Interview with Morgan, Lewis & Bockius

Written by: Fleming. Team

1. Which clauses in the drafting of EPC contracts have become commonly included in the last few years, specifically in the Oil and Gas sector?

The basic form of the construction contract has not changed drastically, but there has been much more attention paid to select areas in the last 5 to 10 years, partly because of changes in the law. Most notable are indemnity and insurance, and this is mostly due to states passing laws to limit the indemnity and/or insurance burdens that contractors have to bear in construction projects. Such laws are generally sought by contractor organizations. For example, in Texas and Louisiana, the jurisdictions that we deal with most often on construction projects on the Gulf coast, a series of legal changes of this sort have been adopted over the last five years. However, such laws are not unique to these two states.

There has also been evolution in the area of compensation and incentives on the contractor side. More grading schemes or incentive schemes which reward contractors for achieving key performance indicators are being used. This has been a definite evolution as well, especially in terms of the partnership aspects of the owner-contractor relationship.

Construction liability, incentive and cost control issues are getting more attention in the recent years, because we are in the middle of a construction boom in the US petrochemical and refining sector. These projects booming are the result of low oil, gas, and feedstock prices. There was little construction in the sector until about 5 years ago in the USA, due to perceived lack of cost competitiveness, but that has changed hugely. We are seeing a lot more attention paid to these issues, simply because we have more big projects than we used to.

2. After the incorporation of Anti-indemnification statute in Texas, do you think this trend to impose greater restrictions on the scope of indemnity will continue?

Certainly, there is going to be pressure from the contractor industry groups to adopt such statutes in jurisdictions where these laws have not yet been passed. It is not clear how much further the statutes will go in states like Texas, because they have already been adopted and are quite restrictive. Texas did adopt a further change regarding insurance this past legislative session, which takes effect in January 2016. It tries to ensure that contractors have full disclosure of insurance requirements before they sign the contract. However, I would call this a secondary-level change compared to the major change that was implemented back in 2012 with respect to indemnities and insurance generally.

3. How common is the inclusion of mutual indemnity in Oil and gas EPC contracts? Are there any sector-specific elements to the way mutual indemnity is incorporated in the contracts?

For us, the term “oil and gas” incorporates everything from upstream to downstream, and there are different anti-indemnity statutes to apply to each segment. For example, there are differences in indemnity limitations between oil well operations and plant construction.

On the plant construction side, the traditional approach for injuries and some extent of property damage is called “knock-for-knock”. Each party takes responsibility for its own people and property, regardless of whose fault causes the injury, death, or property damage. For quite some time, this used to include some level of contractor responsibility for damage to the owner's property. With the anti-indemnity statutes, pure knock-for-knock idemnities are not possible anymore in most cases. Instead, fault-based indemnities are required. For instance - I, the owner, cannot require the contractor to indemnify me for damage to its property, unless the damage is its fault. If I damage the contractor's property, I am going to be responsible and cannot make the contractor absorb that responsibility. This is a change from the traditional knock-for-knock approach.

Texas has included an exception in its statute for injury or death to employees. Knock-for-knock arrangements are still allowed for covering the owner's and contractor's employees, respectively. The reason is that in the state workers' compensation scheme, the employer is responsible when dealing with employee injuries. In these cases, each company can still keep responsibility for injury or death of its employees regardless the cause. There are always mutual indemnities, but the nature of them has changed.

4. Have there been any cases where a failure to include a strong indemnity clause endangered the whole project?

We have certainly seen non-compliant contracts, including forms given to us that did not comply. But in fact, there has been very little litigation related to these new indemnity statutes, precisely because they are very new. In Texas, they came into effect in 2012, and so, if a contract was signed after this time, the project was likely finished in the last year or two. There haven't been that many projects that have given the courts the opportunity to test some of the bounds of these statutes. Overall, indemnities themselves are not likely to kill a project, but unexpected indemnity interpretations can translate into unexpected liabilities for the contracting parties. The goal of the construction contract should be to allocate these liabilities clearly, so that everyone understands the risks they are taking and can insure them. If the contract does not comply with the statutes, and so the apparent indemnities in the contract do not work, a party could have an unpleasant surprise when it is unable to enforce the indemnity that it thought it had.