Indemnity versus exclusion

In the recent case of Farstad Supply A.S v Enviroco Limited and ASCO UK Limited [2009] CSIH 35, the Inner House of the Court of Session considered law on contributory negligence and the operation of section 3(2) of the Law Reform (Miscellaneous Provisions) Act 1940 and its relationship with contractually agreed indemnity clauses. The Court examined the operation of one particular indemnity clause and considered whether it excluded liability on the part of the indemnified party or if it simply allocated who should bear the cost of any liabilities which arose.

Background

The MV Far Service, an oil rig supply vessel owned by Farstad Supply AS (“Farstad”) and chartered by ASCO UK Limited (“ASCO”), was berthed in Peterhead Harbour in July 2002. ASCO instructed Enviroco Limited (“Enviroco”), to clean out the holding tanks of the vessel. As the cleaning was coming to an end an ASCO representative spoke to the master of the vessel (for whom Farstad were liable) about moving from the berth, following which the master of the vessel started the engines and prepared to move. Unfortunately an Enviroco employee had unintentionally opened a valve which released hot oil into the engine room near hot machinery causing the oil to ignite and start a fire. An employee of Enviroco was killed and the vessel was badly damaged.

The issues

Farstad raised an action against Enviroco in respect of the damage to the vessel caused by the negligent acts of Enviroco employees when cleaning. Enviroco sought to bring ASCO in as a third party to the action, claiming that ASCO were partly responsible for the damage caused due to their failure to supervise the cleaning operations and for giving an order to move the vessel before the cleaning had been completed. Enviroco sought to recover sums from ASCO for contributory negligence by virtue of section 3(2) of the Law Reform (Miscellaneous Provisions) Act 1940 (“the 1940 Act”) which states that “Where any person has paid damages…in which he has been found liable in any such action aforesaid, he shall be entitled to recover from any other person who, if sued, might also have been held liable in respect of the loss or damage on which the action was founded, such contribution, if any, as the court may deem just.”

However the Charter Agreement between Farstad and ASCO contained the following indemnity clause; “…the Owner shall defend, indemnify and hold harmless the Charterer…from and against any and all claims, demands, liabilities, proceedings and causes of action resulting from loss or damage in relation to the Vessel…irrespective of the cause of loss or damage, including where such loss or damage is caused by, or contributed to, by the negligence of the Charterer…” (“the Clause”).

The issue for the Court therefore was how the operation of the Clause affected the interpretation of the 1940 Act.

Decision

Lord Hodge pronounced that the Clause operated in such a way that Farstad did not have a right to obtain damages from ASCO and therefore the provisions of s.3(2) of the 1940 Act did not apply. As such Enviroco was prevented from recovering sums for contributory negligence from ASCO.

However, on appeal, the Court held that the Clause was an indemnity clause, not an exclusion clause. The Charter Agreement operated to allocate the costs of liability in the event that ASCO were found liable rather than specifically excluding liability. The wording of the Clause “presupposes the existence of liability for its application”; therefore the indemnity provision will come into effect only if and when liability in reparation is established or accepted and at that point it will be for the indemnified party (ASCO) to recover the costs from the indemnifying party (Farstad). The Court considered the use of the words “defend, hold harmless and indemnify” and confirmed that this combination of words is commonly used in the drafting of simple indemnity provisions despite the fact that the individual words have slightly different meanings in certain contexts. When the words “defend, hold harmless and indemnify” are being used by drafters consideration should be given to the real intention of the clause; if it is a simple indemnity clause these words will be sufficient, however if something beyond an indemnity is intended (i.e. an exclusion of liability) clearer and more precise language will be required.

Having considered the operation of clause 3 of the 1940 Act and the purpose of that clause the Court held that, in these circumstances, ASCO fell within the category of “any other person who, if sued, might also have been held liable in respect of the loss or damage on which the action was founded” under s.3(2) of the 1940 Act, therefore allowing any amount due by Enviroco to be apportioned with ASCO for contributory negligence. It is of no significance that a party, if sued, would have a defence to the action based on a contractual indemnity when establishing whether or not that party is capable of being sued.

Conclusions

In the circumstances of this case the Court agreed that apportionment of the damages payable to Farstad between Enviroco and ASCO was possible. By invoking the indemnity clause ASCO could then demand that Farstad pay out ASCO’s liability for damages (i.e. Farstad pay to themselves). This was seen by the court to be “broadly equitable” as Enviroco would only be required to pay damages attributable to their actual contribution to the loss and Farstad would receive reduced damages as a result of having entered into a freely negotiated contractual indemnity with ASCO.

The decision acts as a further reminder of the importance of ensuring careful drafting of commercial contracts and confirms that if standard oil and gas North Sea indemnities are drafted correctly they will be upheld by the Scottish Courts in the manner intended.