The International Union of Marine Insurance (IUMI) annual conference took place in Toronto last week. On Tuesday 17th September, Tim Taylor, Partner in our energy and marine insurance team, highlighted a range of issues surrounding changes in ownership of offshore assets. Here is a summary of his thoughts on the issues that can arise for insurers.
Does a change of ownership increase the risk profile?
The reasons for the sale of field assets are many and varied but it is not uncommon for large operators to sell late life assets to smaller, leaner and meaner extraction companies.
As offshore assets are increasingly operating beyond their original design life (more than 50% in the UK Continental Shelf), the key concern when there is a change of ownership is the loss of institutional knowledge. If the new operators do not know that there is a problem with ageing assets then insurers won’t either. The UK Health & Safety Executive have highlighted this:
“Ageing equipment is equipment for which there is evidence or likelihood of significant deterioration and damage taking place since new, or for which there is insufficient information and knowledge available to know the extent to which this possibility exists.”
UK HSE definition
What happens legally in the claims context when there is a change of ownership of the assets?
The sorts of issues which can arise and have arisen in practice include:
- If a change of ownership occurs after the loss, the normal situation is that the new owner has no claim. The former owner may try to assign the claim or the benefit of the insurance to the new owner of the assets but the policy terms often bar assignment without the consent of insurers.
- If a loss occurs during one period of ownership but only manifests itself after change of ownership, the immediate issue to consider is whether the loss occurred during the new owner's policy period. In England, the date the cause of action accrues is the date when the peril causing damage occurs even though it may not be discovered until much later. If the damage occurred during the earlier period, there is an obvious difficulty because the new owner had no interest in the property at the time damage occurred and cannot claim, and the former owner is no longer interested. At the very least, there is an evidential issue as to when the damage occurred.
- There can also be problems with pre inception perils. The general principle is that the peril and the damage must occur during the same policy period. There are important exceptions to this where there is express provision in the policy, for example an extension to cover design defects which predate inception or for latent defects.
- Problems can also arise when the damage is progressive over a period of years and over different policy periods. There is little authority concerning the accrual of causes of action in respect of progressive damage under a contract of indemnity insurance. Adjusting practice has been to spread the loss and the deductibles over the relevant years. The general view in England is that there is a separate incidence of loss in each period (attracting its own deductible) unless it can be established that all of the loss occurred in the first period and what happened later did not make the loss worse.
What happens when the corporate entity which owns the assets (as opposed to the assets themselves) changes hands?
In this scenario, the corporate entity which owns the assets has not changed and issues regarding which policy pays may not matter as much but even though the legal identity of the owner may not change, the operational management may change and this will have an impact on the evaluation of the risk.
Also, it is common for the old insurances to be cancelled and for the risks to be bundled as part of the new owner's package which is not always a smooth process. There have been cases where the old insurance was not cancelled for several months and the old insurers have been faced with a new loss arising post sale.
Other problems to consider:
- the effect on LOPI claims where an asset is sold during the indemnity period;
- where the new owner’s package policy contains a generous automatic acquisition clause which gives no effective underwriting control over the assessment of the assets acquired; and
- if there is unrepaired damage which is known at the time of sale, traditional marine policies restrict the recovery to the lesser of the reasonable cost of repair or the depreciation in the value of the asset at the termination of the policy. However, upstream energy policies frequently contain more generous deemed depreciation measures of indemnity which are not really appropriate for end of life assets.
There is a trend where established operators dispose of their ageing assets to new operators towards the end of their lives. Under the regulatory framework applicable in the North Sea, an owner cannot completely dispose of its liability to decommission offshore assets by disposing of them as the time for decommissioning draws closer.
Although those engaged in such sales try carefully to allocate responsibility for decommissioning costs and are quite creative in how this is done by creating funds or using significant tax breaks that are available, The Petroleum Act 1998 and the Energy Acts of 2008 and 2016 recognise that smaller companies might not be able to meet the decommissioning costs and potential liabilities when the time comes despite the allocation of risk. If the operator does not meet its decommissioning costs, liability transfers to previous operators in perpetuity. This is what some (who were around in the 1970's) call the "Hotel California" syndrome, “You can check out any time you like, But you can never leave!”
However, there are various ways in which this exposure can be managed. This seemingly onerous burden may present the insurance market with an opportunity to sell more insurance against the risk of financial default by a new buyer of old field assets which cannot meet the decommissioning costs when the time arises.
There are several potential pitfalls that arise as ownership changes increase and which need to be addressed. These can have important consequences for insurers but give rise to opportunities as well.