The Contract You Thought You Made: The Express Negligence Doctrine


You have negotiated a good deal with the "other side" and secured management approval to enter the deal. However, even though you may have included in meticulous detail various provisions that protect your company, there is the nagging issue of whether or not these clauses are enforceable under the laws of a particular jurisdiction. The drafter of any contract should pay close attention to the applicable or governing law that is agreed by the parties. The applicable or governing law will impact the drafting and enforceability of the provisions of the contract. While some problems can be remedied by careful drafting, other issues cannot be remedied under some jurisdictions no matter what you do, as such provisions can be held to violate the statutes, public policy, or common law of the particular jurisdiction. The purpose of this article is to explore some of these provisions, which are commonly found in international transactions that relate to petroleum projects.

INDEMNITY PROVISIONS MUST BE CLEAR AND UNAMBIGUOUS

Part I of this article will deal mainly with indemnity clauses under Texas law and whether a clause purporting to allow a party to be indemnified from the consequences of that party's own negligence is enforceable. Any "indemnity clause" is usually collateral to the main point of any contract. Indemnities are important because they set forth the way in which risks and liabilities will be shared between the parties, as related to the main point in the contract. Stated another way, an indemnity clause sets forth obligations of one person to secure or cover another person against an anticipated loss, damage, or liability. These clauses, in effect, shift risk from one party to another.

Indemnity provisions must be clear and unambiguous (not capable of two different interpretations or meanings). If an indemnity clause is capable of two different meanings, then it will be unenforceable as a matter of law. (See Transcontinental Gas Pipeline v. Texaco 35 S.W.3rd 658 (Tex. App. – Houston [1st District] 2000). When drafting an indemnity clause, you must be very careful to be as clear as possible and to "expressly" state the liabilities and damages that the parties intend to cover. You should avoid attempting to cover these issues by inference.

USING THE AIPN MODEL FORM JOA

This article will use the Model Form International Joint Operating Agreement published by the Association of International Petroleum Negotiators ("AIPN JOA") as a paradigm for the drafting of a well constructed indemnity clause that complies with the requirements of the Texas Express Negligence Doctrine. Article 4.6 (Operator Liability) of the AIPN JOA is drafted as follows:

ARTICLE 4.6 Limitation on Liability of Operator

(A) Except as set out in this Article 4.6, NEITHER THE PARTY DESIGNATED AS OPERATOR NOR ANY OTHER INDEMNITEE (AS DEFINED BELOW) SHALL BEAR (EXCEPT AS A PARTY TO THE EXTENT OF ITS PARTICIPATING INTEREST SHARE) ANY DAMAGE, LOSS, COST, EXPENSE OR LIABILITY RESULTING FROM PERFORMING (OR FAILING TO PERFORM) THE DUTIES AND FUNCTIONS OF THE OPERATOR, AND THE INDEMNITEES ARE HEREBY RELEASED FROM LIABILITY TO NON-OPERATORS FOR ANY AND ALL DAMAGES, LOSSES, COSTS, EXPENSES AND LIABILITIES ARISING OUT OF, INCIDENT TO OR RESULTING FROM SUCH PERFORMANCE OR FAILURE TO PERFORM, EVEN THOUGH CAUSED IN WHOLE OR IN PART BY A PRE-EXISTING DEFECT, THE NEGLIGENCE (WHETHER SOLE, JOINT OR CONCURRENT), GROSS NEGLIGENCE, STRICT LIABILITY OR OTHER LEGAL bFAULT OF OPERATOR (OR ANY SUCH INDEMNITEE).

(B) Except as set out in this Article 4.6, THE PARTIES SHALL IN PROPORTION TO THEIR PARTICIPATING INTERESTS DEFEND AND INDEMNIFY OPERATOR AND ITS AFFILIATES, AND THE OFFICERS AND DIRECTORS OF BOTH (COLLECTIVELY, THE "INDEMNITEES"), FROM ANY AND ALL DAMAGES, LOSSES, COSTS, EXPENSES (INCLUDING REASONABLE LEGAL COSTS, EXPENSES AND ATTORNEYS' FEES) AND LIABILITIES INCIDENT TO CLAIMS, DEMANDS OR CAUSES OF ACTION BROUGHT BY OR ON BEHALF OF ANY PERSON OR ENTITY, WHICH CLAIMS, DEMANDS OR CAUSES OF ACTION ARISE OUT OF, ARE INCIDENT TO OR RESULT FROM JOINT OPERATIONS, EVEN THOUGH CAUSED IN WHOLE OR IN PART BY A PRE-EXISTING DEFECT, THE NEGLIGENCE (WHETHER SOLE, JOINT OR CONCURRENT), GROSS NEGLIGENCE, STRICT LIABILITY OR OTHER LEGAL FAULT OF OPERATOR (OR ANY SUCH INDEMNITEE).

(C) Nothing in this Article 4.6 shall be deemed to relieve the Party designated as Operator from its Participating Interest share of any damage, loss, cost, expense or liability arising out of, incident to or resulting from Joint Operations.

Check if desired.
[ ] OPTIONAL PROVISION

(D) Notwithstanding Articles 4.6(A) and 4.6(B), if any Senior Supervisory Personnel of Operator or its Affiliates engage in Gross Negligence that proximately causes the Parties to incur damage, loss, cost, expense or liability for claims, demands or causes of action referred to in Articles 4.6(A) or 4.6(B), then, in addition to its Participating Interest share:

Check one Alternative.
[ ] ALTERNATIVE NO. 1 - No Limitation
Operator shall bear all such damages, losses, costs, expenses and liabilities.
[ ] ALTERNATIVE NO. 2 - Joint Property Limitation
Operator shall bear only the actual damage, loss, cost, expense and liability to repair, replace and/or remove Joint Property so damaged or lost, if any.
[ ] ALTERNATIVE NO. 3 - Financial Limitation

Operator shall bear only the first U.S. dollars _________________________ (U.S. $_______________________) of such damages, losses, costs, expenses and liabilities.
NOTWITHSTANDING THE FOREGOING, UNDER NO CIRCUMSTANCES SHALL ANY INDEMNITEE (EXCEPT AS A PARTY TO THE EXTENT OF ITS PARTICIPATING INTEREST) BEAR ANY DAMAGES, LOSS, COST, EXPENSE OR LIABILITY FOR ENVIRONMENTAL, CONSEQUENTIAL, PUNITIVE OR ANY OTHER SIMILAR INDIRECT DAMAGES OR LOSSES, INCLUDING BUT NOT LIMITED TO THOSE ARISING FROM BUSINESS INTERRUPTION, RESERVOIR OR FORMATION DAMAGE, INABILITY TO PRODUCE HYDROCARBONS, LOSS OF PROFITS, POLLUTION CONTROL AND ENVIRONMENTAL AMELIORATION OR REHABILITATION.

Your first thought might be that the conspicuous upper case type is used in error. The drafters of the AIPN JOA (1995 version), however, employed this form for a reason – in order to make it enforceable under Texas law (a common jurisdiction for energy contracts) and any other jurisdiction that adheres to the Express Negligence Doctrine and the associated requirements of conspicuousness. An examination of the Express Negligence Doctrine as it exists under Texas law will explain this apparent word processing aberration.

THE EXPRESS NEGLIGENCE DOCTRINE UNDER TEXAS LAW

In Article 18.1 of AIPN JOA, you should insert your choice of "applicable law" to govern the interpretation and construction of the contract. Let's assume that the parties agree to apply Texas law to govern the contract. Let's also assume that you "fixed" the apparent word processing error in 4.6 to make the entire article lower case and "non-conspicuous". Let's further assume that you deleted the apparently redundant words "....EVEN THOUGH CAUSED IN WHOLE OR IN PART BY A PRE-EXISTING DEFECT, THE NEGLIGENCE (WHETHER SOLE, JOINT OR CONCURRENT), GROSS NEGLIGENCE, STRICT LIABILITY OR OTHER LEGAL FAULT OF OPERATOR (OR ANY SUCH INDEMNITEE)" because you had already said above that the Indemnitees were not to bear any liability in connection with the duties and functions of the Operator. The words appear to be unnecessary.

In order to comply with the Express Negligence Doctrine in Texas and be indemnified for your own negligence, two elements must be present in the agreement for the clause to be enforceable. The first element is that the agreement must expressly (not merely by inference) state that an indemnitee is being indemnified for its own negligence. Simply stated, the first element of the rule provides that "parties seeking to indemnify the indemnitee from the consequences of its own negligence must express that intent in specific terms" within the contract. The second element is that such indemnity or release must be in conspicuous language that calls the reader's attention to the clause. These two elements make up the "fair notice" doctrine described later in this article.

The leading case on the subject in Texas is Ethyl Corporation, et al v. Daniel Construction Company 725 S.W.2d 705 (Tex. 1987). In this case, a Daniel Construction employee was working a construction site on Ethyl's premises. The injuries sustained by the Daniel Construction employee were proximately caused by the comparative negligence of Ethyl (90%) and Daniel (10%), but Ethyl sought to escape paying for these liabilities by asserting the indemnity clause under the construction contract with Daniel Construction and forcing Daniel to pay for these injuries. Ethyl's theory was that, but for the negligence of Daniel, the damages to the employee would not have occurred, even though Ethyl was in fact negligent itself. The indemnity clause reads,

"Contractor (Daniel) shall indemnify and hold Owner (Ethyl) harmless against any loss or damage to persons or property as a result of operations growing out of the performance of this contract and caused by the negligence or carelessness of Contractor."

There is no dispute that injuries were in fact partially caused by Daniel and that but for Daniel's negligence there would not have been any losses or damages. Ethyl argued that "any loss" and "as a result of operations" are clear and unambiguous. "Any loss" means exactly what it says and would necessarily include by inference losses from Ethyl's own negligence.

The Supreme Court stated that there had been a trend for a long time in Texas toward stricter construction of indemnity contracts. In prior cases the court had recognized that Texas had come as close as possible to adopting the express negligence doctrine without doing so. The court found that as Texas moved closer to the express negligence doctrine the drafters of indemnity provisions have been devising novel and innovative ways of disguising these provisions without expressly stating the true intent of these indemnity provisions. The intent of the drafter is to indemnify the indemnitee for its own negligence, yet be just vague enough to conceal the intent from the indemnitor. The result has been a flurry of lawsuits asking courts to construe vague or ambiguous contracts. The Texas Supreme Court now says that you must expressly state clearly and unequivocally (not merely by inference) that a party is being indemnified for its own negligence in order to make the clause enforceable.

In a later case, Dresser Industries, Inc. v. Page Petroleum, Inc. 853 S.W.2d 505 (Tex.1993), the Texas Supreme Court held that the express negligence doctrine applied to both indemnities and releases and that there was a fair notice requirement of conspicuousness where a party seeks to avoid liability for its own negligence in advance. In this case, Page drilled a well and contracted with Dresser to conduct log tests. The contract specified that Page would indemnify and hold Dresser harmless from all claims for subsurface damage or injury to the well, including damages caused by Dresser's negligence. During the testing of the well, a piece of Dresser's equipment got stuck in the hole.

Page then contracted with Houston Fishing to fish the Dresser equipment from the well. The contract between Page and Houston stated that Houston would not be liable to Page on any theory of legal liability (including the sole or concurrent negligence of Houston) for any injury or damage to property. While Houston was fishing for the lost Dresser equipment, it irretrievably lost several thousand feet of wire line and drill pipe down the hole. Page attempted a sidetrack, but was not successful. Page lost the hole and was forced to drill a new well.

Page sued both Houston and Dresser, who relied on their indemnities from Page as a defense. The Texas Supreme Court held that the fair notice requirements of conspicuousness apply to both indemnities and releases and that the contractual provisions were not in conspicuous type. The Court stated that whether these agreements or clauses are labeled indemnities, releases, exculpatory agreements or waivers, all operate to transfer risk. These particular agreements are used to allow a party to avoid the consequences of its own negligence. The court viewed this type of clause as an extraordinary shifting of risk and stated that it had consistently required a fair notice of this intent in these types of agreements. Fair notice has two elements – (1) expressly relieving the indemnitee from the consequences of its own negligence and (2) a "conspicuousness requirement". Both elements must be present in order for the indemnity provision to be enforceable. The first element is satisfied by language as is found in the AIPN JOA..." ...EVEN THOUGH CAUSED IN WHOLE OR IN PART BY A PRE-EXISTING DEFECT, THE NEGLIGENCE (WHETHER SOLE, JOINT OR CONCURRENT), GROSS NEGLIGENCE, STRICT LIABILITY OR OTHER LEGAL FAULT OF OPERATOR (OR ANY SUCH INDEMNITEE)". The second element (conspicuousness) can be satisfied by typing the provision in larger than normal type, or in a different color or bolded, or in all capital letters, or by contrasting it in some distinguishing manner with the other type in the contract. A term or clause is "conspicuous" when it is so written that a reasonable person ought to have noticed it. Likewise, the Court stated the conspicuousness test as, "When a reasonable person against whom a clause is to operate ought to have noticed it, the clause is conspicuous." Since the indemnity and release provisions were not conspicuous, the Court held them to be unenforceable.

WHAT IS THE TREND OF EXPRESS NEGLIGENCE APPLICATION?

It should be noted at this point that the application of the express negligence doctrine in Texas has been expanded past indemnifying persons against their own negligence to other risks including strict statutory liability in FELA claims and strict products liability claims. The trend appears to be to continue expansion of the express negligence doctrine. However, one limitation on this expansion was stated in Transcontinental Gas Pipeline v. Texaco 35 S.W.3rd 658 (Tex. App. – Houston [1st District] 2000). In that case, Transco argued that the trend was for the courts to continue expansion of the express negligence doctrine to cover a widening array of liabilities. Transco argued that the express negligence doctrine should be extended to cover breaches of contract and for indemnification for past acts and not future acts. The Court declined to expand the express negligence doctrine into these areas and held that the rule only applies to future acts of negligence and not past acts, because past acts should be known to the parties. Likewise, the rule will not be applied to a breach of contract because it is not extraordinary or unjust to shift the risk of economic damages (resulting from a breach of contract) where the parties are experienced contractors and familiar with industry customs regarding risk shifting.

DO THESE REQUIREMENTS APPLY TO ALL AGREEMENTS?

One exception to this "conspicuousness requirement" is that if the language is in an extremely short document, then it could be considered conspicuous, even if it is in the normal type of the document, provided that the indemnitor could prove that the indemnitee had actual knowledge of the contents of the indemnity provision. The court in the Page and Dresser case did not elaborate on how short a document must be to constitute an extremely short document, but did give the example of a telegram being an extremely short document.

In Coastal Transport Company v. Crown Central Petroleum Corporation, et al, 20 S.W.3rd 119 (Tex. App. – Houston [14th District] 2000), the court of civil appeals did give us a better idea of what might constitute an extremely short document. Crown, a refiner and marketer of petroleum products, owned and operated a loading terminal. Coastal operated a trucking company loading at and transporting from the Crown terminal. In 1993, a Coastal employee was loading gasoline into a trailer truck at the Crown facility when the gasoline overflowed and caught fire. The evidence showed that Crown's facilities used under the contract were to blame for at least some of the damages resulting from the fire. Coastal was to indemnify Crown for all damages, including damages from Crown's own negligence.

The indemnity provision did comply with one element of the fair notice requirements (it expressly said that Crown would not be responsible for its own negligence), but did not so state the extraordinary shift of these risks in conspicuous language. Nevertheless, Crown contended that the second element of the fair notice doctrine is not applicable in that case because Crown could prove that Coastal had actual knowledge of the indemnity provision. Coastal stipulated at the trial that the President of Coastal (who signed the agreement) had read the agreement prior to signing it. Coastal defended by saying that there was no evidence that the President of Coastal had actually noticed the clause and its contents. Crown countered by asserting that the agreement was less than 2.5 pages in length, that the indemnity clause was by far the longest clause in the short document and that it was cross-referenced in other clauses of the short agreement. If the President of Coastal had read the document as was stipulated, then he must have been aware of the indemnity clause and the extraordinary shifting of the risk. The court agreed with Crown and held that where the agreement is 2.5 pages long and the indemnitor admits to having read the document he signed, then the indemnitor has actual knowledge of the indemnity clause and the requirement that the indemnity language be conspicuous will not be required. The reason for dropping the conspicuousness requirement in this case appears to be because Crown was able to prove that Coastal had actual knowledge of the indemnity provision.

THE TEXAS ANTI-INDEMNEITY ACT

Coastal made another attempt to declare the indemnity provision void by invoking the Texas Anti-Indemnity Act (see Texas Civil Practice and Remedy Code Annotated Section 127.001 et sequel). This law makes void and unenforceable any provision in an agreement for services to be performed pertaining to a well for oil, gas, or water or to any mineral mine if the clause purports to indemnify a person against damages caused by his own negligence. Unfortunately for Coastal, the Texas Anti-Indemnity Act only applies to agreements pertaining to the rendering of services to such wells or mineral mines. The court once again held against Coastal in finding that the agreement in question applied to loading and transporting gasoline and was not an agreement for services related to a well or mineral mine. The point is that if your contract does apply to services dealing with wells or a mineral mine, then even if you comply with the fair notice doctrine and the express negligence doctrine, the clause in which you attempt to be relieved from the effects of your own negligence still will not be enforceable due to the Texas Anti-Indemnity Act. It should be noted that the Texas Anti-Indemnity Act does not apply to pipelines, fixed facilities, purchasing, gathering, selling, or transporting of production, JOAs, or confidentiality agreements, since all are not agreements for services to be performed on a well or mineral mine.

DOES THE AIPN JOA ENTIRELY COMPLY WITH THE EXPRESS NEGLIGENCE DOCTRINE?

In many ways the AIPN JOA should be taken as a paradigm of the way in which you should draft your contracts to comply with the express negligence doctrine. There is one improvement that can be made in the last paragraph of Article 4.6. The last paragraph in Article 4.6 purports to supercede the other terms of 4.6 and states that no party will be liable for consequential or punitive damages. The type is in all capital letters, so it complies with the "conspicuousness requirement". The one element that this last paragraph of Article 4.6 does not have is a statement expressly shifting the extraordinary risk of releasing a party for the effects of its own negligence. As you will recall, the express negligence doctrine applies to releases as well as indemnities. This last paragraph purports to release all parties from punitive and consequential damages. Therefore, the paragraph should not only be in conspicuous type, but it should also contain a statement saying "....EVEN THOUGH CAUSED IN WHOLE OR IN PART BY A PRE-EXISTING DEFECT, THE NEGLIGENCE (WHETHER SOLE, JOINT OR CONCURRENT), GROSS NEGLIGENCE, STRICT LIABILITY OR OTHER LEGAL FAULT OF ANY SUCH INDEMNITEE".

Conclusion

Thus, if a party is to be relieved of the effects of its own negligence in Texas, the other party must be given fair notice of this extraordinary shift in risk. Fair notice has 2 elements – (1) a clause expressly relieving the indemnitee from the consequences of its own negligence and (2) a "conspicuousness requirement".

There are no magic words to use to comply with the express negligence doctrine in Texas, but it would seem clear that the AIPN JOA would be a good example to follow where it states, "....EVEN THOUGH CAUSED IN WHOLE OR IN PART BY A PRE-EXISTING DEFECT, THE NEGLIGENCE (WHETHER SOLE, JOINT OR CONCURRENT), GROSS NEGLIGENCE, STRICT LIABILITY OR OTHER LEGAL FAULT OF OPERATOR (OR ANY SUCH INDEMNITEE)".

In one additional item to consider, the AIPN Model Form Confidentiality Agreement uses language in clause 7 that is similar to the JOA language in Article 4.6 where it states:

Neither Party shall be liable in an action initiated by one against the other for special, indirect or consequential damages resulting from or arising out of this Agreement, including, without limitation, loss of profit or business interruptions, however same may be caused.

Assuming that Texas law is agreed as the applicable law, it would be a good idea to modify this language in the AIPN Confidentiality to comply with the express negligence doctrine as outlined above. This language should be in conspicuous type and contain additional language expressly releasing the parties from the effects of their own negligence.

Some people could argue that no change is needed to the AIPN Model Form Confidentiality Agreement since it is a short document and the Coastal Transport Company v. Crown Central Petroleum Corporation, et al should be relied on to make the provision enforceable as written. This argument, while innovative and laudable for those existing agreements, can fail because generally the AIPN Model Form Confidentiality Agreement is longer than 2.5 pages (it is at least six pages long including the exhibit) and the release language is buried at the end of clause 7. The release is not a dominant part of the agreement and nothing readily or easily calls your attention to that language. Besides all of these facts, there is no language expressly releasing a party from the effects of his own negligence and you cannot rely on getting a stipulation that the signer actually read the document, as Coastal did in that case.