When drafting or negotiating drilling contracts parties need to know what insurance arrangements their companies (or clients) have in place and what insurance is available to cover risks that cannot be negotiated away. Only with full knowledge of the extent of insurance cover can contractual negotiations take place effectively.

A full understanding of a company’s insurance position makes it easier to negotiate contractual provisions efficiently and effectively. It allows parties to identify where they are able to give and take on a particular provision or where they must stand their ground. Some important issues to consider are set out below.

Allocation of liability

In contracts for work on the rig floor it is usual for each party to take responsibility for its own people and property. Such provisions are sometimes referred to as ‘reciprocal indemnities’, ‘knock for knock’ or, interestingly, the principle of ‘burying your own dead’!

Whatever it is called, the intent of this regime is that liability rests with the party who suffers the loss, regardless of fault, and that has no rights of recovery against the other party. There are good reasons for such a regime.

When negotiating such provisions parties need to understand the liability regime which they have created. They need to ensure their insurance is adequate and matches the allocation of risks between the parties. The risk of a failure to properly understand the liability provisions is that an unintended recipient becomes exposed to risks that are beyond its control without insurance to cover those risks. In the worst case, that could be your company!

The usual aim is for liability to pass through all entities working on the rig floor such that regardless of whose fault it is, the person who suffers loss, is responsible for it. This is achieved through broad indemnification provisions. In this way insurers can provide cover for the company’s property and its people and ensure that the premiums are kept at a level that reflects the risks they have agreed to take on in the work.

Sometimes there is a desire to narrow the scope of such broad indemnification. If doing so it will be important to ensure that no unintended consequences flow from any changes to the basic ‘knock for knock’ regime. In particular, it will be vital to understand in what circumstances liability will rest with your company. For example, if a subcontractor’s contract with an operator is effective to allow liability to pass to the operator but a contract between the operator and the drilling company has been narrowed or otherwise modified in such a way that it is not sufficient to allow the liability which has been passed to the operator from the subcontractor to be passed on to the drilling company, then the operator ends up holding the ‘hot potato’. In such a situation, the operator needs to ensure it has adequate cover for such loss. While some companies may have ‘wrap around’ insurance to cover such a situation, if lawyers are diligent on these issues, claims under such insurance may not be needed.

Loss of equipment/tools down hole

Usually the operator takes responsibility for a contractor’s equipment or tools lost down hole. Often this is done on an agreed cost basis, as provided in a schedule to the contract. Sometimes it can be a percentage of the current new replacement cost of such equipment/tools. For each new contract, those costs should be reviewed to ensure they are within the ambit of insurance cover. If they are not, then existing insurance policies should be endorsed to cover that additional exposure.

Loss of reservoir

The operator also takes full responsibility for the hole and underground damage, including to the reservoir. Where each contract relates to a different reservoir it will be important to get an understanding of the extent and hence value of the reservoir and to ensure that the limits of the insurance available for each reservoir are sufficient.

Rights of subrogation

Often contracts contain clauses which require the insurer to waive any rights of subrogation. Clearly, parties should first check with their insurer before agreeing to waive any right that impacts on their rights.

Proportionate Liability Legislation

A key consideration is whether to include a clause excluding the operation of proportionate liability legislation, to the extent permitted by law. Obviously, proportionate liability legislation can be imposed over the top of the contract and affect the liability regime which parties have negotiated.

Usually an operator will want a clause excluding the application of proportionate liability legislation, while service providers may be better off under proportionate liability legislation. For service providers particularly, they should consider their insurance contract before agreeing to exclude the application of such legislation because some policies expressly or impliedly exclude cover for liability assumed by agreement.

There are of course other insurance issues to consider such as third party liabilities, automobile insurance and workers compensation to name a few. Ideally, insurance cover will be consistent with the risks associated with the project.