Movie goers this fall have flocked to theaters nationwide to see “Deepwater Horizon,” the action-adventure dramatization of the 2010 explosion of a BP oil rig. The explosion claimed 11 lives and caused the worst oil spill in U.S. history.
While the film itself may serve as entertainment for action fans, the events following the catastrophe contain a practical lesson for any party entering into a contractual agreement. Before you say, “Wait, this doesn’t affect me since I don’t do deep-sea oil exploration,” think again. If you have any contract with another party who is to protect you from liability, such as a lease, construction contract, architect agreement or other service contract, this case DOES affect you.
Contract and insurance policies
After the explosion, litigation ensued between the developer, BP, and the insurers of Transocean. Transocean owned the oil drilling rig. The dispute focused on whether and to what extent an underlying drilling contract between BP and Transocean limited the scope of insurance coverage available to BP as an additional insured under Transocean’s insurance policies.
In the drilling contract, BP and Transocean agreed to a “knock for knock” allocation of risk. Transocean agreed to indemnify BP for above-surface pollution regardless of fault, while BP agreed to indemnify Transocean for all pollution risk Transocean did not assume, such as subsurface pollution, regardless of fault.
Transocean also agreed to acquire insurance and add BP as an additional insured in each of its policies “for liabilities assumed by (Transocean) under the terms” of the drilling contract. In turn, Transocean acquired a $50-million commercial general liability (CGL) policy and four layers of excess coverage totaling $700 million.
The policies’ additional insured provisions did not specifically list BP as an additional insured, but extended that status to any third party Transocean was obligated under an “insured contract” to provide insurance to.
Facing numerous personal injury and environmental claims after the explosion, BP made a demand for coverage under the Transocean policy. But Transocean’s insurers denied the claim, asserting BP’s additional insured status was limited under the drilling contract solely to liability assumed by Transocean for above-surface pollution.
The case made its way to the Supreme Court of Texas. The court held that while the insurance policies expressed no limitation to BP’s coverage as an additional insured, the additional insured provision in the policy incorporated the drilling contract by reference. Because the contract’s indemnity provisions limited Transocean’s scope of liability in this instance, BP learned that it was not covered for the damages at issue.
An expensive lesson
This case illustrates an expensive lesson that parties regularly entering agreements should adhere to: When allocating risks by way of indemnity provisions within agreements, it’s critical to be aware of the effect the agreement will have on subsequently obtained insurance policies.
The BP and Transocean disagreement comes down to a contract drafting issue. It’s critical to watch what you put into your contract for assumption of liability and how that will impact what the other party will have to provide in terms of insurance coverage. If you limit their liability, you can’t collect on their policy.
Most states recognize the incorporation by reference doctrine, which allows underlying transactional documents to alter the existence and scope of insurance coverage if the insurance policy manifests the intent of the parties to include the document as part of the policy.
To avoid the costly effects of this doctrine — in this case $750 million — a party seeking additional insured status under another party’s CGL policy should guarantee to the extent the policy incorporates an underlying transactional document, the document does not release the insured party from liability to the other additional insured party.
To put it simply, being named as an additional insured on another party's insurance policy but limiting or eliminating the liability of such insured party by contract in many cases will either reduce or fully eliminate your insurance protection as an additional insured. The interplay between contract terms and insurance coverage is an issue that many businesses struggle with when there is a loss — but it can be prevented by having the right legal professional thoroughly review a contract before you sign.
Melissa N. Collar and DeAndre’ Harris are attorneys at Warner Norcross & Judd LLP, the largest law firm headquartered in West Michigan. They can be reached via email at firstname.lastname@example.org and email@example.com.