Understanding Contractors’ Real Exposure Potential Under a Contractual Knock-for-Knock Indemnity Provision

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Analysis

Shale drilling is a lucrative, but risky business for land and rights owners, drilling companies, and all other companies that share responsibility for on-site operations. When great risks are present, complicated risk-shifting schemes develop to allow the players with the most bargaining power to pass risk on to others—particularly, contractors.

As this sector of the oil and gas industry continues its expansion in Pennsylvania and West Virginia, contractual indemnity language, commonly referred to as “knock-for-knock” indemnity, is likewise increasing. These contractual provisions are being invoked for injuries sustained at well sites and other damages, including catastrophic losses.

Knock-for-knock indemnity is a reciprocal or mutual indemnity where each party agrees to defend and indemnify the other party for injuries sustained to their own employees, regardless of fault. In some instances, the indemnification language extends to injuries sustained by a party’s own subcontractors at a particular site. There can be similar indemnity agreements concerning damage to equipment or property. Most, if not all, agreements also contain provisions regarding the purchase of certain types and amounts of insurance coverage for these types of damages.

As a result of the knock-for-knock indemnity language, some contractors are responsible for the entire claim made by their own employees even though they may bear no responsibility for its cause. States, including Louisiana, New Mexico and Texas, where this sector of the energy industry has had an historical presence, have enacted statutory limits to such clauses in oil and gas development contracts.

The Pennsylvania and West Virginia regions have yet to adopt similar legislation. It should be observed that, in the context of construction related contracts, West Virginia prohibits the enforcement of agreements to indemnify where the indemnified party is 100% at fault. That statute becomes inoperable, however, if the contract that contains the indemnity clause also requires the purchase of insurance for the indemnified party. Pennsylvania does not have a comparable statute applicable to contractors or other service companies, preventing this type of indemnity agreement.

What It Means to You

It is of critical importance that contractors operating in Marcellus and Utica shale states fully comprehend the indemnity provisions contained in their contracts and the language of their insurance policies covering bodily injury and catastrophic damages, as well as the interplay between the two. Knock-for-knock indemnity language poses problems for contractors, not only in terms of potential exposure for catastrophic events at well sites, but also in the form of potential coverage disputes with insurers depending on the types of policies issued to the contractors.

Journal Edition

October 2013
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