Last month, in In re Deepwater Horizon, Relator, the Supreme Court of Texas applied a fundamental principle of insurance law to a case with enormous financial implications.  The owner of the Deepwater Horizon drilling rig had made BP an additional insured under its liability policies, but it did so pursuant to a drilling contract in which BP had agreed to be responsible for some of the losses those policies covered.  When BP submitted a claim, therefore, a court had to determine whether, under the applicable “four corners” rule, its construction of the coverage provisions could take account of the underlying liability agreement.  In response to certified questions from the Fifth Circuit, the Texas high court found that the policies “incorporated” the terms of the drilling contract, and so that BP was not entitled to coverage for liabilities it had assumed in that agreement.  In reaching that conclusion, however, the court distinguished its own precedents in ways that make it hard to predict the outcome of future cases.

When Contracts Beget Policies

Deepwater Horizon was a deep sea oil-drilling rig owned by Transocean Offshore Deepwater Drilling, Inc.  It operated in the Gulf of Mexico under a contract (the “Drilling Contract”) between Transocean and BP, an oil-field developer.  On April 10, 2010, an explosion on the rig killed 11 crewmen.  The resulting fire could not be extinguished, and the rig sank in the Gulf two days later, causing the largest oil spill ever to have occurred in U.S. waters.  That spill generated massive claims against both BP and Transocean for environmental damage, including claims based on subsurface oil releases.

In their Drilling Contract, BP and Transocean agreed to a “knock-for-knock” allocation of risk: Transocean agreed to indemnify BP for losses caused by above-surface pollution, regardless of fault, and BP similarly agreed to indemnify Transocean for any pollution losses Transocean did not assume—i.e., losses caused by subsurface pollution.

The Drilling Contract also required Transocean to name BP, its subsidiaries and affiliated companies, co-owners and joint venturers:

as additional insureds in each of [Transocean’s] policies … for liabilities assumed by [Transocean] under the terms of this contract.

Transocean was insured under a $50 million general liability policy and four layers of excess insurance, which provided another $700 million in coverage.  These policies provided coverage on behalf of an “Insured” for any loss that was either “imposed upon the ‘Insured’ by law” or “assumed by the ‘Insured’ under an ‘Insured Contract.'”  An “Insured Contract” is an agreement by Transocean, pertaining to its business, under which Transocean “assumes the tort liability of another party.”

Although BP was not named as an additional insured in any of these policies, the policies defined the term “Insured” to include

[a]ny person … to whom the ‘Insured’ is obligated by … [an] ‘Insured Contract’ … to provide insurance such as afforded by [the] Policy.

Thus, BP could be an additional insured only if several conditions were satisfied:

• BP’s Drilling Contract with Transocean had to be an “Insured Contract,” meaning it needed both (i) to “pertain[]” to Transocean’s business and (ii) to require Transocean to “assume[]” BP’s tort liability.
• If these conditions were met, the Drilling Contract also needed to “oblige[]” Transocean “to provide insurance” of the kind provided by Transocean’s policies.

BP’s Claim

BP made a demand under Transocean’s policies, and the insurers filed a declaratory judgment action in federal court, asserting that BP was not entitled to coverage for subsurface pollution claims.  In that suit, it was undisputed that the Drilling Contract was an “Insured Contract” within the meaning of the policies, and so that BP was an additional insured for at least some purposes.  It was also undisputed that none of the insurers was a party to the Drilling Contract.  Nevertheless, the insurers contested coverage on the ground that the Drilling Contract required Transocean to make BP an additional insured only “for liabilities assumed by [Transocean] under the terms of” that contract.  BP countered that the insurers’ actual policies contained no term that limited coverage in this way.

The question before the court, therefore, was whether the scope of coverage should be determined by the four corners of the policies, or if those policies should be interpreted by reference to the terms of the Drilling Contract.  The district court resolved the issue against BP, holding that BP was not an “Insured” under the policies for purposes of subsurface pollution liabilities.  The Fifth Circuit reversed and held, based on Evanston Ins. Co. v. ATOFINA Petrochemicals, Inc., 256 S.W.3d 660 (Tex. 2008), that courts applying Texas law must resolve coverage disputes based solely on the four corners of the policies:  because the policies themselves “imposed no relevant limitations upon the extent to which BP [was] covered,” the company’s subsurface claim had to be honored.  Id. at 341.

On rehearing, however, the Fifth Circuit withdrew its opinion and certified two questions to the Texas Supreme Court:

1. Whether Evanston Insurance Co. v. ATOFINA Petrochemicals, Inc., 256 S.W.3d 660 (Tex. 2008), 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”?
2. Whether the doctrine of contra proferentem applies to the interpretation of the insurance coverage provision of the Drilling Contract under the ATOFINA case, 256 S.W.3d at 668, given the facts of this case?

In re Deepwater Horizon, 728 F.3d 491, 500 (5th Cir. 2013).

Texas Widens Its Horizons

The Supreme Court began its analysis with the four corners of the policies.  Although the policies contain no language explicitly limiting the scope of BP’s coverage, the court explained, it has “long held [that] insurance policies can incorporate limitations on coverage encompassed in extrinsic documents by reference to those documents.”

Moreover, no “magic words” are necessary to effect the incorporation: “it is enough that a policy clearly manifests an intent to include the contract as part of the policy.”  So, while the inquiry might start with the coverage grant in the insurance policy, it may not end there.

One way to “manifest” such intent is to establish a relationship between the existence of coverage and the terms of  the underlying agreement:

By tying additional-insured coverage to the terms of an underlying agreement, the parties procure only the coverage the insured is contractually obligated to provide, thereby minimizing the insurer’s exposure under the policy and the named insured’s premiums.

Alternatively, the named insured may gratuitously choose to provide more coverage than contractually required.  This occurs when the coverage term does not reference the contract requiring the additional insured coverage.

The court explained that the insured had taken the latter approach in the case that was cited in the certified questions, and on which BP was relying for its claim.  It is not obvious, however, that the policy in ATOFINA did not “t[ie] additional-insured coverage to the terms of an underlying agreement.”  In ATOFINA, the named insured’s liability policy extended additional-insured coverage to  “[a] person … for whom [the named insured has] agreed to provide insurance as is afforded by this policy … .”  But the underlying contract also required the named insured to obtain a certificate of insurance, expressly identifying ATOFINA as an additional insured.  In the Deepwater Horizon case, the Supreme Court reasoned that “[t]he existence of a certificate … meant … there was no need to look to the underlying service contract to ascertain ATOFINA’s status as” an additional insured.

BP, on the other hand, did not receive a certificate of insurance, nor was it expressly identified as an additional insured by an endorsement to Transocean’s policies.  According to the Texas court, this meant that

if the coverage inquiry were constrained to the language in the insurance policy, BP would have no coverage at all.

The coverage inquiry was not so “constrained,” the court found, because “the policies confer coverage by reference to the Drilling Contract.”  Thus:

The language in the insurance policies providing additional-insured coverage ‘where required’ and as ‘obliged’ requires us to consult the Drilling Contract’s additional-insured clause to determine whether the stated conditions exist.  … [W]hen we do so, it becomes apparent that the only reasonable interpretation of that clause is that the parties did not intend for BP to be named as an additional insured for the subsurface pollution liabilities BP expressly assumed in the Drilling Contract.

Those are Some Big Corners

It is hard to argue with the Supreme Court’s reading of the Drilling Contract, which expressly provided that Transocean was required to provide BP with insurance only “for liabilities assumed by [Transocean] under the terms of this contract.”  What is less clear is the court’s insistence that this language fell within the “four corners” of the insurance policies Transocean ended up purchasing.  More particularly, it is difficult to say what it was about the language of those policies that “tied” coverage to an underlying contract in a way that the policy in ATOFINA failed to do.

It might be significant, in this regard, that BP’s real adversary in the case was Transocean, rather than the insurers, because the policies provided “a finite sum of insurance,” under which Transocean was also seeking coverage.  (For this reason, Transocean was permitted to intervene in the litigation and align itself with the insurers.)  It remains to be seen whether Texas courts will be willing to find the “four corners” of a policy equally expansive in cases where their doing so might result in a denial of coverage to all insureds.

Image source: Petty Officer 2nd Class Justin E. Stumberg (Wikimedia)