Thursday, June 14, 2012

Knock-for-knock Indemnities

A knock-for-knock indemnity is a reciprocal or mutual indemnity that is frequently used in the oil or gas industry where injuries could occur only to the employees of the contracting parties and damage could occur only to the property of both parties. Under a knock-for-knock indemnity both parties agree to indemnify the other against claims for injuries or damages that they or their employees sustained regardless of who was at fault or who was negligent.

For example under a knock-for-knock indemnity, you could have Oil Company X and Drilling Company Y. In a knock-for knock or mutual indemnity Oil Company X will be responsible for any damages to Oil Company X’s property or employees and has to indemnify Drilling company Y against any claims and pay any damages awarded.The same would apply if an employee of Drilling Company Y were to sue Oil Company X for injuries they sustained from Oil Company X or Oil Company X’s employees negligence. In that suit Drilling Company Y would indemnify Oil Company X from those claims and would be responsible to defend and pay any damages awarded. Over time a number of companies have modified the true “knock for knock indemnity” where they exclude gross negligence or willful misconduct from those indemnities. The problem is when you do that it become similar to comparative negligence in that the parties have to establish those behaviors.

Knock-for-knock indemnities help avoid the cost of litigation that occurs with comparative negligence claims. A comparative negligence claims is one where both parties are sued and the court determines the percentage of negligence that applies to each of the parties. They share the responsibility to pay the damages based upon their percentage of negligence. Knock for knock creates a simple sharing of the risk where each party agrees to be fully responsible for any damages they sustain or that their employees sustain and not look to the other party.

Where a knock-for-knock indemnity doesn’t work or would need to be modified is when the property of a third party is damaged or a third party who is not an employee of either of the parties to the agreement is injured. Those types of claims are outside the scope of the knock-for-knock indemnity. If you failed to address claims by third parties if one party was sued and felt the other party was fully or partially responsible, they would need to enjoin the other company in the law suit and because there was no indemnification relating to third party claims, the court would decide the responsibility for damages. The damages would be apportioned based upon their percentage of negligence that was attributed to the parties.

Having an indemnity doesn’t fully protect a party, especially where it’s a Buyer / Supplier or Prime Contractor /Subcontractor situation Even if the court found the supplier or subcontractor to be 100% of the cause for the negligence, even that may not excuse the buyer or prime contractor from payment. Under the theory of agency, those parties are considered principals and the other company is consider an agent. Principals are liable for the acts of their agents.
So if the Supplier or Subcontractor didn’t have the insurance coverage to cover those damages and didn’t have the assets to make the payments, the principal could be forced to pay the damages.