In a case that has been closely watched by the oil and gas industry and its insurers, the Supreme Court of Texas issued its opinion in In re Deepwater Horizon on February 13, 2015, and settled the debate concerning whether a company’s insurance policies stood alone or were married to and dependent upon an insured’s limited obligation in a separate contract to insure and indemnify a third party. Specifically, the court found that Transocean’s $750 million primary and excess insurance policies did not offer unrestricted coverage to BP as an additional insured, but instead incorporated and were bound by the limitations placed on Transocean’s liability under the parties’ drilling contract (the “Drilling Contract”).

Major Takeaways: Know Your Partner, Know Your Risks, and Know Your Insurer

Offering practical guidance on contract drafting and interpretation, the decision highlights the importance of: (i) knowing the language of a party’s insurance policies as they relate to assumed liabilities in third-party contracts; (ii) ensuring that the indemnification obligations in such third-party contracts are consistent with obligations to insure a third party; and (iii) clearly defining both parties’ assumption of risks.

The Holding: It’s a Mutual Relationship; the Underlying Contract Can Limit Insurance Coverage

The In re Deepwater Horizon, No. 13-0670, 2015 WL __________ (Tex. Feb. 13, 2015) decision responded to the 5th Circuit Court of Appeals’ certified questions surrounding its prior withdrawn opinion that Transocean’s insurance policy, read alone, did not limit the amount of coverage to BP even though the Drilling Contract did not require unrestricted indemnity of BP by Transocean. The Supreme Court of Texas made three instructive findings:

  1. Transocean’s insurance policies incorporated the coverage limitations expressed in the Drilling Contract with BP;
  2. The Drilling Contract imposed a limitation on the additional insured coverage under Transocean’s primary and excess insurance policies; and
  3. There was no ambiguity in the additional insured provision in the Drilling Contract.[1]

The Underlying Case: In the Breakup, BP Claimed All of Transocean’s Insurance Coverage

BP and Transocean’s predecessors-in-interest entered into a Drilling Contract that provided that Transocean would indemnify BP for above-surface pollution regardless of fault and that BP would indemnify Transocean for all pollution risk Transocean did not assume.[2]The Drilling Contract also required Transocean to name BP as an additional insured in each of Transocean’s insurance policies, “except Workers’ Compensation for liabilities assumed by [Transocean] under the terms of this contract.”[3] Following a catastrophic well blow-out resulting in a three-month-long oil spill into the Gulf of Mexico, BP sought coverage from Transocean’s insurers for BP’s liability for below-surface pollution.[4] In response, Transocean’s insurers sought a declaration that BP was not entitled to additional insured coverage for subsurface pollution claims because of the limitation of liability in the Drilling Contract.[5] The District Court for the Eastern District of Louisiana agreed with Transocean’s insurers; however, on appeal, the Fifth Circuit reversed in favor of BP.[6]

Following a petition for rehearing, the Fifth Circuit withdrew its opinion and certified two questions to the Supreme Court of Texas:

  1. Whether BP was covered for the damages at issue, because the language of the umbrella polices alone determines the extent of BP’s coverage as an additional insured if, and so long as, the additional insured and indemnity provision of the Drilling Contract are “separate and independent.”
  2. Whether the doctrine of contra proferentem applies to the interpretation of the insurance coverage provision of the Drilling Contract given the facts of this case.[7]

The Texas Court Analysis: It’s a Two-Step Process

The Supreme Court of Texas began its analysis by reviewing the language in Transocean’s insurance policies.8 The policies defined an “Insured” as:

“any person or entity to whom the ‘Insured’ is obligated by an oral or written ‘Insured Contract’”

and further defined an “Insured Contract” as:

“any written or oral contract or agreement entered into by the ‘Insured’ … and pertaining to business under which the ‘Insured’ assumes the tort liability of another party.”[9]

Additionally the policies provided that “additional insured” status is afforded “where required by written contract, bid or work order.”[10] Based on the internal references to extrinsic documents in the insuring agreement, the court found that “at a minimum, [Transocean’s] insurance policies require reference to the underlying Drilling Contract to determine BP’s status as an additional insured.”[11]

Turning next to the Drilling Contract and the analysis of whether the additional insured and indemnity provisions of the Drilling Contract were “separate and independent,” the court looked at the additional insured language which required Transocean to name BP as an additional insured on its insurance policies, “except Workers’ Compensation for liabilities assumed by [Transocean] under the terms of this contract.” (Emphasis added)[12] The court noted that the insurance provision was “inexorably linked, at least in some respect,” to Transocean’s indemnity obligation; however, the parties differed as to the intended breadth of the limiting language.[13]

Focusing on the lack of a comma between “Compensation” and “for,” BP argued that the emphasized language was a narrow exception to Transocean’s general obligation to name BP as an additional insured, arguing that the quoted exception applied only to Transocean’s obligation to assume liability for workers’ compensation policies covering Transocean’s employees.[14] Transocean and its insurers argued that the language excepted only workers’ compensation policies from the general additional insured obligation and limited BP’s additional insured status to the extent of Transocean’s indemnity of BP.[15]

The court agreed with Transocean and its insurers on the grounds that BP’s argument was either inconsistent with other provisions in the Drilling Contract (which required BP to assume responsibility for “all claims, demands and causes of action” asserted by its employees for work-related personal injury) or rendered the words “liabilities assumed by [Transocean] under the terms of the contract” meaningless.[16] As such, the court concluded that BP was an additional insured only as to liabilities assumed by Transocean under the Drilling Contract.

In addressing the second question certified to it, the court noted that the question was directed at resolving the parties’ disagreement about whether the doctrine of contra proferentem (here, interpreting ambiguous language in favor of coverage) should apply to insurance-coverage disputes between sophisticated parties as well as the extent to which the rule applies to a contract incorporated by reference into an insurance policy.[17]Because the court did not find any ambiguity in the insurance coverage provision in the Drilling Contract, it declined to answer this question.[18]

Conclusion: Communication Is Critical; Focus on Congruency Between the Policy, the Contract, and the Insuring and Indemnity Clauses

The court’s holding in In re Deepwater Horizon highlights the importance of ensuring that both agreements to indemnify and to insure a third party are congruent and consistent with any associated underlying policy of insurance. First, the insurance policy that supports indemnity and additional insured provisions in the drilling contract, master service agreement, or similar agreement should reference the fact that its scope and interpretation rely upon limitations in the underlying contract. Without the insurance policy’s internal references to the underlying Drilling Contract, the Supreme Court of Texas may not have been required to go beyond the policy language to review the underlying contract to determine the scope of the agreement between Transocean and BP. Second, the parties to a services, equipment, or operations contract should clearly restrict the scope of any agreement to procure insurance for a third party to the amount of indemnity or other liability obligations expressly assumed by the insuring and indemnifying party. Absent language making the clauses dependent upon one another, the Supreme Court of Texas might not have relied upon the indemnity provisions as providing a limitation on Transocean’s duty to add BP as an additional insured on its liability policy. A party cannot rely upon its insurer to address this issue through a specific and limited additional insured endorsement alone; the decision makes clear that oilfield participants must be clear in their agreements as to the interrelationship of the liabilities, indemnities, and insurance that they assume in their contracts.