Interpreting a mutual indemnity: It takes two to exclude

26th May 2016

The Court of Appeal has considered the meaning of a mutual indemnity/’knock-for-knock’ exclusion clause in an energy sector commercial contract. Commercial Dispute Resolution specialist Gwendoline Davies explains the practical points arising from Transocean Drilling v Providence Resources.

Facts and contract

In the recent Court of Appeal case of Transocean Drilling v Providence Resources [1] the owner of an oil rig contracted with another company for the drilling of an oil well. The contract was based on a standard industry agreement (known as the ‘LOGIC’ form), which the parties adapted to meet their particular needs. However, the principles considered in the case are of significant interest and applicability to many commercial contracts, not least those within the energy sector. The wording of a contractual exclusion formed the subject of this dispute when a defect in the rig caused a delay to drilling of the well. When Providence sought to recover what were known as ‘spread costs’, namely the costs of goods and services supplied by third parties which were wasted (either in the sense that Providence had no use for them while drilling was suspended or in the sense that they did not contribute to the process of completing the well), the court had to decide whether the loss claimed was caught, and therefore excluded, by the contract.

The provision in question was a mutual, or cross, indemnity, sometimes known as a ‘knock-for-knock’ agreement, pursuant to which each party indemnified, or held harmless, the other from the former’s own consequential loss (as defined). The provision amounted to an exclusion of liability clause and it was part of a broader, sophisticated scheme in which the parties, who were each of equal bargaining position, agreed to allocate risks between themselves.

The provision excluded recovery by either party of liability for consequential loss (as defined) as follows:

“(i)        …any indirect or consequential loss or damages under English law, and/or

(ii)       to the extent not covered by (i) above, loss or deferment of production, loss of product, loss of use (including, without limitation, loss of use or the cost of loss of use of property, equipment, materials and services including, without limitation, those provided by contractors or subcontractors of every tier or by third parties), loss of business and business interruption, loss of revenue… loss of profit or anticipated profit, loss and/or deferral of drilling rights and/or loss, restriction or forfeiture of licence, concession or field interests, whether or not such losses were foreseeable at the time of entering the contract…”.

Court of Appeal decision

Placing emphasis primarily on the plain and natural meaning of the clause, and finding that the words “loss of use (including, without limitation, loss of use or the cost of loss of use of property, equipment, materials and services including, without limitation, those provided by contractors or subcontractors of every tier or by third parties)” were “plainly apt” [2] to catch the spread costs claimed, the Court of Appeal decided that the clause was effective in excluding liability.

Legal and practical points to note

The following legal and practical points are confirmed by this important case:

• The starting point in any contractual interpretation exercise should always be the natural meaning of the language itself [3].
• The Court of Appeal found that the clause plainly covered the claimed losses when the ordinary natural meaning of the wording was considered. The court was also assisted by the fact that the parties had emphasised the intended width of the clause by their inclusion, twice, of the phrase “without limitation”.
• Where there is ambiguity in the wording, the court may consider other factors. These can include the background facts, context, and underlying purpose of the provision in question; commercial common sense; and legal principles of interpretation.
• One such principle is the eiusdem generis principle: that general words may be interpreted as having a limited meaning when they follow a list of specific matters or examples of a similar kind. The court again took into account the parties’ repeated use of the phrase “without limitation”, which is often deployed to counteract the eiusdem generis principle to preclude such an interpretation in this case.
• Another such principle is the contra proferentem rule which provides that where there is ambiguity, a contractual provision will be construed against the person who seeks to rely upon it. The contractual wording in this case, however, was not ambiguous and the court found that this was therefore not a case in which the contra proferentem rule could be applied.
• Limitation and exclusion clauses restrict a party’s contractual obligations or legal remedies. Parties should not lightly to be taken to have limited their rights or remedies without clear wording to that effect.  However, there is no special rule or presumption that exclusion clauses should necessarily be interpreted narrowly.
• There is a line of authority [4] which endorses the argument that a clause should not be interpreted so as to effectively divest a contract of meaningful legal content. The Court of Appeal stated that such a principle should be applied only as a last resort.  In addition, on the facts, that argument was not made out in this case in any event: “it cannot be said that the contract is devoid of legal content just because the parties have agreed that neither should be entitled to recover from the other consequential, as opposed to direct, loss” [5].
• Finally, freedom of contract is a crucial concept within English commercial contract law. This case is an important affirmation of the ability for parties – in particular commercial parties of equal bargaining strength entering into sophisticated ‘knock-for-knock’ arrangements – to apportion responsibility and risk howsoever they see fit.

WM Comment

The Transocean case does not make new law but it is of interest and value to commercial parties for its clear illustration that, where sophisticated parties agree contractual terms which very clearly define the exclusions and limitations of risks to which they have agreed, the courts will uphold such exclusions even if this will deprive an innocent party of sums due following a breach of contract.

It is important that parties carefully consider the risk and effect of wide mutual exclusions of liability. This is relevant not only in terms of the impact on excluding claims against a party, but also in properly assessing what claims an innocent party might need to bring.  If a party acts to restrict liability for its defensive benefit, this should be weighed against the fact that it may also impact its ability to enforce the obligations of its counterparty, upon which it relies.

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[1] Transocean Drilling UK Limited v Provident Resources plc [2016] EWCA Civ 372
[2] Ibid. para 17
[3] Arnold v Britton [2015] UKSC 36.  See our earlier briefing (https://www.walkermorris.co.uk/publications/disputes-matter-july-2015/contract-is-king-says-supreme-court/) for more information.
[4] Transocean Drilling v Provident Resources paras 26 and 27
[5] Ibid. para 35.