On the Eve of a Historic Trial, the Court in the Deepwater Horizon Litigation Extends Indemnity in the BP-Transocean Drilling Contract to Include Transocean's Gross Negligence

Before the most anticipated maritime trial so far this century begins on Monday, it is important to consider the indemnity ruling reached a few weeks ago that substantially impacts the litigation and potentially has far-reaching implications for maritime indemnity contracts. In this alert, we also look ahead to the parameters of the anticipated trial should a settlement not be reached.  

A New Framework Suggested for Interpreting Maritime Indemnity Clauses

On January 26, 2012, the United States District Court for the Eastern District of Louisiana issued its order and reasons requiring BP American Production Co., BP Exploration and Production, Inc. and BP p.l.c. (collectively referred to as BP) to indemnify Transocean Offshore Deepwater Drilling Inc. (et al.) (Transocean), as owner of the Deepwater Horizon rig, for pollution claims asserted by third parties, even if the claims were caused by Transocean’s own gross negligence. The court also held that the indemnity was unenforceable as against public policy for punitive damages, as well as Clean Water Act (CWA) civil fines and penalties.1

The decision was one of several pre-trial motions pending before Judge Carl Barbier in the multi-district litigation (MDL). The MDL is comprised of the thousands of claims for death, personal injury and pollution damage that arose from the April 20, 2010 explosion and fire on the Deepwater Horizon and the subsequent discharge of millions of barrels of oil into the Gulf of Mexico.2 Transocean’s motion was filed in the context of two actions: (1) a limitation action filed by Transocean as owner of the Deepwater Horizon pursuant to the Shipowner’s Limitation of Liability Act (the Act)3; and (2) the U.S. government action by way of the Department of Justice seeking a declaration of unlimited liability for legal costs and damages under the Oil Pollution Act of 1990 (OPA 90) against both the BP and Transocean related entities, and for civil penalties under Section 311(b)(7) of the CWA.

Transocean’s motion for partial summary judgment requested that the court uphold its indemnity against BP from claims and liabilities relating to pollution originating below the surface of the water “even if Transocean is strictly liable or the pollution was caused by Transocean’s fault or gross negligence.”4 BP admitted that the contract required it to indemnify Transocean for such pollution claims arising from Transocean’s “fault or negligence,” but argued that there was no reference in the indemnity provision to gross negligence. In addition, BP opposed Transocean’s motion on the basis of the fairly well-settled maritime law concept that public policy prohibits and invalidates a contractual indemnity that purports to include gross negligence or intentional misconduct.5 The parties agreed that maritime law governed the interpretation of the contract.  

Incorporation of Gross Negligence to Indemnity Provision

As an initial matter, the court interpreted the BP-Transocean drilling contract indemnity to cover liability of Transocean “whether such negligence be sole, joint or gross,” based on incorporation of the risk allocation language contained in the contract’s catch-all indemnity clause. In doing so, Judge Barbier found that the term “negligence or fault” was not controlling; instead the catch-all reference to “gross” negligence meant the parties agreed that grossly negligent conduct by Transocean would be allocated to BP for pollution originating below the surface of the water. Thus, the public policy arguments would not be assessed on a contractual “clean slate,” but instead the court’s incorporation of the catch-all reference shifted the analysis to focus on weighing public policy concerns against the expressly negotiated terms of the contract.

Turning to the legal analysis, the court distinguished a contract that acts as a “release” from an “indemnity” for damages owed a third party: “As distinguished from a release, a true indemnity agreement determines which party to a contract ultimately bears the risk of injury to a third party.” (bold in original) (citations omitted). Judge Barbier’s distinction between a release and a pure indemnity situation had not previously been relied upon in any reported maritime cases analyzing public policy limits on gross negligence in indemnity provisions.

Expansion of Indemnity Under Maritime Law to Include Gross Negligence

The court distinguished all Fifth Circuit precedent on the issue, largely adopting the arguments proffered by Transocean. Concerning the most recent decision, Baker v. Tidewater, Inc., 586 F.3d 358, 367 (5th Cir. 2009), Judge Barbier observed that the indemnity agreement in Baker was held expressly not to extend to gross negligence.6 The court then dispensed with the more aged decisions in Houston Exploration Co. v. Haliburton Energy Services, Inc.,7 and Todd Shipyards Turbine Serv., Inc.,8 by indicating that both cases involved a contractual release from liability, as opposed to a true indemnity.9 The court concluded: “because public policy was not an issue in Becker, and because Houston Exploration and Todd Shipyards concerned releases, not indemnities, this Court is free to decide this question.”10

The court next reviewed the two competing principles underlying extension of indemnity to include grossly negligent conduct: “the issue creates tension between two policies: freedom of contract, which weighs in favor of enforcing the indemnity, and a reluctance to encourage grossly negligent behavior, which weights against enforcing the indemnity.” As for the freedom of contract issues, the court held that Transocean and BP appear to have held roughly equal bargaining power both being sophisticated entities engaged in a “potentially lucrative and obviously risky endeavor.”11 It considered the drilling contract to reflect the parties’ attempts to “allocate risk ahead of time in order that a certain degree of certainty may be brought to the risks inherent in that undertaking.”12 The court also noted that with a true indemnity, the injured third party typically is not restrained from seeking compensation; rather, the source of the compensation is shifted to the indemnitor.

Indemnity Invalidated as to Punitive Damage and CWA Penalties

Relying on the Restatement (Second) of Contracts § 195, references to Williston on Contracts and case law support from other jurisdictions that have held that indemnification for gross negligence does not violate public policy, the court concluded: “if Transocean committed gross negligence that caused pollution originating below the surface of the water, public policy would not bar its claim for contractual indemnity from BP. However, this holding is limited to compensatory damages, and does not include any punitive damages which might arise if Transocean is found grossly negligent.”13

With respect to CWA penalties, the court reviewed the legislative history underlying Section 311(b)(7), noting that the civil penalty “has multiple goals including restitution, but the primary objectives are to punish and deter future pollution.”14 The court also noted that assessing a civil penalty requires consideration of several factors such as the seriousness of the violation, the defendant’s culpability, and the economic impact of the penalty on the defendant. Because the CWA penalty should be “tailored” to the defendant, and is primarily intended to deter future violations, the court held that public policy invalidated the indemnity provision to the extent it includes civil penalties under Section 311(b)(7) of the CWA.

The Trial Ahead

After years of legal maneuvering, the first of three Deepwater Horizon trial phases is scheduled to begin on February 27. Because this is a limitation of liability action under U.S. law where the vessel owner15 is seeking to cap its liability to the value of the rig lost and pending freight (or charter hire), the shipowner traditionally has the burden of proof in showing it is entitled to invoke the defense. But Transocean is not presenting the first witness here. After many letters, motions and hearings, the Department of Justice will instead be calling the first witness, a senior U.S. executive from BP.

The Department of Justice will be ready. Having taken over several floors of an office building right across from the federal courthouse in New Orleans soon after the spill, the DOJ has been involved in every aspect of the litigation. The potential fines and penalties sought are massive, and Judge Barbier has made clear that all parties are legitimate targets given that public policy has been invoked to invalidate any indemnity for these penalties, as we discussed above. Phase One of the trial will probe the causes of the blowout and both fact witnesses and expert witnesses will be called. With motions limiting the number of witnesses, reports and exhibits to be used at trial still being considered, the length of the first trial phase is not yet certain. Phase Two’s focus will cover post-blowout events, and the actions taken by all involved parties in trying to contain the oil spill. The final phase will assess the containment results and the actions of a larger group of parties involved in those efforts. Judge Barbier, not a panel of jurors, will determine the ultimate findings of fault and apportion a percentage of responsibility to the parties.

Although the spill is often referred to as the “BP” oil spill, BP may well benefit from the trial phase system as constituted by Judge Barbier. Although BP’s witnesses will be probed immediately, BP has the advantage of being able to hear the case in chief of the government (let alone other parties) play out before their witnesses and case in chief are heard. Short of a settlement prior to trial, everything from witness lists to courtroom guest lists to courtroom spaces for companies and real-time computer technology are in place. Come February 27, oil services companies, their investors and their counsel will be paying careful attention to the massive trial in New Orleans.  

Conclusion

We do not use the term “groundbreaking” lightly: the significance of this indemnity decision is undeniable. The lasting legal legacy of the Deepwater Horizon incident may surprise the maritime and legal communities. It may not be the record speed to trial (less than two years post-incident), the multi-billion-dollar penalties sought by the government or the expediency of the Gulf Coast Claims Facility and its impact on plaintiffs’-side litigation. Rather, it may be Judge Barbier’s decision interpreting maritime indemnity provisions in the context of sophisticated companies that has the potential to rewrite the meaning of many contracts already in place for maritime projects, and to influence the drafting of those yet to be written.