Knock-for-knock clauses may not always be what they seem

The contractual regulation of liability through knock-for-knock clauses has been an important feature of North Sea offshore contracts for many years. But a recent judgment by the Norwegian Court of Appeal demonstrates that the agreed liability regime does not always hold-up under legal examination.

Mechanics and overall purpose of knock-for-knock clauses

Njord platform A. Image from Statoil.

Knock-for-knock clauses are frequently used in the offshore and supply industries to regulate the liability of owners and charterers or contractors. Examples include clauses found in the standard form of contracts for offshore construction and subsea works as well as BIMCO's Supplytime, Windtime, Towcon and Towhire forms. Becoming an increasingly common feature throughout the offshore and supply industries, owners and operators should also be aware of the limitations in the application of knock-for-knock principles and the potential impact on the agreed distribution of risk and liability.

Knock-for-knock clauses normally stipulate that each party bears the risk of damage or injury to its own (group's) equipment, property, and personnel. They also establish that all parties are liable to named third-parties and/or for specific third party liabilities (including pollution), and that there will be no recourse between the parties in respect of such third-party liabilities.

Under a typical knock-for-knock clause, the parties agree to indemnify each other from any liability that in light of the agreed division of liability has been misdirected, in the process restoring the agreed division of liability.

Normally, the parties agree that the knock-for-knock principle should apply regardless of fault. For example, Clause 14 of Supplytime stipulates, "… even if such loss, damage, injury or death is caused wholly or partially by the act, neglect or default of the Charterers' Group [Owners' Group]"). In such cases, the knock-for-knock clause effectively operates as a mutual exclusion of liability clause. The knock-for-knock clause is also typically coupled with an exclusion of liability for indirect and/or consequential losses.

If the national courts make exceptions to the applicability of the knock-for-knock principle e.g. in situations where one party is at fault, the intended benefits of contractual certainty and conflict-avoidance are challenged, and the consequences may be far reaching.

Njord in my back yard

Njord B. Image from Statoil.

While the agreed liability regime in knock-for-knock clauses has been tested and found to hold water by the English courts in, among other cases, the "Mobius" and the "A Turtle" judgments, a recent decision by one of the Norwegian Courts of Appeal demonstrates that the Norwegian courts take a more restrictive approach to wide-ranging exclusion of liability clauses in situations where the party seeking to rely on the exclusion is at fault.

The judgment rendered by the Norwegian Court of Appeal in the "Njord B" case (LG-2012-77280) concerned, among other issues, the interpretation of a knock-for-knock clause in a contract of affreightment (CoA) for the offloading and transportation of crude oil from the Njord B field in the North Sea. Following a collision between the FSO "Njord B" and the shuttle tanker "Navion Hispania", the "Njord B" licensees claimed damages from the owners of the "Navion Hispania", who in turn sought an indemnity from the charterer under the CoA's knock-for-knock clause (the licensees were alleged to be part of the "Charterer's Group" as defined in the CoA).

The Court of Appeal held that the charterer was not liable to indemnify the "Navion Hispania" interests, primarily on the basis of an interpretation of the term "Charterer's Group" as defined in the CoA. The court also ruled that the "Navion Hispania" interests could not rely on the indemnity provision in the knock-for-knock clause as they were found to have acted with gross negligence.

The judgment should be of interest to anyone involved in contracts governed by Norwegian law where the parties have used or intend to use a knock-for-knock clause or another form of exclusion or limitation of liability.

The extent to which a contracting party may exclude liability for loss or damage arising out of its own fault has been a contentious point under Norwegian law for many years. It is settled law that a party cannot validly exclude liability for loss or damage caused with intent or willful misconduct. The contentious point has been to what extent and in what situations the parties may validly exclude liability for loss or damage arising as a result of gross negligence. There is no decisive Supreme Court judgement on this point, and legal scholars hold different views.

Within the Norwegian Continental Shelf offshore industry, Norwegian law is, to some extent, mandatory. It categorizes gross negligence as a distinct form of negligence, separate from - and in some respected treated differently to - ordinary negligence. Gross negligence has been described by the Norwegian Supreme Court as a "marked deviation from reasonable care" or "significant lack of due care", often coupled with the words "recklessness" or "reproachable behavior".

Understanding the implications of court interference on what the parties have agreed

The immediate consequences of the agreed liability regime being set aside are threefold:

1. A party may be held liable for damage or injury which is of a nature that, pursuant to the contract, should be borne by the other party;

2. The contractual limitations on liability in terms of absolute numbers or exclusion of indirect and consequential losses may be set aside; and

3. A party may not be entitled to the indemnities from the other party provided for in the contract.

In addition, it may distort the intended passing of liability in a chain of contracts on back-to-back terms if the agreed liability regime at one end of the contractual chain is set aside. Finally, any court interference in the parties' agreed liability regime may have unintended consequences for the parties' liability insurers and potentially also the parties' insurance cover.

The Court of Appeal judgement in the "Njord B" is the latest, but most probably not the final, word in this debate, and further clarification from the courts in this regard should be welcomed. In the meantime, consideration should be given to the drafting and review of such clauses to ensure that comprehensive exclusions or limitations of liability operate on a mutual basis and also exclude intent or willful misconduct, thereby reducing the risk of the courts interpreting the clause as a mere "boiler plate" provision incorporated without due consideration by the parties.

Henrik Hagberg is a partner at Wikborg, Rein & Co. DA Advokatfirma, Oslo, Norway