Look Before You Leap: Are Your Oil Patch Liability Clauses

Among the many risks of doing

business in the oil and gas industry,

perhaps the most precarious is wellsite

liability, which has the potential to

havefor participants to spending more

time litigating mishaps than nding

and producing oil. This article analyzes

common risks the laws of a civil law

jurisdiction to a Wellsite Contract.

I. INTRODUCTION

The oil and gas industry requires huge

investments involving extraordinary

nancial, environmental and safety

risks. Dramatic images of the

Deepwater Horizon (Gulf of Mexico,

2010); Alpha Piper (Scotland, 1988);

P-51 (Brazil, 2001); and Campeche

(Mexico, 1979) disasters offer chilling

reminders of the monumental loss of

life, property and environmental

integrity that can quickly result from

human error. Once the rst responders

have performed their heroic well

control feats, and perhaps even before,

armies of lawyers wage war to transfer

liability from their clients to others.

With this backdrop, industry partici-

pants and their insurers learned early

on that the normal fault-based

approach to wellsite liability did not t

the nature and needs of the petroleum

business. Rather, it ran the risk that

operators and their various service

companies would spend more time and

effort suing each other over inevitable

mishaps than nding and producing oil.

This article will analyze the risks inherent

in applying the laws of a civil law

jurisdiction to a Wellsite Contract.

will assume that the reader is contem-

plating the negotiation of a Wellsite

Contract subject to the laws of a civil law

jurisdiction, such as Brazil, and needs to

understand the relevant implications in

order to devise a mitigation strategy.

II. BACKGROUND

Wellsite Contracts need to predict and

effectively address the oil patch realities

described in Section I. Based on

industry experience, a complex system

of liability and indemnity clauses

(“Standard Approach”) has developed,

including what are called “knock-for-

knock” (“K4K”) provisions.

The

Standard Approach is designed to

allocate various types of liabilities

between operators and contractors in a

way that (i) avoids litigation, (ii) focuses

on ability to control, (iii) dovetails with

insurance coverage and (iv) balances risk

and reward. Indeed, the Standard

Approach tends to reect economic

reality and arguably is more concerned

with efcient allocation of risk than

assignment of fault.

Norman Nadorff

nnadorff@mayerbrown.com

+1 713 238 2653

Maria Beatriz Gomes

mbgomes@mayerbrown.com

+55 21 2127 1621

By Norman Nadorff

and Maria Beatriz Gomes

Look Before You Leap: Are Your Oil Patch Liability Clauses Enforceable?

An Analysis Under Civil Law Jurisdictions with Emphasis on Brazil

April 2021

2 MAYER BROWN | Look Before You Leap: Are Your Oil Patch Liability Clauses Enforceable? An Analysis Under Civil Law Jurisdictions

with Emphasis on Brazil

Wellsite Contract liability provisions are largely based

on common law principles and work particularly well

in common law jurisdictions. Thus, contracting parties

typically prefer, when operating in civil law jurisdic-

tions, to apply the law of England and Wales

Wellsite Contracts. English law is favored because it is

(i) generally regarded as user-friendly,

(ii) particularly

well suited to interpreting the nuances of a contract

drafted in English,

(iii) exible, pragmatic and com-

mercially minded, seeking to uphold freedom of

contract and (iv) provides a healthy body of oil and

gas case law.

In addition, English courts are highly

respected for their independence, efciency, predict-

ability and probity.

On the other hand, operators and contractors alike

generally avoid applying the laws of civil law jurisdic-

tions to Wellsite Contracts, even when operations

take place in such countries. This is due primarily to

the differing approach to liability between common

law and civil law jurisdictions, given that the civil

codes of these jurisdictions often feature rigid

fault-based allocation of risk. Nonetheless, the

courts of some civil law jurisdictions have favorably

viewed K4K provisions and upheld their application

to Wellsite Contracts.

Most National Oil Companies (“NOC”s) insist on

having their national law govern Wellsite Contracts

that they enter. Typically, the matter is not negotiable,

and contractors need to reect that requirement in

their Wellsite Contract risk and cost analyses.

III. STANDARD APPROACH

“A person may cause evil to others not only by his

actions but by his inaction, and in either case he is

justly accountable to them for the injury.”

– John Stuart Mill

As indicated above, K4K clauses are designed to

streamline the allocation of liability among parties to

Wellsite Contracts arising from tortious events and

thus minimize related litigation. The Standard

Approach works well when the stakes are low and

factual clarity is high.

K4K began to emerge in the late 1960s, presumably

based on (i) the highly dangerous nature of petroleum

operations, (ii) the stark difference in size and prot

potential of industry participants and (iii) the desire to

reduce litigation. K4K generally assigns liability to the

“owner” of property and the “employer” of person-

nel. Under the Standard Approach, each party,

regardless of fault, agrees to protect and indemnify

the other against (i) all damage to the indemnifying

party´s property and (ii) all injury to or death of its

personnel. Many contracts expand K4K through a

complex system of cross-indemnities. When fully

implemented, all entities involved in an oil and gas

operation participate in the cross-indemnity arrange-

ment, indemnifying each other from harm to their

own property and personnel.

The Standard Approach is generally considered the

best and most efcient model of risk allocation and

liability distribution for oileld services contracts. It

has long been incorporated into most model forms

developed by independent associations, including

the AIPN and major industry players. The Standard

Approach arguably (i) simplies contract negotia-

tion, (ii) reduces litigation, (iii) facilitates contract

administration, (iv) allocates liability according to

nancial ability and reward, and (v) ultimately con-

tributes to cost savings. Typically, the parties to a

Standard Approach Wellsite Contract will purchase

insurance coverage for some of their assumed risks,

typically providing mutual waivers of subrogation

and third-party assured status.

IV. TRADITIONAL NOTIONS OF

LIABILITY (RESPONSABILITÉ)

UNDER CIVIL LAW

“Every right implies a responsibility; Every opportu-

nity, an obligation, Every possession, a duty.”

– John D. Rockefeller

Under civil law, the general rule for liability is that

any person, whether natural or legal, is liable (obliga-

tio) for breaching an obligation that causes damages

to another party (debitum). Thus, any damage

should be compensated, provided that the underly-

ing obligation is not unlawful.

In order to establish a duty to remedy damages, the

following elements must exist: (i) a duty of care, (ii) a

breach of such duty and (iii) the damages claimed

were caused by the breach.

The conduct that

3 MAYER BROWN | Look Before You Leap: Are Your Oil Patch Liability Clauses Enforceable? An Analysis Under Civil Law Jurisdictions

with Emphasis on Brazil

triggers the responsibility to remedy may be an act

or an omission. A fourth element, fault, may be

required depending on the particular matter pro-

tected at law (e.g., consumer relations and

environmental issues).

There are two sources of civil liability: (i) those

arising from the breach of an obligation established

by an agreement (i.e., contractual liability) and (ii)

those derived from the breach of an obligation

established by law (i.e., extra-contractual liability).

Regarding the contractual liability, the pacta sunt

servanda principle holds the parties true to the

contracted terms and conditions; thus, any breach of

contract is considered fault. In summary, contractual

liability arises from noncompliance with the terms

and conditions of an enforceable contract. Damages

may also lie for breach of ancillary obligations, such

as good faith.

Extra-contractual liability derives from the Roman

law lex aquilia, which established the ability to

“assign blame for unjustly caused damage, regard-

less of a pre-existing contractual relation between

the parties.”

In essence, extra-contractual liability

derives solely from operation of law without the

need for contractual privity.

However, in certain instances, such liability and the

corresponding right to seek damages are limited or

even excluded, such as: (i) enforcement of vested

rights; (ii) necessity; (iii) exclusive guilt of the victim;

(iv) third-party factor; (v) force majeure; (vi) limitation

of liability clauses and (vii) liquidated damages.

V. CHOOSING APPLICABLE LAW

AND MITIGATING THE EFFECTS

“Risk comes from not knowing what you’re doing.”

– Warren Buffett

There are three basic scenarios in which the laws of a

civil law jurisdiction might be applied to a Wellsite

Contract: (i) the operator is an NOC that insists on

applying domestic law, (ii) the operator is an

International Oil Company (“IOC”) headquartered in

a non-common law jurisdiction that prefers applying

laws of its home nation or those of the country where

operations will take place and (iii) the contractor

wishes to apply the laws of a non-common law

jurisdiction perhaps for “home turf” or enforceability

reasons. In scenario (i) and, to a lesser extent, sce-

nario (ii) the operator may also insist on “take it or

leave it” acceptance of its standard Wellsite Contract.

Each of the scenarios described in the preceding

paragraph requires customized legal and commercial

analysis based on the relevant circumstances.

Nonetheless, some or all of the following risk mitigat-

ing strategies may prove useful in a given situation.

1. LEGAL OPINION

An obvious rst step is to seek legal advice regarding

the enforceability of proposed K4K and other provi-

sions in the relevant Wellsite Contract. Ideally, chosen

counsel will be both well versed in the theory of

responsabilité and familiar with Wellsite Contracts. In

addition to reviewing any on-point case law and

jurisprudence, counsel should also consider analo-

gous legal or administrative rulings upholding other

types of clauses familiar to the petroleum industry but

alien to the jurisdiction in question.

2. LIABILITY LIMITS

If contractor’s counsel opines that K4K clauses would

not be enforceable in the relevant jurisdiction, the

inclusion of limitations on liability should be consid-

ered as an alternative. Rather than requiring one party

to indemnify the other party for the latter’s own

negligence, a limitation on liability simply relieves

such party against a certain type of liability or limits

its liability at a stipulated monetary amount. Through

clever drafting, liability caps may be able to create a

bottom-line nancial risk prole similar to one

achieved through K4K, without offending the fault-

based biases of the dispute resolver. Indeed, prior to

the recent inclusion of K4K provisions in its standard

drilling and charter party agreements, Petrobras

included elaborate limits of liability for certain catego-

ries of loss as a way of achieving a similar result.

3. ARBITRATION

If parties wish to include K4K provisions in a Wellsite

Contract notwithstanding enforceability concerns,

they are likely better off choosing arbitration, rather

than local courts, for dispute resolution. The reasons

include (i) presumed superior knowledge of the

petroleum industry (and appreciation of the

4 MAYER BROWN | Look Before You Leap: Are Your Oil Patch Liability Clauses Enforceable? An Analysis Under Civil Law Jurisdictions

with Emphasis on Brazil

compelling logic behind K4K clauses), (ii) indepen-

dence from political pressure (in the case of

state-owned litigants), (iii) the tendency of arbitrators

to focus on equity rather than legality, (iv) participa-

tion in the arbitrator selection process and (v) an

ability to craft instruction language empowering

arbitrators to interpret applicable law in the light of

international and industry norms and practices.

4. INSURANCE

Some portion of contractor’s liability risk may be

covered by insurance. Of course, insurance has a cost

that must be passed on to the operator or absorbed by

the contractor. Unfortunately, certain “catastrophic”

risks (loss of production, loss of reservoir, blow-out

cratering, etc.) are uninsurable or carry uncommercial

price tags. So, while insurance plays an important role

in liability risk allocation, it is not a panacea.

5. NEGOTIATIONS

In many instances, Wellsite Contracts are tendered by

NOCs on a strictly “take or leave it basis,” thus leaving

no room for negotiation, even in terms of drafting

“improvements” that demonstrably would help both

parties by enhancing clarity. Even IOCs at times

purport non-negotiability of their standard Wellsite

Contracts terms and conditions. In either case, the

Portuguese saying, quem não chora não mama (a baby

that doesn’t cry doesn’t nurse) holds true. If nothing

else, doing so highlights contractor concerns to the

NOC (or IOC) operator for future reference. More

importantly, it may later support an argument that a

disputed “non-negotiable” Wellsite Contract consti-

tutes an adhesion contract, thus bringing into question

the fairness or enforceability of its provisions.

6. JUST SAY NO!

In the nal analysis, a contractor’s assumption of

liability risk constitutes one of many costs (along with

labor, materials, nance, etc.) that should be consid-

ered when pricing rates for Wellsite Contracts. The

higher the risk, the higher the rates (at least in theory).

When faced with liability clauses so draconian as to

render the contract unprotable or literally expose the

contractor to extinction (e.g., assuming liability for

certain catastrophic losses), the contractor may well

be advised to walk away, if not run. Hopefully, in most

cases, logic and reason will prevail, and the contractor

can salvage the deal through effective implementa-

tion of the mitigation tactics outlined above.

VII. BRAZIL: AS ALWAYS, DANCING

TO ITS OWN BEAT

“Brazil is where I belong, the place that feels like

home. They love their family, their country and God,

and are not afraid to let anybody know it.”

– Dionne Warwick

K4K clauses are not common in contracts governed by

Brazilian law. As discussed in Section IV, the pervasive

standard of civil liability in Brazil is reected throughout

its jurisprudence and legislation, and a party to a

contract must compensate its counterparty for any

contract-related damages that the former causes the

latter through negligence

or contract breach.

Typically, awardable damages are limited to those that

are direct in nature,

which may include loss of prots.

As so, K4K clauses would be considered a precluded

limitation on liability under Brazilian law.

The enforceability of limitation of liability clauses in

Wellsite Contracts has not been extensively tested by

courts, and Brazilian law does not specically address

them. In one case, however, the Superior Court of

Justice

pronounced that limitation of liability clauses

are enforceable if (i) they are reasonable and propor-

tional to the anticipated damage and (ii) their inclusion

does not stem from unequal bargaining power. If this

were indeed the relevant and unyielding standard or

review, then criterion (i) would be problematical: in

K4K clauses, limits of liability are often intentionally

not proportional to the anticipated damage.

Criterion (ii) is less problematical, since oil and gas

transactions typically involve players with at least

reasonable, if not equal, bargaining power.

In addition, the Civil Code expressly allows liqui-

dated damage clauses (cláusulas penais), under

which the parties predetermine what damages will

be assessed to each, regardless of actual damages

suffered. To be enforceable, liquidated damages

should (i) not exceed the value of the “main obliga-

tion” in the contract and (ii) be the maximum

compensation due to the aggrieved party, even if

the actual damages incurred were higher.

5 MAYER BROWN | Look Before You Leap: Are Your Oil Patch Liability Clauses Enforceable? An Analysis Under Civil Law Jurisdictions

with Emphasis on Brazil

The willingness of Brazilian courts to wholeheartedly

embrace the full range of industry standard limitation

of liability clauses in an eventual high-prole case is

uncertain, especially where interests of state are

involved. Based on analogous oil patch cases, how-

ever, the prospects are promising. On balance, based

on court and administrative rulings and actions to

date, we believe the Brazilian courts, and, even more

so, arbitral tribunals, are more likely to uphold limita-

tion of liability clauses (particularly K4K clauses),

especially those that reect the clear commercial will

of the parties and were freely negotiated.

VIII. PETROBRAS ADOPTS K4K

“If you can’t beat them, join them.”

– Ancient proverb

Petrobras, Brazil’s semi-public NOC, has traditionally

not included K4K clauses in its Wellsite Contracts.

Instead, its standard contracts generally used mon-

etary liability limits (i.e., “caps”) to allocate liability

other than on a strictly fault-based basis. The result

was a standard Wellsite Contract that, while far from

exemplary, was obviously acceptable to contractors,

given their clear willingness to provide services at

competitive rates. After all, Brazil is too attractive of a

market, and Petrobras too large of a potential client,

for contractor to forego based merely on their law-

yers’ dislike of Petrobras standard form contracts.

Things appear to be changing. Petrobras recently

revised its standard drilling services and charter

party agreements so as to include a basic K4K

provision. Nonetheless, the specic wording in some

cases leaves room for improvement, though a

detailed review of the clause is beyond the scope of

this article. Until some of the kinks are worked out of

the K4K clauses and their interaction with other

clauses, Contactors might long for the “good old

days” when disproportionate allocations of liabilities

were achieved with basic, but easily understandable

and administered, liability caps.

IX. CONCLUSION

“An ounce of prevention is worth a pound of cure.”

– Benjamin Franklin

The international petroleum business involves high

risks and high rewards for investors. The true value

of the rewards can only be calculated by considering

the true cost of those risks. Generally, operators

have greater potential rewards than contractors, and

thus, over time, special risk allocation methodolo-

gies, including K4K clauses and liability limitations

(as well as insurance), have developed to reect that

fact. Without them, wellsite contractors, faced with

limited rewards and uncapped liabilities, would likely

either not execute contracts or be wiped out by one

false step. The typical K4K and other liability limiting

Wellsite Contract clauses have largely been devel-

oped in common law jurisdictions, drafted by

common law lawyers and interpreted by common

law judges. For a variety of reasons, many Wellsite

Contracts are governed by the laws of a civil law

jurisdiction. In such cases, the lawyers for each side

must engage in a three-prong review process

considering (i) the suitability of the wording of the

clause, regardless of jurisdictional questions; (ii)

enforceability of the clause in the proposed jurisdic-

tion; and (iii) possible strategies to mitigate issues

raised by applying common law concepts in a civil

law context. When properly conducted, such review

should result in either (i) a recommendation against

using a particular liability clause in the subject

jurisdiction (or in a particular forum); (ii) a suggestion

of a viable alternative jurisdiction or forum; or (iii)

conrmation of the suitability of the clause for the

jurisdiction (and forum) in question, perhaps with

modications. In any case, these issues merit serious

consideration (and negotiation), and those who face

them are well advised to “look before you leap!”

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Endnotes

This is a condensed version of the article of the same name originally published in The Journal of World Energy Law & Business (“JWELB”), Volume 14,

Issue 1, March 2021, Pages 49–66,https://doi.org/10.1093/jwelb/jwab004, and published here with the permission of the JWELB editor

Counsel, Mayer Brown. Adjunct Professor – University of Houston Law Center and Distinguished Resident Practitioner –Ohio State University Moritz

College of Law. https://www.mayerbrown.com/en/people/n/nadorff-norman?tab=overview

Associate, Tauil & Chequer Advogados in association with Mayer Brown. https://www.tauilchequer.com.br/en/people/g/

maria-beatriz-gomes?tab=overview

A Wellsite Contract is an agreement covering support services for petroleum operations, such as drilling, cementing, mud, wireline, workboats,

seismic and aviation.

See description at infra Robert Mead and Nicholas Neuberger, “Knock-for-knock indemnities: risk allocation in offshore oil and gas contract” (2019)

LexisNexis. https://bracewell.com/sites/default/les/news-les/Knock-for-Knock%20Indemnities%20–%20Risk%20Allocation%20in%20Offshore%20

Oil%20and%20Gas%20Contracts.pdf , accessed June 10, 2020.

United Kingdom of Great Britain and Northern Ireland has three separate and distinct legal systems: (i) Scotland; (ii) England and Wales; and (iii)

Northern Ireland. Indeed, the Scottish courts and the Scottish legal profession operate separately from the courts of England. Thus, it is prudent to

refer to the Laws of England and Wales.

Peter Roberts, Petroleum Contracts, English Law and Contracts, Second Edition, 2016. Paragraph 1.06 (p. 3).

Ibid, Paragraph 1.08.

Ibid, Paragraph 1.09.

From ON LIBERTY, retrieved January 7, 2021, from https://www.brainyquote.com/quotes/john_stuart_mill_109325 , accessed January 8, 2021.

Quoted at https://www.academicintegrity.org/responsibility/quotes-blog-5-responsibility/ , accessed January 8, 2021.

See Christophe Quezel-Ambrunaz, “Fault, Damage and the Equivalence Principle in French Law” (2012) 3:1 J of European Tort Law 21.

See Caio Mario da Silva Pereira, “Instituições de Direito Civil – Introdução ao Direito Civil: Teoria Geral do Direito Civil”, (2011) 24 ed., Vol. 1, Rio de

Janeiro: Editora Forense, p. 553.

In Brazil, the consumer and environmental law regimes generally apply strict liability, thus obviating the presence of fault.

Brazilian civil law establishes the principle that trust is an ancillary obligation of contracting parties. This principle derives from the requirement of

good faith dealing imposed on contracting parties by Article 422 of the Civil Code. Typically, contracts do not specically require parties to act in

good faith. But the failure by a party to do so may, by operation of Article 422 and general civil law principles, entitle the aggrieved party to damages

or even contract termination.

See Sílvio de Salvo Venosa “Direito Civil: responsabilidade civil” (2015), Vol. 4. 15th edition, São Paulo: Atlas. p. 21.

“The Three Essential Warren Buffett Quotes to Live By” by James Berman, www.forbes.com., April 20, 2014.

Dionne Warwick Quotes. (n.d.). Retrieved January 7, 2021, from: https://www.brainyquote.com/quotes/dionne_warwick_480628

Technically, culpa or dolo.

That is, damages that directly stem from the event (e.g., physical damage) rather than indirectly (e.g., loss of reputation).

See Special Appeal nº 1.076.465 – SP (2008/0160567-4), published on November 21, 2018.

Indeed, in K4K clauses, liabilities are allocated for convenience, avoidance of litigation, and ability to pay, but not on the basis of proportionality to

the anticipated damages

From, “On Protection of Towns from Fire, 4 February 1735,” printed in The Pennsylvania Gazette, February 4, 1734/5, accessed at https://founders.

archives.gov/documents/Franklin/01-02-02-0002 , January 8, 2021.