A well drilling company has an insurance policy that covers property damage to any well, hole, or formation, or to any drilling or well servicing machinery or equipment, arising out of operations performed by the drilling company.  The policy contains an exclusion for damage due to the performance of professional services.  If a well that the insured is drilling blows and damages well drilling equipment,  can the professional services exclusion swallow up all the coverage for damage to the well and the equipment?  According to a Texas federal court, it can and it does.

It happens more often than it should.  A construction contractor gets sued by the project owner for some alleged defect or damage.  The contractor purchased liability insurance thinking that such claims would be covered, only to have the carrier deny the claim because of a “professional services” exclusion in the policy.  Every contractor, after all, brings specialize construction, engineering, and other knowledge and experience to a project.  If it weren’t for such expertise, we could all simply do the work ourselves.  The professional services exclusion, if not limited to its proper scope, can swallow up all of the coverage otherwise provided by a contractor’s liability policy.  Unfortunately, such coverage-killing interpretations are too often applied by courts.  It happened again recently in Nicklos Drilling Co. v. Ace American Ins. Co., Civ. Action No. V-14-021 (S.D.Tex. Nov. 5, 2014).  (Get a copy here.)

The claim came up because of a petroleum well blowout caused by mistakes that were made during drilling.  Miramar Petroleum was the owner of a petroleum lease in Jackson County, Texas.  It hired Nicklos Drilling Company as a contractor to drill the well and it named Nicklos as an additional insured on a general liability insurance policy issued by Ace American.  The Memorandum and Order by the U.S. District Court for the Southern District of Texas is fairly light and bare-bones on analysis of the facts and the policy.  Getting a fuller picture of the way the dispute happened requires a review of the parties’ briefs on Nicklos’s motion for partial summary judgment.

In a droll expression of understatement, Nicklos observes: “Drilling operations did not go as planned.”  (Get a copy of Nicklos’s brief in support of its Motion for Partial Summary Judgment here.)  The problems arose as a result of “mud weight.”  Mud is the colloquial word that well drillers use to refer to drilling fluids that drilling companies employ to maintain hydrostatic pressure in the borehole as the well is being drilled.  The employee who is responsible for ensuring that the borehole contains sufficient mud is known as the Drilling Fluids Engineer.  But it’s more fun to refer to this person by the title most often used by well drillers: the “Mud Man.”  Among other tasks, the Mud Man has to monitor the weight of the mud in the borehole.  If the Mud Man fails to maintain the proper pressure from drilling fluids in the borehole, a kick or blowout can result, which is a very bad thing to have happen on a drilling project.  (These facts are not essential to the outcome of the Nicklos case; I just like using the phrase “Mud Man.”)

Getting back to the Nicklos dispute, the complaint against it, for which it was seeking coverage under the Ace policy, alleged that Nicklos “should have recognized that the well was on the verge of blowout and that the mud weight was insufficient.”  The complaint claimed that Nicklos “had experienced well operators on site who should have recognized that the pressure in the well exceeded the weight of the mud.”  According to Nicklos, it employed “roughnecks” to do the physical and manual labor of actually drilling the well.  It was not hired to consult with Miramar or to design or plan the well drilling operations.

The blowout damaged the well.  In addition, some of the equipment, the drill pipe, and other drilling tools were broken inside the well.  Nicklos sought a defense to the complaint from Ace.  The carrier denied the claim and Nicklos brought a coverage action in the U.S. District Court for the Southern District of Texas.

Unfortunately, such coverage-killing interpretations are too often applied by courts.

A key provision of the policy, one not mentioned in the Court’s Memorandum and Order, is an endorsement to the policy called the “Underground Resources and Equipment Coverage Endorsement.”  The upshot of this provision is that it provided coverage to Nicklos for claims of property damage to “oil, gas, water or other mineral substances” that have not yet reach the earth’s surface; to “any well, hole, formation or strata” through which exploration or production is being conducted; and to “any casing, pipe, bit, tool, pump or other drilling or well servicing machinery or equipment” located in a hole or well.  The policy covered Nicklos for claims of such property damage “arising out of the operations performed by you or on your behalf” during well drilling operations.

As is true of essentially all Commercial General Liability policies, the Ace policy contained a Professional Services exclusion.  This particular exclusion provided that the insurance would not apply to “preparing, approving, or failure to prepare or approve maps, shop drawings, opinion, reports, surveys, field orders, change orders, or drawing and specifications and supervisory, inspection, architectural or engineering activities” and “[a]ny other professional services provided by the insured.”  The policy did not define the term “professional services.”

Courts apply exclusions in coverage narrowly.  If there is any reasonable interpretation that would make the exclusion inapplicable to a particular claim, the court will — or should — choose that interpretation.

For the undefined term “professional services,” the Nicklos court used the definition under Texas case law: “The task must arise out of acts particular to the individual’s specialized vocation, [and] . . . it must be necessary for the professional to use his specialized knowledge or training.”  The Court might also have observed, but didn’t, that other courts generally recognize professional services as those involving work that is “predominantly mental or intellectual, rather than physical or manual.”  Lawyers, doctors, priests, engineers, architects — these are people who provide advice, opinions, recommendations, and consultations based upon specialized professional training.

What did Ace think it was insuring when it agreed to cover an oil rig operator for property damage “arising out of the operations” the rig owner had contracted to perform?

The Nicklos Court attached no such limitations to the term “professional services.”  It found, instead, that the complaint against Nicklos alleged that it “breached its contract because it failed to exercise its specialized knowledge regarding the pressure and mud weight required to prevent a blowout of the well. Miramar did not sue Nicklos in the Underlying Lawsuit based on any conduct other than Nicklos’s failure to utilize its allegedly specialized knowledge to prevent a well blowout.”

Presumably, however, preventing a well blowout is nothing more than one of an infinite number of tasks that drilling rig operators must perform to achieve the purpose of the job; that is, to reach and extract oil or gas out of the ground.  Very nearly every task performed by any employee on an oil rig requires some kind of “specialized knowledge.”  By equating the specialized knowledge required to operate an oil rig with the undefined term “professional services” in the Ace policy, the Nicklos Court nullified essentially all of the coverage Ace had agreed to provide.

One question to ask when analyzing the application of the professional services exclusion in this case might have been, “What did Ace think it was insuring when it agreed to cover an oil rig operator for property damage ‘arising out of the operations’ the rig owner had contracted to perform?”  The Nicklos Court is not the first to apply the undefined term “professional services” expansively, to include much more than the work provided by people who are traditionally or conventionally considered “professionals.”  Nor will it likely be the last.

But when courts permit insurers to use this exclusion to swallow up essentially all of the coverage the insurer provided to a contractor, they give insurance companies an undeserved and un-bargained-for windfall and the interests of proper policy interpretation — not to mention the pocketbooks of unsuspecting policyholders — suffer as a result.