CIn

Tuesday, March 5, 2013Houston, TX

2:45–4:00 p.m.

DRILLING CONTRACTS AND MASTER SERVICE AGREEMENTS

Presented by

Harold J. Flanagan, J.D.Partner

Flanagan Partners LLP

Drilling contracts and master service agreements (MSAs) are key contracts that allo-cate risk and insurance purchasing responsibilities in the oil patch. While drilling con-tracts have been standardized to a large extent, there is much variation in approachesto MSAs, which are increasingly used by operators to facilitate the rapid engagementof contractors. This workshop will explore the common approaches to risk allocation inthese agreements, including the operation of anti-indemnity statutes and approachesto insurance provisions.

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to minimize Risk:

Harold J. Flanagan, J.D.Partner

Flanagan Partners LLP

Mr. Flanagan is a founding partner of Flanagan Partners LLP in New Orleans, Louisiana, and a for-mer shareholder in the Maritime, Oilfield, and Insurance Section of the New Orleans office of Lis-kow & Lewis. Mr. Flanagan’s practice includes both contracts and litigation in the areas of insur-ance coverage and recovery, construction, admiralty, oil and gas production, casualty, andcommercial matters. He has extensive experience in contract drafting for oil and gas producersand is frequently called upon to investigate casualties and advise clients on matters involving wellblowouts, explosions, drilling rig and vessel accidents, and various other oil field tort claims. Inaddition, he has extensive experience in drafting construction contracts and litigating construc-tion disputes for contractors and property owners.

Mr. Flanagan graduated from Loyola University with a B.S. in business management in 1984 andfrom the Loyola School of Law in 1995, cum laude. For the past 11 years, he has taught insurancelaw at Tulane Law School. His outstanding service to the school was recognized when he wasawarded the Monte M. Lemann Distinguished Teaching Award in 2003 and 2010. Mr. Flanaganlectures and writes frequently in the areas of oil and gas law, construction contracts and litiga-tion, and insurance coverage.

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Notes

This file is set up for duplexed printing. Therefore, there are pages that are intentionally leftblank. If you print this file, we suggest that you set your printer to duplex.

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Presented By:

Harold J. Flanagan

Flanagan Partners LLP

RISK ALLOCATION ISSUES IN DRILLING

CONTRACTS AND MASTER SERVICE AGREEMENTS

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� General considerations� Common risk allocation issues� Risk allocation in drilling contracts� Risk allocation in MSAs� Conclusion and recommendations

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� The drilling contract drives the bus� IADC, operator forms predominate�Modified reciprocal indemnity�Operator indemnifies driller for any

operator or service contractor loss�No pass-through

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� But it�s a �standard� contract form; it�s got to be fair!

� Industry custom: deal with it, but don�t surrender

� Everyone is worried

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� General indemnity precepts� Scope issues�Magic language� Types of schemes� Pass through�Unallocated risk� Complicated issues

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� �incident to, arising out of, in connection with�

� �the Work and/or the Agreement�� Broadly construed; connexity similar to

cause-in-fact

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� �Contractor shall defend, indemnify, andhold harmless Operator Group�.�

� Contractor shall release, defend, protect,indemnify, and hold harmless OperatorGroup�.�

� Sundance Cruises Corp. v. American Bureau ofShipping; Wallerstein v. Spirit

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� Courts� general hostility to indemnity without fault

� Burden on indemnitee � Enforceability� Louisiana��Unequivocal��Perkins v. Rubicon� Texas��Express Negligence��Ethyl Corp. v.

Daniel Constr. Co.� Wyoming��Clear and Unequivocal��Wyoming

Johnson, Inc. v. Stag Indus., Inc.

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� ... the negligence of any degree or character (regardless of whether such negligence is sole, joint or concurrent, active, passive or gross) of any party or parties, including the party seeking the benefit of the release, indemnity or assumption of liability, or any other theory of legal liability.�

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� Strict liability� Preexisting conditions� Breach of contract/warranty� Contractual liability� Punitive damages� Gross negligence � Attorneys� fees

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� Broad reciprocal: includes contractors and subcontractors (creates extensive potential liability for company; without a �pass-through� provision, there may be no backup indemnity)

� Narrow: each party responsible for its own employees and property (simple; doesn�t require reliance on what�s in other contracts)

� Variations: modified reciprocal; fault-based reciprocal; hybrid

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� �Group� definition: expand the indemnitees to include contractors and subcontractors�Campbell v. Sonat Offshore Drilling, Inc.

� Indemnity without a pass-through provision won�t solve the problem! Foreman v. Exxon

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� �At law��What does that mean?

� Stealth allocation�Residual liability approach�Third-party damage unallocated�But unallocated fault is for company

� Affirmative statement of liability according to fault or negligence?

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� Land owners, neighbors, trespassers, government (invitees?)

� Typical formulation is that third-party damage is allocated �at law�� Special contribution statutes

� Be specific (�to the extent caused by each party�)

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� Special events clause:� All claims �arising from� blowout, fire,

explosion, etc.�Usually controls over basic indemnity�Needs limitation

� Primacy, within and without

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� Exceptions to the reciprocal indemnity scheme

� Based on custom/tradition, market factors� Tools in the hole, blowouts, warranty� �Notwithstanding anything else contained in

this Agreement to the contrary, �� � What about property damage or bodily injury

in connection with a blowout?� Don�t let the exception swallow the rule

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1. �Subject to the general indemnity provision...�

2. �This indemnity shall in no way affect any protection, release, or indemnification for bodily injury, illness, death or property damage.�

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� Four states have oil and gas acts�LA, NM, TX, WY

� Inequity, safety � Pertain to well for oil, gas, water, etc.� Plan for them� Are there work-arounds?� Construction acts?

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� Restricts indemnity and insurance� Personal injury only� Pertaining to a well?� Extent of commingling of different wells� Contract�s involvement with operations related to the

exploration, development, production, or transportation of oil, gas, or water

� Exceptions� JOA� Sulphur� Radioactivity� Wild well� Oil spills and control

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� Party receiving insurance benefit must bear all material cost of insurance

� If Marcel applies, LOIA is inapplicable� Unwritten �working policy� whereby contractors

could factor in the cost of procuring insurance is insufficient�Hodgen v. Forest Oil Corp.

� Amoco v. Lexington Ins. Co. suggests that calculating premium for additional protection may be difficult

� But Rogers v. Samedan holds that if the premium was paid in full, the insurance exception will be enforced

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� Personal injury and property damage� Exceptions� JOAs� Wild well� Property damage from underground/reservoir

damage� Radioactivity� Property damage from pollution� Worker�s compensation� Surface owner damage

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� Exceptions for indemnity supported by insurance� Unilateral indemnity ($500,000)� Mutual indemnity (up to amount of insurance obtained �for

the benefit of the other party as indemnitee�)�no longer required to specify equal amounts)

� Act does not apply to insurance that does not directly support the indemnity�Getty Oil Co. v. Insurance Co. of N. Am.; Certain Underwriters at Lloyd�s London v. Oryx Energy Co.

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� Two prongs to maximize enforceability

� Presents a contract �architecture� challenge:�Two different insurance requirements �One supports indemnity; other doesn�t� Insurance should apply to all policies

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� Same scope as Texas (property and bodily injury/death)

� Different as respects exceptions�No unilateral or mutual indemnity exceptions

like Texas�Workers compensation okay

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� Amoco v. Action Well Serv.�Insurance exception not allowed

� Reagan v. McGee Drilling Corp. �Allowed enforcement of an insurance exception if the TOAIA applied under choice law provision (public policies the same)

� 1999 amendment to New Mexico Act invalidated �a provision in an insurance contract indemnity agreement� naming a person as additional insured

� Pi�a v. Gruy Petroleum�TOAIA �is fundamentally inconsistent with important New Mexico public policy.�

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� Similar to Texas in basic scope (property damage and personal injury/death)

� But only applies to contracts �closely related to well drilling��Gainsco Ins. Co. v. Amoco

� And to contracts for work directly on a well�Union Pac. Res. v. Dolenc

� No unilateral or mutual indemnity exceptions

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� Provides �shall not affect the validity of any insurance contract or benefit conferred by the Worker�s Compensation Law� but no caselaw

� True Oil v. Mid-Continent ��Insured contract� means valid obligation

� Wyoming courts will honor choice of law if not offensive to Wyoming public policy�R&G Elec. v. Devon

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� Similar to oil and gas acts, but ...� Very broad coverage� �Construction contract� often defined to

include any alteration or maintenance of a �structure�

� Presents some of the same challenges� Subject to abuse� Insurance obligations are invalid� Plan for it!

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� Know your jurisdiction� Insurance sometimes provides more

protection� Belt and suspenders approach� Savings/severability clause� Choice of law

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� Impact of anti-indemnity acts� Consistency, especially in multistate

operations� Savings clauses; alternate schemes

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� �Big three� insurance protections; AI, waiver, primary

� Limit scope of protection as intended� Dovetail with indemnity

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� Correct third-party and first-party coverages

� Contractual liability coverage� ISO language refers to �insured contract��GL contractual liability coverage is in the

exception to an exclusion and the definition of �insured contract�� Potential for aggressive application� Colony Nat�l Ins. Co. v. Manitex, LLC

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� Require contractual liability insurance that matches the indemnity obligation

� �Contractor shall obtain contractual liability insurance that provides coverage for all of the release, defense, indemnity, and hold harmless obligations undertaken by Contractor in Section ____ of this Agreement.�

� Make sure you comply, too.

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� A party guilty of breaching a contract is liable for damages caused by the breach

� Becomes the �insurer� of the obligation� Don�t promise what you don�t have� Broker review is a no-brainer

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� Independent contractor provision� Potential game changer in third-party claims� Proper contractual language is primary

focus of courts� Statutory employer� Louisiana only� Correct language in contract makes

rebuttable presumption of statutory employee status� Employee cannot sue employer in tort

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� Indemnity for gross negligence�Deep Water Horizon�indemnity for gross

negligence allowed, but shifting punitive damages not�Other courts disagree

� Consequential damages waiver� Ensure it is given for a narrow group�Use broad language

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� ACORD form is inadequate� Basic policy forms, dates, limits, insurers�No info on major exclusions,

endorsements� Produced by clerical personnel�Disclaimers regarding content and notice

of cancellation�TIG Ins. Co.� Consider custom certificate or policy

review

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� Minimum precautions� Contractually reserve right to reject

inadequate certificate: �Contractor shall provide an insurance certificate on a form satisfactory to Company, evidencing that the above coverages are in place.� � Ensure that �big three� protections noted� Can help when there is a close call on a

coverage question. Jessop v. City of Alexandria

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� Careful with restrictive AI endorsements� Limit insurance coverage �to the extent of

risks and liabilities assumed��Forest v. Strata

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� Indemnity provision may impliedly limit the enforceable indemnity obligation to the amount of insurance required under contract�Dickerson

� Specify that indemnity is not limited by insurance requirements

� Could add �unless required by applicable law�

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� The indemnity scheme�Modified reciprocal�no protection� Affects all underlying MSAs with other

contractors� Texas law refinements necessary

� Drilling rig is the big-ticket item

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� Hidden dangers� Floating magic language� Primacy issues� Risk allocation not limited to indemnity

section

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� Specific pitfalls� Floating magic language� Sound location�Miller Exploration v. EDC� Termination of liability� Primacy issues�Sonerra Res. Corp. v.

Helmerich & Pain Int�l Drilling Co.� Insurance needs supplementation

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� Same rules as above� There�s no such thing as a �good contract�

form� It�s a risk allocation �program��be

consistent among all contracts� Inconsistent contracts usually result in

company/operator holding the bag

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� Broad reciprocal indemnity scheme is typical in MSA� Puts pressure on operator� Requires protection from each contractor�Must get the pass through

� Warranty limitation and potential indemnity impact

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� Some of the same pitfalls in drilling contracts�Warranty limitation; potential indemnity

impact� Stealth risk allocation� Special events aka catastrophic loss

provisions� Texas law modifications

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� Company/operator signs IADC form drilling contract and typical big service company MSA form

� Rig burned down by service company crew; driller sues service company

� Service company tenders lawsuit to company/operator pursuant to MSA

� Company/operator tries to tender rig claim back to driller, but there is no pass-through in drilling contract

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� Consistency is the key to happiness� Contract administration� Pick up the phone� Don�t be a lemming� Use your insurance broker!

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� �Risk Allocation in Onshore Drilling Contracts,� IRMI, Contractual Risk Transfer (2010)

� �Risk Allocation Provisions in Master Service Agreements,� IRMI, Contractual Risk Transfer (2012)

� �Onshore Drilling Contracts: Avoiding the Pitfalls of Form Drilling Contracts,� Rocky Mt. Min. L. Fdn. 2004

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