The Texas Supreme Court has looked to the drilling contract between Transocean and BP to limit BP’s “additional insured” coverage for liability arising out of the Deepwater Horizon disaster.

Since the April 2010 explosion and ensuing spill, oilfield developer BP American Production Company and its affiliated companies (“BP”) have sought “additional insured” status under $750 million of primary and excess liability policies issued to the Deepwater Horizon rig owner Transocean Offshore Deepwater Drilling, Inc. and its affiliates (“Transocean”).  Transocean and its insurers have argued that BP was only entitled to “additional insured” coverage for above-surface pollution liability since the drilling contract between BP and Transocean required BP to indemnify Transocean for subsurface pollution risk.

In March 2013, the Fifth Circuit Court of Appeals ruled that, as long as the indemnity agreement between BP and Transocean and the insurance coverage provision in the drilling contract are “separate and independent,” only the terms of the subject umbrella policy itself—and not the provisions of the drilling contract—determine the scope of coverage afforded to BP.

While the Court of Appeals also originally found that the subject umbrella policy “imposes no relevant limitations upon the extent to which BP is covered,” the Court later withdrew that decision and certified two questions to the Texas Supreme Court.  The first question examined the scope of BP’s “additional insured” status, including whether under existing precedent the policy or the drilling contract is determinative.  The second question asked whether in interpreting the insurance provisions of the drilling contract, the insured is entitled to the benefit of the doubt in resolving any ambiguities in wording.

In the February 13th decision issued by the Texas Supreme Court, the Court did not expressly abandon the “separate and independent” test articulated in prior authorities.  Instead, the Court framed the following standard: “We determine the scope of coverage from the language employed in the insurance policy, and if the policy directs us elsewhere, we will refer to an incorporate document to the extent required by the policy.  Unless obligated to do so by the terms of the policy, however, we do not consider coverage limitations in underlying transactional documents.”

In BP’s case, the Court found that, among other things, the language in Transocean’s policies insuring those whom Transocean “is obliged” by “Insured Contract” to provide insurance points to the “additional insured” provision in the underlying drilling contract, which limits BP’s coverage to liabilities assumed by Transocean under the terms of the contract, i.e., above-surface pollution risk.  Accordingly, “BP’s status as an 'additional insured' is inexorably linked, at least in some respect, to the extent of Transocean’s indemnity obligations.”  Because the Court found an unambiguous limitation on BP’s insured status in the drilling contract, the Court did not reach the second issue certified by the Court of Appeals.

Many policies issued currently contain updated “additional insured” endorsements expressly limiting the scope of coverage to the limits and breadth of liabilities required under a separate contract.  See, e.g., CG 20 10 04 13, GC 20 37 04 13. The Court’s decision in Deepwater Horizon validates this approach.

For policies not already containing these or similar endorsements, this decision will inevitably prompt additional questions regarding the importance of “certificates of insurance”; how explicit a reference within an insurance policy must be; or what nexus that reference must have with a coverage limitation before “additional insured” status will be circumscribed. The decision also begs the question of whether a similar “incorporation by reference” standard may be applied to the determination of an insurer’s duty to defend, which is normally limited to the “four corners” of the suit against the insured. While these issues await further development, for now, BP’s “additional insured” status extends only to its above-surface pollution liability in the Deepwater Horizon spill.