7/27/2011

Offshore and Onshore

Drilling Contracts

Mary Shaddock Jones

Attorney at Law

 Why have “Model” Drilling Contracts?

 Overview of a “Model” Drilling Contract
 Daywork Contract
 Footage Contract
 Turnkey Contract

 Typical Contractual Allocation of Risks

 Typical Insurance Policies to Cover Risks

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 Previous presentations have explained the fundamentals of the offshore

and onshore drilling and “what could go wrong”.
 One purpose of Drilling Contracts is to allocate who is responsible for
what loss when one of those things goes wrong- before any incident
occurs.
 Remember- never, ever assume that any contract is “standard”. In any
negotiation between parties- there is “give and take.” You must read the
contract!
 Today I will make some assumptions about what is in a “model” drilling
contract, how the risks are generally allocated and some possible
insurance policies applicable to cover the allocated risks.

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 The Typical drilling contract will allocate certain risks on a reciprocal basis
(including personal injury, damage to property, certain pollution risks and
consequential damages), regardless of fault.
 Other risks, such as well control, downhole pollution, loss or damage to
the hole or downhole tools and reservoir damage, are often assumed by
the operator, at least to some degree.
 The drilling contract is one of the most important contracts an operator
will enter into. Other related contracts, such as vessel charters, service
agreements, etc. will often be based upon the risk allocation scheme in
the primary drilling contract.

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 Companies initially negotiated and drafted their own set of contracts with
each other. This took up significant time and resources.
 Over the last several decades, the industry has worked to some extent on
a cooperative basis to develop and use various types of petroleum model
contracts to gain the benefits of standardization and efficiency.
 Two recognized Model contracts today for onshore drilling contracts are
those by the International Association of Drilling Contractors (IADC) and
American Petroleum Institute (API).
 Not surprisingly, the IADC form favors the drilling contractor, while the
API form favors the operator.

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 A drilling contract addresses the rights and obligations around the

provision of a drilling rig and personnel by a drilling contractor to
an operating company.
 It could be for either onshore or offshore operations and covers a
wide variety of rig structures.
 These contracts provide compensation to the drilling contractor in
one of three ways:
 Daywork (calculated by the amount of time),
 Footage or meterage (calculated by the amount of depth drilled), and,
 Turnkey (a lump sum payment for meeting a set predetermined
target).

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 The three contracts provide compensation to the

drilling contractor in different ways.
 The higher the risk (i.e. Turnkey), the higher the
compensation.
 There is a significant difference between the
daywork and turnkey or footage contracts in
respect of risk allocation and insurance.

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 Day Work Contract. A day work contract is "a contract for the drilling of an
oil and gas well under which 'the drilling contractor furnishes the drilling
crew and drilling equipment; he is paid an agreed sum of money for each
day spent in drilling regardless of the number of days involved or the
depth drilled.
 The contractor waits for direction by the operator, and most importantly
the contractor retains only the specified risks detailed in the contract.
 All other risks, whether detailed in the contract or unaddressed by the
written agreement, are shifted to the operator.
 This is the most common type for onshore drilling contracts.

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 A footage contract provides that payment is made based on

an agreed sum per foot of hole drilled. Much like a day work
contract, "the drilling contractor furnishes the drilling crew
and the drilling equipment… and is paid an agreed sum of
money for each foot actually drilled, irrespective of whether
the proposed depth is reached or not.
 This type of contract is generally not utilized in offshore
drilling.

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 A turnkey contract is a contract wherein the drilling contractor drills the

well, establishes production and turns the completed job over to the
operator for the amount specified in the contract.

 Here all work of drilling and completing a well for production is borne by
the contractor. The operator simply waits for the contractor to complete
working before becoming the owner of the well.

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 I believe that the interests of both contracting parties are

furthered by establishing a firm risk allocation scheme which
allocates responsibility for specific risks and enables each party
to measure the risk exposures it will absorb or insure.
 This only can be accomplished by a straightforward and
unconditional risk allocation structure.
 Provisions which provide that one party will assume a specific
risk of loss or liability unless the other party is negligent or
otherwise culpable do not accomplish this objective.
 To the contrary, they create a situation where a determination
of culpability is a prerequisite to identifying which party must
absorb the risk.
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 In order to have a clear demarcation of who is responsible for what risks-

risks generally are allocated to the contracting parties without regard to
cause. (i.e. regardless of sole or concurrent negligence, etc). The only
exception may be a carve out for gross negligence or willful misconduct.

 You may think that it is inappropriate to protect a party guilty of

negligence or misconduct; however, remember that a fundamental
purpose of risk allocation is to create a clear line of demarcation so each
party will be able to evaluate its risk exposure and obtain appropriate
insurance (or elect to self-insure).

 If you don’t want a clear line of demarcation- then there is no need to

contractually allocate the risk. The risk will be allocated by law.

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 A “Scope of Indemnity” clause often is included in drilling contracts to

specifically obligate an indemnifying party to release, defend, and
indemnify the other party against all liabilities and costs including
“reasonable attorney fees” associated with any claims subject to the
indemnity.
 Another common feature of such clauses is an “inurement” provision
which extends the contractual assumptions of liability and indemnities to
each party’s parent, affiliate and subsidiary companies and their
respective officers, directors, shareholders and employees.
 In offshore contracts, the inurement provision also should extend to the
drilling rig as an entity (in rem) since maritime law generally classifies
MODU’s as vessels which may be named as defendants in lawsuits.

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 Customary practice in the offshore drilling industry provides that the

contractor bears risks of personal injury or death of its personnel and
generally assumes liability for rig and associated contractor equipment
loss or damage.

 Conversely, the operator normally accepts liability for its own personnel
and property and, in daywork contracts, generally assumes responsibility
for well related risks (including pollution, wild well control, well damage or
loss) and reservoir damage.

 The principle that each party assumes liability for its own property and
personnel, often referred to as “knock for knock”.

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 The “knock for knock“ concept frequently is adopted to allocate risk for injury
or death of the respective employees of the contractor and operator.
 What about responsibility for claims of third party personnel, both in respect
of the various subcontractor and service company personnel which may be
dispatched to the rig site by either of the parties and as respects “true” third
parties (i.e., the general public and others who have no contractual
relationship with either party)?
 As respects the employees of subcontractor or service companies, such as
cementing, logging and casing crews, the operator and contractor often
indemnify each other for injury or death of employees of their respective
subcontractors and other contractors. This is based on the understanding that
the party that hires such services will negotiate the terms of engagement and
should require the service company or subcontractor to contractually extend
an indemnity for injury or death of its own personnel.
 Liability for loss or damage to true “third parties” is generally based “At Law”
or “upon percentage of negligence”.
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 The “knock for knock” approach also generally applies to equipment and
property of each party. Here again, the respective parties are expected to
insure (or self-insure) their own assets against damage or loss and thus
should be prepared to accept the associated risk in the context of a
drilling contract.
 The contracts generally allocate damage or loss of equipment and
property provided by their respective subcontractors and other
contractors. The operator and contractor should then be able to allocate
the property risks to the asset owners in the subcontract agreements.
 Among traditional exceptions to the “knock for knock” principle is the
compensation customarily afforded contractors for inhole and subsea
equipment damaged or lost while working on a daywork basis.

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 Risks related to the well being drilled pursuant to the contract generally
are allocated to the operator in daywork offshore drilling contracts since
such risks traditionally are insured (or retained on a self-insured basis) by
operators through placement of “Owner’s Extra Expense” insurance
coverage.

 It would be unreasonable to impose well risks upon contractors in

daywork contracts because such risks customarily are excluded from the
insurance coverage routinely maintained by contractors.

 When working on a turnkey basis, the contractor generally directs and

controls drilling operations and absorbs or insures the well risks.

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 Pollution and environmental liability are major components of risk

allocation.
 Generally, the contractor is required to extend an indemnity and assume
full responsibility for spills of refuse, garbage, fuel, lubricants, paint, pipe
dope, waterbased drilling fluids, ballast and bilge which may be spilled,
dumped or discharged from the drilling unit.
 The balance of the pollution and environmental risks generally are
absorbed by the operator in daywork contracts and the operator’s
indemnity customarily covers responsibility for pollution liability
(including cleanup and removal) to the full extent not expressly assumed
by the contractor.
 The liability for pollution and environmental liability is generally assumed
by the contractor is a turnkey contract.

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 The third well related risk customarily covered by Owner’s Extra Expense
insurance relates to wild well control. In daywork contracts, the operator
normally assumes liability and extends an indemnity for the costs of
controlling a wild well, including relief well(s).

 Reservoir loss or damage is a risk traditionally assumed by operators.

Although the prospects of damaging a productive reservoir or formation
during a drilling operation are rather remote, the associated potential
liabilities are akin to consequential damages and normally are allocated to
the operator which has a proprietary interest in the reservoir.

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 As noted earlier, the risk allocation for “people and property” are
generally performed on a “ knock for knock” basis, wherein each party
assumes responsibility for loss or damage to its own people and property.

 A potential deviation from the “knock for knock” principle relates to war
and political risk exposures to the contractor’s MODU in international
contracts.

 Liability for loss or damage as a result of War or Political Risks are

generally negotiated on a case by case basis.

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 Consequential damages resulting from drilling operations may

encompass lost profits, production losses or delays, or business
interruptions.

 Offshore drilling contracts customarily include a consequential damages

clause stating that each party waives its rights to seek recourse from the
other party for indirect or consequential damages arising from
performance of the contract.

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 After the parties have agreed upon a risk allocation matrix for a drilling
contract, careful consideration should be given to selection of the governing
law and inclusion of provisions which will assure that the agreed indemnity,
risk allocation and insurance provisions are enforceable.
 The Texas and Louisiana anti-indemnity statutes render certain liability and
indemnity provisions of a drilling contract unenforceable in the absence of
mutual indemnities and insurance or, in certain circumstances, in the event of
negligence by indemnitee.
 Be careful, however, because in certain circumstances, such as in performance
of inland waterway drilling in a state with an anti-indemnity statute, it
generally is accepted that the parties are free to designate an appropriate
governing law for most international offshore drilling contracts and for
domestic contracts involving MODU operations in the Ocean Continental
Shelf (where “general maritime law of the United States” is an appropriate
governing law designation)

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 The Texas Oilfield Anti-Indemnity Act (the TOAIA applies to both property
damage claims and claims for bodily injury or death.
 The TOAIA recognizes two exceptions: a limited unilateral indemnity and a
mutual indemnity. The unilateral indemnity is valid if the parties agree, in
writing, that the indemnity will be supported by insurance (up to $500,000).
 The “mutual” indemnity exception is limited “to the extent of the coverage
and dollar limits of insurance or qualified self-insurance each party as
indemnitor has agreed to obtain for the benefit of the other party as
indemnitee.”
 Significantly, the TOAIA does not apply to insurance that does not directly
support the indemnity, and this means that insurance provisions can provide
more protection than indemnity agreements in certain instances.

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 The Louisiana Oilfield Anti-Indemnity Act (LOIA) invalidates indemnification

provisions for death or bodily injury; but not for property damage .
 The courts have applied a two-step process for determining whether the LOIA
applies. First, the contract must pertain to an identifiable well, and second,
the contract must be related to the exploration, development, production, or
transportation of oil, gas, or water.
 Even insurance protection for the indemnity is generally held to be invalid.
However, Marcel v. Placid Oil Co., provides a narrow exception to this rule if
the indemnitee/additional insured is able to prove that it has actually paid for
the required insurance.
 In addition, a waiver of subrogation may be valid if there is no accompanying
indemnity claim.

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 Maritime law also has certain potentially applicable restrictions on indemnity. The
Longshore and Harbor Workers Compensation Act (LHWCA) prohibits an indemnity claim
by a “Vessel” (including a jack-up rig) against the employer of an injured longshoreman.
 However, there are exceptions. First, a reciprocal indemnity under 33 U.S.C. 905(c) is allowed
when the Outer Continental Shelf Lands Act (OCSLA) is applicable, and insurance protection
is enforceable even if the indemnity is invalid under 33 U.S.C. 905(b).
 Second, section 905(b) only prohibits indemnity from an LHWCA employer to a “Vessel.”
Indemnity from a non-employer is not affected by section 905(b). Similarly, a non-Vessel is
not prohibited from obtaining indemnity from an LHWCA employer.
 When an operator acts in more than one capacity, such as charterer of a crewboat and
operator of a fixed platform, section 905(b) may only preclude indemnity for “Vessel”
negligence, i.e., negligence in the capacity of vessel owner or charterer.
 If you are dealing with an offshore drilling contract- one significant issue will be to
determine if the rig is considered a vessel and if it is operating on the Outer Continental
Shelf. This is a very fact specific exercise.

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 It is generally permissible for a contract to require that one party (the indemnitor) indemnify
another party (the indemnitee) for the indemnitee's own negligence. But that intent must
be clearly expressed.
 Under maritime law and Louisiana law, for example, no talismanic (i.e. “required”) language
is required to make an indemnity agreement enforceable, but the intent to indemnify
against the indemnitee's negligence must be expressed in “clear” and “unequivocal terms.”
 Texas courts follow a two-part test for enforceable indemnities, which requires that (1) the
intent to indemnify the indemnitee for its own negligence must be stated in “specific”
terms, and (2) the provision must be “conspicuous.” The first part of that rule is the “express
negligence” doctrine, which is a stricter standard than that required under Louisiana and
maritime law.
 It is advisable under all three tests, maritime, Louisiana, and Texas, for the contract to cover
not merely indemnification for the “negligence” of the indemnitee, but to specifically
include the “sole or concurrent” fault or negligence of the indemnitee. Otherwise, the
indemnitor may argue that the provision is not sufficiently clear.

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 Insurance provisions are important aspects of drilling contracts and

customarily specify the types of coverage and policy limits which are to be
maintained by the contractor.

 The insurance provisions specify the types of coverages the contractor is

required to maintain, such as worker’s compensation, employer’s liability,
comprehensive general liability, property coverage and excess liability
coverage. In offshore contracts, Protection and Indemnity and Hull and
Machinery coverages customarily are specified.

 We will discuss the specific types of policies in more details later in the
presentation.

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 Generally, insurance should be provided only to cover the indemnity obligations of

the insured.
 However, when a contract provides that the operator shall be named as an
unqualified additional insured (or have an unqualified waiver of subrogation)
under the contractor’s insurance policies (other than Worker’s Compensation) or
states that the contractor’s insurance shall be deemed primary coverage, the
parties may inadvertently override many provisions of the liability and indemnity
risk allocation section of the contract and also may create potential issues
regarding application of the contractual liability insurance coverage.
 To properly delineate the extent the operator may directly have access to the
contractor’s insurance, provisions requiring inclusion of the operator as an
additional insured under the contractor’s policies or stating that such insurance
shall be deemed primary coverage often are qualified and limited “to the extent
the contractor expressly assumes liability” under the contract. (or visa versa for
indemnity by the operator)

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 Being named an additional insured is an affirmative protection that gives the

additional insured direct rights under the policy of insurance. Additional insureds
generally have the same rights to coverage as a named insured.
 The company's contracts should also require a waiver of subrogation in favor of all
indemnified parties. The waiver of sub-rogation is a defensive protection that
prevents the contractor's insurer from asserting a claim against an indemnified
party for its proportionate fault following a casualty.
 Additional insured protection is most effective in a liability policy, while the waiver
of subrogation is most common in conjunction with a property policy or a workers'
compensation policy.
 As discussed in the previous slide, I recommend limiting the additional assured
and waiver of subrogation “to the extent of the contractual indemnity obligations
assumed by (owner/contractor)”.

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 It is preferable to express insurance policy limits as stated amounts rather

than as 10 minimum requirements” or coverage in an amount “not less than.”
This will serve to remove any uncertainties concerning the contractor’s
insurance obligations, an important delineation whenever a liability or
indemnity contractually is limited to the amount of applicable insurance
(most commonly in third party liability clauses) or where the operator is an
additional insured.
 It also is prudent to specify the applicable deductible amounts, especially in
contracts where the operator effectively absorbs the deductible in certain
situations (such as in-hole or subsea equipment losses).
 The contractual insurance provisions often state that, except where a liability
or indemnity expressly is limited to a stated policy limit, the limits of
insurance are not intended to serve as limitations on the risks otherwise
assumed under the drilling contract.

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 Another key protection is to require that the insurance provided by the

contractor is primary to any other coverage in favor of the indemnified
parties, at least for the risks and liabilities assumed by the contractor.

 Otherwise, the court may compare the “other insurance” clauses in the
contractor's policies and require the company's policies to share a loss.

 This can completely negate the parties‘intent that the contractor's

insurance will respond to a loss that was allocated to the contractor.

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 First Party Insurance Policies

 Property damage
 Business Interruption
 Operators Extra Expense

 Third Party Insurance Policies

 Workers Compensation/Employers Liability
 MEL/LHWCA
 Automobile Policies
 Comprehensive General Liability
 Excess/Umbrella Liability Policies

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 Maritime Policies
 Hull and Machinery
 Charterer’s Legal Liability
 Protection and Indemnity

 Other Possible Policies

 Stand Alone Pollution
 Professional (Engineering)
 Kidnap, Ransom, and Extortion
 Employers Liability
 Directors and Officers Liability

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 The next hour, we will examine an offshore

drilling accident scenario and test your
knowledge of what we learned in this hour!
 Stay Tuned… ..

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 I would be remiss if I did not state that much of the

information I included in this presentation was
obtained in publications written by William W. Pugh
and Harold Flanagan (Liskow & Lewis- New Orleans)
and Cary A. Moomjian.
 Although the articles were written in the late 1990’s,
the information contained therein was invaluable to
putting all of these concepts together.

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Mary Shaddock Jones, LLC

Attorney At Law
1202 Kirkman St.
Lake Charles, LA 70601
337-515-8527 (cell)
337-513-0335 (office)
msjones@msjllc.com

 Mrs. Jones’insurance practice provides assistance with insurance policy interpretation,

evaluation of coverage, advice regarding contractual indemnity and insurance
provisions. She can provide clients with a pre or post-loss coverage review of their
entire risk management program, identifying potential gaps in coverage and
highlighting significant areas of concern. She has experience in virtually all types of
policies, including builder’s risk, CGL, D&O, employment practices, energy, excess, first
party, maritime, offshore energy, pollution and contamination, and property damage
liability.

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