Oil and gas contracts are typically involve parties putting forward significant funds with significant risk. An overlooked clause, perhaps one forgotten or perhaps one lacking detail is enough to bring what could have been a smooth, profitable investment project between two parties to a length legal dispute.
Most companies already understand this, but sometimes the danger lurks where you aren’t looking. So I will breakdown 5 legal points that can make or break a contract, supported by case law to help drive home the point.
1. Indemnity Clauses
Firstly, it’s important we establish what exactly an indemnity clause is. In a traditional contract these are just provisions that allocate financial liability for loss or damage.1 The liability could be specific, or non-specific. Naturally, it depends entirely on the wording of the clause. However, it should be noted that in oil and gas contracts, this responsibility usually also extends to environmental liabilities.
Liability allocation in the oil and gas industry though is most often done through what are known as “knock-for-knock” clauses. It has been a theme that parties to these types of contracts tend to prefer this over the traditional tort system, and as the name perhaps implies, regardless of fault, each party will take responsibility for their own personnel and property, thus insuring against their own losses.2
However, it should be noted that enforcement will be dependent on the jurisdiction governing the contract. As there are also statutory limitations. This does add an extra layer of complexity to the matter. For example, in the UK, an oil and gas contract cannot exclude liability for negligence (unless deemed “reasonable”).3 While in the US, this would depend on the state law involved. For instance, Texas state law has “anti-indemnity statutes” which essentially prohibit the ability to shift the liability from one party to the other, this especially includes personal injury and gross negligence.4
Therefore, for the purposes of enforceability it is important to ensure that your indemnity clauses are not only explicit, but also juristically compliant. It also would help if they were very detailed in order to avoid being exposed to liability beyond the intended scope.
Importantly, after the catastrophic oil spill caused by the Deepwater Horizon Drilling rig in 2010 has led more recent Oil and Gas contracts to place a much greater emphasis on indemnity clauses covering pollution also.5
2. “Standard” Force Majeure Clauses
A standard force majeure, which translates to “greater force” from French, is a clause freeing all parties involved in the contract from liability upon events caused by a “greater force”. Put simply, any event that is beyond the control of the parties, making the fulfilment of their contractual duties impossible.6 his could include rioting and striking, but also ‘Acts of God’, such as wars, natural disasters, epidemics, etc.
However, it is noteworthy that some jurisdictions interpret these clauses very narrowly, and in some instances, if there is doubt the event has prohibited the non-performing party from fulfilling their duties then courts may refuse the force majeure clause.7 This is an issue that appears in many standard boilerplate clauses.
There are various oil and gas related disputes we can learn from. In Transocean Drilling v Providence,8 force majeure was attempted to be relied on for the demand of payment during “unforeseen events”. However, Judge Parker LJ deemed these unforeseen eventualities to be caused by negligence, and thus force majeure could not be used as a shield from said negligence.9 Companies often assume force majeure is a catchall clause in the event of “causes beyond the control” of the parties.10But such vague wording invites litigation, and courts would prefer not to relieve parties of their contractual duties. Therefore, it is essential that the clause is explicit in what events will be covered by force majeure.
A well-drafted, clear and explicit force majeure clause could save parties from lengthy disputes. It is essential that specific events are defined, and obligations in the case of force majeure is clarified, this includes “partial performance”.
The International Chamber of Commerce (ICC) has been so kind as to provide an up to date (2020) model force majeure clause,11 and its widely accepted as the standard for contracts.
3. Governing Law
Although a governing law clause should be boilerplate in most contracts, specifically under the section covering potential arbitration, it can still occasionally it will be overlooked, leading to unneeded complications in the event of a dispute.
Considering also different legal systems have their own regulatory controls on matters, as well as interpretations, it should be certain the selected law meets your needs. For example, if parties opted to use the English legal system as their governing law, they would receive far more autonomy in the drafting of the contracts terms, considering English law strongly favours freedom of contract.
It’s especially important in oil and gas contracts, considering the nature of oil and gas operations is often multi-jurisdictional with assets, suppliers and stakeholders spread across territories. It is very rare though for oil and gas contracts to omit it, which only highlights how important it is.
But ‘If it is so rare to exclude this clause, why mention it at all?’ I hear you ask, and this is because one such case, which did include a governing law clause, was still met with serious arbitration issues. In PDVSA v PetroSaudi,12 there was supposedly an English law governing clause, to be arbitrated in Paris under the ICC. But given the entangled mess of both parties involved, following through with the arbitration clause proved difficult. One party was involved in a huge corruption scandal, while the other was in political and economic turmoil. It is not uncommon for a country like Venezuela to ignore international rulings, which was the first issue with the governing law clause, it was then muddied further by PDVSA refusing to pay PetroSaudi under the belief the whole deal was fraudulent.
You may now find yourself asking “why would you mention this if the issues in this case are so specific?” well despite including a governing law clause, as has been the theme with the previous section, being extremely detailed in the crafting of the clause is how to avoid being in a situation like PDVSA v PetroSaudi. For example, instead of simply stating that English law will govern the contract, you could also waive sovereign immunity in the event of the companies involved is state-owned, along with explicit recognition of the awards under an applicable treaty. In hindsight of this case, mention of fraud or misrepresentation in the arbitration clause may have avoided some of the issues that cropped up. In the event one of the parties is from an unstable country like Venezuela, a Material Adverse Clause (MAC) could help protect against contractual performance issues resulting from any political or economic shifts and allow party withdrawal.13
4. Cash Flow Disputes and Ambiguous Payment Terms
Given the nature of oil and gas operations, it is easy to deduce the most common issue for disputes: money. Unsurprisingly, cash flow disputes crop up in litigation more so than anything else. As we already know, these investments involve very high startup costs with revenue far on the horizon.
Contract terms within the industry can sometimes be less clear than they need to be to avoid disputes over who owes what, how much, and when. A perfect case we can use to illustrate this is Exxon v Alabama.14 In this case Exxon was accused of underpaying their royalties, however, of course there was a difference in opinion on how the payment clause should have been interpreted. Exxon believed deductions should have been made, but Alabama believed these deductions were not permitted per the contract. Ultimately resulting in a dispute from 1993 to 2007. Originally Exxon were ordered to pay a massive damages award, however, the Alabama Supreme Court themselves overturned the award. Believing a state should not possess the power to order a sum so large based on a different interpretation of a poorly constructed payment clause.
This is a situation no one wants to find themselves in, so we can try our best to avoid it by defining financial terms, such as the basis for royalties e.g. are they based on gross or net revenue after deductions (deductions that should be specified in the contract). Clear payment timelines need to be laid out, as well as penalties for late payments. One more clause that could help repeating the Exxon/Alabama case is audit rights. If parties were allowed to verify calculations, disputes could be resolved without ever having been escalated to litigation.
Similar to the force majeure clause, adopting a standardized agreement could mitigate the chances of disputes cropping up. One such example is the International Swaps and Derivatives Association (ISDA) Master Agreement.15 It includes payment terms that should prevent any ambiguity, and hopefully, disputes.
5. Confidentiality and IP Ownership
Probably quite a surprising aspect of oil and gas contracts to consider is ownership. It certainly isn’t the first thing most would think about. However, disputes in the industry regarding this do appear from time to time. Essentially, seismic data, drilling techniques, operational software, these are all owned, and the unauthorized sharing of this data, particularly with competitors, could lead to serious issues.
There are cases that highlight the issue, although the facts of them are fairly straightforward. For example, in Schlumberger Ltd v Rutherford,16 a former employee shared trade secrets (proprietary software) with a competitor. So, if ownership and confidently about, say reservoir modelling or fracking techniques, aren’t clearly defined in the contract, you may find yourself in a battle of ownership.
Just like all aforementioned points, simply being very detailed in your IP protection, intellectual property clauses, and ensuring non-disclosure/non-compete agreements are signed and in place should avoid most issues that could arise. It would also be wise to conduct regular audits to protect any sensitive data sharing from occurring.
Final Thoughts
The crux of the issues we saw in the cases I mentioned typically stemmed from vague, open-to-interpretation clauses, that otherwise could have been avoided if they were perhaps more thorough in their wording.
Following industry-standard contracts is a good place to start, followed by ensuring that liability, insurance, confidentiality and payment structures are very clearly defined. By doing so, hopefully this will mitigate your legal risk and secure a more stable agreement that can be hard to dispute.
- https://thelawdictionary.org/indemnity/ ↩︎
- Gideon Parchomovsky, Endre Stavang ‘CONTRACTING AROUND TORT DEFAULTS: THE KNOCK-FOR-KNOCK PRINCIPLE AND ACCIDENT COSTS’ CREE, Working Paper 14/2013 ↩︎
- Unfair Contract Terms Act [1977] s 2(2) ↩︎
- Texas Oilfield Anti-Indemnity Act, Tex. Civ. Prac. & Rem. Code Ann. § 127.002 ↩︎
- https://www.oilandgasiq.com/legal-and-regulatory/articles/six-clauses-every-oil-gas-professional-should-know ↩︎
- Legal Information Institute, https://www.law.cornell.edu/wex/force_majeure ↩︎
- Rudolph v. United Airlines Holdings, Inc. 519 F.Supp.3d 428 ↩︎
- Transocean Drilling UK Ltd v Providence Resources Plc [2014] EWHC 4260 (Comm) ↩︎
- Transocean Drilling UK Ltd v Providence Resources Plc [2014] EWHC 4260 (Comm) Paragraph 42 p162 col 2 https://www.oeclaw.co.uk/images/uploads/judgments/44._Transocean_Drilling_UK_Ltd_v_Providence_Resources_Plc.pdf ↩︎
- Owen L Anderson ’The Anatomy of an Oil and Gas Drilling Contract‘ (1990) Tulsa Law Journal, Vol 25 3, 458, available at https://digitalcommons.law.utulsa.edu/cgi/viewcontent.cgi?article=1876&context=tlr ↩︎
- ICC Force Majeure and Hardship Clauses, ICC (2020) downloadable here: https://iccwbo.org/news-publications/icc-rules-guidelines/icc-force-majeure-and-hardship-clauses/#:~:text=The%20new%202020%20clauses%20update,a%20reference%20to%20this%20Clause. ↩︎
- PDVSA Servicios S.A. v. PetroSaudi Oil Services Ltd [2015] ↩︎
- Material adverse change (MAC) clause, https://uk.practicallaw.thomsonreuters.com/0-107-6824?transitionType=Default&contextData=(sc.Default)&firstPage=true ↩︎
- Exxon Mobil Corp. v. Alabama Department of Conservation and Natural Resources, 986 So. 2d 1093 [2007] ↩︎
- ISDA Master Agreement [2002] available: https://www.isda.org/book/2002-isda-master-agreement-mylibrary/ ↩︎
- Schlumberger Ltd v Rutherford 472 S.W.3d 881 [Tex. App. 2015] accessible: https://casetext.com/case/schlumberger-ltd-v-rutherford-2 ↩︎