A Look at Drilling Contracts Under Pennsylvania Law

You may have heard that there is a bit of natural gas drilling going on in Pennsylvania.  Thus far, the legal issues have dealt with environmental regulations, zoning, leasing, and rights of way.  The players involved in those matters have generally been landowners, government agencies, and the natural gas companies (the well operators).  The Courts have seen few – if any –  “intra-industry” disputes, that is disputes between drillers (and other trades) and operators or drillers and other trades.

Because litigation is like death and taxes, it is only a matter of time before a significant intra-industry dispute finds it way to a Pennsylvania court (as I will explain there is a reason the dispute will be resolved in Pennsylvania and not another jurisdiction).  According  to the International Association of Drilling Contractors, the IADC Daywork Drilling Contract is the most utilized contract form by operators  and drillers.  Because much of the case law interpreting the IADC contract’s terms comes from traditional oil and gas jurisdictions like Louisiana and Texas it is worth reviewing certain provision of a Standard IADC Daywork Drilling contract under Pennsylvania law.

1.  Payment Terms

Under paragraph 5.2 of the Daywork Contract,  the length of time an operator has to pay an invoice is left blank and, therefore, left to negotiation between the parties.  Here, we have the first instance where the Daywork Contract intersects with the Pennsylvania Contractor and Subcontractor Payment Act, 73 P.S. 501, et. seq. (the “Payment Act”), which broadly applies to any agreement to perform work on any real property within the Commonwealth.  Under Section 505 of the Payment Act, if the agreement is silent on when payment is due, payment must be made within twenty days of receiving an invoice.  Therefore, if no time frame is inserted into the Daywork Contract, under the Payment Act twenty days will be the default period for payment.  Drillers should consider this when negotiating their Daywork Contracts and be waryof agreeing to a payment period greater than statutorily prescribed.

Interestingly, the Daywork Contract contains a provision quite similar to Sections 506 and 511 of the Payment Act, whereby an Operator can withhold payment for a disputed item by giving the Driller notice of the disputed item within fifteen days of receiving the invoice, with timely payment of any undisputed portion of the invoice being made.  Under Section 511 of the Act, a contractor can likewise withhold payment to a subcontractor for disputed items, however, it must do so within seven, rather than 15, days.  Therefore, Drillers should consider changing the standard 15 day period to 7 to be consistent with Pennsylvania law.

Finally, paragraph 5.3 of the Daywork Contract states that invoices not paid by the prescribed due date shall bear a certain rate of interest.  Here, the parties to a Daywork Contract should be aware of the stringent penalties of the Payment Act.  Under the Payment Act, unpaid invoices shall bear interest at 1% per month.  Moreover, if litigation is commenced to recover payment, a Court may assess an additional 1% penalty per month on outstanding amounts.  Finally, if litigation is commenced to recover payment, there is a mandatory award of attorneys fees to the substantially prevailing part.

2. Liens

The Contract states that the Driller will not allow liens from “third parties” to be filed against the “lease, well, or other property” of the Operator.  Following the 2007 Amendments to Pennsylvania’s Mechanics Lien Law, lien waivers – except those given in exchange for payment – were declared void as a matter of public policy.  To the extent this clause is intended to act as an indemnification clause for lien claims, then it would pass muster.  However, to the extent it is intended to act as a waiver of any lien rights of third parties, it would not.  Finally, it is interesting that the clause relates only to third party claims, thus allowing a Driller itself to file a lien, notwithstanding any prohibition under Pennsylvania Law.

3.  Venue

The Contract contains a choice of law clause which permits the parties to stipulate to enforcement of the contract under a the law of a certain jurisdiction.  Under the Payment Act, “[m]aking a contract subject to the laws of another state requiring that any litigation, arbitration or other dispute resolution process on the contract occur in another state, shall be unenforceable.”   As will be discussed below, this impacts the indemnification provision of the Contract the most.

4.    Indemnification

Last but certainly not least are the Contract’s indemnification provisions.  The Contract’s indemnification provisions are more comprehensive than a typical construction contract.  State law dictates whether an indemnification provision of a contract is enforceable and because Pennsylvania law will apply because of the Act, it is important to know how Pennsylvania law views the various indemnification provisions of the Contract.

Generally, the Contract contains a  “broad form” indemnification provisions that state that each party agrees to indemnify the other for all claims, demands, and causes of action arising from the actions of the others employees, subcontractors, or agents.  The right to indemnification is “without regard to  . . . the negligence of any party or parties.”  Presumably, this is a lawyer’s way of saying “including the indemintee’s own negligence.”

Additionally, the Contract contains indemnification provisions related to pollution or contamination.  Under those indemnification provisions, the Driller indemnifies the Operator for any claims arising from pollution or contamination that originates above the surface.  Conversely, the Operator agrees to indemnify the Driller for any claims arising from pollution or contamination originating elsewhere.  However, the environmental indemnification provision is silent on whether the indemnity is triggered even if the pollution is caused by the other party’s negligence.

Pennsylvania Courts hold that an indemnification provision will not be construed to require indemnification for an indemnitee’s own negligence unless this intention is stated explicitly in clear, precise, and unequivocal terms and distinguish between indemnity clauses that specifically refer to liability arising from a party’s own negligence and those that call for indemnity for “all liability” or “all loss.”  If an indemnity clause does not expressly mention liability arising from the indemnitee’s own negligence, the clause will not cover that situation despite broad, all inclusive language that might suggest otherwise.

While the language of the Contract’s general indemnity provision may be sufficient under Pennsylvania law to trigger indemnification of the other party even when the other party is negligent, the parties should not risk it.  The parties would be better off amending the Contract’s general indemnification language to simply say “including the indemnitee’s own negligence.”  Otherwise, the parties are inviting litigation over the interpretation of contractual language novel to Pennsylvania courts.  Furthermore,  the parties should decide whether the environmental indemnification provisions will include indemnification for the other party’s negligence and, if so, include it in the Contract.  Otherwise, the unsuspecting indemnitee may be left without indemnification.

It is only a matter of time to we see our first Pennsylvania case litigating these issues.  Hopefully, you are prepared.

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