Knock for knock indemnities form part of the liability allocation model frequently found in contracts in the oil and gas industry.1They were originally used as a tool to protect drilling contractors from accepting liability for a client’s property in high risk off-shore environments involving multiple contractors.
It was acknowledged by the industry that contractors’ balance sheets would be unable to cope with potential liability for the destruction of an entire oil rig facility and it also assisted with risk allocation at a practical level, because in an off-shore environment it was common for the sharing of tasks between different contractors and a blurring and overlapping of responsibilities, making it difficult to determine fault if an issue occurred.
Most large oil and gas companies have bespoke pro forma contracts which contain knock for knock indemnity clauses, such as British Gas, Conoco Phillips and Inpex.
It seems the use of knock for knock indemnities in an on- shore environment occurs due more to custom now rather than to address any particular concerns in an on-shore environment.
What is a knock for knock indemnity?
A knock for knock indemnity is a reciprocal or mutual indemnity in which the client and the contractor agree to indemnify and hold harmless each other against any claims or liabilities arising in respect of damage to their own property (whether owned, hired or leased) and personal injury, illness or death to their own personnel. The effect being that a client will not be liable to a contractor for damage it has caused to a contractor’s property or injury that a client causes to a contractor’s personnel and vice versa.
A knock for knock indemnity makes each party responsible for the death or injury of its own employees and for loss or damage to its own property regardless of the cause, negligence or fault of any party. The parties undertake to indemnify each other for such claims or costs.
They are also usually intended to be effective even if the loss or damage arises due to a breach of statutory duty or breach of contract on the part of the indemnified party.
In that case it is a contractual allocation of risk which is based on the identity of the claimant or owner of property, rather than who is at fault, and is therefore contrary to traditional risk allocation in construction contracts and the rules at common law.
It does not cover liability to third parties, as this is not considered a mutual concern, and generally the use of unilateral indemnities is retained for this liability.
Over time certain legislatures in the United States have determined that such clauses may be onerous and inappropriate in certain contexts and have developed statutes introducing limits and conditions on knock for knock indemnities. The Oilfield Anti-Indemnity Acts in Louisiana, Texas, New Mexico and Wyoming specifically prohibit certain indemnity agreements contained in or related to oilfield contracts.2
Generally these Acts provide that any provision in an agreement relating to a well for oil, gas, water or drilling for minerals is void to the extent that it is an indemnity for loss or damage arising out of or resulting from personal injury or death which is caused by the sole or concurrent negligence or fault of the indemnified party or its agents, employees or contractors. That is, a knock for knock indemnity which relieves the client from liability for the client’s own negligence causing personal injury or death (or relieves the contractor for the contractor’s own negligence) is considered void.
Significant disasters have also shaped the drafting of knock for knock indemnities in drilling and maritime contracts. After the Piper Alpha disaster in 1988 and the Macondo incident in 2010, both killing a number of workers and causing significant property and environmental damage, clients are increasingly pursuing carve outs from knock for knock indemnities for a contractor’s gross negligence or wilful misconduct.
The courts in the United States have held that a party to a knock for knock indemnity in a maritime contract should not be permitted to shield itself contractually from liability for gross negligence3 and harm wilfully inflicted.4
There is no specific legislation in relation to the prohibition or use of knock for knock indemnities in Australia. This could be the result of an oil and gas industry which is still developing and the absence of the testing of such clauses in major oil and gas industry litigation in this country to date.5
Interaction with insurance
Knock for knock indemnities raise a number of issues concerning their interaction with insurances.
For example, issues may arise where there is dual insurance covering the same risk, such as public liability insurance policies held by both the contractor and the client in relation to injuries to workers caused by the client combined with an indemnity (such as a knock for knock indemnity) where the contractor contractually indemnifies the client for injuries caused by the client to the contractor’s employees.
In that scenario the rights under the contractual knock for knock indemnity, rights of contribution, rights of subrogation, the terms of the policy and the operation of the Insurance Contracts Act 1984 (Cth) intertwine to create a complex web of claims where in the absence of specific drafting in the construction contract, disputes may arise in determining which obligation is primary and who is ultimately responsible to compensate the injured party.6
Interaction with legislation
The operation of legislation in Australia may also pose problems for parties where it is inconsistent with knock for knock indemnities.
For instance, what is the situation in those jurisdictions where parties are unable to contract out of the proportionate liability legislation in relation to property damage caused by concurrent wrongdoers?
How does a knock for knock indemnity operate where there is strict liability for breaches of work health and safety legislation due to personal injury and death of workers?
How would an indemnified party’s “group” (for eg. its joint venturers, related companies or other contractors) who also have the benefit of the knock for knock indemnity under the relevant contract also have the ability to utilise the indemnity where they are not a party to the relevant contract and are not in a jurisdiction which allows third party beneficiaries of the indemnity an actionable right under legislation?7
The use of knock for knock indemnities may not be appropriate in on-shore Projects in circumstances where each contractor’s site during the construction period is clearly defined, the location is not inherently hazardous and the risks are not as significant as in an off-shore environment.
Knock for knock indemnities may not promote best for project or safe behaviour, as there is the potential that parties may not be held accountable for the consequences of their reckless behaviour or default causing personal injury, death or property damage.
Such a situation may unfairly burden a contractor who is likely to have more exposure to losses during the construction period, as the client normally has only very few of its own personnel or property at the site (especially at a Greenfield site) and may unreasonably expose the contractor to additional risks if the client’s other contractors at the site do not adequately supervise or manage their personnel.
If a knock for knock regime must be used, then it should be balanced and comprehensive.
The parties should seek advice from their insurance brokers to ensure the best insurance position having regard to the insurances held by the other party. The contract should set out how the indemnity interacts with insurance, including which party’s insurance is primary.
The parties should include specific and detailed work health and safety obligations which set out clearly each party’s responsibilities, and the knock for knock indemnity should deal expressly with such liability.
There should be no carve outs for ‘gross negligence’ or ‘wilful misconduct’ from a knock for knock indemnity in order to preserve certainty in the regime, or if such carve outs are included make sure such terms are clearly defined in the contract.
The contractor should be provided with evidence that the knock for knock regime has been applied to all of the client’s contractors consistently who are working on and in the vicinity of the site, ensuring that the contractor has the benefit of the entire knock for knock regime where third party contractors may be involved in the Project.