Oil & Gas: Breakdown and Spread – issues not just for Christmas

The High Court recently sought to answer two burning questions regularly raised in the context of drilling unit contracts, in deciding that: (1) the rate applicable during periods of breakdown was not payable when the breakdown occurred due to a breach of contract by Contractor; and (2) a consequential loss clause, similar to the form found in many equivalent agreements, did not exclude Company’s right to claim its “spread costs” against Contractor during periods of Contractor default.

Although drilling unit contracts will vary in wording, the reasoning of the High Court sets important benchmarks/guidelines for those drafting or negotiating drilling unit contracts.

Facts

The Claimant / Contractor (“Transocean”) provided the rig GSF Arctic III (“the Rig”) to the Defendant / Company (“Providence”) pursuant to a drilling contract dated 15 April 2011 (“the Contract”). The Rig was a six-leg semi-submersible drilling unit built in 1984. The dispute related to the financial consequences of delays which occurred to the drilling of an appraisal well in the Barryroe Field off the south coast of Ireland between November 2011 and March 2012.

The delays occurred following problems with the Blow Out Preventer (BOP) stack, between 18 December 2011, when operations were first interrupted as a result of BOP misalignment problems, and 2 February 2012 when the Rig was in a position to resume operations. This period was described by the parties as “the Disputed Period”.

Transocean claimed remuneration of US$13,035,083.97 and £3,516,758.45 in accordance with the rates provided for in the Contract together with reimbursables. Only a minority of this amount arose in respect of the Disputed Period.

Providence contended that (1) in respect of the remuneration claim for the Disputed Period, it was not liable for periods of delay caused by breaches of contract by Transocean and (2) in respect of most of the balance of the remuneration claim, it was entitled to set off its counterclaim, which is for wasted costs comprising “spread costs” (costs of personnel, equipment and services contracted from third parties, which it says were wasted as a result of the delay).

The Contract

The Contract included the following day rates: Daily Operating Rate of US$250,000, Standby Rate of US$245,000, Fishing Rate of US$245,000, Redrill Rate of US$225,000, Repair Rate of US$245,000, Force Majeure Rate of US$225,000 and Waiting for Weather Rate of US$245,000. The Repair Rate was expressed to apply as follows:

“Except as otherwise provided, the Repair Rate will apply in the event of any failure of [Transocean's] equipment (including without limitation, non-routine inspection, repair and replacement which results in shutdown of operations under this CONTRACT including the time up to recommencement of [Providence's] operations at the same point (including any trip time, eg "drill to drill") as when the failure occurred excluding any period when the failure has been remedied but operations cannot proceed due to adverse weather or sea conditions, or while waiting on [Providence's] instructions, materials or services or any period of time when the failure or repair has been caused due to an act or omission of any member of COMPANY GROUP or a Force Majeure Event…”

The Contract also contained a broad exclusion of “Consequential Loss” that was defined to mean:

“(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 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 (which for the avoidance of doubt shall not include payments due to [Transocean] by way of remuneration under this CONTRACT), 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”

In respect of rates to be paid during the Disputed Period, Transocean argued that the rates listed in the Contract were a complete code (exclusive list of rates for all events) and, in accordance with the “knock for knock” provisions common in the industry, were to be applied regardless of fault. In fact, some rates, such as the Redrill Rate and Fishing Rate gave a clear indication that rates applied even if Transocean were negligent.

In relation to “spread costs”, Transocean argued that the spread costs claimed were “loss of use” for the purposes of the second limb of the Consequential Loss definition and recovery was therefore excluded.

Decision

The Court disagreed with Transocean on both points of contractual construction.

In relation to the rate due during the period of breakdown, the Court reasoned:

• The starting point was the well-known line of authorities that, absent clear language, a clause will not be construed as enabling a party to take advantage of its own breach.
• The principles applicable to interpreting rig contracts were the same as any other contract for goods/services, and it did not assist Transocean to argue that such contracts are generally “knock-for-knock”.
• In framing the remuneration provisions as being in return for Work, rather than reference to a particular period of time, it was indicative that any right to abatement for failure to perform Work would be preserved.
• There was express provision for Transocean to exercise care. It was inherently unlikely Providence intended to make payment if Transocean was in breach of such provision.
• If Transocean were correct, it would be entitled to payment for periods where delays were caused by its own deliberate breach – which indicates that the interpretation was not correct.
• It followed that, in the absence of express induction to the contrary, the Repair Rate (or any other rate) was not due if the breakdown was for Contractor fault.
• The Court also considered that the law of abatement may be relevant in these circumstances, where the value of performance was diminished by breach.

In relation to “spread costs” the parties agreed that:

• “consequential loss” (undefined) meant the second limb of Hadley v Baxendale.
• “Spread costs” fell within the first limb of Hadley v Baxendale i.e. direct losses.
• The question was therefore whether the additional words in the second limb of the Consequential

Loss definition for “loss of use” etc excluded direct “spread costs”.

The Court decided that the additional words used did not exclude “spread costs”. The words “loss of use” meant loss of benefit/profit from the equipment or property under contract. In this respect the Court reiterated that exclusion clauses should be interpreted contra preferentem. The burden was on Transocean to establish that the words showed a clear intention of the parties to deprive Providence of a remedy to which it was otherwise entitled. Transocean did not discharge such burden.

Implications

It remains open to the parties to agree an alternative allocation of risk and loss in a drilling unit contract to that in this case. However, the clear implication of the Court’s decisions is that, absent express words, the English Courts will be slow to find that: (i) a contractor is entitled to payment of a breakdown rate when the breakdown is due to a contractual breach by the contractor; and (ii) a broad, unspecific, “consequential loss” clause will be unlikely to exclude a company’s right to claim its “spread costs” in the event of delay due to its contractor’s breach / default.

Although drilling unit contracts will vary in wording, the reasoning of the High Court sets important benchmarks/guidelines for those drafting or negotiating such contracts. In the context of drilling units subject to external finance, with the daily rate being relied upon to pay down debt, the wording of the drilling unit contract concerning breakdown rates and the exclusion for claims for “spread costs” could have particularly important implications for the finance parties as well as the contractor.

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