Article: March 2015: Energy Litigation Update

Drilling Contracts and Rig Maintenance. Drill rig contracts, which take a similar format around the world, have for years been construed by many as entitling contractors to be paid a day rate while fixing equipment failures caused by their poor maintenance practices. This is not only dangerous but counter-intuitive. It has also now been held to be wrong by the London Commercial Court in a judgment which should have repercussions through the offshore oil and gas drilling industry: Transocean Drilling UK Ltd v. Providence Resources Plc.

The dispute arose under a contract by which Providence Resources hired a rig from Transocean to drill a well off the south coast of Ireland in 2012. One of the critical pieces of safety equipment on a rig is its blowout preventer (BOP). The BOP sits on the seabed and serves as the primary barrier to a pressure surge from the well. Its components are operated electronically and hydraulically to close the well down. If it fails to work, the consequences can be catastrophic.

A vivid recent example of a BOP not working was on Transocean’s rig at Macondo in the Gulf of Mexico in 2010. The disastrous consequences of that blow out, both as to loss of life and the financial liabilities faced by BP as a result, are well known. In a recent judgment on Macondo, a Texas court found that the BOP had failed to work on the Deepwater Horizon because it had not been properly maintained by Transocean.

Despite the Macondo tragedy, and the lessons that should have been learned from it, the rig Transocean delivered to Providence in late 2011 was found by a judge also to have had a defective BOP. This was again due to a lack of maintenance, a fact which the Judge held that Transocean later concealed from Providence in a doctored report on the root causes of the BOP failures.

Fortunately, there was no blow out and no disaster on this occasion. But when the fault was discovered, the BOP had to be raised to the surface and repaired before drilling could proceed. Weeks were lost and during this time Providence paid for the backup services required by the rig which could not be used. Such costs are known in the industry as “spread costs”.

The delivery of a rig with a defective BOP was a breach of the drilling contract, but Transocean maintained that it could still claim day rates during the period of delay and that it was not liable for any spread costs by virtue of an exclusion clause in the contract. As to the day rates, Transocean argued that the contract contained a “complete code” which provided for the rates payable per day in all eventualities, including periods when the rig was broken down and being repaired. It did not matter, Transocean said, that the repair was required because it had failed to maintain the BOP properly. Providence, on the other hand, argued that Transocean could not benefit from its own breach of contract. It cannot have been intended that Transocean could actually earn more from the contract by breaching it and then collecting day rates during a period of repairs necessitated by Transocean’s own poor rig maintenance. (For the principle that a contract will not be construed as enabling a party to benefit from its own breach, see: Alghussein Establishment v. Eton College [1988] 1 WLR 587.)

Mr. Justice Andrew Popplewell agreed with Providence. He also held that the exclusion clause did not cover the spread costs. If it did, and Transocean were also entitled to day rates, Transocean would never have any liability, or ever be held to account for any breach of the contract.

This is a landmark decision for the industry. Certainly, day rates for an offshore drilling rig can be enormous—$250,000 per day in this case—but the significance of this decision goes much further, or at least it should. If contractors have little or no liability for the consequences of their actions, they will have less incentive to take due care. And if, as Transocean argued in its case against Providence, the contract entitled it to earn more by failing to maintain the rig properly, the incentive is reversed. The consequences of such a reverse incentive for safety and the environment are obvious.

It is to be hoped that the decision in the Providence case will help re-balance the incentives for contractors to maintain rigs properly. While their ability to insure against losses must be taken into account in apportioning the risks of a failure, they should neither be wholly insulated from liability nor have an economic incentive to under-maintain equipment, with potentially catastrophic consequences.