When parties contractually agree to support their mutual indemnity obligations with a "minimum" amount of insurance, their indemnity obligations may not be limited to the "minimum" amount stated in the contract.

Throughout the United States, natural gas exploration and production is a multiparty endeavor. Oilfield operators enter into form drilling contracts (i.e., IADC onshore drilling contracts) or Master Service Agreements (MSA) with contractors, under which the contractors agree to provide services and materials for the operators. Owners of mineral leases enter into farmout agreements that provide for the provision of services in exchange for a percentage ownership in the lease. Parties with mineral lease interests enter into joint exploration and development agreements. All of these agreements can include indemnity provisions that dramatically shift the risks and liabilities of the parties.

For those companies operating in the state of Texas, oilfield indemnity agreements must be tailored to satisfy Texas’ anti-indemnity statute – the Texas Oilfield Anti-Indemnity Act (TOAIA).

How TOAIA Limits a Party’s Indemnity Exposure

In its current form, TOAIA provides that agreements pertaining to a well for oil, gas, or water, or to a mine for a mineral, are void as a matter of public policy if they purport to indemnify a party against liability for its own negligence. TEX. CIV. PRAC. & REM. CODE ANN. § 127.003 (West 2016). However, TOAIA offers a loophole. TOAIA will not operate to void indemnity agreements that purport to indemnify parties against liability for their own negligence if the parties agree in writing that the “indemnity obligation will be supported by liability insurance coverage to be furnished by the indemnitor … .” Tex. Civ. Prac. & Rem. Code § 127.005(a). Where two parties agree to support their mutual indemnity obligations with liability insurance, those obligations are “limited to the extent of the coverage and dollar limits of insurance or qualified self-insurance each party as indemnitor has agreed to obtain for the benefit of the other party as indemnitee.” Tex. Civ. Prac. & Rem. Code § 127.005(b).

Thus, a mutual indemnity provision in Texas will be limited by TOAIA to the lowest level of insurance both parties contractually agree to obtain in support of their indemnity obligations. Ken Petroleum Corp. v. Questor Drilling Corp., 24 S.W.3d 344 (Tex. 2000). This is sometimes called the “lowest common denominator” rule.

Practical Example

An operator and a drilling contractor enter into an MSA, which contains mutual indemnity provisions. A provision on insurance states as follows:

• “In support of its indemnity obligations contained herein, OPERATOR agrees to obtain insurance coverage in an amount equal to $5,000,000…”
• “In support of its indemnity obligations contained herein, CONTRACTOR agrees to obtain insurance coverage in an amount equal to $3,000,000…”

Since the parties agreed to provide differing amounts of coverage in support of their mutual indemnity obligations, the obligations are limited to the lower amount of insurance under TOAIA. Here, the parties’ indemnity obligations would be capped at $3,000,000.

The rationale for the lower-common-denominator rule adopted by the Texas Supreme Court is that oilfield companies do not purchase insurance for specific contracts, but instead “purchase blanket insurance policies and umbrella policies that will provide coverage for a multitude of contracts.” Id. at 350.

For example, a company that enters into an oilfield contract may purchase $25 million in liability insurance coverage each year, but only agree to obtain $10 million in support of its mutual indemnity obligations under the contract because of risk-management guidelines or other contractual obligations. Meanwhile, the other party to the oilfield contract may purchase $15 million in liability insurance, but only agree to obtain $5 million in support of its mutual indemnity obligations under the same contract.

In such circumstances, both parties’ indemnity obligation is capped at $5 million under the lowest-common-denominator rule, even though both parties have additional coverage available. Still, parties to oilfield contracts do not always agree to support their indemnity obligation with an exact amount of insurance.

Parties Frequently Agree to Obtain a ‘Minimum’ Amount of Insurance to Support Indemnity

It has become common within the industry for parties to use form contracts under which they agree to support their indemnity obligations with a “minimum” amount of insurance.

Examples

• “Contractor shall, during the term of this Agreement, carry at its own expense the following minimum insurance coverage … .”
• “In support of the mutual indemnity obligations contained in Section X below, Contractor and Company shall provide, each for the benefit of the other, coverage and amounts of liability insurance which in no event shall be less than the minimum set out in Exhibit YY … .”
• “Except as otherwise provided herein, Contractor and Company shall procure and maintain in force at all times during the term hereof sufficient insurance or self-insurance as may be required by law to protect Contractor and Company from third-party claims arising out of or connected with the performance of Services hereunder. All such insurance shall be of the types and in at least the amounts specified in Exhibit Y … .”

Yet, when parties agree to obtain a minimum amount of insurance in support of their indemnity obligations, neither has agreed to “dollar limits” of insurance that will serve as a cap on their indemnity obligations under TOAIA. See Tex. Civ. Prac. & Rem. Code § 127.005(b).

Texas Courts Hold That Indemnity Obligations May Extend Beyond the Contractually Agreed Minimum to the Amount of Insurance Actually Carried

The Texas Supreme Court has held that, where the express provisions of a contract do not limit a party’s insurance obligation to a set dollar amount, that party has contractually agreed to fully insure or self-insure its indemnity obligation.  Ken Petroleum Corp. v. Questor Drilling Corp., 24 S.W.3d 344, 352–53 (Tex. 2000). Thus, where the parties fail to contractually establish the limits of insurance that support their indemnity obligations, TOAIA will limit the parties’ indemnity obligation to the amount of insurance carried by both parties. For example, in Liberty Mutual Fire Ins. Co. v. Axis Surplus Ins. Co., a United States District Court in Austin held that, where parties simply agreed to “carry adequate insurance limits [ ] in support” of their mutual indemnity agreement, the parties’ indemnity obligations were capped under TOAIA at the lesser amount of insurance actually carried in support of the indemnity obligation. Liberty Mutual. 2017 WL 6420920, at *4-5.

In those instances where the parties to an oilfield service agreement agree to obtain minimum limits of insurance (e.g., “no less than”) in support of their indemnity obligations, the prospective indemnitee is not foreclosed from seeking indemnity in an amount that exceeds the minimum insurance limit specified in the contract. See Lirette v. Union Tex. Petroleum Corp., 467 So.2d 29, 34 (La. Ct. App. 1985) (holding that TOAIA permitted the operator to obtain contractual indemnity up to the full amount of insurance obtained by the contractor despite the insurance provision requiring “not less than” certain amounts in coverage); Maxus Exploration Co. v. Moran Bros., Inc., 773 S.W.2d 358 (Tex. App.—Dallas 1989), aff’d on other grounds, 817 S.W.2d 50 (Tex. 1991) (holding that both parties “voluntarily and mutually assumed” the obligation of indemnity without limitation and that nothing in TOAIA prevented an indemnitor from voluntarily providing more insurance than required under an agreement).

In 2020, a United States District Court out of the Midland-Odessa Division in the Western District  of Texas finally confronted the question of how to interpret language in an oilfield contract requiring that the parties support their indemnity obligations with specified minimum amounts of insurance. St. Paul Fire and Insurance Company v. CP Well Testing, LLC, 489 F.Supp.3d 635 (W.D. Tex. 2020) (appeal pending).

In CP Well Testing, Cimarex and CP Well executed an MSA under which CP Well was hired to perform flow back services at a well in Beckham County, Oklahoma, that was owned and operated by Cimarex. Id. at 637. The MSA contained a mutual indemnity provision requiring Cimarex and CP Well to indemnify the other against claims for personal injury or illness or death of any member of their “group” as defined in the MSA, and further required both parties to obtain minimum amounts of insurance specified in the MSA. Id. at 637-638. Under the MSA, Cimarex was required to obtain a minimum of $26 million in coverage to support its indemnity obligation while CP Well was required to obtain a minimum of $3 million in coverage. Id.

A member of CP Well’s group was injured while working at the wellsite and brought suit against Cimarex, among others. Id. at 639. Cimarex settled the lawsuit for $4.5 million and turned to CP Well for the full settlement amount. Id. When CP Well refused to indemnify Cimarex under the MSA for more than $3 million, Cimarex’s insurer, St. Paul Fire and Insurance Company (St. Paul), covered the remaining $1.5 million and brought suit against CP Well to recover the difference. Id. The gravamen of St. Paul’s argument was that CP Well’s indemnity obligation was not limited under TOAIA to the $3 million minimum set forth in the MSA but rather extended to $11 million – the amount of insurance CP Well actually carried. Id.

The court agreed with St. Paul that, because the parties only agreed to obtain minimum amounts of insurance, the MSA did not limit the amount of coverage the parties agreed to obtain to support their indemnity obligations and that “TOAIA applied to limit the parties’ indemnity obligations to ‘the lowest common denominator of insurance coverage between the parties.’” Id. at 643 (quoting Liberty Mut. Fire Ins. Co. v. Axis Surplus Ins. Co., No. 1:16-CA-00870-SS, 2017 WL 6420920, at *4, 2017 U.S. Dist. LEXIS 206187, at *12 (W.D. Tex. Dec. 14, 2017)). However, the court did not agree with St. Paul that CP Well agreed to maintain $11 million in liability insurance to support its indemnity obligation under the MSA simply because CP Well carried insurance in that amount. Id. at 643-44. Instead, the court looked to extrinsic evidence, in the form of CP Well’s liability insurance policy, and held that CP Well only obtained $3 million in support of the indemnity obligation. Id. at 645.

Regardless, the CP Well Testing opinion confirmed what previous courts only held by implication – that TOAIA does not limit a party’s indemnity obligation to any minimum amount set forth in an oilfield contract.

Is It Time to Revise Your Form Oilfield Contracts?

The CP Well Testing case is currently on appeal to the 5th Circuit (Case No. 20-50892). However, if your form oilfield contract contains mutual indemnity provisions and language requiring that the parties obtain minimum amounts of liability insurance in support, it is important to consider whether a revision would better serve your risk-management objectives. Many parties in the oilfield currently use form contracts with the minimum insurance language discussed throughout this article and mistakenly believe that their indemnity exposure is limited to that minimum amount of insurance. This mistake can be costly.

For more information on navigating indemnity in the oilfield, you can review the Texas Oilfield Indemnity Handbook by Tom Donaho.