knock Principle under Danish Law

30 November 2010

The Seminar

• Welcome

• A few practicalities

• Background of the seminar

• The agenda • First part: introductory remarks

• Second part: jurisdictions

01/12/2010 SANDROOS 2

Physical Loss, Damage or Injury

• Physical loss or damage to property • Equipment is lost

• A module under construction turns over

• Personal injury, illness • A broken leg, a broken back, pneumonia

As opposed to the liability for

• Defects • E.g. non-compliance with specifications, or

• unskilled labour

• Delay • E.g. late delivery of the module, or

• late arrival of crew

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Rationale of Contractual Regulation of Liabilities

1. Risks of offshore E&P activities • Weather conditions, working far from shore, at sea

• On top of hydrocarbon accumulations – brought into industrial process

• Flammable, explosive

2. High number of offshore contractors • Suppliers, sub-suppliers, sub-sub-suppliers

• Complex collaboration pattern, work flows

• Without contractual regulation • Basis of liability – fault or statutory liability and payment of damages

• Necessitates thorough and individual investigations

• Can the damaging party be blamed? Strict liability?

• Causality between loss and the specific circumstances?

• Loss a natural and foreseeable consequence of these circumstances?

• Investigations subjective

• No forecasting of potential liability, or chances of loss recovery

• Risk management suffers, insurance becomes challenging

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The Contractual Solution

• Regulation of liability separated from traditional law of torts • Liability distributed to where the damage/loss occurs – who has

suffered the loss

• Holds the other party harmless from claims from third parties

• Irrespective of how arisen, negligence, by whome, and (principally) what the loss amounts to

• An agreed channelling of liability with financing of loss via insurance

• Time-saving

• Avoids litigation

• Predictable

• Issues to consider • Protected interests

• Peoply, Property, ”Work”/”Permanent Work”

• Third-party liability

• Other assets/interests to be covered

• Time, Geography, Exclusions, Other issues

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Knock-for-knock

directs

management

attention to the

critical path

Risk Zones

Subcontractors (with affiliates) incl.

management, employees and consultants

Contractors (with affiliates) incl. management,

employees and consultants

Operator (with affiliates) incl. management,

employees and consultant + partners (co-venturers)

Company

Fabrication

Compressors for processing

facility

Supplies for

steel jacket

Installation

Anchor handling

vessel

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Operator’s nuclear family

Operator’s extended family

Contractor’s family

(Genuine) Third-parties

Main Elements

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Assume liability for own losses (indemnity)

No recourse against the other party

Hold the other party harmless for third-party claims

Optimize the coverage of (existing) insurance

Knock-for-Knock Components

Type of contract and the protected interests: The Work – personnel – property – third parties - other

Negotiation and drafting

Liability

Insurance

Company’s All Risk insurance

Coverage and deductibles (Contractor)

Contractor’s property

and personal injury insurances

Coverage

Contractor’s third-party liability insurance

Coverage

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Types of Knock-for-Knock Regimes

• Principle developed in fabrication, EPC/EPIC contracts

• Transportation • Carriage of goods by sea

• Maritime contracts/charter parties – ”agreed documents”

• Drilling contracts • Main rule: knock-for-knock

• Exclusions – damage to

• downhole equipment, subsea equipment

• the borehole/well (excl. gross negligence. ”Liability”: time risk - re-drill at lower dayrate)

• the reservoir, geological formation

• Exclusions – liability for

• pollution emanating from reservoir, cuttings, muds, radioactive sources

• blow-out, uncontrolled well condition, incl. costs to control well, removal

• Limitations under the Maritime Act

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Principal Reservations

• No incentives for loss prevention • Safety

• Quality

• Risk of abuse of market power

• Unless reciprocal, risk of skewed balance of rights

• Considerations as per Contracts Act §36, UK Unfair Contract Terms Act

• May require lengthy ”front-loaded” negotiations

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Why Would a Party Seek to Set-Aside a Knock-for-Knock Provision

Company Contractor

Scenarios

Due to Contractor’s perceived grossly negligent behaviour in causing the total loss of the Work

Due to Company’s perceived negligent behaviour in causing the loss of Contractor’s critical equipment

Challenge

Can the other party exclude his own gross negligence?

Can the other party exclude his own (gross) negligence? (+ Contract Act §36)

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What kind of liabilities can you Limit or Excempt – as a General Rule?

Managerial Personnel Employees

Intentional No (?) Yes

Willful misconduct ? Yes

Gross negligence ? Yes

Negligence Yes Yes

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The Professional Standards – In Contract • How will the court look at

• The offshore industry (requiring highest levels of quality and safety)

• Company

• Contractor

• Contractor: professional standard, e.g. fabricator of topside • Guarantees

• Expert

• Assertions of own competence

• Level of technical ”ambition”

• Negligence in QA/QC • Easily become ”systemic” failures – the responsibility of management

• Quality processes

• Defined

• Implemented

• Verified

• If causality between loss and lack of quality is demonstrated, burden of proof is reversed

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Stricter standards

Summing Up – Knock-for-Knock Drafting

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Knock-for-Knock in various Jurisdictions - Overview

• US • Offshore: federal law, generally upholds – with exceptions

• UK • Generally upholds – subject to proper drafting

• Norway • Upholds – not really tested

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US • Federal law – state law

• Onshore + shallow waters: state law

• Outer Continental Shelf: federal law (maritime/admiralty law)

• Main rule: knock-for-knock clauses upheld

• Indemnity and exculpatory clauses must pass test • ”Conspicuousness”

• Bigger

• Bolder

• Set apart by headings

• Must express clear and unequivocal intent

• State anti-indemnity acts • E.g. AL, TEX, LOU, NME, WYO, NY, CAL

• Prohibiting indemnities (but allowing limitations of liability)

• Clauses upheld as long as ”the limitation is reasonable and not so drastic so as to remove the incentive to perform with due care”

• Some states allow insurance cover to circumvent the prohibition

01/12/2010 16 SANDROOS

UK

• Generally upholds indemnity/limitation clauses

• Indemnity drafting becomes crucial • Express reference to negligence, or

• ”no liability whatsoever”, ”under no circumstances”, ”howsoever caused”, ”howsoever arising”, ”arising from any cause whatsover”

• Construed strictly

• Interpret ”contra proferentem”

• Importance of sole or contributory negligence - ”London Bridge” case (Piper Alpha)

01/12/2010 17 SANDROOS

Norway

• Generally accepts indemnity/limitation clauses • Only partly tested once, in Sleipner A-litigation

• Standard contracts NF05, NTK05, NSC – agreed documents

• Norwegian Contracts Act §36 (as in Denmark) • §36 is a general clause likely to replace the often ”hidden” strict

interpretation by the courts

• Legal theory asserts the need for construing the clauses according commercial needs and considerations, including insurances

• Agreed documents

• Access to the best advisors, commercial and legal

• Large values, long term investments need for predictability

• The ”bar” for §36 will be raised considerably

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Knock-for-Knock Clauses under Danish Law

• Regulatory starting point

• Legal theory

• Some case law

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Regulatory Starting Point

• Contract interpreted according to Danish law • DK contract law interpretation principles

• Contracts Act

• Freedom of Contract

• §36

• Sale of Goods Act

• ”General Conditions….” (”AB92”…)

• Danish courts hesitant to exclude or limit liability for gross negligence

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Danish Contracts Act

36.-(1) A contract may be modified or set aside, in whole or in part, if it would be unreasonable or at variance with the principles of good faith to enforce it. The same applies to other juristic acts. (2) In making a decision under subsection (1) hereof, regard shall be had to the circumstances existing at the time the contract was concluded, the terms of the contract and subsequent circumstances.

Legal Theory

• Restrictive position on exclusions/limitations of liability

• Gomard, ”Obligationsret”:

”An exclusion of liability does not include damage caused intentionally or through gross negligence, see for statutory limitations the Maritime Act §§174, 283, 347 and 424 and the CMR Act §37 and for agreed limitations UfR 1993.851H and 1995.302SH. Creditor does not expect debitor to behave grossly negligent and debitor has no natural need to protect himself from liability emanating from such behaviour. However it cannot always be excluded that debitor may exempt himself from liability for, or at least liability for his employees’ intent or gross negligence. The quoted provisions of the Maritime Act (but not the CMR Act) only relate to the employer’s own mistakes. It cannot as a general rule be excluded that liability even for grave mistakes made by employees, against the wishes and instruction of management, and despite reasonable control, may be exempt, however presumably not for mistakes made by managerial personnel.”

01/12/2010 SANDROOS 21

Case Law UfR 1999.1161 H

• Transportation of cars onboard ship that burns (total loss)

• Pre-payment with ship-owner’s liability excluded

• Gross negligence on the part of the ship-owner (”særdeles grove fejl”)

• Fire alarm faulty due to corrosion

• No sound from alarm system on the bridge

• Ventilation systems/procedure onboard violated regulations

• Fire doors did not close due to bad design

• CO2 system ineffective due to cargo sections not being compartmentalised

• Exclusion of liability upheld. The clause

• was clear and unambigous,

• not uncommon, and

• entered into between professional parties

• Only set aside due to changed circumstances or Contract Act §36 (not applicable)

• Supreme Court:

• ”The Maritime Act is based on international conventions whose protective provisions have been adapted to the international maritime transport markets. Hence [….] the Contract Act §36 is not applicable.”

01/12/2010 22 SANDROOS

Case Law

Maritime and Commercial Court (2004, settled, unreported) • Towage of ferry to a repair yard – ferry sustains damage

• BIMCO ”TOWCON” charter party

• Plaintiff, the ferry owner (hull and machinery insurance company), claimed that the knock-for-knock provision should be put aside as a matter of principle under Danish law as the clause was so favourable to the tug owner that it would be unfair to apply it

• Defendant, tug owner, claimed that the knock-for-knock clause has the potential to benefit both parties

• Court held that

• TOWCON is a charter party commonly used in the industry

• Developed with participation of and under the influence of BIMCO

• shipowning companies through BIMCO most likely must have accepted the wording of the standard clause, and the allocation of risk and liability

• Burden of proof was not on the tug owner

• Court recommended withdrawal of plaintiff’s claim

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Other Case Law

Smit vs. Mobius (2001, CLC 1545) • Facts compable to the Danish 2004 case, only tug owner caused damage

on both the tow (a barge) and a third party dredging vessel

• BIMCO TOWHIRE charter party containing a knock-for-knock clause

• Plaintiffs, the barge owner, claimed that the tug (responsible for the damage) was un-seaworthy (gross negligence) – knock-for-knock provision must assume that the tug is – at least – seaworthy (captain was drunk).

• Court held that

• A commercial/businesslike approach must be taken

• Knock-for-knock is a ”crude but workable allocation of risk and responsibility”

• Allocation is clearly defined, even though it may seem unfair from time to time

• Arguments of seaworthiness would ”significantly lessen the effectiveness of the knock-for-knock arrangement”

• The provision anyway stated that the indemnity applies ”whether or not the same is due to the breach of contract”

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Putting it Together

Knock-for-knock

Insurance

Activity specific risks

Exclusions or carve-outs

Sole or contributory negligence

Protected interests

Time

Geography

Degree of negligence

Definition of risk zones

01/12/2010 25 SANDROOS

Company

Affiliates / Group

Its/their

- Managers

- Employees

- Consultants

- Subcontractors

Co-venturers

Intent

Willful misconduct

Gross negligence

Negligence

Start and finish

Worksites

Transportation routes

World-wide

Prior to contract signing

Design, pre-studies

During suspension/stop

Termination

Completion Certificate

Warranty period

After warranty period

Personal illness, injury and death

Property

The Work / Permanent Work

Third-parties

The environment

Other contract clauses………

Sole negligence

Contibutory negligence

Risk zones

Degrees of negligence

Geopgraphic sites

Time periods

Protected interests not covered

- Special types of equipment

Sole/contributory

Drilling: subseq and borehole equipment

Diving/ROV: specific equipment

Lift: the crane, the heavy-lift vessel

Company’s insurances

Construction All-Risk (CAR)

- Coverages

- Deductibles

Contractor’s insurances

- Workmen’s compensation

- P&I, Hull & Machinery

- Third-party Liability

- Aircraft, Automobiles, Other

The Knock-for-Knock Principle under Danish Law

30 November 2010