The modern offshore sector, be it oil and gas or renewables, is built on knock-for-knock agreements. They allow parties to operate expensive assets in close proximity to each other, in the most challenging conditions. They facilitate information sharing, avoid a proliferation of claims and legal disputes and ultimately reduce the operating costs of all parties, particularly their insurance costs. However, the principles once considered axiomatic are increasingly under threat from an unlikely source.
We have written in the past about the importance to Members of retaining knock-for-knock principles when engaging in offshore work. For years we have seen Members resist requests to contract on proposed contracts with negligence-based liability terms, or standard form Bimco contracts with the knock-for-knock clause removed. This has been largely successful, and the industry is all the healthier for it.
However, more recently we are seeing an increasing number of what are often labelled as ‘hybrid’ knock-for-knock agreements. On the face of it, these can sound like a suitable compromise; Members obtain a knock-for-knock agreement in broad terms, and the charterers get some of what they ask for. But, as always, the devil is in the detail. The reason these contracts are called hybrids is because the liability section is a blend of two arrangements. Firstly, there is a negligence or fault-based[i] layer, often from the ground up to US$ 1 million or US$ 2 million[ii]. Secondly, there is a layer above that consists of liabilities allocated on traditional knock-for-knock terms.
One might be forgiven for thinking that agreeing to such a scheme is not too consequential. After all, the reasonable scope of claims a typical OSV may be exposed to could be said to range from a few thousand dollars[iii], up to around US$ 100 million[iv]. From that perspective, an initial layer of liability which is limited to claims in the one or two-million-dollar band could seem like a mere percent or two of the overall contract risk.
However, if we consider the actual makeup of offshore claims, a different picture emerges. As you will see from the table below, the vast majority of offshore vessel claims would fall into the quantum bands such contracts seek to avoid the knock-for-knock regime applying to.
Therefore, agreeing to hybridise a knock-for-knock, so it only applies above US$ 1 million for example, is akin to disapplying it almost entirely. It would no longer be relevant in 99% of the typical claims expected.
Inevitably, in the longer term, this would mean higher chartering costs for customers. The increased costs of insurance, the incursion of deductibles in each claim and the added administration time of dealing with disputes will need to be factored into the vessel’s operating budget. No doubt ship owners will continue to therefore make the case for maintaining the true principles of knock-for-knock, and advocate for the benefits they deliver.
However, we understand that sometimes it can be commercially difficult to avoid such arrangements entirely. As a result, some of the key points that Members may wish to bear in mind if they are considering a hybrid knock-for-knock contracting proposal are as follows:
- Format of the initial layer: There are degrees to which the initial liability layer can be exempt from the general knock-for-knock arrangement. At the least onerous end of the spectrum, there may be a simple confirmation that the knock-for-knock does not apply between the parties below a set level. More onerous than this is an express agreement that Members will be liable in the event they or their group are negligent or ‘at fault’. In the most onerous scenarios, contracts can suggest the ship owners will be liable if any damage occurs to certain property during the term of the contract. This is effectively a strict liability, where Members can be held liable even where they have done nothing wrong, and the damage was beyond their control.[v]
- Reciprocity: Ideally, any agreement to disapply the knock-for-knock regime between the parties below a certain quantum level would apply to both sides equally. So, if a Member’s vessel was damaged by the negligence of the charterer and the claim was below the set level below which the knock-for-knock applied, they would not be blocked from claiming damages from the charterer. However, it is not uncommon to see an arrangement proposed where the knock-for-knock is only disapplied in one direction. This means that the ship owner is restricted from claiming from the ground up but does not receive the same protection in return.
- Application to non-property claims: A common reason given for hybrid knock-for-knock proposals, is that the charterers have a large deductible on their property insurance policies. Accordingly, their ideal contracting scenario is where any indemnity they give for damage to their property aligns with their insurance deductible for that property. This way, any claims for damage to their property will either be paid by the ship owner or by their insurers, with no responsibility remaining with the charterer themselves. Given this rationale, if a hybrid agreement is being considered, there is no reason why the whole knock-for-knock should be disapplied. Only the elements of it relating to property damage should be isolated and disapplied below the relevant level.
As always, the Club is here to support Members with cover that can be tailored to meet their individual contracting position, whether it is on standard knock-for-knock terms, a hybrid arrangement or otherwise. We can also assist with advice on cover during the contracting negotiation or tendering process and would invite Members to send us their contracts for review if they have any questions.
Alexander McCooke
Offshore Syndicate Claims Manager
Global Offshore Claims & Contract Specialist
[i] In very onerous versions, there may be some form of strict liability arrangement in the primary layer. See footnote v.
[ii] Although it can be much higher on some occasions. We have seen on occasion proposals for an initial layer of US$ 100 Million layer to be allocated on fault-based terms.
[iii] For minor illnesses or lower cost fender/equipment damage matters.
[iv] Such high figures are likely to arise in complex cases of wreck removal, platform damage or pollution. Of course, it is possible to have a very catastrophic claim that exceeds even this level. We have seen OSV operator Members incur claims in excess of US$ 100 Million occasionally, but such matters are thankfully extremely rare.
[v] Such strict liabilities generate exposures that are clearly in excess of those arising under general law and would accordingly require contractual liability cover.