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05 October 2020

Offshore wind farms – how to properly interpret an indemnity?

The recent judgment of Gwynt y Môr OFTO Plc v Gywnt y Môr Offshore Wind Farm Limited and ors [2020] EWHC 850 (Comm) concerned the proper interpretation of an indemnity in a sale and purchase agreement for the offshore transmission assets of one of the UK’s largest offshore wind farms.  This case is an interesting example of how the courts will interpret indemnities, which are commonly included in contracts regarding offshore wind farms.

The SPA and repair of the cables

By a sale and purchase agreement dated 11 February 2015 (the SPA), the Defendants agreed to sell and the Claimant agreed to buy the business of owning, maintaining and operating the electrical transmission link between Gwynt y Môr wind farm and the National Grid. The assets covered by the SPA included four subsea export cables. The transaction completed on 17 February 2015.

On 2 March 2015, one of the export cables (SSEC1) failed, with a second export cable (SSEC2) subsequently failing on 25 September 2015. As a result, the Claimant had to undertake substantial emergency repairs. The cost of reinstatement was agreed between the parties at £15 million.

Following examination of the faulty sections of cable, it was discovered that the cables had suffered from severe corrosion. It was undisputed that the most likely cause of damage was to part of the polyethylene (PE) sheath during the process of manufacture, permitting seawater to penetrate and starting the process of corrosion.

The Claimant claimed the reinstatement costs from the Defendants and relied upon an indemnity in clause 8.2 of the SPA (the Indemnity), which stated as follows:

If any of the Assets are destroyed or damaged prior to Completion (Pre-Completion Damage), then, following Completion, the [Defendants] shall indemnify the [Claimant] against the full cost of reinstatement of any Assets affected by the Pre-Completion Damage.”

In addition, the Vendors (comprising the 2nd to 9th Defendants) gave a specific warranty (the Warranty) as to the absence of damage to the assets as at the date of the SPA (save as disclosed). The Warranty was limited to what had been (a) discovered and (b) was reasonably likely to cause material disruption to the offshore transmission system.

The period encompassed by “prior to Completion”

The dispute centred on what was meant by the phrase “prior to Completion” in the Indemnity. The Claimant contended that the natural and ordinary meaning of the Indemnity was that it applied if any of the assets were damaged at any time before completion, including before the execution of the SPA.

However, the court came to the opposite conclusion, for the following reasons:

  • The SPA must be interpreted as at the date it comes into force, so the natural and ordinary meaning of the phrase “If any of the Assets are destroyed or damaged prior to Completion…” (emphasis added) is that it applies to destruction or damage which occurs thereafter, i.e. after execution but before completion.
  • Regarding the context of the provision within the SPA, it was obvious that clause 8.1 dealt with execution of the SPA and clause 9 dealt with completion. The insertion, between those provisions, of the Indemnity was understood as intended to relate to damage occurring between execution and completion.
  • To the extent there was a question about whether the Indemnity covered the warranted matters (pre-execution), the existence of the Warranty was a powerful indication that the Indemnity did not so extend. The court considered it unlikely that the intention was for the limited Warranty to be subsumed and rendered largely ineffective by the all-embracing Indemnity. Further, if the Defendants would be liable for reinstating the damage in any event, the Indemnity would remove the suggested incentive to make full disclosure.

In light of the above, the court determined that the specific wording of clause 8.2 and the broader structure, provisions and commercial sense of the SPA supported the case that the Indemnity related only to damage occurring between the execution of the SPA and completion.

The meaning of “are destroyed or damaged”

The court then considered the phrase “are damaged or destroyed” in clause 8.2. The Claimant argued that, as the corrosion to the cables constituted an adverse change to the physical condition of the cables, beyond the pre-existing defect in the PE sheath, and as it affected the value or worth of the cables, there was damage to the cables triggering the Indemnity.

The court found no basis for confining the phrase to entirely new damage, or to damage caused by an external event. However, it did observe that the phrase requires damage to be patent, i.e. readily observable or discoverable, and so did not include undiscoverable corrosion which had not adversely affected the performance of the cable.

The key reasons for this were:

  • The word “damaged” is coupled with and follows “destroyed”, indicating that either destruction or damage short of destruction is contemplated. This phrase is inappropriate to encompass the slow process of continuing corrosion.
  • The contrasting wording of the Warranty refers to “defect or damage”. The Indemnity did not cover either defects or damage flowing from defects, undoubtedly because it was intended to impose liability where it did not arise under the Warranty (except in the case of destruction or damage).
  • Further, even if unobservable corrosion could in principle have constituted damage within the terms of the Indemnity, it would only do so if it impaired the value or usefulness of the cables. There was no evidence or reason to believe that corrosion during the six days between execution and completion was in itself sufficient to impair the value or usefulness of either export cable.

The court therefore found that the Claimant was not entitled to the Indemnity under clause 8.2 of the SPA.

Rectification

In case the court’s findings above proved to be wrong, the court also considered whether the Indemnity should be rectified to limit it to the period between execution of the SPA and completion. In light of the pre-contractual communications between the parties, and in particular the contemporaneous documents that were exchanged, the court found that the Defendants would have been entitled to an order for rectification of the Indemnity, had that been necessary.

Conclusions

While this case turns on the precise wording of the SPA, it demonstrates the potential issues that can arise from the drafting of an indemnity clause and the importance of absolute clarity in their drafting to avoid disputes about what they should cover.

This case illustrates that where the contract has been heavily negotiated between two experienced parties, the court is much more likely to focus its interpretation to the wording of the contract (and place less reliance on any background factors, such as “business common sense”). The court is therefore likely to focus on differences in wording with other clauses and making sure that clauses can be read together in such a way that they do not contradict each other or render another clause ineffective.


This article was written by Amelia Hamilton. For more information, please contact Amelia on +44 (0)20 7438 2285 or at amelia.hamilton@crsblaw.com, or your usual Charles Russell Speechlys contact.

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