Seadrill Case Highlights Importance of Contract Risk Management

Tim Haïdar

The economic climate has put pressure on various aspects of the oil and gas industry, with operators and contractors being forced to cut costs.

"We continue to experience a very competitive market," said Michael J Bradley, president and chief executive officer of Matrix Service, following the oil and gas equipment maintenance firm's release of its third quarter financial results.

"Increased competition, coupled with a tough environment, have put pressure on contractors to decrease margins and accept a shift in risk allocation including more demanding contractual terms and conditions," he continued.

However, despite the economic situation, he insisted that contract risk management would be not be compromised.

"While we work with customers to consistently provide high-quality solutions at a competitive price, we remain disciplined in our approach to project selection, contract risk management and project execution," Bradley stated.

High Court Case

The recent high court case of Seadrill Management Services vs. OAO Gazprom highlighted matters of contract risk management.

This case concerned an agreement for provision of a drilling rig in the Bay of Bengal. Gazprom contracted Seadrill to deliver the rig and the case arose from an incident in January 2006, where, during preloading operations, the rig experienced difficulties and was badly damaged. This resulted in it being removed from the site for repairs.

Gazprom terminated the contract on the basis of Seadrill's negligence during the preloading and related operations. In the meantime, it drilled the well itself using another vessel.

However, Seadrill argued that the Russian company's notice of termination was a repudiatory breach of contract. Gazprom, in turn, counterclaimed for damages, alleging that it suffered substantial losses due to Seadrill's failure to complete the well as negotiated and on time.

Interpretation of Contracts

Importantly, the case was taken to court in the UK, despite the work taking place off the coast of India and the companies having Russian and Norwegian owners. The agreement between the two companies was based on a well-known standard form, the International Daywork Drilling Contract (IADC)–Offshore form, produced by the International Association of Drilling Contractors.

It was the first time that a case concerning the IADC form had been taken to court in England and, according to legal practice Herbert Smith, which represented Gazprom, its outcome has considerable implications for contract risk management and the interpretation of agreements.

Not all the issues handled within the case can be covered here, but one of the main questions arising from the case was the extend to which Seadrill was responsible for completing the contract with reasonable skill and care, or whether all risk of accidents and delays had been passed on to Gazprom, irrespective of fault.

"Seadrill's argument was, essentially, that the contract did not impose on Seadrill any particular standard of performance for operation of the rig," Melanie Willems, of global law firm Howrey, explained.

However, the honourable Mr Justice Flaux ruled that this could not be substantiated, declaring that the claims failed. He also decided that Gazprom's counterclaims of a repudiatory breach of contract by Seadrill were unfounded.

Although Seadrill attempted to use decisions by US courts as legal precedent, but the judge held that this American case law did not apply as the contract in question was governed by English legislation.

Justice Flaux also ruled that Gazprom were entitled to recover as damages any costs and expenses in relation to the rig, "to the extent that they were truly wasted as a consequence of Seadrill's breach," but was not entitled to retrieve any outlays in relation to the drilling of the second well.

Implications for Contract Risk Management

As far as contract risk management is concerned, Herbert Smith said that rig hirers and contractors should be aware that there is now binding authority for the interpretation of the IADC form under English law following the case, unless this is overturned by a higher court.

"There is an implied obligation in the IADC form that a rig is to be operated with reasonable care and skill," the legal practice said.

Global law firm Clifford Chance said that the case shows that contracts are "tricky things" and therefore contract risk management becomes extremely important. "Escaping liability for breach of contract remains very difficult, but equally seeking to terminate for breach is not for the faint-hearted," the firm said. "Get it wrong, and any benefit of the contract may vanish."