TX Supreme Court: Extrinsic Document Determines Coverage, BP Faces $750 Million in Uninsured Pollution Damages from Deepwater Horizon Explosion | Practical Law

TX Supreme Court: Extrinsic Document Determines Coverage, BP Faces $750 Million in Uninsured Pollution Damages from Deepwater Horizon Explosion | Practical Law

The Supreme Court of Texas (TX Supreme Court) held in In re Deepwater Horizon that a commercial liability insurance policy's additional insured coverage can be limited by an extrinsic contract if the policy refers to the extrinsic document in defining additional insured coverage. The TX Supreme Court's opinion answered a question certified by the US Court of Appeals for the Fifth Circuit in connection with the 2010 BP Deepwater Horizon explosion in the Gulf of Mexico.

TX Supreme Court: Extrinsic Document Determines Coverage, BP Faces $750 Million in Uninsured Pollution Damages from Deepwater Horizon Explosion

by Practical Law Commercial
Published on 25 Feb 2015 • Texas
The Supreme Court of Texas (TX Supreme Court) held in In re Deepwater Horizon that a commercial liability insurance policy's additional insured coverage can be limited by an extrinsic contract if the policy refers to the extrinsic document in defining additional insured coverage. The TX Supreme Court's opinion answered a question certified by the US Court of Appeals for the Fifth Circuit in connection with the 2010 BP Deepwater Horizon explosion in the Gulf of Mexico.
On February 13, 2015, the Supreme Court of Texas (TX Supreme Court) answered questions on certification from the US Court of Appeals for the Fifth Circuit , in In re Deepwater Horizon, and held that a commercial general liability (CGL) policy's additional insured coverage can be determined by looking to an extrinsic document if the policy defines additional insured coverage by referring to the terms of the extrinsic document (No. 13–0670, (Tex. Feb. 13, 2015)).
The TX Supreme Court's opinion clarifies its precedent on the issue and, considering the $750 million uninsured exposure BP faces after this decision, serves as an important reminder for parties contemplating commercial transactions to reconcile relevant insurance policies with any risk allocation and indemnity provisions in their underlying contracts.

Background

Drilling Contract and Insurance Policies

Transocean Offshore Deepwater Drilling, Inc. (Transocean) and BP America Production Company and some of its affiliates (BP) entered into a contract for drilling oil in the Gulf of Mexico (Drilling Contract). Under the terms of the agreement, the oil was drilled:
  • By Transocean's employees using Transocean's deep sea oil rig (the Deepwater Horizon), in exchange for scheduled fees paid by BP.
  • Under BP's direction and drilling license.
The Drilling Contract also included the following terms and provisions:
  • The parties agreed to mutual hold harmless provisions (commonly referred to as a knock-for-knock allocation of risk), as is standard in the oil and gas industry.
  • Transocean agreed to indemnify BP for above-surface pollution.
  • BP agreed to indemnify Transocean for all pollution risk that Transocean did not assume. Relevantly, this was determined to mean that BP indemnified Transocean for all subsurface pollution, which includes pollution in and to waterways.
  • Transocean agreed to carry multiple types of insurance at its own expense, including CGL coverage for the indemnity with BP.
  • Transocean was also obligated to name BP as additional insureds in each of Transocean's insurance policies "for liabilities assumed by [Transocean] under the terms of [the Drilling] Contract (emphasis added)."
To cover its insurance obligations, Transocean secured and maintained:
  • A $50 million CGL policy as its primary policy.
  • Coverage totalling $750 million, from four layers of excess-insurance from several insurers.
Transocean's insurance policies were governed by Texas law and covered losses that were either:
  • Imposed on Transocean by law.
  • Assumed by Transocean under an insured contract (the Drilling Contract).

Deepwater Horizon Explosion and Coverage Demands

After the Deepwater Horizon oil rig exploded in April 2010, resulting in the discharge of millions of gallons of oil into the Gulf of Mexico, both Transocean and BP sought coverage under Transocean's primary- and excess-insurance policies to cover the losses related to the subsurface pollution (see Drilling Contract and Insurance Policies).
In response to BP's demands for coverage, Transocean's insurers sought a judgment in the US District Court for the Eastern District of Louisiana declaring that BP was not entitled to coverage as an additional insured because Transocean's additional insured coverage was limited only to liabilities Transocean assumed in the Drilling Contract (see Drilling Contract and Insurance Policies).

Coverage Dispute Litigation between BP, Transocean and Transocean's Insurers

The federal district court held at trial that BP was not entitled to coverage as an additional insured because additional insured status in Transocean's policy was defined and limited by provisions in the Drilling Contract. The US Court of Appeals for the Fifth Circuit originally overturned the district court, reasoning that Texas state precedent did not allow the use of extrinsic evidence in construing the scope of an insurance policy.
The language in the Drilling Contract most at issue in both the district court and Court of Appeals was the description of BP as an additional insured "for liabilities assumed by [Transocean] under the terms of [the Drilling] Contract" (see Drilling Contract and Insurance Policies).
After a rehearing, the Court of Appeals certified the following dispositive question of Texas state law to the TX Supreme Court:
"Whether [TX Supreme Court precedent] compels a finding that BP is covered for the damages at issue, because the language of the umbrella policies alone determines the extent of BP's coverage as an additional insured if, and so long as, the additional insured and indemnity provisions of the Drilling Contract are "separate and independent"?"
(In re Deepwater Horizon, 728 F.3d 491, 500 (5th Cir. 2013).)

Outcome

The TX Supreme Court answered the Court of Appeals' certified question by holding that:
  • Transocean's policies defined coverage for additional insured by referring to the Drilling Contract's provisions obligating Transocean to provide BP coverage.
  • The Drilling Contract's insurance obligation provisions only provide BP additional insured coverage (defining additional insured status when incorporated into Transocean's policies) for the damages Transocean assumed under the indemnification provisions.
  • Under the indemnification provisions:
    • Transocean assumed liability for all above-surface pollution damages; and
    • BP assumed liability for all damages Transocean did not assume, including damages resulting from subsurface pollution.
    (See Drilling Contract and Insurance Policies.)
  • Because BP assumed all damages resulting from subsurface pollution and Transocean assumed all damages resulting from above-surface pollution in the Drilling Contract's indemnity provisions, BP was not entitled to additional insured status.
In reaching these conclusions, the TX Supreme Court clarified that under its precedent, specifically Evanston Insurance Co. v. ATOFINA Petrochemicals, Inc., 256 S.W.3d 660 (Tex. 2008), insurance coverage can be determined and limited by the terms of an extrinsic document if the policy specifically references the terms of the extrinsic document.

Practical Implications

Evaluating Coverage Limitations

When assessing, preparing for or reacting to catastrophic losses, parties to commercial agreements should first determine which state's law governs the relevant insurance policies. For information on choice of law clauses, see Practice Note, Choice of Law and Choice of Forum: Key Issues. For a sample choice of law clause, see Standard Clause, General Contract Clauses: Choice of Law.
The degree to which extrinsic documents can limit coverage under CGL policies varies by state and can roughly be summarized as:
  • The majority of states allow extrinsic evidence (including for CGL policies, underlying commercial agreements) to be used to confirm or expand coverage for additional insureds.
  • A significant minority of states allows the use of extrinsic evidence both to:
    • limit or defeat coverage; and
    • confirm or expand coverage.
  • Another significant minority of states does not allow extrinsic evidence to determine a policy's coverage for any purpose.
This case makes clear that under Texas law when a policy defines the scope of coverage by explicitly referencing an extrinsic agreement, it is permissible to examine that extrinsic document to determine the scope of coverage.
For a suite of resources on commercial insurance coverage and claims, see Insurance Policies and Coverage Toolkit. For an overview of insurance policies and coverage see, Practice Note, Insurance Policies and Coverage: Overview.

Entering Commercial Agreements

This case also illustrates that parties contemplating commercial transactions need to reconcile or, at a minimum, be aware of any gaps between:
  • The scope of insurance coverage from all relevant policies.
  • The allocation of risk and liability in the underlying agreement.
For information on allocating risk in commercial agreements, see Practice Note, Risk Allocation in Commercial Contracts. For a guide on avoiding common problems associated with risk allocation, see Avoiding Key Risk Allocation Pitfalls under Commercial Contracts Checklist.
Best practices for parties owed insurance coverage obligations include demanding that they either:
  • Are added to the policies in a scheduled endorsement.
  • Receive a certificate of insurance.
Coverage is determined by the language of these documents and is not limited by the provisions of any underlying agreement. For example, BP may have assumed that the terms of the Drilling Contract obligated Transocean to provide general coverage for its indemnity agreement and that coverage would have been available had Transocean used either a scheduled endorsement or certificate of insurance.
For parties that owe insurance coverage obligations, it is important to remember that their insurance obligations run separately from the indemnification and other risk allocation provisions. Best practices for parties that owe an insurance coverage obligation include ensuring that the coverage is consistent with the parties' intent. This usually entails making sure that the coverage provided by an endorsement is not broader than the contract's indemnification. Conversely, a party may be found liable for breaching its insurance obligations if a court later interprets the indemnification provisions to be broader than the insurance coverage.
For general information on negotiating, reviewing and drafting commercial agreements, see Practice Note, Drafting or Reviewing a Commercial Contract.