Why it matters: The Texas Supreme Court rejected BP’s $750 million claim for coverage under Transocean insurance policies. Since the April 2010 Deepwater Horizon oil spill that killed eleven crew members and spilled millions of gallons of oil into the Gulf of Mexico, BP has paid tens of billions in claims. In order to recover some of its losses, BP filed claims of its own as an additional insured under a Transocean insurance policy seeking coverage for underground pollution losses. In a separate service agreement entered into by the parties, Transocean agreed to indemnify BP for above-surface losses regardless of fault and BP agreed to indemnify Transocean for underground losses. In contrast, the insurance policy, standing alone, had no such limitation. Accordingly, BP argued that the insurance policy’s additional insured provision was separate and distinct from the service contract and independently covered BP for all losses whether incurred aboveground or belowground. The court disagreed and held that the two contracts were inextricably intertwined and could not be independently considered. Reading the two contracts together, as required by the operative language, the insurance policy incorporated the service contract’s limitation. The Transocean policies required that the additional insured obligation arise from a contract involving an indemnity agreement and specify that additional insured coverage is extended as “obliged” and “where required” therein.

Importantly, the court’s decision was expressly dictated by the contractual language and the court distinguished other contradictory Texas case law on that basis. Thus, absent a finding that the contracts were inextricably bound, BP could have prevailed. It is important that all similarly situated policyholders review their existing indemnity agreements and any policies in which there may be additional insureds in order to understand ahead of time the relationship of such agreements. The court’s reasoning also should be taken into account when negotiating future indemnity arrangements.

Detailed discussion: Transocean owned Deepwater Horizon, a mobile offshore drilling unit which operated in the Gulf of Mexico pursuant to a 1998 contract between Transocean and BP.

In the indemnification provisions of the drilling contract, Transocean agreed to indemnify BP for above-surface pollution regardless of fault and BP agreed to indemnify Transocean for subsurface pollution.

To fulfill its obligations, Transocean maintained a $50 million general liability primary policy and four layers of excess policies with an additional $700 million in coverage. Each of the policies extended “Insured” status to those entities covered by an “Insured Contract.”

On April 20, 2010, the Deepwater Horizon rig suffered an explosion, caught fire, and then sank to the bottom of the Gulf. Eleven crew members died and millions of gallons of oil were discharged into the Gulf of Mexico, resulting in thousands of personal injury and environmental claims against BP and Transocean.

Both parties sought coverage under the primary and excess insurance policies. Although there was no dispute that BP was an additional insured, Transocean and the insurers argued that the drilling contract limited the scope of coverage for BP to those liabilities Transocean had expressly assumed—specifically, above-surface pollution and not subsurface oil releases as a result of the Deepwater Horizon incident.

A federal district court sided with the insurers and Transocean. The Fifth Circuit initially reversed, holding that the coverage dispute should be decided based solely on the insurance policy and not consideration of the drilling contract. But on rehearing, the federal appellate panel withdrew its prior opinion and certified contract interpretation issues to the Texas Supreme Court:

The Texas Supreme Court ruled that (1) the Transocean insurance policies include language that necessitates consulting the drilling contract to determine BP’s status as an “additional insured”; (2) under the terms of the drilling contract, BP’s status as an additional insured is inextricably intertwined with limitations on the extent of coverage to be afforded under the Transocean policies; (3) the only reasonable construction of the drilling contract’s additional-insured provision is that BP’s status as an additional insured is limited to the liabilities Transocean assumed in the drilling contract; and (4) BP is not entitled to coverage under the Transocean insurance policies for damages arising from subsurface pollution because BP, not Transocean, assumed liability for such claims,” the state’s highest court ruled.

The court rejected BP’s position that the existence—and extent— of coverage should be limited to consideration of the four corners of the Transocean insurance policies. Because the drilling contract was an “Insured Contract” and BP was an “Insured” under the policies, the company told the court its operations were automatically covered for all “liability imposed by law,” including subsurface pollution.

While the court started its coverage analysis with the policy itself, it noted that Texas has long held that insurance policies can incorporate limitations on coverage encompassed in extrinsic documents by reference.

Considering the insurance policies at issue, the Texas Supreme Court noted that BP was not named in any of them or expressly included as an additional insured in an endorsement or certificate of insurance. “[T]hus, if the coverage inquiry were constrained to the language in the insurance policy, BP would have no coverage at all,” the court pointed out.

Instead, the policies conferred coverage by reference to the Drilling Contract. “The language in the insurance policies providing additional insured coverage ‘where required’ and as ‘obliged’ requires us to consult the Drilling Contract’s additional insured clause to determine whether the state conditions exist,” the court explained. “It is immediately apparent from the plain language of this provision that BP’s status as an insured is inexorably linked, at least in some respect, to the extent of Transocean’s indemnity obligations.”

One judge filed a dissenting opinion in the case, writing that although he agreed with the majority’s principles applicable to construing insurance contracts, he would not have limited the liabilities Transocean assumed in the drilling contract. Instead, he would have limited his inquiry to the “coverage” section of the policies.

While providing that parties would be covered under an “Insured Contract,” the provision did not explicitly incorporate the language of the drilling contract and its limits, nor did the policy provide for other documents to become part of the policy, Judge Phil Johnson wrote.

To read the opinion in In re Deepwater Horizon, click here.

To read the dissenting opinion, click here.