Insurers: Watch Out What Contracts You Reference In Your Insurance Policies

Taking a page from the Texas Supreme Court’s insurance coverage decision arising from the Deep Water Horizon oil spill, on June 10, 2015 the 5th Circuit U.S. Court of Appeals read oilfield drilling contract limitations into insurance policies purchased to cover liability exposures undertaken by the contracting parties. (Ironshore Specialty Ins. Co. v. Aspen Underwriting, Limited, 2015 U.S.App. LEXIS 9696.)

The facts of Ironshore Specialty were that Endeavor Energy Resources (Endeavor) and Basic Energy Services (Basic) entered into an oil drilling master services agreement (MSA) containing an indemnity provision in which the parties agreed to absorb any liability for claims brought by their own employees, even if the other party was at fault. The parties agreed to obtain at least $5 million of insurance that would cover such claims. Basic’s policies, totaling $51 million, did not expressly limit the coverage for additional insureds like Endeavor to the contract specified $5 million amount.

A fire occurred at a Texas oil well owned by Endeavor, killing two of Basic’s employees. The total liability for the two fatalities likely to exceed $5 million, so Endeavor’s excess insurer, Ironshore Specialty Insurance Corporation (Ironshore) sued Basic’s excess insurers to establish that Basic’s insurers must provide coverage up to the full limits of their policies, not just $5 million, because Basic’s policies themselves did not expressly limit coverage for an additional insured like Endeavor. In response, Basic’s insurers contended that their policies imposed a $5 million limit for Endeavor because the policies referred to the MSA, which did so.

The Court of Appeals affirmed the District Court’s ruling limiting Endeavor’s coverage to $5 million, based in large part on a decision handed down February 13, 2015 by the Texas Supreme Court in the Deep Water Horizon oil spill litigation. The Deep Water Horizon case mattered because Texas law applied to the coverage dispute, so the federal court must apply the law as interpreted by that state’s highest court.

In that case, In Re Deep Water Horizon, there was a coverage dispute arising from BP’s 2010 offshore oil spill. BP, an oil field developer, contracted with Transocean, an owner of a drilling rig in the Gulf of Mexico. The parties’ drilling contract called for Transocean to indemnify BP for any above-surface pollution, and BP was to indemnify Trans Ocean for all other pollution risk. The drilling contract also required Transocean to name BP as an additional insured in its insurance policies, except workers’ compensation policies for liabilities assumed by Transocean under the terms of the drilling contract. BP sought coverage under that policy after the rig caught fire, submersed into the ocean, killed a number of crew members, and discharged millions of gallons of oil.

As in the case under discussion, the parties in Deep Water Horizon disputed whether the terms of the contract between the oilfield companies limited the coverage owed under the insurance policies. Transocean’s insurers argued that BP was not entitled to coverage for below surface pollution claims because its coverage was limited to liabilities assumed by Transocean under the drilling contract. BP argued that the existence and extent of coverage had to be ascertained exclusively from the four corners of the Transocean insurance policies, which did not themselves limit the extent of coverage to above-surface pollution.

The Deep Water Horizon matter was presented to the Fifth Circuit U.S. Court of Appeals which certified the key questions to the Supreme Court of Texas. The Texas Supreme Court found that Transocean’s policies did incorporate limitations from the drilling contract. In so doing it relied on two provisions of the insurance policies, one almost identical to the “insured contract” language in Basic’s policies. The other, the Court found, had no analog in those policies. The Texas Supreme Court found that, in these circumstances, the drilling contract required Transocean to name BP as an additional insured only for the liability Transocean assumed under the contract. Accordingly, Transocean had separate duties to indemnify and insure BP for certain risks, but the scope of those risks of either indemnity or insurance purposes extended only to above-surface pollution. The Supreme Court of Texas thus found that BP was an additional insured only to the extent of the liability Transocean assumed for above-surface pollution, and the court denied coverage for liability based on the below surface pollution.

Although the insured contract provision in Basic’s policies was essentially the same as the corresponding provision in Transocean’s policies, the federal Court of Appeals said that this did not resolve the coverage question because it was not clear what effect the In re Deep Water Horizon court gave to the insured contract provision alone. The court there also relied on another provision that is not present in Basic’s policies, adding additional insureds where required by written contract. The Fifth Circuit then had to decide whether both the “insured contract” and the “where required” provisions were necessary to the result in In re Deep Water Horizon or whether each provision standing alone formed an independent basis for the decision. The Court of Appeals said that its best reading of In re Deep Water Horizon is that each provision standing alone was a sufficient and independent basis for the decision.

The nearly identical language in Basic’s policies thus compelled the same result, according to the Fifth Circuit Court of Appeals. Because Basic was obliged only to procure $5 million in insurance, the Court of Appeals affirmed the district court’s grant of summary judgment in favor of the defendants, so that the limitation was carried over to Basic’s insurance policies.

Richard B. Wolf is a partner in the Los Angeles office of the nationwide law firm of Lewis Brisbois Bisgaard & Smith LLP. Since 1970 Wolf has specialized in insurance coverage advice and litigation.