Clifford Chance

A very quick review of so-called knock-for-knock indemnities and why and where they are applied.

Most construction and OM contracts contain conventional fault-based indemnity clauses based on the principle that a party who causes injury to another person/damages property/ infringes a third party's intellectual property rights/ or breaches the law giving rise to fines, penalties, etc., should be liable for resulting claims.

In certain sectors, these indemnities will become wider and stray into no-fault territory. For example, an EPC contractor might indemnify its employer should anyone be injured by the carrying out of the works, even if that is not the result of the contractor's own negligence, unless injured by the employer itself.

There are also situations and sectors where the norm is a knock-for-knock indemnity structure where one party indemnifies the other for a risk, irrespective of cause, including where caused by the other party. Examples include:

• Employee knock-for-knocks: The principle here is that each party should cover and insure (or self-insures) the risk of injury to their employees and so indemnifies the counterparty irrespective of who causes the injury. This is often seen in contracts let by Government bodies.
• Offshore: The convention for offshore projects is that each party is responsible for its own property (for example, if contractor A's vessel causes a collision with that of contractor B, each contractor remains responsible for the damage to its own vessel). Traditionally, knock-for-knock indemnities in individual contracts were supported by multi-party waiver agreements to prevent contractors evading the knock-for-knock principle with a direct claim against another responsible contractor. More recently on offshore wind projects we have seen developers instead rely on provisions in their contracts to achieve the same effect.
• Related party management contracts: Often such contracts feature low-margin low-liability structures (aka 'no-gain no-loss'). Knock-for-knock arrangements reflecting the restricted liability arrangements are a common feature.
• Risks too large to bear or insure: Certain projects feature risks out of all proportion to the costs of the works and any individual contractor's price (and balance sheet) and, accordingly, those risks are often allocated to the project developer who will benefit from the project upside if successfully delivered. Traditionally, this has been applied in the nuclear energy industry (both reflecting nuclear liability channelling conventions and legislation and gaps in the same) and also on offshore oil and gas projects in relation to environmental risks. However, following the Macondo Prospect well tragedy (Deepwater Horizon) in 2010, many offshore developers evolved their standard indemnities to leave a first tier of risk with contractors to ensure prevention and preparedness against risks.

Knock-for-knock indemnities can seem counter-intuitive at first ('the contract says that you will exercise all due care but, if you do not and damage my property, it appears that I have to pay the bill?') and unfortunately that can lead to attempts to adjust them in complex ways. However, once it is understood they are intended to dovetail with project insurances, it becomes clearer that through reallocating responsibility for any deductible/excess, they can help reduce the number of potential disputes that can arise.

It would be interesting to hear from insurers as to whether there is any evidence that knock-for-knock indemnities leads to more risk-taking by contractors whose negligence would notionally go unpunished by virtue of the knock-for-knock regime.