Industry in search of better system to manage pollution compensation

Expanded version of OPOL in northern Europe could be good starting point

By Jeremy Farr and Clare Kempkens Ince & Co

The fallout from major pollution incidents is well known: huge volumes of claims, fights over cleanup methods, political recriminations, finger pointing and labyrinthine legal proceedings.

Pollution should not happen. It is trite but true that prevention is better than cure. Regulation seeks to deal with that.

But must a legal free-for-all also exist to act as a deterrent, or is there a better way? Can regulation and compensation be split? Can a system be put in place that provides prompt compensation to those in need, shares the burden in a fair manner, and clears the way for in-depth investigation and lesson learning without implications for civil suits?

The best solution lies through industry. It is the industry that could make the difference.

We say “solution,” but clearly there is no cure for all ills. No system is perfect under such emotive circumstances. In particular, states will always require that criminal penalties be in place to some degree for breach of regulations. However, the industry might be able to put a system in place that would vastly improve how civil claims are dealt with to the benefit of pollution victim, operator, contractor, insurer and regulator alike. With adequate civil arrangements, the motivation for criminal penalization may, over time, be reduced.

The certainty issue

Such a system requires certainty of risk allocation in order to function. Fault-based liability cannot provide that certainty. If victims are to be compensated quickly, their compensation cannot depend on the outcome of an investigation (judicial or otherwise) into blame. Civil liability must be pre-allocated by reference to something other than fault for a particular incident. It is that pre-allocation which all involved are likely to find most difficult to swallow. The need for certainty represents the biggest hurdle to improving the current position.

Certain allocation of liability is, however, not without precedent. The CLC and Fund regime is in place outside the US to deal with liability for oil pollution from tankers. Under this system, the owner of the tanker from which oil has leaked is (virtually) strictly liable up to a limit. That limit is very hard to break – it requires a claimant to show that the pollution damage resulted from the tanker owner’s “personal act or omission, committed with the intent to cause such damage, or recklessly and with knowledge that such damage would probably result.”

Above that limit, claims are paid up to a further limit by the International Oil Pollution Compensation (IOPC) Fund. That organization is funded by contributions from oil receivers in member states who are parties to the Fund convention.

A similar tiered liability scheme between contractor and operator interests is, in our view, a prerequisite for any improved compensation system. There must be liability limits, and these must apply irrespective of fault, save perhaps for the most egregious forms of it.

We’re not suggesting that a similar system of international conventions and a similar body to the IOPC Fund are required. Efforts to put something similar in place have failed in the past. The CLC and Fund system has a number of important lessons to teach us, but we believe that the industry could achieve a great deal through contractual agreement.

A sensible first step in any such system would be the agreement of a standard set of pollution liability-sharing clauses. These would replace the current pollution indemnities in drilling and other contracts and form the basis of the tiered liability. 

Why should the industry consider trying?

What might Drilling Contractors Gain?

Let’s look at where we are now.

• Potential exposures are huge;

• Available insurance is limited;

• Pollution indemnities are being eroded by the introduction of fault as a relevant factor; and

• Even where pollution indemnities are contractually watertight, they are only secondary protection. At law, the contractor may well be liable. If the operator cannot pay indemnities, they are no protection at all. On each well, the contractor bets its future on the solvency of its client.

A tiered liability system would enable contractors (not necessarily just drilling contractors) to exchange the uncertainty of potentially very large civil claims for the certainty of a limited and readily insurable form of strict liability.

A truly tiered system would require legislation and conventions. However, if a contractual mechanism were in place ensuring risk allocation was clear and a second tier of funding was certain (and not subject to individual operator insolvency), then contractual arrangements might come very close to achieving the same result. In some respects, they might avoid many of the problems associated with a change in law.

Why Might Operators
Agree?

If the limit is set at the right level, then contractors would make a contribution to pollution liabilities. The pain would be shared, albeit not on a fault basis.

Regulators are looking at financial responsibility criteria. There has been much talk about the current position, and there are initiatives in place that may lead to additional regulatory burdens being imposed. If the industry acts together and shows it can produce a workable system, then further intervention may not be required or may take account of the functionality of existing arrangements.

It is in the whole industry’s interest to show it can respond to an emergency in a coordinated and responsible fashion. In other related areas, such as oil spill response, it has already done so.

Operators already face the risks that would be dealt with by this system. With proper implementation, a system could:

• Provide a certain contribution from contracting partners;

• Enable proper planning and insurance (without the aggregation risks and uncertainties that presently have to be factored in and potentially with greater capacity available as a result); and

• Promote cooperation rather than confrontation between contracting partners in incident management and claims handling.

The form of mechanism needed to stand behind the individual operator is the most complex question. Oil majors, whose insolvency risk is very low and whose internal procedures perhaps very strict, may be understandably reluctant to pool risk with smaller emergent companies. However, we think risk pooling could be kept to a minimum, insolvency risk and well risk could be individually assessed and contributions to risk bearing tailored accordingly. Overall, we believe it is possible to construct a system of benefit to all.

There are a number of possibilities. These include a fund set up to respond to claims (similar to the IOPC Fund or the Oil Spill Liability Trust Fund in the US), a high-level insurance program, a more complete risk pool or a combination of some or all of these. However, the most attractive starting point, in our view, is an expanded version of the current OPOL (Offshore Pollution Liability Agreement) arrangements in place in northern Europe. These function by contract but (within the UK, at least) with regulatory encouragement/mandate in that membership is, in practical terms, a prerequisite for a license. Such an arrangement is, in our view, capable of being refined to offer an optimal blend of flexibility and certainty with or without regulator involvement.

This article is based on a presentation at the 2014 IADC Contracts and Risk Management Conference, 14-15 October, Houston.