Digging Deeper Into Deepwater Horizon

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1 Portfolio Media. Inc. 860 Broadway, 6th Floor New York, NY Phone: Fax: Digging Deeper Into Deepwater Horizon Law360, New York (May 31, 2013, 12:24 PM ET) -- In a wakeup call to insurers and policyholders alike, the Fifth Circuit Court of Appeals recently extended additional insured coverage beyond the scope of liabilities assumed in an underlying service contract between the policyholder and an additional insured. The Fifth Circuit panel concluded that BP was an additional insured under Transocean s insurance policies with respect to subsurface pollution arising out of the Deepwater Horizon oil spill, even though Transocean agreed to assume only liabilities arising from surface pollution and agreed to extend additional insured coverage to BP for liabilities assumed by [Transocean] under the terms of this Contract. The Fifth Circuit held that BP was an additional insured as to liabilities beyond those for which Transocean agreed to indemnify BP because the policies did not contain any limitation on additional insured coverage or incorporate limits from the underlying drilling contract. See In re Deepwater Horizon, 710 F.3d 338 (5th Cir. 2013). The Fifth Circuit should grant the unusual remedy of rehearing the case en banc and should vacate the panel decision. The most reasonable reading of the policies is that the insurers provided BP with additional insured coverage only for liabilities that Transocean assumed under the drilling contract that is, only for liabilities from surface pollution but not the subsurface pollution at issue in the Deepwater Horizon blowout. The Fifth Circuit panel based its decision on a Texas Supreme Court decision that is factually distinguishable and did not follow Fifth Circuit precedent supporting the insurers position. The decision could affect thousands of policies and drilling contracts in the heart of the U.S. oil and gas industry. In the wake of In re Deepwater Horizon, meanwhile, insurers and policyholders should consider expressly limiting additional insured coverage to the scope of liabilities assumed in underlying contracts. Digging Deeper Into In Re Deepwater Horizon Transocean and BP entered into a contract for exploratory drilling at the Macondo Well in the Gulf of Mexico. Under the drilling contract, Transocean assumed liability for surface pollution, while BP assumed liability for subsurface pollution. Transocean agreed to indemnify BP against losses arising from surface pollution. Likewise, BP agreed to indemnify Transocean from liabilities arising from subsurface pollution.

2 The contract required: Without limiting the indemnity obligation or liabilities of [Transocean] or its insurer, at all times during the term of this Contract, [Transocean] shall maintain insurance covering the operations to be performed under this Contract as set forth in Exhibit C. Exhibit C to the drilling contract required, in paragraph 1.c, that Transocean carry Comprehensive General Liability Insurance, including contractual liability insuring the indemnity agreement as set forth in the Contract. Exhibit C also required, in paragraph 3, that BP be named as an additional insured in each of [Transocean s] policies, except Workers Compensation for liabilities assumed by [Transocean] under the terms of this Contract. Transocean s insurance policies provided that the insurers agreed to pay for ultimate net loss by reason of liability assumed by the Insured under an Insured Contract. The policies defined insured as any person or entity to whom the Insured is obliged by written Insured Contract... to provide insurance such as is afforded by this Policy but only with respect to... liability arising out of operations conducted by the Named Insured or on their behalf. They defined insured contract as any contract entered into by the Insured and pertaining to business under which the Insured assumes the tort liability of another party to pay for... Property Damage... to a Third Party. A general condition of the policies was that the insurers agree where required by written contract [that] additional insureds are automatically included hereunder. The policies were governed by Texas law. The Deepwater Horizon Blowout In April 2010, Transocean s Deepwater Horizon offshore drilling platform exploded and sank, resulting in the spilling of millions of gallons of oil into the Gulf of Mexico. BP claimed additional insured coverage under Transocean s insurance policies following the blowout. BP argued that it was entitled to additional insured coverage beyond the scope of Transocean s contractual indemnity of BP (since Transocean indemnified BP only for liabilities from surface pollution, while the liabilities at issue stemmed from subsurface pollution). Transocean s insurers sought a declaratory judgment that they had no additional insured obligations to BP. The insurers argued that additional insured coverage was limited to the scope of liabilities that Transocean assumed and as to which Transocean indemnified BP under the underlying drilling contract. The Fifth Circuit ruled that BP was an additional insured under the policies. It relied on Texas Supreme Court precedent to conclude that the insurance policies, and not the indemnity provisions of the drilling contract, governed whether BP was an additional insured. It concluded that the policies did not contain any limitation on additional insured coverage or incorporate any limits from the underlying drilling contract, as long as the insurance provision and the indemnity provision in the drilling contract were separate and independent. An exhibit to the drilling contract required, in one paragraph, that Transocean obtain insurance coverage for its contractual liabilities. The same exhibit, in a separate paragraph, required that BP be named as an additional insured in Transocean s policies.

3 The court concluded that the insurance provision and the indemnity provision in the drilling contract were separate and independent. It therefore held that the additional insured coverage was not limited by the scope of Transocean s contractual indemnity to BP, and thus, BP was an additional insured. Why the Fifth Circuit Should Grant En Banc Review and Vacate the Panel Decision The policies afford BP additional insured coverage only for liabilities assumed by Transocean for which Transocean provided indemnity to BP in the drilling contract. The drilling contract required that Transocean insure the indemnity agreement as set forth in the drilling contract. It required that BP be named as an additional insured in each of [Transocean s] policies, except Workers Compensation for liabilities assumed by [Transocean] under the terms of this Contract. Transocean agreed to indemnify BP against losses arising from surface pollution but not subsurface pollution. The drilling contract thus required Transocean to provide additional insured coverage to BP for liabilities assumed by Transocean and as to which Transocean indemnified BP, namely, for surface pollution, but not subsurface pollution. The policies, in turn, insured against liability assumed by an insured under an insured contract, defined as any contract under which the Insured assumes the tort liability of another party to pay for... Property Damage... to a Third Party. The insurers agreed to add additional insureds where required by written contract. The most reasonable interpretation of these provisions is that BP was an additional insured only for liabilities assumed by Transocean under the terms of the drilling contract. In a belt and suspenders approach, the policies and the drilling contract provided coextensive additional insured and indemnity coverage to BP. Read reasonably, BP was an additional insured only to the extent that Transocean assumed such liabilities in the underlying drilling contract. After all, drilling contracts are designed to provide an operator with rigs and crews, not with insurance coverage for its own risks. The Texas Supreme Court s decision on which the Fifth Circuit relied, Evanston Ins. Co. v. ATOFINA Petrochems. Inc., 256 S.W.3d 660 (Tex. 2008), did not compel a ruling that BP s additional insured coverage was broader than liabilities Transocean assumed in the drilling contract. In ATOFINA, the Texas Supreme Court held that a refinery owner was an additional insured under its contractor s insurance policies in connection with liabilities from a wrongful death lawsuit. The Fifth Circuit in Deepwater Horizon distilled from ATOFINA and the Fifth Circuit s decision in Aubris Resources LP v. St. Paul Fire & Marine Ins. Co., 566 F.3d 483 (5th Cir. 2009), the principle that only the umbrella policy itself may establish limits upon the extent to which an additional insured is covered. In re Deepwater Horizon, 710 F.3d at 347. However, the Fifth Circuit incorrectly extended the rulings of ATOFINA and Aubris beyond the facts of those cases. First, the policy in ATOFINA did not refer to the underlying service contract. The policy in ATOFINA defined insured as a person or organization for whom you have agreed to provide insurance as is afforded by this policy. ATOFINA, 256 S.W.3d at 664.

4 By contrast, the Transocean policies defined insured as an entity to whom the insured was obliged by an insured contract to provide insurance. An insured contract was a contract under which Transocean assumes the tort liability of another party. The insurers agreed to add additional insureds only where required by written contract. The Transocean policies unlike the policy in ATOFINA required resort to the drilling contract to determine the scope of additional insured coverage. Second, the additional insured provision in Aubris was broader than the additional insured provision in the Deepwater Horizon drilling contract. The service contract in Aubris required that Aubris shall be named as additional insureds in each of Contractor s policies except Workers Compensation; however, such extension of coverage shall not apply with respect to any obligations for which United has specifically agreed to indemnify Contractor. Aubris, 566 F.3d at 487. The additional insured provision granted broad coverage with a limited exclusion, whereas the BP- Transocean drilling contract provided limited coverage only for liabilities assumed by [the policyholder] under the terms of this Contract. The court in Aubris concluded that a separately considered and extra-contractual decision was required for Aubris to specifically agree to indemnify the contractor and thus exclude additional insured coverage. Id. at 490. The court found additional insured coverage because there was no separate, specific indemnity agreement. Unlike the contract in Aubris, the BP-Transocean drilling contract s insurance provision referred to the drilling contract itself rather than to extra-contractual indemnities and therefore it permitted a court to consider the indemnity provision in determining additional insured coverage. The conclusion in ATOFINA and Aubris that the court must consider only the insurance policy, and not the service agreement, in determining the scope of additional insured coverage flowed directly from the language of the contracts in those cases. That rule, however, does not apply where the relevant contracts extend additional insured coverage for liabilities assumed by [the policyholder] under the terms of this Contract language which requires that the policies and the drilling contract be read together to determine coverage. Moreover, Fifth Circuit precedent permits courts to consider an underlying services contract in determining the scope of additional insured coverage under an insurance policy. In Becker v. Tidewater Inc., 586 F.3d 358, 370 (5th Cir. 2009), the insurance policy defined assured as a person the named assured was obligated by contract to name. The service agreement required Tidewater to name Becker as an additional insured but only with respect to the risks assumed by [Tidewater] in this Charter. The court held that the scope of coverage was limited to risks assumed by Tidewater under the underlying services contract. Id. at Limiting BP s additional insured coverage to liabilities Transocean assumed in the BP-Transocean drilling contract is therefore consistent with ATOFINA, with prior Fifth Circuit precedent and with the wellestablished principle that courts must give effect to the parties unambiguous agreement. Insurers and policyholders may nonetheless wish to ensure that service contracts and insurance policies expressly limit additional insured coverage to the scope of liabilities assumed in underlying contracts, where they desire, if only to confirm the plain meaning of such contracts and to avoid costly litigation.

5 For example, a form contract of the International Association of Drilling Contractors provides that a contractor shall name an operator as an additional insured under its policies of insurance but only to the extent of the indemnification obligations assumed herein. See IADC Daywork Drilling Contract 13. Similarly, insurers may wish to consider language limiting additional insured status to the extent that the named insured has assumed the additional insured s liability in a written insured contract. Insurers and policyholders should, of course, consult closely with counsel to draft effective language in light of the relevant contractual relationships and recent case law in the governing jurisdiction. Such language may confirm the plain meaning and intent of the contracts in In re Deepwater Horizon: that the insurers named additional insureds only to the extent of the liabilities assumed under the underlying services contract. --By Ethan V. Torrey, Choate Hall & Stewart LLP Ethan Torrey is a partner in the insurance and reinsurance practice group at Choate Hall & Stewart in Boston. The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice. All Content , Portfolio Media, Inc.