Indemnity, Insurance, and Limitation of Damages Provisions

When oil and gas executives negotiate a contract, their focus is understandably on the commercial terms: what is being sold, how long is the deal, and, of course, price. The parties are aligned toward a common goal of planning and executing on a successful project and rarely carefully consider the practical implications of “boiler plate” provisions that are the stuff of lawyers. But market conditions shift, accidents occur, supply chains are disrupted, and even a global pandemic can strike. While no one can predict the future or contract against every possible “what if,” parties would be well-served to think carefully about the potential risks and how the risk-shifting provisions in the agreement allocate that risk. These riskshifting provisions include indemnification, insurance, and limitation of damages. Instead of falling back on standard provisions used in prior agreements, parties should think critically about the potential risks and how these provisions will impact both sides if a dispute arises.

This article will explain the purpose of these provisions and recommend considerations for negotiating their terms. Entire articles and treatises are devoted to each of these topics. This article is merely a starting point for things to consider. The wise negotiator will include a litigator on their deal team to provide guidance on drafting these provisions in light of the specific contract, including its value, place of performance, and anticipated risks.

Indemnities

Indemnity provisions are intended to allocate risk in advance of a loss for the purpose of managing that risk, often including through the purchase of insurance. When drafting indemnity provisions, parties should thoroughly evaluate the potential losses that may arise out of the agreement and which party can adequately cover those losses. Indemnities are intended to provide more certainty as to which party bears what loss because they shift liability from one party to another. However, efforts to provide certainty are not always successful. For example, if the indemnitor cannot afford the indemnity, if there is any room for contrary interpretation, or if the clause may be unenforceable, litigation often ensues.

An important preliminary consideration in drafting an indemnification clause is its breadth. Will the indemnification be narrow and limited to instances where the indemnitor is at fault or broad enough to cover situations where the accident or property damage is solely the fault of the indemnitee? Indemnity clauses are typically sorted into three buckets: narrow: The indemnitor indemnifies losses caused by its own fault and the indemnitee’s negligence bars indemnification.

Intermediate: The indemnitor owes indemnity for losses caused in part by the indemnitee, but the indemnitee’s sole negligence bars indemnification. Broad: The indemnitor owes indemnity without regard to the fault of the indemnitee, including losses caused by the sole or concurrent negligence of the indemnitee.

Parties should take note that the broader the indemnity, the more likely it is governed and limited by specific laws. Indemnification provisions can also be mutual or unilateral. In a mutual ar- rangement, the parties agree to indemnify each other. In a unilateral scheme, one party agrees to indemnify the other without receiving reciprocal indemnification. “Knock-for-knock” indemnity provisions are a common form of mutual indemnity in the oil and gas industry pursuant to which each party is responsible for the death or injury of its own employees and/ or for loss or damage to its own property. Where subcontractors may be involved, the parties also need to consider how the indemnity provisions in the master contract and subcontracts are intended to, and actually do, interact.

While the above examples are types of standard indemnities, absent statutory requirements, the scope of an indemnity provision is in the control of the contracting parties. A single clause can cover all types of losses, cover only specific types of losses, or the parties can draft separate indemnity provisions applicable to distinct types of loss (e.g., environmental, property, or personal injury). The parties can also include defense of any claim within the scope of the indemnity. If defense is included, parties should expressly contract for the right to control the defense, including selection of counsel and settlement. Parties can also limit the amount of indemnity provided and whether it must be backed by collectable insurance. Parties should also expressly provide for the notice to be provided, including timing and scope (i.e., promptly provide all notices, demands, and claims).

The previous paragraphs discuss the many factors parties should consider when tailoring indemnification provisions to their specific commercial objectives. But parties must also understand and comply with laws that limit or outright bar certain types of indemnity arrangements. Because indemnity provisions contractually shield a party from liability it would otherwise have under the law, there are numerous laws governing their enforceability. Moreover, many of these laws are considered a matter of public policy and, thus, a choice of law provision selecting contrary law may be unenforceable. For this reason, it is not enough to include a choice of law provision and assume the indemnity will be enforced, provided it complies with the chosen law. The parties must also consider whether another state’s law may apply and draft the indemnity provisions with that state’s law in mind (or at least include a severability provision and be mindful of the risk the indemnity may be invalidated).

In Texas, as in many states, there are anti-indemnity statutes that restrict the use of indemnity provisions in certain circumstances. For example, the Texas Oilfield Anti-Indemnity Act (TOAIA) imposes limitations on indemnification arrangements involving oilfield operations. There are also common law requirements that must be considered. An indemnity provision that purports to indemnify a party for its own negligence must meet the Express Negligence Doctrine and the conspicuousness requirement to be enforceable.1 The Express Negligence Doctrine holds that “[a] party seeking indemnity from the consequences of [its] own negligence must express that intent in [clear and] specific terms within the four corners of the contract.”2 The Conspicuousness Requirement requires the indemnity to be written such that “a reasonable person against whom it is to operate ought to have noticed it,”3 (i.e., must be visually flagged, e.g., with Bold, CAPS, italics). Texas law is unclear as to whether a party may be indemnified for its own gross negligence, intentional torts, or punitive damages.4

Insurance

As with indemnity, insurance is another way to allocate risk. As briefly mentioned above, it would be wise for parties to include insurance requirements to support the parties’ indemnity obligations. Under TOAIA, certain safe harbors apply to salvage indemnity obligations if those obligations are supported by insurance. In addition to specifying the type and limits for required insurance, parties may also wish for the non-procuring party to be listed as an additional insured. An additional insured can obtain insurance rights under the policy directly for a covered loss, including defense. This gives the party an additional source of funds to cover a loss. The parties may also want the insurer to waive any right of subrogation against the non-procuring party. A waiver of subrogation prevents an insurance company from suing to recover amounts paid for an insured loss. Absent an agreement to the contrary, an insurance company typically has the right to “stand in the shoes” of its insured to recover insurance funds paid for a covered loss. Insuring a loss may save a company from responding to a lawsuit from its counterparty, but without a waiver of subrogation, the policy may serve only to change the name on the other side of the “v” to that of the insurer.

Parties should be mindful that the scope and validity of additional insured provisions and anti-subrogation clauses depend not only on the language of the contract, but also on the language of the policy. While it is common for parties only to obtain a certificate of insurance, that document is not enforceable and does not describe the policy’s terms, including exclusions. The best practice is to obtain and review the insurance policies in connection with drafting any insurance requirements and confirming they have been followed.

Limitation Of Damages

Limitation of damages provisions are useful to cut off the scope of the parties’ risk under a contract. Damages can be limited by amount or type of damages, or both. They can also be narrow in scope, applying only to claims under the agreement, or be broad in scope, applying to claims relating to the subject matter of the contract. In drafting limitation of damages provisions, it is important to understand the type of damages being limited and the risk that such damages will occur. Parties also need to consider whether the limitation of damages applies to any indemnity obligation. For example, parties often exclude consequential damages. But what constitutes consequential damages is not easily understood and is heavily litigated. By law, consequential damages “result naturally, but not necessarily, from the defendant’s wrongful acts” and must be foreseeable.5 On the other hand, direct damages are “the necessary and usual result of the defendant’s wrongful act; they flow naturally and necessarily from the wrong.”6 A party seeking to avoid liability will argue that the damages sought are consequential, not direct, relying on the limitation of damages provision. Instead of using the oft-litigated term “consequential damages,” consider using a damages cap or more specific terms, such as lost profits, lost use, or business interruption.

Conclusion

In closing, parties must remember that a court or tribunal will interpret the contract based on the words the parties chose and not based on what the parties actually intended, unless the agreement is ambiguous. It is therefore critical for parties to write what they mean and mean what they write. While this seems obvious, after days, weeks, and even months of negotiations, it can be easy for the parties to read the contract to say what they intended instead of what is actually stated. One of the best ways to guard against litigation is to have a relative stranger to the negotiation do a cover-to-cover review of the contract prior to execution to look for ambiguities and inconsistencies. In a dispute, the parties interpreting the agreement—successor parties, litigation counsel, arbitrator, judge, and jury—will almost assuredly not have been its drafters.

A careful drafter will consider the “what if” scenarios and how the allocation of risk under the contract may apply under those scenarios. To mitigate risk as much as possible, a drafter should pay close attention to the language of any indemnity, insurance, or damages limitation provisions. Keeping these drafting tips in mind will help ensure that a contract has the intended outcomes—no matter what disputes arise.

Courtney Ervin is a partner with the litigation boutique Hicks Thomas LLP, where she serves as lead counsel for numerous clients in the energy industry, including major E&P companies, independent producers, and service providers in business disputes. Courtney also serves as national counsel to a leading property and casualty insurer.

Colin Watterson is also a partner at Hicks Thomas LLP, where he focuses his practice on complex commercial litigation in state and federal courts and in arbitration. Colin has represented oil and gas companies in numerous disputes involving master service agreements, joint operating agreements, and other oilfield service contracts.

D. Ryan Cordell, Jr. is an associate at Hicks Thomas LLP, where he has experience handling a variety of complex commercial litigation matters, including contract disputes, tortious business conduct, trade secret misappropriation, and infringement of various other types of intellectual property. Ryan also has experience in mass torts and personal injury litigation.

Endnotes

1. See Storage & Processors, Inc. v. Reyes, 134 S.W.3d 190, 192 (Tex. 2004).

2. See Dresser Indus., Inc. v. Page Petroleum,853 S.W.2d 505, 508 (Tex. 1993) (citing Enserch Corp. v. Parker, 794 S.W. 2d 2, 8 (Tex. 1990)).

3. See id. (citations omitted).

4. Compare Webb v. Lawson-Avila Constr., Inc., 911 S.W.2d 457, 461–62 (Tex. App.—San Antonio 1995, writ dism’d) (such indemnification provisions do not violate public policy and are enforceable when the parties are sophisticated entities bargaining from positions of substantially equal strength) with Smith v. Golden Triangle Raceway, 708 S.W.2d 574, 576 (Tex. App.—Beaumont 1986, no writ) (pre-injury releases of gross negligence violate public policy and are not enforceable).

5. Arthur Andersen & Co. v. Perry Equip. Corp., 945 S.W.2d 812, 816 (Tex. 1997).

6. Id

By JaClyn i. BarBosa