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Rules and industry standards

Describe any industry-standard form contracts used in the energy sector in your jurisdiction.

Oil & Gas UK, a not-for-profit representative body for the UK offshore oil and gas industry, publishes a standard form joint operating agreement, confidentiality agreement, pipeline crossing agreement and decommissioning security agreement. Its subsidiary, LOGIC, supports a suite of 10 standard contracts covering a broad range of oil and gas operations in the UK Continental Shelf (UKCS), including onshore and offshore services, well services, construction (including marine construction) and supply of equipment. These standard forms are widely used across the industry.

A Master Deed for UKCS asset transfers has also been developed as part of a joint industry and government initiative to lower barriers to UKCS development. The Master Deed aims to standardise existing pre-emption arrangements, create pro-forma transfer agreements and reduce complexities around signature and the timing of completions. LOGIC facilitates these transfers by acting as the administrator for the Master Deed.

The Association of International Petroleum Negotiators (AIPN), an independent not-for-profit professional membership association that supports international energy negotiators also publishes model form contracts, including a joint operating agreement, farmout agreement, confidentiality agreement, gas sales agreement and unitisation and unit operating agreement, although these are less commonly used in the UK.

What rules govern contractual interpretation in (non-consumer) contracts in general? Do these rules apply to energy contracts?

Contractual interpretation is the task of ascertaining the meaning that the words of a contract would convey to a reasonable person. Under English law, modern contractual interpretation is a matter of applying general principles of construction rather than strict rules. These principles apply equally to energy contracts, as to other contracts. The starting point for the court will be to look at the language used by the parties and to interpret it in accordance with its conventional usage in order to understand the parties’ intentions. Those intentions will be assessed objectively.

Where there are two or more possible interpretations of a term, that which has most business common sense will typically prevail. However, while the courts will be reluctant to adopt an interpretation that will lead to a very unreasonable result, it will keep in mind that the parties may indeed have agreed to something unreasonable or commercially unwise. In the Supreme Court decision in Arnold v Britton [2015] EWSC 36, judges were cautioned not to disregard the literal wording of the contract in pursuit of commercial common sense. Lord Neuberger said: ‘First, the reliance placed in some cases on commercial common sense and surrounding circumstances . . . should not be invoked to undervalue the importance of the language of the provision … the clearer the natural meaning the more difficult it is to justify departing from it’. In Wood v Capita Insurance Services Limited [2017] UKSC 24, the Supreme Court confirmed that a court will look at both the language of the contract (textualism) as well as the commercial context in which the contract was drafted (contextualism) to ascertain the objective meaning of the clause in question. However, in Barnardos v Buckinghamshire [2018] UKSC 55 the Supreme Court has held that ‘In deciding which interpretative tools will best assist in ascertaining the meaning of an instrument, and the weight to be given to each of the relevant interpretative tools, the court must have regard to the nature and circumstances of the particular instrument.’

In the recent decision of Amey Birmingham Highways Ltd v Birmingham City Council [2018] EWCA Civ 264, the Court of Appeal remarked on the importance of parties to ‘relational contracts’ that is, contracts based upon a long-term relationship of trust, adopting a reasonable approach to the interpretation of such contracts and not ‘latching onto . . . infelicities and oddities . . . to disrupt the project and maximise their own gain’. While Amey concerned the maintenance of the road network in Birmingham under a long-term PFI contract, the court’s observations are of broader relevance to energy companies since energy contracts typically call for similarly high levels of interaction, cooperation and communication between the parties over the life of the economic relationship.

As considered in more detail below, clear words must be used to exclude rights or remedies that arise by operation of law. The courts will start on the premise that neither party intends to abandon any remedies that arise by operation of law. Express wording should therefore be used to rebut that premise (Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 689). The principle of contra proferentem will also be used in certain circumstances, including where a clause is relied on that only stands to benefit one party. The principle states that an ambiguous clause must be interpreted in a manner adverse to the interests of the party that suggested its inclusion. The Court of Appeal decision in Persimmon Homes Ltd v Ove Arup & Partners Ltd [2017] EWCA Civ 373 casts doubt on whether the contra proferentem principle continues to apply to the interpretation of exclusion clauses and is increasingly seen by the courts as outdated. In Persimmon Homes, the court emphasised that the wording of the clause, the relevant context, and commercial common sense should be sufficient in determining the meaning of a contract term.

In limited circumstances the court may be willing to imply certain terms if, having regard to the express wording of the agreement, it is unable to ascertain the meaning. However, the courts are not permitted to imply essential terms (ie, where the effect is to make a contract where one would not otherwise exist) as per Wells v Devani [2016] EWCA Civ 1106. Similarly in the case of Teekay Tankers Ltd v STX Offshore Ltd [2017] EWHC 253, the Commercial Court confirmed that where the parties have deliberately agreed to specify an essential term at a later date (eg, delivery dates), the courts will not imply a term in order to uphold the parties’ contractual bargain especially in the absence of any objective criteria or mechanism through which any such essential term may later be finalised (eg, expert determination).

Finally, where a general phrase follows a list of specific items in a contract, the phrase will generally be interpreted as being limited to other examples of the same type. This is known as the ejusdem generis rule.

Describe any commonly recognised industry standards for establishing liability.

The terms ‘wilful misconduct’ and ‘gross negligence’ are commonly used in contracts in the UK energy sector to define and allocate liability between contracting parties. However, these terms are not recognised principles of English law. Their meaning must therefore be defined in the contract or they will be subject to interpretation by the courts in accordance with usual principles of contractual construction.

The English courts have been reluctant to define these terms but in Porter v Magill [2001] UKHL 67 the court referred to ‘wilful misconduct’ as deliberately doing something which is wrong, knowing it to be wrong or having reckless indifference as to whether or not it is wrong. In National Semiconductors (UK) Ltd v UPS Ltd J [1996] 2 Lloyd’s Rep 212 Longmore J held that wilful misconduct requires either an intention to do something that the actor knows to be wrong; a reckless act that the actor is aware may cause loss but does not care whether loss will result or not; or the taking of a risk that the actor knew he or she ought not to take. There is, however, no need to prove motivation or intentional malice.

The English courts have distinguished gross negligence from simple negligence by looking at the seriousness of the act or omission committed, or whether the conduct complained of equates to recklessness (see Red Sea Tankers Limited v Papachristidis [1997] 2 Lloyd’s Rep 547).

Parties may also hold themselves to the standard of ‘reasonable and prudent operator’. Again, this is not a recognised principle of English law and therefore a definition of the standard will typically be found in the contract. In Scottish Power UK PLC v BP Exploration Operating Company Limited & Ors [2015] EWHC 2658, the Commercial Court (as upheld by the Court of Appeal) held that a party that deliberately decides not to perform one of its contractual obligations is not acting as a reasonable and prudent operator and cannot hide behind that standard to justify its breach.

Finally, there is no general duty to perform contracts in good faith under English law. While parties can include an express duty to act in good faith, or wording of a similar nature in a contract, the English courts have generally been reluctant to develop any doctrine of good faith. For example, in Monde Petroleum SA v WesternZagros Ltd [2016] EWHC 1472 the court refused to imply a term that a party could not terminate the agreement in bad faith. The dispute concerned a consultancy agreement requiring Monde to assist WesternZagros in securing an oil contract in exchange for a fee and an option to hold a 3 per cent stake in the future investment. Shortly after the contract was secured, WesternZagros terminated the consulting agreement, depriving Monde of its future interest in the investment.

The courts may, however, use the concept of good faith to imply fact-specific duties into the parties’ relationship (see for example the 2013 decision Yam Seng Pte Limited v International Trade Corporation Limited [2013] EWHC 111) and in an industry where relational contracts are common, any developments in this area will be watched with interest. In the recent case of Al Nehayan v Kent [2018] EWHC 333 (Comm), the High Court implied a duty of good faith into an oral joint-venture contract between the parties on the basis that it was essential to give effect to the parties’ reasonable expectations and also satisfied the business necessity test.

Performance mitigation

Are concepts of force majeure, commercial impracticability or frustration, or other concepts that would excuse performance during periods of commodity price or supply volatility, recognised in your jurisdiction?

English law takes a strict approach to contractual performance and will only excuse discharge of a party’s contractual obligations in very limited circumstances. The basic premise is pacta sunt servanda or ‘agreements must be kept’. The English court’s approach to keeping parties to their contractual bargain was recently exemplified in the case of MT Hojgaard AS v EON Climate and Renewables UK Robin Rigg East Ltd & Anor [2017] UKSC 59. In this case it was held by the Supreme Court that where two related contractual obligations imposed different or inconsistent standards or requirements, rather than concluding that they were inconsistent, the correct analysis under the contract was that the more rigorous or demanding of the two standards or requirements must prevail. The less rigorous standard could be treated as a minimum requirement.

Only where a supervening event has rendered performance of a contract impossible, or essentially and radically different from that which the parties contemplated, will the common law doctrine of frustration apply. As a consequence of frustration the contract is automatically discharged and the parties are excused from their future obligations. A contract is not discharged by frustration where it is merely less attractive or more difficult or expensive to perform (Seadrill Ghana Operations Ltd v Tullow Ghana Ltd [2018] EWHC 1640). These will generally be considered foreseeable risks, which are capable of allocation between the parties by the express terms of the contract.

While there is no English law concept of force majeure, it is common to see express force majeure clauses in contracts. These clauses define what constitutes an event of force majeure and set out the consequences of such an event. As well as widening the circumstances in which performance may be excused beyond the very narrow range of events that will frustrate a contract, a force majeure clause can also provide for the consequences of such an event, whereas if a contract is frustrated, it is treated as immediately and totally terminated (irrespective of the wishes of the parties). The court held that a force majeure event must be the only effective cause of default by a party under a contract relying on a force majeure provision. In Seadrill Ghana v Tullow Ghana, the court determined that Tullow had been prevented from fulfilling its contractual obligation to provide drilling instructions to the claimant due to the occurrence of two matters; one force majeure, the other not. Tullow was therefore not entitled to rely on the force majeure clause to avoid its contractual obligation. The court emphasised that force majeure is a creature of contract. The construction of any clause to that effect will ultimately turn on the words used therein. It is relatively uncommon for parties to treat commodity price or supply volatility as events of force majeure, and in some cases it is explicitly excluded. For example, in AIPN’s model form gas sales agreement, the force majeure clause provides that the definition of force majeure will not include changes in the market. Instead, parties may use hardship clauses or material adverse change clauses to relieve a party from continued contractual performance where it has become economically disadvantageous (but not impossible).

A hardship clause operates so that if, over time, changes in the market result in relative ‘hardship’ to a party, it can reopen the terms of the contract to negotiate better economic or other terms. Some clauses provide that if agreement of revised terms cannot be agreed, an independent third party will decide the issue.

Finally, if there is an accepted threshold beyond which it is uneconomic or impossible to continue to supply goods or services, then the parties can link these thresholds to the contractual termination provisions.

Nuisance

What are the rules on claims of nuisance to obstruct energy development? May operators be subject to nuisance and negligence claims from third parties?

Nuisance claims can be divided into common law nuisance (private and public) and statutory nuisance under Part III of the Environmental Protection Act 1990. There are 11 categories of statutory nuisance including noise from premises (including vibration); dust, steam, smell or other effluvia from industrial, trade or business premises; and any accumulation or deposit.

For a claim of private nuisance, the claimant must have a direct proprietary interest in the land affected by the nuisance. A claimant can bring civil proceedings against a defendant for damages or injunctive relief requiring the defendant to abate a continuing nuisance and to prevent its recurrence. This means that energy developments can be halted by injunctions where the claimant entity establishes a claim in nuisance.

In contrast to private nuisance, the claimant in public nuisance and statutory nuisance claims is not required to have a proprietary interest that is affected. Further, for statutory nuisance the onus and cost is on a local authority to take action to ensure that the nuisance is abated.

For certain types of development, including the construction of windfarms and solar parks and hydrocarbon extraction, an environmental impact assessment (EIA) is needed before a project can receive development consent. The purpose of an EIA is to assess the potential impact of the project on the environment. Any successful planning permission application will have conditions attaching to it to minimise any potential nuisance. However, the fact that a defendant has planning permission for the activity is not a defence to a common law nuisance claim. Neither is the defendant’s compliance with an environmental permit, of itself, a defence.

Liability and limitations

How may parties limit remedies by agreement?

Contracts in the energy sector will typically include comprehensive regimes for the allocation of liabilities between parties, using a variety of contractually agreed remedies and exclusions of liability. As a matter of English law, contracting parties have a wide freedom to limit remedies by agreement, although this must be done expressly. In Strachan & Henshaw v Stein Industrie (UK) Limited and GEC Alsthom Limited [1997] EWCA Civ 2940, the Court of Appeal observed that if parties wished to limit their potential liability to one another then there was ‘no reason why the law should stand in their way and prevent them from doing so’. However, courts will generally proceed on the basis that parties do not intend to give up rights or claims that the general law gives them and accordingly any such rights are only capable of being excluded and limited using clear words to that effect (Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 689). In Scottish Power UK PLC v BP Exploration Operating Company Ltd and Others [2016] EWCA Civ 1043, Scottish Power (buyer) entered into long-term agreements for the sale and purchase of natural gas from the sellers. The agreements provided that the only remedy the buyer was entitled to in respect of any under-deliveries was default gas at the default gas price (at 70 per cent of the contract price). The buyer subsequently initiated proceedings against the sellers, claiming that in under-delivering gas the sellers had breached their obligation to operate the facilities to the standard of a reasonable and prudent operator (RPO). Accordingly, Scottish Power claimed that it was entitled to common law damages, rather than default gas. Scottish Power argued that a breach of the RPO standard was not caught by the default gas regime, which only applied to underdeliveries caused by events such as non-negligent accident or a natural cause (ie, underdeliveries despite compliance with the standard of RPO). However, the Court of Appeal held that the contractual drafting was sufficiently clear in providing for the exclusive remedy of default gas in respect of any underdeliveries (howsoever caused) and that there was therefore no scope for the payment of additional common law damages. This case demonstrates that clear and unequivocal drafting can operate to replace common law rights with a different contractual remedy.

Agreements in the oil and gas sector may include an overall cap on one party’s liability to the other. The cap can be applied annually or over a lifetime of the relevant agreement and can be expressed in a variety of ways (eg, by reference to the contract price, tariff or capacity payments in gas transportation agreements).

Liquidated damages clauses are also used, which prescribe a fixed sum or sums to be paid in the event of certain specified breaches of contract (again, often up to an agreed cap). They are frequently used in construction contracts for delay-related breaches and will typically be an exhaustive remedy precluding the innocent party from claiming general damages. Liquidated damages can also apply to other breaches of contract, for example, as above for under-deliveries in long-term supply contracts.

If a liquidated damages clause amounts to a penalty it will not be enforceable on grounds of public policy. The traditional definition of a penalty looks at whether the liquidated damages constitute a genuine pre-estimate of loss and whether the overriding objective was deterrence from breach rather than compensation for damage suffered. However, the Supreme Court reconsidered the law on penalties in Cavendish Square Holding BV v El Makdessi [2015] 3 WLR 1373 and Parking Eye Ltd v Beavis [2015] UKSC 67. In these cases, the Supreme Court laid down a two-fold test for penalty clauses: first, the provision in question must give rise to a secondary obligation and second, the secondary obligation must impose a detriment out of all proportion to athe legitimate interest of the innocent party. This rationale has been upheld by the High Court in Vivienne Westwood Ltd v Conduit Street Development Ltd [2017] EWHC 350 (Ch). Vivienne Westwood is the first case involving the application of the restated test for penalties set out in Makdessi and Beavis in which the impugned clause has been found to be penal. The ruling highlights the risk for commercial parties in negotiating termination provisions which give them a substantial benefit, or which impose a significant financial detriment on their counterparty, in the event of a breach. As in this case, the courts may find a clause to be an unenforceable penalty despite the fact that the provision was agreed between two parties of equal bargaining power.

Clauses excluding liability for particular types of loss are also commonly used and, consistent with the principle of freedom of contract, permissible under English law. However, as set out above, such clauses will be interpreted strictly and the courts will only accept that a party has surrendered legal remedies where clear words to that effect are used. In First Tower Trustees Ltd v CDS (Superstores International) Ltd [2018] EWCA Civ 1396, it was held that contractual estoppel and non-reliance clauses were not immune from scrutiny under section 3 of the Misrepresentation Act 1967. Such clauses could not prevent liability arising if they failed to satisfy the reasonableness test under section 11(1) of the Unfair Contract Terms Act 1977. Accordingly, a landlord was not permitted to rely on a clause in a lease restricting its liability for representations, where it had misrepresented to the tenant that it had no knowledge of environmental problems affecting the property, when in fact it was aware of asbestos problems. Recovery of consequential losses are often excluded from recovery but the definition of what constitutes a ‘consequential loss’ is a matter of debate among English lawyers and accordingly these clauses are frequently litigated. The general rule under English law for the recovery of damages following breach of contract is set out in Hadley v Baxendale [1854] 9 Ex 341. Recoverable losses are those that either arise naturally or directly from the breach of contract (known as direct losses) or those that were within the contemplation of the parties at the time of the contract (known as indirect or consequential losses). Where ‘consequential loss’ is excluded under an exclusion clause it will typically be interpreted as excluding recovery of losses under the second limb. Accordingly, where a party can show that a loss of profit is a direct loss those losses will be recoverable. In Star Polaris v HHIC-Phil Inc [2016] EWHC 2941 exclusion of liability for ‘consequential losses or expenses’ was given an expansive meaning by the court, and reducing the range of recoverable damages under the contract. Similarly, in the recent appeal decision in Transocean Drilling UK Ltd v Providence Resources Plc [2016] EWCA Civ 372 the court held that parties must be prepared to accept that by the operation of limitation of liability clauses, claims that may have otherwise been recoverable at law may well be excluded.

Other types of contractually agreed remedies seen in joint operating agreements in the energy sector include, loss of voting rights, loss of petroleum entitlements, forfeiture and withering clauses to give parties access to remedies that would not be available at law and to promote contractual certainty. Historically there had been concern that forfeiture could amount to a penalty but the recent Supreme Court cases mentioned above have alleviated these concerns in the context of joint operating agreements as such agreements would seem to be good examples of cases where there is a wider legitimate interest beyond compensating the innocent party.

Is strict liability applicable for damage resulting from any activities in the energy sector?

Strict liability applies to certain health and safety, and environmental offences. The UK has a highly developed health and safety and environmental regulatory regime that applies to all industries and includes a particular focus on the extractive industries, which are perceived as high risk. Lessons learnt from incidents that have occurred in the oil and gas sector, such as the Piper Alpha disaster, have contributed to the development of this regime.

Strict liability applies to the operators of nuclear installations and extends to any damage to third parties caused by radioactive emissions from the installation. The nuclear liability regime in the UK is based on the Paris and Brussels Conventions together with the yet to be ratified 2004 Protocols. In preparation for the ratification of the Protocols, on 4 May 2016 the UK government issued the Nuclear Installations (Liability for Damage) Order 2016. The Order puts the existing UK nuclear liability regime in line with the Protocols by increasing the scope of operators’ liability and broadening coverage in the event of a nuclear incident. Once the Protocols are ratified, the order will come into force.