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Standard Form Contracts – Choice of Law Can Change Everything
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October 5, 2009
(This paper first appeared in the October 2009 edition of Decisions, Decisions, Howrey’s dispute resolution and international arbitration newsletter.)
By Melanie Willems
Howrey LLP
Picture the following: Your company, a drilling rig contractor, is negotiating a contract with a counterparty from another jurisdiction. The contract is based on a well-known standard form published by an international industry body. This standard form is attractive to your company because it contains wide-ranging exclusion and limitation clauses in favour of the contractor. Even better, these clauses have been considered judicially – say at first instance and then again by a District Court in the United States – and were held to be effective. This seems to leave your company with little risk. On that basis, limited liability insurance is taken out for the project. Your counterparty, however, then proposes that the contract be governed by English law and that disputes be heard either in the Commercial Court in London or by London arbitrators since that is a neutral forum.
The issue recently came before Flaux J in the Commercial Court (Seadrill Management Services Limited v OAO Gazprom [2009] EWHC 1530). The defendant, Gazprom, was party to a production-sharing contract with the Gas Authority of India. Under that agreement, Gazprom was engaged in exploration for offshore natural gas deposits in the Bay of Bengal. It hired the claimant, Seadrill, to provide a rig for drilling operations under a form of contract published by the International Association of Drilling Contractors, the International Daywork Drilling Contract-Offshore or IDDCO.
Seadrill’s rig arrived on location in January 2006, and preloading began. Preloading of a rig involves placing the maximum vertical loads that the rig may generate during operations onto the seabed before drilling commences. Preloading relies on both the weight of the rig itself and seawater ballast. It is meant to ensure that the rig sits evenly on all (three) legs and does not sink any further into the seabed during drilling. In this case, however, things went wrong and the preloading process failed. During the final stages, the legs on the stern side of the rig sank deeply and unevenly into the sub-soil. The legs “bound” and could not be moved either upward or downward: The rig was well and truly stuck. A rescue operation was mounted, and in mid-February 2006, the rig limped off to the Keppel Fels yard in Singapore for repairs, as well as upgrade work needed for Seadrill’s next engagement.
By May 2006, Gazprom had written to Seadrill terminating the contract on the basis of Seadrill’s negligence during the pre-loading and related operations. Seadrill did not accept this, countering that Gazprom’s notice of termination was itself a repudiatory breach and also terminating for non-payment of hire. Seadrill went to the Commercial Court to claim unpaid hire for the unexpired period and sought to recover some of the costs of the repairs under the terms of the contract. Gazprom, having eventually drilled the well itself using another vessel, counterclaimed for damages. Gazprom alleged that it had suffered substantial losses due to Seadrill’s failure to complete the well as agreed and on time.
One of the key issues between the parties was whether Seadrill was under an obligation to use reasonable skill and care in operating the rig or whether all risk of accidents, delays and so on had been passed to Gazprom, irrespective of fault. Not all provisions of the contract are quoted in the judgment, but Seadrill’s argument was, essentially, that the contract did not impose on Seadrill any particular standard of performance for operation of the rig. Seadrill relied on statements that it was only to be subject to liabilities that had been “specifically assumed.” While Seadrill had promised to undertake the pre-loading operation that had gone wrong and to operate the rig, nowhere in the contract had Seadrill specifically assumed any liability in damages if it fell short of any particular standard in performing these obligations. The lynchpin of Seadrill’s argument was Paragraph 911, part of Article IX of the contract:
911 General Intent.
The parties recognise that the performance of well drilling, workover, and associated activities such as those to be performed under this Contract have resulted in bodily injury, death, damage or loss of property, well loss or damage, pollution, loss of well control, reservoir damage and other losses and liabilities. It is the intention of the parties hereto that the provisions of this Article IX and Paragraphs 606, 608 and 1310 shall exclusively govern the allocation of risks and liabilities of said parties without regard to cause (as more particularly specified in Paragraph 910) it being acknowledged that the compensation payable to Contractor as specified herein has been based on the express understanding that risks and liabilities shall be determined in accordance with the provisions of this Contract.
Seadrill submitted that Paragraph 911 was part of a complete code through which the parties allocated all risks that might be encountered during drilling operation between themselves, without regard to “cause” or fault. Seadrill argued that this approach was commercially sound and had the benefit of certainty: Depending on what risk led to the loss in question (ground conditions, site access, obstructions or the like), the parties would know who was responsible without the need for a factual investigation as to who was to blame. In support of this argument, Seadrill referred to commentary by U.S. academics and a decision in the Louisiana courts on the contract. The form had been written to include the “magic” wording in Article IX to avoid unforeseen liabilities that would go against the parties’ risk allocation.
So, despite the fact that the contractor might promise to undertake certain tasks elsewhere in the contract, failing to perform these obligations would not give rise to a liability in damages unless Seadrill had specifically accepted a liability in Article IX.
One can see where Seadrill were coming from. The first part of Paragraph 911 does refer to the risks inherent in offshore drilling operations – they can lead to “bodily injury, death, damage or loss of property, well loss or damage, pollution, loss of well control, reservoir damage and other losses and liabilities.” The next sentence goes on to state that Article IX (and a handful of other provisions) “shall exclusively govern the allocation of risks and liabilities of said parties without regard to cause.” It might, therefore, be said that these risks and liabilities of the parties, which are exclusively allocated by Article IX, are all the risks and liabilities that might lead to the losses mentioned in the first sentence -- pretty much everything that could possibly go wrong during drilling works was covered (notice the reference to “other losses and liabilities” at the end of that sentence, which Seadrill said was a “catch-all”).
As against that, Gazprom advanced a more traditional, or conventional, “English” construction. The starting point under English law was that if someone promised to provide services under a contract, the law implied a term that the services would be provided with reasonable skill and care. See, §13 of the Supply of Goods and Services Act 1982. Seadrill promised to carry out the pre-loading (under another provision in the contract) and, in the absence of clear words to the contrary, would be liable for any negligence in so doing that caused Gazprom loss.
Flaux J accepted this:
[S]ince this is an English law contract, the starting point is that the court must construe the contract as a whole, without preconceptions, but applying established English law principles of contract construction. One of those principles is that clear words are necessary before a court will hold that a contract has taken away rights or remedies which one of the parties to it would have had at common law: Lewison paragraph 12.19, citing, inter alia, Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Limited [1974] AC 689….
In that case Lord Diplock stated the principle at 717H and 718E as follows:
But in construing such a contract one starts with the presumption that neither party intends to abandon any remedies for its breach arising by operation of law, and clear express words must be used in order to rebut this presumption.… To rebut that presumption one must be able to find in the contract clear unequivocal words in which the parties have expressed their agreement that this remedy shall not be available in respect of breaches of that particular contract.
Seadrill was, therefore, on the back foot since it had to disprove the presumption that Gazprom would not have wanted to give up its entitlement to damages under English law for any negligence by Seadrill.
In trying to rebut the presumption, Seadrill had placed reliance on U.S. commentary and the development of the standard form by the industry. It also had relied on decisions by the federal courts in Louisiana and Texas, which Seadrill submitted showed that Article IX was a complete code as far as liabilities and risk allocation were concerned. In short, Seadrill was saying that everyone in the industry knew that a drilling contractor was protected by Article IX in a case of this nature and that the federal courts had effectively endorsed this view. One might add to this, though Seadrill did not quite put it that way, that international businessmen (aware of the history of the form of contract and of U.S. decisions) would not have thought they were altering the bargain just by changing the governing law to that of England.
Flaux J, however, stated that it did not matter that the U.S. courts already had considered the contract while the English courts had not. While the history and development of the contract could form part of the factual and commercial background to the contract against which the contract is construed,
it cannot be used to subvert the normal English law principles of construction and arrive at a construction of the contract which would not be legitimate applying those principles of construction.
The U.S. courts had, in any event, construed different contracts governed by a different law. Flaux J urged caution in relying on American academics or decisions of the U.S. courts because their approach would, inevitably, be influenced by U.S. principles of law that would not necessarily be the same as those under English law. The judge recognised that U.S. maritime law, which had been applied in the U.S. cases, perhaps was closer to English law than the law of Texas or Louisiana but commented that the cases Seadrill was relying on suggested that the U.S. courts had applied principles that were “by no means identical to English law”.
English law would take notice of industry practice – such as particular contractors always excluding liability for certain risks, risks that were in turn routinely accepted by employers. However, that did not actually improve Seadrill’s position. What mattered was the particular bargain struck between Seadrill and Gazprom, and that had to be governed by the contract as construed under English law:
It is well recognised that offshore contracts of one kind or another (be it drilling contracts or, for example, towage contracts) contain risk allocation provisions which allocate certain risks between the parties irrespective of fault. However the existence of that commercial approach does not assist much in the construction of this particular contract and, in particular, in deciding whether, as Seadrill contends, the risk allocation provisions in this contract are all-encompassing and preclude any claim for damages.
As matter of English law, Seadrill had assumed the obligation to operate the rig, and it was a “necessary incident”, or inevitable consequence, that it had to do so with reasonable skill and care. 1/ The term would be implied unless there was something in the express terms that would be inconsistent with implying this standard of performance.
Flaux J concluded that in fact there was nothing in the contract, or in Article IX, that would make implication of the term inconsistent. Article IX allocated risks for various types of loss in a number of sub-clauses that appear before Paragraph 911. The judge found that the words “…other losses and liabilities” at the end of the first sentence in Paragraph 911 had to be read as referring to other losses and liabilities that were actually allocated under Article IX but not any other losses that might conceivably occur as a consequence of a breach of contract.
The judge’s ultimate conclusion was that Paragraph 911 had the effect of making Article IX into a complete code for those matters that it dealt with expressly – but no more. Flaux J was looking for additional words, not found in the contract, such as (for instance): “Both parties accept that neither can be liable to the other for any matter whatsoever arising under or in connection with this contract beyond the provision of this Article IX (including, for the avoidance of doubt, for any negligent failure to perform any of the obligations under this contract).” Flaux J also would have expected such an important clause to have its very own place in the contract rather than being a sub-clause at the end of an Article.
With that conclusion in mind, we can revisit the wording that was in fact used:
The parties recognise that the performance of well drilling, workover, and associated activities such as those to be performed under this Contract have resulted in bodily injury, death, damage or loss of property, well loss or damage, pollution, loss of well control, reservoir damage and other losses and liabilities. It is the intention of the parties hereto that the provisions of this Article IX and Paragraphs 606, 608 and 1310 shall exclusively govern the allocation of risks and liabilities of said parties without regard to cause.
How many of our readers would have had the initial reaction that this wording “did the trick” – if it is not in Article IX, Paragraph 606, 608 or 1310, then you cannot be liable for it? Flaux J’s decision serves as a useful reminder of the reluctance of English law to allow one party to offer to perform services without accepting the ordinary consequences or liabilities that the law imposes. Based on Seadrill’s arguments, that reluctance may not be something shared by the laws of Texas or Louisiana.
The result of the decision is that a negligent contractor was responsible for the losses caused by his own negligence and could not ask the employer to repair the rig that the contractor’s own employees had damaged. Looked at from this perspective, one might describe the Flaux J’s judgment as “just.”
Finally, you may take comfort from the fact that if you are contracting on the basis of an industry standard form, which has been considered by the English courts, and you adopt English law, then previous decisions on what particular clauses mean in the contract will be given some weight.
As Lord Hoffman said in Beaufort Developments Limited v Gilbert-Ash Limited [1999] AC 2662:
It is also important to have regard to the course of earlier judicial authority and practice on the construction of similar contracts. The evolution of standard forms is often the result of interaction between the draftsmen and the courts and the efforts of the draftsman cannot be properly understood without reference to the meaning which the judges have given to the language used by his predecessors. 2/
As Chitty puts it, the courts will assume that the parties contracted on the basis of the meaning of the words in the accepted legal sense – but that “legal sense” is that under the system of law they have chosen rather than any other system of law where the point has been decided. This means that particular care is needed when a “neutral” governing law is chosen (and this may well be English law): In reality, the parties may have no knowledge at all as to what the accepted legal sense of words under that law would be, yet they are presumed to have that knowledge. It is worth bearing that in mind – especially if a change to the governing law is suggested by your counterparty as something you could live with since “everyone knows this form of contract so well.”
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For more information about the issues covered in this report, please contact Melanie Willems in our London office at 44-20-7936-5354 or at WillemsM@howrey.com or contact your Howrey attorney. For more information about Howrey's Construction Practice Group, click here.
ENDNOTES
| 1/ | See further, Exxonmobil Sales and Supply v Texaco Ltd [2004] 1 All ER 435 at 441 paragraph 27
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| 2/ | Followed in Henry Boot Construction Ltd v Alstom Combined Cycles Ltd [2005] EWCA Civ 814, at 29.
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©2009 Howrey LLP
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