The Magazine of the Canadian Association of Petroleum Landmen

October 2015

THE NEGOTIATOR

Operating Agreement Models for Unconventional

Shale Projects

Re-Evaluating Your Drilling ContractsPrecision Drilling Canada Limited Partnership

vs Yangarra Resources Ltd.

Inability to Withhold Payments under Processing Agreements

Where Prior Billings Arguable

MANAGING THELIFE CYCLE OF

SHALE PROJECTS

For information on the services McMillan’s Energy Group can provide, please visit our website or contact Michael Thackray, QC.

Your energy partnerBuilding on over 20 years of recognized oil and gas leadership and valued relationships with CAPL, McMillan continues to be your trusted and experienced energy counsel.

Michael A. Thackray, QCe: michael.thackray@mcmillan.cat: 403.531.4710

Senior Editorial BoardDirector of Communications

Kent Gibson [ph] 403-698-8822Advertising Editors

Kevin Young [ph] 403-831-4908Trevor Rose [ph] 403-233-3136

Coordinating Editor Krissy Rennie [ph] 403-663-2595

Feature Content EditorMark Innes [ph] 403-818-7561

Regular Content EditorMartin Leung [ph] 403-699-5864

Social Content EditorJason Peacock [ph] 403-691-7077

Editorial CommitteeJosh Lewis [ph] 403-233-4446Amy Kalmbach [ph] 403-619-2868Nathan Roberts [ph] 403-268-3006Dinora Santos [ph] 403-470-1558

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2015–2016 CAPL Board of DirectorsPresident

Nikki Sitch, P.Land, PSLVice-President

Larry Buzan, P.LandDirector, Business DevelopmentAlberta & British Columbia

Ted Lefebvre, P.LandDirector, Business DevelopmentSaskatchewan & Alberta Oilsands

Michelle CreguerDirector, Communications

Kent GibsonDirector, Education

Bill Schlegel, P.LandDirector, Field Acquisition & Management

Paul Mandry, PSLDirector, Finance

Andrew WebbDirector, Member Services

Ryan Stackhouse, P.LandDirector, Professionalism

Noel Millions, PSLDirector, Public Relations

Gary Richardson, PSLDirector, Technology

Mandy CooksonSecretary/Director, Social

Jordan MurrayPast President

Michelle Radomski

Readers may obtain any Director’s contact information from the CAPL office. Suite 1600, 520 – 5 Avenue S.W. Calgary, Alberta T2P 3R7 [ph] 403-237-6635 [fax] 403-263-1620www.landman.ca

Kaitlin Polowski reception@landman.caDenise Grieve dgrieve@landman.ca Irene Krickhan ikrickhan@landman.caKarin Steers ksteers@landman.ca

Also in this issue

14 Ugly Oil Speakeasy Fundraiser

16 H1 M&A Report

24 October General Meeting Guest Speaker

26 2015 CAPL Golf Tournament

THE NEGOTIATORThe Magazine of the Canadian Association

of Petroleum Landmen THE NEGOTIATOR

Features October 2015

2 Unconventional Risk Allocation: Managing the Life Cycle of Shale Projects

Fenner L. Stewart & Anthony G. Cioni

9 Knock-for-Knock Indemnification Clauses in the Oil and Gas Industry

Kourtney Rylands

12 Summary Judgement on Contested Amounts Owing under Natural Gas Processing and Related Agreements

Nigel Bankes

In Every Issue 8 The Negotiator’s Message From the Board: Communications

15 Roster Updates

19 Get Smart

27 The Social Calendar

28 CAPL Calendar of Events

28 October Meeting

28 November Meeting

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THE OIL AND GAS INDUSTRY IN ALBERTA AND INTERNA-TIONALLY IS LARGELY GOVERNED BY STANDARD FORM CONTRACTS.1 These types of agreements provide certainty and

efficiency to contractors and operators alike, on the assumption

that the parties have read and fully understand the implications

of entering into such a contract. However, a recent decision of the

Alberta Court of Queen’s Bench illustrates how even sophisticated

entities can be caught off guard by the practical results of the

provisions in standard form drilling contracts.2 In Precision Drilling

Canada Limited Partnership v Yangarra Resources, 2015 ABQB 433, the

court upheld a bilateral no fault contract between a contractor and

an operator, resulting in multi-million dollar losses for the operator.

This case illustrates that Alberta courts have been more than willing

to hold experienced and sophisticated commercial entities to their

agreements, and serves as a cautionary tale for industry to be fully

informed about what is contained in its contracts, especially those

that purport to allocate liability in a particular manner.

In this case Yangarra Resources Ltd. (“Yangarra”), an oil

and gas operator, contracted with Precision Drilling Canada

Limited Partnership (“Precision”) to drill two wells. The agree-

ment between the parties was governed by a bilateral no fault

contract, or reciprocal indemnity agreement. Agreements such as

these are commonly referred to as “knock-for-knock” contracts

because, pursuant to the contract, each party agrees to bear the

risk of damage to its own assets even if its assets are destroyed or

damaged by the fault of the other.

The losses to Yangarra occurred during the drilling of the second

well when an employee of Precision improperly mixed the drilling

mud. Precision employees then “neglected to test or carelessly

tested the drilling mud and wrongly advised Yangarra’s supervisor

that the drilling mud was in order.”3 During drilling, the drill string

and bit subsequently became stuck in the hole and could not be

extracted, resulting in equipment losses to Yangarra of approxi-

mately $300,000.00. It was assumed these losses were due to the use

of the improperly mixed drilling mud. Yangarra also incurred addi-

tional expenses in the amounts of $720,000.00 in attempts to retrieve

the drill string and bit and $2.5 million to drill a replacement well.

This decision may be surprising to some as Precision success-

fully sued Yangarra for all of its fees, including the extra expenses

incurred in fishing operations and to drill the replacement well.

Yangarra was required to pay the full amount of Precision’s bill

and was not able to set off any of its losses. This scenario was

made possible by the wording of the knock-for-knock drilling

contract. The contract provided that Yangarra was to assume all

of the risk of damage to its equipment or the hole “regardless of

the negligence or other fault of Precision or howsoever arising.”4

The contract further provided that Yangarra was to

assume all of the risk of and be solely liable for the cost of

repairing and re-drilling a lost or damaged hole, including,

without limitation, the cost of fishing operations, regardless of

the negligence or other fault of Precision or howsoever arising.5

The court relied on a plain language reading of the agreement to

find that Yangarra was required to assume all of the losses caused

by Precision. Yangarra was also required to pay for Precision’s day

work. Yangarra attempted to counterclaim against Precision for

the losses it suffered based on arguments of negligence, gross

negligence, breach of contract, negligent and fraudulent misrep-

resentation and unjust enrichment. However, under the contract,

Yangarra had released Precision from any and all claims based on

negligence or any other theory of legal liability. The court was not

willing to overturn the clear intentions of the contract or find a

carve-out the parties did not specifically agree to.6 The ultimate

question asked by the court and those who have read this deci-

sion is: “why would anyone knowingly make such a contract?”7

Oil and gas companies around the world rely on model forms.

As commentators have noted, this practice “saves the parties

time and transaction costs and gives comfort that they are using

documents with which they are already familiar.”8 One of the

most common provisions of a standard form oil and gas service

contract is the apportionment of liability or knock-for-knock

provision.9 These types of agreements have become common in

the oil and gas industry because they can offer significant bene-

fits to all parties, such as reduced costs with respect to litigation,

increased certainty with respect to risk allocation, and decreased

friction between multiple parties at a wellsite.10 However, the

Precision case is an example of the most significant drawback of

the knock-for-knock regime: the requirement for a contracting

party to assume liability for damage for which it is not responsible.

Depending on the jurisdiction, courts have taken different

approaches with respect to the enforcement of knock-for-knock

indemnification clauses. For example, there is legislation in place

in the United States that generally prohibits indemnification for an

indemnitee’s own negligence.11 In addition, some courts have raised

the issue of public policy with respect to the enforcement of knock-

for-knock provisions.12 In the Precision case Yangarra attempted

to make the public policy argument that the enforcement of the

knock-for-knock provisions would encourage negligent and grossly

negligent behaviour in the oil and gas industry, therefore placing

Knock-for-Knock Indemnification Clauses in the Oil and Gas Industry

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the public at risk.13 However, the Alberta court made clear that

Precision and Yangarra were sophisticated commercial entities

with equal bargaining power who had significant motivation to

avoid negligent behaviour; the court determined that enforcing the

knock-for-knock contract under those circumstances was neither

unconscionable nor contrary to public policy.

As might be expected, negotiating knock-for-knock indemnifi-

cation provisions can be a time consuming and heated endeavour.

Part of this negotiation process often involves the carve-out of

specific circumstances in which liability will be apportioned to each

party. For example, a knock-for-knock contract may have a carve-

out for negligence or gross negligence. One of the key factors in this

decision was that the contract provided indemnification for damage

based on any theory of legal liability. In Canada, there is no legis-

lation in place which prohibits this type of broad indemnification

clause.14 In the Precision case the court found that the indemnity

clause covered all heads of damage advanced by Yangarra and

concluded that the indemnity clause would only be unenforceable

in circumstances in which intentional harm was inflicted.15

As discussed, standard form contracts (some complete with

knock-for-knock provisions) are common in the oil and gas industry

worldwide. These types of agreements are often drafted by experts

over many years and negotiated with certain purposes in mind.

For example, if we look slightly closer to home, the CAPL 2007

Operating Procedure is a widely used and accepted standard form

document. The Operating Procedure is by all accounts a “norm based”

standard form document and was designed by its drafters to serve

“typical” situations and transactions (remember $90.00/bbl oil?), all

in an acknowledged environment of ever-increasing non-typical

situations and transactions. Modifications to the norm were expected

to address special circumstances and efforts were made (see the

inclusion of special related annotations to assist users in recognizing

areas for which modifications might be appropriate) to highlight this

potential need and to facilitate special circumstance customization.

However, to understand when modifications to a standard form

document are necessary, one first has to completely understand what

the norm is and what the standard form document purports to do. I

have it on good authority that it was never the drafters intention to

create a document that could be mindlessly stapled onto a generic

and one-size-fits-all head agreement. Quite the contrary in fact. The

situation faced by Yangarra with respect to the use of a standard form

drilling contract should cause every reader to reach to their shelf to

review the liability provisions of the Operating Procedure.

In the Precision case, the contract used by the parties was

not a CAPL standard form document, but instead was negotiated

between the Canadian Association of Oilwell Drilling Contractors and

the Canadian Association of Petroleum Producers.16 As cautioned,

contractors and operators alike must still carefully consider and fully

understand the provisions of such contracts, including the liability and

release provisions they are committing to. For example, parties might

turn their minds to allocating certain risks between them instead of

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releasing each party completely. One way parties can accomplish this

is to identify in advance certain circumstances in which one party

has complete control of a particular aspect of the job and carve out an

exception to the knock-for-knock contract that allocates responsibil-

ity to such a party.17 In this instance the parties had the opportunity to

allocate some risk to Precision, which might have covered the prepa-

ration of the drilling mud. However, the contract used by Precision and

Yangarra noted that the risk allocated to Precision would be “nil.”18

If parties do proceed with the broad form of indemnification they

need to consider whether there are gaps in their insurance coverage

which a knock-for-knock contract might expose. Additionally, parties

should be aware of how the indemnification clauses in their agree-

ments interact with the contract’s payment terms. Here the parties

agreed that Precision would be paid day rates, which resulted in

additional losses for Yangarra due to Precision’s continued work at

the wellsite. A requirement for Precision to drill a complete well may

have resulted in reduced losses to Yangarra. Finally, operators head-

quartered in jurisdictions outside of Alberta with a different approach

to the interpretation of indemnification clauses should carefully

consider choice of law clauses in their standard from agreements.

The results of this case indicate that Alberta courts may hold sophis-

ticated commercial entities to their agreements and will not hesitate

in enforcing them, whatever the result may be. m

Kourtney Rylands

Notes1. Trent Mercier, Josh Kane, and Sharbil Nammour, “Drafting Oilfield

Master Service Agreements”, 52 Alta L Rev 245 (2014) at p 247 [Drafting

Oilfield Master Service Agreements].

2. Precision Drilling Canada Limited Partnership v Yangarra Resources, 2015

ABQB 433 at para 5 [Precision v Yangarra].

3. Ibid at para 17.

4. Ibid at para 11.

5. Ibid at para 29.

6. Ibid at para 36.

7. Ibid at para 44.

8. Toby Hewitt, “An Asian Perspective on Model Oil and Gas Services

Contracts”, 28 J Energy & Nat Resources L 331 (2010) page 331 [Model

Oil and Gas Services Contracts].

9. Model Oil and Gas Services Contracts, supra note 10 at p 333; Drafting

Oilfield Master Service Agreements, supra note 1 at p 255.

10. Nick Kangles, R Ben Rogers, and Chris Harris, “Risk Allocation

Provisions in Energy Industry Agreements: Are We Getting It Right?”,

49 Alta L Rev 339 (2011-2012) at p 340 [Risk Allocation]; Christopher L

Evans and F. Lee Butler, “Reciprocal Indemnification Agreements in the

Oil and Gas Industry: The Good, The Bad And The Ugly, 77 Def Counsel

J 226 (2010) at p 227-229 [Reciprocal Indemnification Agreements].

11. Risk Allocation, supra note 12 at p 342.

12. Ibid at p 247.

13. Precision v Yangarra, supra note 2 at paras 101-112.

14. Risk Allocation, supra note 12 at p 341.

15. Precision v Yangarra, supra note 2 at para 37.

16. Precision v Yangarra, supra note 2 at para 5.

17. Reciprocal Indemnification Agreements, supra note 12 at p 231.

18. Precision v Yangarra, supra note 2 at para 30.