Oil & Gas / Shipping – Black Holes and Revelations

In Dr Jones Yeovil Ltd v The Stepping Stone Group Ltd [2020] EWHC 2308 (TCC), the Technology and Construction Court has raised the spectre of oil and gas companies not being able to recover full damages from contractors or suppliers for defective performance under construction, procurement or supply chain contracts due to a “black hole”. The risk arises from “boiler plate” third party wording. Although many contractual arrangements in the oil and gas industry will already negate this risk, it is critical that parties are alive to the issue identified by the court.

Legal “black hole”

A legal “black hole” is said to arise when one party to a contract is unable to claim full damages in relation to a breach of the contract because the loss is incurred by a third party. An example might be a defect in the work under a field development (EPC) or ship construction contract where the Company or Employer engaging the Contractor is not the Owner of the facilities or vessel arising from that work. There is also potential for issues to arise in procurement contracts entered into by an operator under joint operating agreements.

The principle of “transferred loss” has traditionally allowed one party to claim losses of more than itself in the event of breach. It was developed to overcome black holes.

In Dr Jones Yeovil Ltd v The Stepping Stone Group Ltd, the issue arose as to whether the principle of transferred loss would apply where parties have included wording in their contract disclaiming any intention to confer rights on third parties. Such wording is commonly included as boilerplate language in standard form oil & gas and shipping contracts.

Facts

An Employer engaged a Contractor to build and refurbish assisted living units for elderly residents. The Employer’s subsidiary owned the property. The property was placed by the subsidiary on three separate long leases to third parties.

The Employer alleged defects in the Work, as the Contractor had installed off-spec, inefficient heat pumps. The Employer claimed for the resultant increase in electricity usage costs.

The Contractor claimed that the Employer had not itself suffered any increased electricity costs, as it was neither the owner nor the occupier of the property; the electricity costs were suffered by the leaseholders.

The Employer sought to rely on the principle of “transferred loss” – arguing that the development was ultimately for the benefit of the leaseholders, which was known and agreed to by the Contractor. In other words, its interest as Employer under the contract enabled it to recoup the losses suffered by the leaseholders.

The Contract was based on a standard JCT contract. The standard third party rights clause read:

“…nothing in this Contract confers or is intended to confer any right to enforce any of its terms on any person who is not a party to it.” There were carve outs for third party rights specified in the Contract in favour of purchasers, tenants or funders – not “leaseholders”.

In evidence, the Employer stated that there was a deliberate decision not to confer on the leaseholders third party rights or the benefit of collateral warranties so as to avoid them being left to bring their own claims against the Contractor. The Employer’s view was that it was following “housing association practice” in this regard.

Transferred Loss and Third Party Rights

HH Judge Russen QC reviewed the authorities on the principle of transferred loss.

The reasoning underpinning the principle of transferred loss was the need to avoid an unacceptable “legal black hole” where a contract-breaker escapes financial accountability because its contractual counterparty cannot be shown to have suffered the relevant loss. As the key to avoiding such a consequence lies in establishing that the parties to the contract knew that one or more third parties were to benefit from its proper performance (and would likely suffer the resulting loss if there was a breach) it is also clear that the principle touches upon some elementary principles relating to privity of contract and the recognition of separate legal personalities.

These considerations include the potential significance of the Contracts (Rights of Third Parties) Act 1999. The court will not recognise the existence of a black hole (as between the contract-breaker and its counterparty) if the third party who benefits from contractual performance has its own, separate right of redress or where a company contracts for the benefit of an associated company but does not tell the other party (the contract-breaker) that it is doing so.

As the principle of transferred loss is an exception to a fundamental principle of the law of obligations, it is driven by legal necessity. The fundamental implications of recognising the distinct legal personality of a company indicates that those who decide to contract through a chosen corporate entity may face difficulties in making out such necessity if the black hole can be said to be of their own making.

Decision

The black hole was upheld. There was no room for the operation of the principle of transferred loss in the face of the third party rights clause under the Contract.

The carve outs to the general exclusion of third party rights in the Contract were in favour of specified, named or identified third parties (in this case purchasers, tenants or funders). However, no such rights had been specified for leaseholders, pursuant to what the Employer had said to be “housing association practice” not to leave leaseholders to bring their own claims against the Contractor.

The Judge said that the third party rights provisions:

“were express contractual provisions amounting to a positive disclaimer of the suggested third party benefit. To put it another way, they constituted a contractual agreement as to the factual position which is sufficient to support a contractual estoppel against the existence of knowledge of any such benefit…the principle of transferred loss is an exception to the law of obligations. When the parties to the contract have specifically addressed the lack of third party entitlement, and curtailed obligations accordingly, I can see no proper basis for overriding their agreement”.

Comment

To shoehorn in lyrics from Muse’s delightful single, “Starlight”, the Employer in this case may have had “hopes and expectations” of its ability to claim the losses but it was met with “black holes and revelations”. And what revelations they are: boilerplate third party rights provisions can oust any opportunity for the principle of transferred loss to be applied, even if the intention – at least of one party – was for third parties to benefit. As ever: it depends what the contract says.

Since the enactment of the Contracts (Rights of Third Parties) Act 1999, clauses disclaiming any intention to benefit third parties have become commonplace. The court’s finding that such boilerplate provisions will prevent the principle of transferred loss from applying is therefore significant.

However, as many practitioners will know, many standard forms in the oil & gas and shipping industries will expressly provide for certain third party rights to be enforceable so as to avoid the black hold identified by the court.

For example:

LOGIC Decommissioning:

Clause 37.1: “Subject to Clause 37.3, the PARTIES intend that no provision of the CONTRACT shall, by virtue of the Contracts (Rights of Third Parties) Act 1999…confer any benefit on, nor be enforceable by any person who is not a PARTY to the CONTRACT.”

Clause 37.3: “[the provisions of the indemnity regime] are intended to be enforceable by a Third Party”. “Third Party” includes, among others, the affiliates and contractors of the parties.

However, such third party rights are generally limited to the indemnities – it would not cover losses arising from a breach of a contract to which the third party is – by definition – not party.

In respect of oil & gas assets, commonly held in joint ownership, the joint venture arrangements side-step the third party rights / transferred loss issue entirely by introducing agency principles into procurement arrangements with contractors – in other words the parties suffering loss (the field / concession owners) are in fact party to the contract.

For example:

Clause 6.5.8 of OGUK JOA:

“[Operator] shall use reasonable endeavours to include in all contracts made pursuant to this Agreement, a provision which ensures that the Operator makes the contract on behalf of all the Participants…” and the provision to be included in such contracts reads in material part: “…the COMPANY and only the COMPANY is entitled to enforce the CONTRACT on behalf of all CO-VENTURERS as well as for itself. For that purpose the COMPANY shall commence proceedings in its own name to enforce all obligations and liabilities of the CONTRACTOR and to make any claim which any CO-VENTURER may have against the CONTRACTOR.”

Article 4.3.18 of the AIPN JOA:

“Operator shall…[i]nclude in its contracts with independent contractors and to the extent practical and lawful, provisions that …permit Operator, on behalf of the Parties, to enforce contractual warranties and indemnities against such contractors and their sub-contractors, and to recover from such contractors and sub-contractors losses and damages suffered by the Parties that are recoverable under their contracts.”

In the shipping industry, BIMCO mainly approaches the issue through “Himalaya clauses” with a broad agency mechanism entitling identified third parties to have rights under the charter party. For example, Clause 14(d) of BIMCO SUPPLYTIME 2017:

“Himalaya clause – All exceptions, exemptions, defences, immunities, limitations of liability, indemnities, privileges and conditions granted or provided by this Charter Party or by any applicable statute, rule or regulation for the benefit of the Charterers shall also apply to and be for the benefit of the Charterers’ Group and their respective underwriters.

All exceptions, exemptions, defences, immunities, limitations of liability, indemnities, privileges and conditions granted or provided by this Charter Party or by any applicable statute, rule or regulation for the benefit of the Owners shall also apply to and be for the benefit of the Owners’ Group and their respective underwriters; the Vessel and its registered owners; and the Crew.

The Owners or the Charterers shall be deemed to be acting as agent or trustee of and for the benefit of all such persons and parties set forth above, but only for the limited purpose of contracting for the extension of such benefits to such persons and parties.”

Procurement contracts in the oil & gas industry, or charters in the shipping industry, that do not include these standard carve outs to the boilerplate exclusion of third party rights will have the effect of displacing the principle of transferred loss, such that a party to a contract cannot claim losses on behalf of third parties.

An example commonly encountered in the oil & gas industry (including a number of operators’ standard contracts) concerns contracts where the Operator is not acting as agent for the joint venture in contracting with the supply chain and there is not a specific clause allowing it to claim co-venturers losses in the supply chain contract. This could leave the Operator in the invidious position of not being able to claim losses caused to its co-venturers by a contractor under a procurement contract and, at the same time, potentially facing claims from the co-venturers that it is in breach of the JVA/JOA obligation to ensure that the supply chain contract permits co-venturers to have rights under the contract.

The potential exclusion of the “transferred loss” principle through boilerplate third party language makes it more important than ever that the usual precautions are put in place. Parties should therefore give careful thought to the contractual structures agreed for a given project or development and ensure that black holes are avoided through the use of appropriately worded development agreements.

Dr Jones Yeovil Ltd v The Stepping Stone Group Ltd [2020] EWHC 2308 (TCC).

For further analysis of the case, particularly in the context of the construction industry, please see our Law-Now: Black Holes and Construction Disputes: New Cause for Concern?