Contracting tips: Group definitions and third party risk

In this article, Oleksandra Leginevych looks at the importance of the definitions section of a contract and particularly how the party Groups are defined, and how this effects third party risk in the context of both mutual and commercial covers.

During long and difficult negotiations, contracting parties may overlook the definitions section of the contract. However, from an indemnities perspective, this is an extremely important part as subtle variations of "Charterer Group" and "Owner Group" can have a significant effect on both the allocation of liabilities and insurance cover. Group definitions(1)

Offshore services typically have numerous parties involved, all operating under separate contracts. This, in part, has influenced the development of the knock-for-knock indemnity regime which deals with liability issues in a practical way. Under true KFK contracting, each party in the field is responsible for their own property and personnel, regardless of any fault or negligence of any other party. This is arranged contractually and can be done either by all parties signing up to a specific mutual hold harmless agreement or, more simply, by incorporating Group definitions into the contract, extending the indemnity regime to each party's contractual or corporate connections.

If the second option is chosen, it is important to ensure that the Group definitions are drafted sufficiently broadly to ensure that all parties which should fall under the Group umbrella do. An ideal Group definition should include, in addition to the Party itself, its affiliates, contractors (of any tier), employees, invitees and, if relevant, customers and co-ventures. If any of those parties fall outside the Group definition, they will be Third Parties for the purpose of the indemnity regime and thus a potential liability exposure for the assured.

In practice, we see that the Charterers frequently use their stronger bargaining position to exclude from Charterer Group some of the parties which should be included therein. This reflects a recent trend for Charterers to try to minimise their contractual liability exposure. Doing so, however, may simply end up being a false economy as additional costs may be passed to them by Owners in other ways.

A Third Party liability regime is not always expressly outlined in operational contracts. When it is not contractually apportioned, it will be decided at law which, generally speaking, will be on a "fault" basis. Where it is agreed in advance, ideally it should also be on a fault basis. However, with increasing regularity those further up the contractual chain seek to pass additional risk downward, altering the liability exposure.

Unfortunately, more and more frequently we see contracts which make the owner liable to the charterer for an initial layer of third party liability and, in some contracts, all third party liability is passed to the Owner on a strict liability basis. This is a significant liability exposure for the Owner, even when the Groups are ideally defined, but if there are more Third Parties than there ideally should be due to narrow Charterer and Owner definitions, the additional third party liability exposure is even more significant.

When looking at Third Party risks in the context of offshore P&I insurance, it is important to understand the distinction between "proximate" third parties and "true" third parties. "True" Third Parties are those which have no connection with the contract at hand, such as fishing vessels operating close to the field or owners of harbours where a vessel is berthed to receive supplies. "Proximate" Third Parties, on the other hand, are those which ought to be covered under a Group definition but which, for commercial reasons, fall outside that, such as the Charterer's other contractors, or their customer, or property in the field.

Generally speaking, "true" third party risk will be picked up under offshore P&I insurance in the way that it would be under P&I insurance for more traditional shipping operations. However, as oil and gas service contracts have a tradition of incorporating a KFK liability regime, liabilities arising from incidents involving "proximate" third parties should be dealt with under that and not as "true" and out of contract third party risks.

As a key service offering to our assureds, Skuld Offshore will assist with peer review of operational contracts. This review is designed to highlight issues such as how the contractual parties are defined and the effect that this has on the liabilities faced and the insurance cover in place. However, we are conscious of the commercial realities, and that it may not be possible to amend the definitions of the contract so as to have a balanced and reciprocal indemnity regime, particularly in respect of third party claims.

With input and support from Skuld Offshore, the assured can make a qualified assessment of their risk exposure and decide on what risks are commercially acceptable and which risks they want to transfer to Skuld for balance sheet protection. To the extent that P&I cover will not respond, Skuld may offer additional cover by way of Extended Contractual Liability (ECL) cover, which can be tailored to contractual risks.