Recent Supreme Court decision highlights importance of exclusions and indemnities

The value of mutual hold harmless indemnities in the energy industry has been highlighted by the recent Supreme Court decision of Farstad Supply AS v Enviroco Limited and Asco UK Limited [2010] UKSC 18. In this case, the court considered the true construction of a clause contained in a charterparty agreement between Farstad Supply AS ("Farstad") and Asco UK Limited ("Asco").

6th July 2010

The value of mutual hold harmless indemnities in the energy industry has been highlighted by the recent Supreme Court decision of Farstad Supply AS v Enviroco Limited and Asco UK Limited [2010] UKSC 18. In this case, the court considered the true construction of a clause contained in a charterparty agreement between Farstad Supply AS ("Farstad") and Asco UK Limited ("Asco").

An oil rig supply vessel belonging to Farstad was damaged by fire while in Peterhead harbour in July 2002. The vessel was under charter to Asco at the time and Asco had contracted Enviroco Limited ("Enviroco") to clean the vessel's tanks. Asco instructed the master of the ship to move the vessel to another berth in the harbour. There was an oil spill in the engine room when the engines were started, due to a valve having been mistakenly left open. The oil caught fire, resulting in the death of one Enviroco employee and damage to the vessel itself.

Farstad sued Enviroco for compensation for the damage, arguing that the fire was caused by the negligence of an Enviroco employee. Enviroco made a claim against Asco for contributory negligence in relation to Asco's instruction that the vessel be moved even although the cleaning had not yet been completed.

Enviroco's claim relied on section 3(2) of the Law Reform (Miscellaneous Provisions) (Scotland) Act 1940 (the "Act"). The Act states that where a defender has been held liable and pays damages, they have a right to recover a contribution from any third party who, if sued, might also have been held liable for damage.

The terms of the charterparty agreement included an obligation on Farstad to "defend, indemnify and hold harmless" Asco from any liability relating to damage to Farstad's vessel. The court considered whether this clause amounted to an exclusion of liability or simply an obligation upon Farstad to reimburse Asco for any liability incurred for damage. Considering the language of this clause in the context of the charterparty as a whole, the court held that a true construction of the phrase "defend, indemnify and hold harmless" was that it completely excludes liability for damage to the vessel. If sued, Asco would therefore have a defence that liability is fully excluded under contract.

The court also considered whether Asco would be liable to make a contribution under the Act if the relevant charterparty clause had been viewed as merely an obligation to indemnify Asco. It was decided that even if this had been the case, Asco could not be found liable to pay compensation, as the action would be circuitous. If Asco was ordered to contribute to the damages paid to Farstad, Farstad would be obliged to reimburse Asco under the terms of the charterparty.

The outcome of this case is very significant in that the exclusion clause in question prevented Enviroco from making a claim against Asco, even although the clause only concerned the contractual relationship between Farstad and Asco. This illustrates that contractors in the supply chain may find themselves bearing a greater proportion of liability because of exclusions and indemnities in contracts between other parties. To avoid this situation, parties should carefully consider the contractual matrix as a whole and ensure that they have sufficient cross indemnities and mutual hold harmless indemnities in place to ensure they are not adversely affected by exclusions and indemnities between other parties.