Knock-for-Knock Indemnification Clauses in the Oil and

THE
NEGOTIATOR
Th e M a g a z i n e o f t h e C a n a d i a n A s s o c i at i o n o f Pe t ro l e u m L a n d m e n
October 2015
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Precision Drilling Canada Limited Partnership
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Fenner L. Stewart & Anthony G. Cioni
9 K nock-for-Knock Indemnification Clauses
in the Oil and Gas Industry
Kourtney Rylands
12 S ummary Judgement on Contested
Amounts Owing under Natural Gas
Processing and Related Agreements
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Knock-for-Knock Indemnification
Clauses in the Oil and Gas Industry
THE OIL AND GAS INDUSTRY IN ALBERTA AND INTERNATIONALLY IS LARGELY GOVERNED BY STANDARD FORM
CONTRACTS.1 These types of agreements provide certainty and
the negligence or other fault of Precision or howsoever arising.”4
efficiency to contractors and operators alike, on the assumption
assume all of the risk of and be solely liable for the cost of
that the parties have read and fully understand the implications
repairing and re-drilling a lost or damaged hole, including,
of entering into such a contract. However, a recent decision of the
without limitation, the cost of fishing operations, regardless of
Alberta Court of Queen’s Bench illustrates how even sophisticated
the negligence or other fault of Precision or howsoever arising.5
The contract further provided that Yangarra was to
entities can be caught off guard by the practical results of the
provisions in standard form drilling contracts.2 In Precision Drilling
The court relied on a plain language reading of the agreement to
Canada Limited Partnership v Yangarra Resources, 2015 ABQB 433, the
find that Yangarra was required to assume all of the losses caused
court upheld a bilateral no fault contract between a contractor and
by Precision. Yangarra was also required to pay for Precision’s day
an operator, resulting in multi-million dollar losses for the operator.
work. Yangarra attempted to counterclaim against Precision for
This case illustrates that Alberta courts have been more than willing
the losses it suffered based on arguments of negligence, gross
to hold experienced and sophisticated commercial entities to their
negligence, breach of contract, negligent and fraudulent misrep-
agreements, and serves as a cautionary tale for industry to be fully
resentation and unjust enrichment. However, under the contract,
informed about what is contained in its contracts, especially those
Yangarra had released Precision from any and all claims based on
that purport to allocate liability in a particular manner.
negligence or any other theory of legal liability. The court was not
In this case Yangarra Resources Ltd. (“Yangarra”), an oil
willing to overturn the clear intentions of the contract or find a
and gas operator, contracted with Precision Drilling Canada
carve-out the parties did not specifically agree to.6 The ultimate
Limited Partnership (“Precision”) to drill two wells. The agree-
question asked by the court and those who have read this deci-
ment between the parties was governed by a bilateral no fault
sion is: “why would anyone knowingly make such a contract?”7
contract, or reciprocal indemnity agreement. Agreements such as
Oil and gas companies around the world rely on model forms.
these are commonly referred to as “knock-for-knock” contracts
As commentators have noted, this practice “saves the parties
because, pursuant to the contract, each party agrees to bear the
time and transaction costs and gives comfort that they are using
risk of damage to its own assets even if its assets are destroyed or
documents with which they are already familiar.”8 One of the
damaged by the fault of the other.
most common provisions of a standard form oil and gas service
The losses to Yangarra occurred during the drilling of the second
contract is the apportionment of liability or knock-for-knock
well when an employee of Precision improperly mixed the drilling
provision.9 These types of agreements have become common in
mud. Precision employees then “neglected to test or carelessly
the oil and gas industry because they can offer significant bene-
tested the drilling mud and wrongly advised Yangarra’s supervisor
fits to all parties, such as reduced costs with respect to litigation,
that the drilling mud was in order.”3 During drilling, the drill string
increased certainty with respect to risk allocation, and decreased
and bit subsequently became stuck in the hole and could not be
friction between multiple parties at a wellsite.10 However, the
extracted, resulting in equipment losses to Yangarra of approxi-
Precision case is an example of the most significant drawback of
mately $300,000.00. It was assumed these losses were due to the use
the knock-for-knock regime: the requirement for a contracting
of the improperly mixed drilling mud. Yangarra also incurred addi-
party to assume liability for damage for which it is not responsible.
tional expenses in the amounts of $720,000.00 in attempts to retrieve
Depending on the jurisdiction, courts have taken different
the drill string and bit and $2.5 million to drill a replacement well.
approaches with respect to the enforcement of knock-for-knock
indemnification clauses. For example, there is legislation in place
fully sued Yangarra for all of its fees, including the extra expenses
in the United States that generally prohibits indemnification for an
incurred in fishing operations and to drill the replacement well.
indemnitee’s own negligence.11 In addition, some courts have raised
Yangarra was required to pay the full amount of Precision’s bill
the issue of public policy with respect to the enforcement of knock-
and was not able to set off any of its losses. This scenario was
for-knock provisions.12 In the Precision case Yangarra attempted
made possible by the wording of the knock-for-knock drilling
to make the public policy argument that the enforcement of the
contract. The contract provided that Yangarra was to assume all
knock-for-knock provisions would encourage negligent and grossly
of the risk of damage to its equipment or the hole “regardless of
negligent behaviour in the oil and gas industry, therefore placing
9
TH E NEGOTIATOR / OCTO BER 20 15
This decision may be surprising to some as Precision success-
the public at risk.13 However, the Alberta court made clear that
Precision and Yangarra were sophisticated commercial entities
with equal bargaining power who had significant motivation to
avoid negligent behaviour; the court determined that enforcing the
knock-for-knock contract under those circumstances was neither
unconscionable nor contrary to public policy.
As might be expected, negotiating knock-for-knock indemnification provisions can be a time consuming and heated endeavour.
Part of this negotiation process often involves the carve-out of
specific circumstances in which liability will be apportioned to each
party. For example, a knock-for-knock contract may have a carveout for negligence or gross negligence. One of the key factors in this
decision was that the contract provided indemnification for damage
based on any theory of legal liability. In Canada, there is no legislation in place which prohibits this type of broad indemnification
clause.14 In the Precision case the court found that the indemnity
clause covered all heads of damage advanced by Yangarra and
concluded that the indemnity clause would only be unenforceable
in circumstances in which intentional harm was inflicted.15
As discussed, standard form contracts (some complete with
knock-for-knock provisions) are common in the oil and gas industry
worldwide. These types of agreements are often drafted by experts
over many years and negotiated with certain purposes in mind.
For example, if we look slightly closer to home, the CAPL 2007
Operating Procedure is a widely used and accepted standard form
document. The Operating Procedure is by all accounts a “norm based”
standard form document and was designed by its drafters to serve
“typical” situations and transactions (remember $90.00/bbl oil?), all
in an acknowledged environment of ever-increasing non-typical
situations and transactions. Modifications to the norm were expected
to address special circumstances and efforts were made (see the
inclusion of special related annotations to assist users in recognizing
areas for which modifications might be appropriate) to highlight this
potential need and to facilitate special circumstance customization.
However, to understand when modifications to a standard form
document are necessary, one first has to completely understand what
the norm is and what the standard form document purports to do. I
have it on good authority that it was never the drafters intention to
create a document that could be mindlessly stapled onto a generic
and one-size-fits-all head agreement. Quite the contrary in fact. The
situation faced by Yangarra with respect to the use of a standard form
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drilling contract should cause every reader to reach to their shelf to
review the liability provisions of the Operating Procedure.
In the Precision case, the contract used by the parties was
THE NEGOTIATO R / OC TO BER 20 15
not a CAPL standard form document, but instead was negotiated
between the Canadian Association of Oilwell Drilling Contractors and
the Canadian Association of Petroleum Producers.16 As cautioned,
contractors and operators alike must still carefully consider and fully
understand the provisions of such contracts, including the liability and
release provisions they are committing to. For example, parties might
turn their minds to allocating certain risks between them instead of
10
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releasing each party completely. One way parties can accomplish this
Notes
is to identify in advance certain circumstances in which one party
1.
Trent Mercier, Josh Kane, and Sharbil Nammour, “Drafting Oilfield
has complete control of a particular aspect of the job and carve out an
exception to the knock-for-knock contract that allocates responsibility to such a party.17 In this instance the parties had the opportunity to
Master Service Agreements”, 52 Alta L Rev 245 (2014) at p 247 [Drafting
Oilfield Master Service Agreements].
2. Precision Drilling Canada Limited Partnership v Yangarra Resources, 2015
ABQB 433 at para 5 [Precision v Yangarra].
allocate some risk to Precision, which might have covered the prepa-
3. Ibid at para 17.
ration of the drilling mud. However, the contract used by Precision and
4. Ibid at para 11.
Yangarra noted that the risk allocated to Precision would be “nil.”
18
If parties do proceed with the broad form of indemnification they
5. Ibid at para 29.
6. Ibid at para 36.
7. Ibid at para 44.
need to consider whether there are gaps in their insurance coverage
8.Toby Hewitt, “An Asian Perspective on Model Oil and Gas Services
which a knock-for-knock contract might expose. Additionally, parties
Contracts”, 28 J Energy & Nat Resources L 331 (2010) page 331 [Model
should be aware of how the indemnification clauses in their agreements interact with the contract’s payment terms. Here the parties
Oil and Gas Services Contracts].
9.Model Oil and Gas Services Contracts, supra note 10 at p 333; Drafting
Oilfield Master Service Agreements, supra note 1 at p 255.
agreed that Precision would be paid day rates, which resulted in
10.
Nick Kangles, R Ben Rogers, and Chris Harris, “Risk Allocation
additional losses for Yangarra due to Precision’s continued work at
Provisions in Energy Industry Agreements: Are We Getting It Right?”,
the wellsite. A requirement for Precision to drill a complete well may
49 Alta L Rev 339 (2011-2012) at p 340 [Risk Allocation]; Christopher L
have resulted in reduced losses to Yangarra. Finally, operators headquartered in jurisdictions outside of Alberta with a different approach
Evans and F. Lee Butler, “Reciprocal Indemnification Agreements in the
Oil and Gas Industry: The Good, The Bad And The Ugly, 77 Def Counsel
J 226 (2010) at p 227-229 [Reciprocal Indemnification Agreements].
to the interpretation of indemnification clauses should carefully
11. Risk Allocation, supra note 12 at p 342.
consider choice of law clauses in their standard from agreements.
12. Ibid at p 247.
The results of this case indicate that Alberta courts may hold sophis-
13. Precision v Yangarra, supra note 2 at paras 101-112.
ticated commercial entities to their agreements and will not hesitate
14. Risk Allocation, supra note 12 at p 341.
in enforcing them, whatever the result may be. m
15. Precision v Yangarra, supra note 2 at para 37.
Kourtney Rylands
18. Precision v Yangarra, supra note 2 at para 30.
16. Precision v Yangarra, supra note 2 at para 5.
17.Reciprocal Indemnification Agreements, supra note 12 at p 231.
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