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As the recent Permian Basin buying spree and increased offshore capital expenditures by super majors reveal, the energy industry downturn of recent years may be turning a corner. Market movement has companies looking to position themselves to take advantage of opportunities on the horizon. Is your company ready?
Just as maintaining physical assets is necessary, preventive maintenance in your contracting practices is equally critical. Such efforts should include evaluating risk allocation as well as updating policies and procedures that could affect the bottom line. With political and regulatory shifts evolving in the U.S. and globally, now is the time for a comprehensive check of your company’s contracts, insurance and regulatory compliance strategies.
Contract Assessment Before an Incident
When was the most recent review of your company’s contracts? Are the most updated master service agreements (MSAs) and purchase orders being used? Has anyone checked whether the contractor’s work order contains conflicting terms, which could nullify key risk allocation, warranty or insuring provision? Much to a litigant’s dismay, the protections one thought existed in its commercial assets (i.e., MSAs and associated documents) often fall short of the mark. To avoid pitfalls, periodic contract maintenance should be conducted.
Indemnity Provisions: What do they really mean?
To account for the variety of risks common to energy exploration and production, such as personal injury, property damage or environmental harm, an indemnity clause is commonly found in a master service agreement. An indemnity clause is an extraordinary risk-shifting provision, because it transfers the risk of a party’s negligence to another who may not be culpable. A true indemnity provision allows contracting parties to determine who will be responsible in advance of a loss, regardless of fault.
Parties often mistakenly believe they are protected by an indemnity provision. Many contracts actually contain a contractual contribution clause disguised as an indemnity clause. Such provisions obligate a party to indemnify the other only for its own respective share of negligence, rather than shifting the risk. A contribution clause is often simply a restatement of comparative fault principles that may vary by jurisdiction. Such clauses rarely offer any indemnity at all, because that requires a determination of fault. Given that the overwhelming majority of cases settle before trial, a contribution “indemnity” provision thus offers little value for one seeking certainty in advance of calamity.
Choice of Law
When considering the validity of an indemnity clause and accompanying insuring obligations, the location of operations is critical. Louisiana, New Mexico Texas, and Wyoming all have oil field anti-indemnity statutes. Federal law can also extend the reach of the Texas and Louisiana statutes to operations conducted on the Outer Continental Shelf.
Depending on how the jurisdiction applies its anti-indemnity statute, a contractual choice of law clause may be rendered meaningless and the indemnity clause in the controlling MSA voided. The application of these statutes is often highly technical and may involve a complex choice of law issues. Such analysis is multifaceted and fact-specific to a particular incident. Understanding how a court may apply your agreement before an incident is invaluable. An off-the-shelf MSA might not contain the language necessary to comply with or meet an exception to a state’s anti-indemnity statute. Understanding the law of the states where the company is going to work is crucial.
Contractual obligations concerning insurance are often corollary to indemnity provisions. Thus, your company should review its insurance programs—and its contracting parties’ insurance—to ensure adequate protections are in place for potential exposures. MSAs usually require parties to provide specific coverages and limits, which are evidenced by a certificate of insurance (COI). At the most basic level, has your contractual partner provided you with a COI for the correct policy year that accurately reflects the insurance limits required by the master service agreement? If the insurance has lapsed or the appropriate premium has not been paid, the additional insurance coverage you thought was available may be nonexistent. A simple double-check of the paperwork now could save a company many headaches, if a dispute occurs.
Further, an additional insured clause in a MSA can either be stand-alone or tied to an indemnity provision, depending on the contract’s wording. Recent cases have confirmed the enforceability of separate and independent additional insurance obligations. A review of your contracts would be prudent to ensure full-risk allocation protections are in place. Otherwise, you may be unaware that the scope of additional coverage may be curtailed by the indemnity clause.
Keeping Up With Your Regulators
Allocating risk contractually requires a full understanding of the state or federal regulations applicable to your operations. State and federal regulators usually provide updates on their websites with notices of proposed rule-making with a comment period before the final rules are enacted. There are a variety of services that provide regulatory updates via email. A periodic review of any new or proposed regulations will enable a company to manage risk contractually, ensure regulatory compliance and ultimately avoid any unpleasant surprises.
As the old saying goes, an ounce of prevention is worth a pound of cure. A periodic check of the critical agreements that your company relies on to conduct business can save significant costs down the road and put your company in a better position as the energy market moves forward.