Knock-for-knock carve-outs on the increase

May 01 2014

The traditional knock-for-knock regime has been utilised in offshore contracts and related shuttle tanker contracts for many years*.

This regime is a contractual arrangement whereby each party agrees to bear the risk of damage to its own equipment, property, or personnel occurring in the performance of the contract and agrees to provide an indemnity where any such liability is misdirected to the other party.

Liability for damage to third parties is apportioned on the basis of fault or, more often, as in the case of pollution, on the basis of each of the party's sphere of control.

In its purest form, the knock-for-knock regime enables both parties to put in place effective insurance cover that matches each of their liabilities and avoids the need for lengthy enquiries, or litigation, to determine liability based on fault.

The knock-for-knock regime diverges from the ordinary allocation of liability and there is recent evidence of a trend towards an increased willingness to depart from the traditional regime. Parties are looking for certain acts, particularly gross negligence, or wilful misconduct, to be dealt with outside the contractual liability regulation.

Courts in England and Norway have also indicated a willingness to apply such carve-outs from the knock-for-knock regimes where, as in the case of English law, such limitations have been expressly agreed by the parties and under Norwegian law as a matter of principle.

Shuttle tanker services are generally operated on the basis of terms and conditions developed by the major international oil companies. The current knock-for-knock clauses are significantly more detailed than those of five, or 10 years ago. Modern versions generally exclude gross negligence. Furthermore, these standard terms generally exclude the right to claim indirect and/or consequential losses arising from any claim.

Introducing carve-outs within knock-forknock clauses is intended to create a more balanced liability system. The exclusion of indirect and consequential losses is in turn intended to ensure that the most severe loss in the offshore section, namely loss arising from a halt in production at an offshore field, is carried by the party most easily able to carry the consequences of such losses, namely the oil companies.

Finer details

It is easy to stumble on the finer details of this type of regulation.

 For example, the term ‘consequential loss’ is interpreted differently under English and Norwegian law. The much narrower interpretation applied by the English courts considers how the loss has been caused rather than the nature of the loss incurred. If the clause is not drafted widely enough, it may end up providing much less protection than expected. Furthermore, ‘gross negligence’ is not a defined concept under English law and, in the absence of a contractual definition, the manner in which the exemption is applied may be difficult to predict and could end up being far wider than the parties intended.

The Norwegian courts are also increasingly willing to apply carve-outs from contractual regimes even where the parties have not expressly agreed that this should happen. In doing so, the courts have applied various techniques, such as restrictive interpretations, concluding that the conditions for relying on the clause could not be met, or stating that it would be contrary to the parties’ intentions and/or assumptions at the time the agreement was entered into to allow application of the clause.

In the recent Njord B case before the Norwegian appeal court, the court did not elaborate on the basis on which it set aside a knock-for-knock clause, due to gross negligence, but rather proceeded on the basis that the clause could not be applied as a matter of law where the loss was due to gross negligence. The case concerned a collision between a shuttle tanker and an FSO caused by a blackout on the shuttle tanker’s dynamic positioning system.

The English courts, on the other hand, have been more willing to apply knock-for-knock clauses even in the face of gross negligence.

One example is the decision in the A Turtle where, due to poor planning, a tug ran out of fuel and disconnected the rig, which was left drifting in the South Atlantic until it grounded on a remote island. The rig owners argued that the knock-for-knock clause should not apply as the breach by the tug owner was so fundamental that it fell outside the scope of the clause.

This argument was rejected by the judge, who held that the clause would be applied since the loss occurred in connection with the performance of the contract. The case has led to some criticism on the grounds that it creates uncertainty in relation to the application of the knock-for knock regime.

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