Oil & Gas: Default Gas exclusive remedy in natural gas sale agreement

The English Court of Appeal has upheld the Commercial Court decision that a Default Gas remedy in a natural gas sale and purchase agreement was the sole and exclusive remedy for underdeliveries to a buyer caused by a shut-in for the purposes of constructing third party access (Scottish Power UK PLC v BP Exploration Operating Company Ltd and Others [2016] EWCA Civ 1043). In deciding that the buyers were entitled to compensation for the underdeliveries caused by the shut-in, the Commercial Court had highlighted the dilemma likely to be faced by a North Sea industry implementing MER UK. In deciding that Default Gas was the sole remedy for the underdeliveries, the Court of Appeal emphasised the importance of the drafting of the contractual structure in dealing with damages and/or compensation for contractual breaches resulting in underdeliveries. As similar provisions are used in many natural gas sale and purchase agreements internationally, the decision will be of interest to a wide range of natural gas buyers and sellers with long-term natural gas sale and purchase agreements.

Facts

Scottish Power UK PLC (“Scottish Power”) entered into four long-term agreements (on materially identical terms) for the sale and purchase of natural gas (“Agreements”), whereby it agreed to purchase from the sellers (BP Exploration Operating Company Limited, Talisman Sinopec North Sea Limited, ENI TNS Limited and JX Nippon Exploration and Production (UK) Limited (the “Andrew owners” or the “Sellers”)) natural gas produced from the Andrew Field.

The obligation to deliver an amount of natural gas in accordance with Scottish Power’s proper nomination was contained in Article 6.12 of the Agreements, which provided that:

“the Seller shall deliver on each Day at the Delivery Point the quantity of Natural Gas properly nominated by the Buyer under this Agreement for delivery on such Day.”

Article 16 established a regime whereby, when an underdelivery occurred on any day, the quantity of gas which the Sellers had failed to deliver was classified as Default Gas and the Buyer would become entitled to receive a like quantity of gas in a subsequent month at the Default Gas Price, which was 70% of the Contract Price.

The provision at the centre of the dispute was Article 16.6, which stated:

“The delivery of Natural Gas at the Default Gas Price and the payment of the sums due in accordance with the provisions of Clause 16.4 shall be in full satisfaction and discharge of all rights, remedies and claims howsoever arising whether in contract or in tort or otherwise in law on the part of the Buyer against the Seller in respect of underdeliveries by the Seller under this Agreement, and save for the rights and remedies set out in Clauses 16.1 to 16.5 (inclusive) and any claims arising pursuant thereto, the Buyer shall have no right or remedy and shall not be entitled to make any claims in respect of any such underdelivery.”

The agreements also provided a reasonable and prudent operator (“RPO”) standard at Article 7.1, which required:

“Throughout the Contract Period the Seller will, in accordance with the Standard of a Reasonable and Prudent Operator, provide, install, repair, maintain and operate those Seller’s Facilities which are (in the opinion of the Seller and the other Sellers) necessary to produce and deliver at the relevant times the quantities of Natural Gas from the Andrew Field which are required, in accordance with the terms of this Agreement, to be delivered to the Buyer at the Delivery Point.”

A Reasonable and Prudent Operator was defined in Article 1 as:

“a Person seeking in good faith to perform its contractual obligations and, in so doing and in the general conduct of its undertaking, exercising that degree of skill, diligence, prudence and foresight which would reasonably and ordinarily be expected from a skilled and experienced operator engaged in the same type of undertaking under the same or similar circumstances and conditions, and the expression the ‘Standard of a Reasonable and Prudent Operator’ shall be construed accordingly.”

Production of natural gas was shut-in for a period of over three and a half years, between 2011 and 2014, so that work could be done to tie-in a nearby oil and gas field to the Andrew platform.

In summary, the Sellers (the Andrew owners) broadly accepted that their failure to deliver gas to Scottish Power was a breach of Article 6.12 of the Agreements. It was common ground that the sole remedy for any breach of that clause was Default Gas under Article 16. However, it was Scottish Power’s case that, during the relevant period, the Andrew owners were also in breach of their obligation under Article 7.1 to operate the Sellers’ Facilities for which it was entitled to separate damages.

The Commercial Court decided that the Andrew owners were in breach of the Article 7.1 RPO obligation to operate the Sellers’ Facilities, but Scottish Power’s remedy for that breach was limited to the Default Gas Price. There was no separate right to damages at common law. A summary of the case in the Commercial Court can be read here.

Scottish Power appealed its right to common law damages to the Court of Appeal.

Court of Appeal Decision

Scottish Power contended that in refusing to grant a separate remedy of damages for a breach of Article 7.1, the Commercial Court had lost sight of the fact that there is a presumption that the parties do not intend to give up rights or claims which the general law gives them: Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 689; that clear words are required to exclude or limit that right; and that, since the Commercial Court had held that there were two possible meanings, it should have adopted the meaning which did not involve Scottish Power losing what may be very valuable rights – said to amount to up to £85 million.

However, the Court of Appeal did not regard the Commercial Court as having erred. It decided the fact that there are two possible meanings is the beginning of the inquiry, not its end. It is then necessary for the court to apply “all its tools of linguistic, contextual, purposive and common sense analysis to discern what the clause really means”. If as a result of so doing the answer becomes clear the court should give effect to it, even though the interpretation may deprive a party of a right at law which it might otherwise have had. It is open to the parties to make an agreement which has that effect.

The Court of Appeal considered that the Agreements clearly did displace Scottish Power’s rights. The Court of Appeal decided that “Article 16.6 is not a pure exclusion clause. It is a clause which replaces common law rights with a different contractual remedy, which may, in certain circumstances, be more valuable than the right to damages”. Its reasons for reaching this conclusion were:

1. First, the Agreements were carefully drafted and long-term contracts. Article 16 lays down what is in effect a contractual remedial regime in respect of underdeliveries which by Article 16.6 is intended to be comprehensive and to the exclusion of any other remedy. It would be “odd” if a breach of Article 7 provided an additional remedy as it would result in Article 16.6 having a confined application to a limited number of circumstances – particularly in the context of the force majeure clause meaning that any non-negligent mishap is likely to be already excluded from the application of Article 16.6.
2. Second, it seemed unlikely that a reasonable person would intend the words “rights, remedies and claims howsoever arising … in respect of underdeliveries” in Article 16.6 to apply only to claims where an actual nomination and consequent underdelivery was an essential ingredient of the claim.
3. Third, the words “...in full satisfaction and discharge of all rights, remedies and claims howsoever arising whether in contract or in tort or otherwise in law on the part of the Buyer against the Seller” relate in effect to causes of action (every possible one) and the rights, remedies and claims arising therefrom, and that the words that follow (“in respect of underdeliveries”) refer to the factual consequences of the breach of contract or duty in respect of which the relevant right, remedy or claim arises. Contrary to Scottish Power’s submissions, they do not mean that an underdelivery following a nomination is a requisite element of Article 16.6 applying.

Comment

As with many natural gas sale and purchase agreements, the Agreements in dispute were “lengthy and complex documents”.

On one view, the Court of Appeal simply decided that the Agreements were clear. In the face of this clarity there was no need to apply Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd. The Court of Appeal might be said to have reached its view on this clarity by applying “all its tools of linguistic, contextual, purposive and common sense analysis to discern what the clause really means” and deciding that only one interpretation of the Agreements made sense – which was that Default Gas provided an exclusive remedy for all underdeliveries. As a consequence of the sufficiently clear drafting, Scottish Power had agreed to give up its common law rights to damages for all underdeliveries caused by breach of the Agreements.

However, the reasoning of the Court of Appeal is not entirely clear on the point. The Court of Appeal appears to accept that that there might be more than one meaning to the contractual provisions, but then rather than simply favouring the presumption in Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd, the Court of Appeal sought to apply “all its tools of linguistic, contextual, purposive and common sense analysis to discern what the clause really means”. In this context, the presumption in Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd was displaced by a further analysis of the Agreements beyond that which was found in its clear words. Although the difference with the above approach might seem semantic, it is of very real importance to drafting and construing agreements. This approach would arguably downgrade the presumption in Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd.

For oil and gas lawyers drafting sale and purchase agreements for natural gas, the drafting lessons from this case appear to be:

1. In the context of the obligations in the Energy Act 2016 to maximise economic recovery on the UKCS (“MER UK”), RPO obligations that require a party to comply with the agreement (without carve out for complying with competing regulatory obligations) should be considered with care. Such an obligation may place a party in the invidious position of choosing between a breach of contract and breach of regulatory obligation under MER UK to shut-in for constructing third party access.
2. In the absence of clarity on whether express contractual remedies are the sole remedy in the event of breach of contract and negligence, there is prospect for dispute in the event of breach. In natural gas sales and purchase agreements, where Default Gas provisions are commonly included to address underdeliveries, the extent to which those clauses govern underdeliveries caused by breach or negligence will depend upon the exact drafting of the sale and purchase agreement. Parties should consider carefully when drafting natural gas sale and purchase agreements whether the Default Gas provisions should govern potentially long periods of shut-in caused by a decision of the seller, in breach of contract, to cease producing or merely short term, intermittent, underdeliveries. These are obviously very different circumstances. However, the Court of Appeal suggests that broad drafting in a Default Gas provision means that both of these circumstances can, with some ease, be captured in a Default Gas clause and common law damages excluded.

Please click here for a copy of the judgement.