Does the Insurance Policy Incorporate the Service Contract by Reference? An Examination of In Re Deepwater Horizon
In 2015, the Texas Supreme Court issued a ruling that changed the way additional insured coverage under an insurance policy is analyzed when there is an underlying drilling contract limiting the additional insured coverage to the scope of the liability assumed in the service contract. In In re Deepwater Horizon, the court faced the issue of whether a drilling contract limits the scope of coverage extended to an additional insured.1 This article discusses Deepwater Horizon, which governs allocation of risk, assumed liabilities, and the granting of additional insured status in underlying service contracts, and the precedent the case established.
The insurance coverage dispute arose from the 2010 explosion and sinking of the Deepwater Horizon drilling rig in the Gulf of Mexico.2 BP, the oil-field developer, and Transocean, the drilling-rig owner entered into a drilling agreement for a mobile offshore drilling unit (“Drilling Contract”).3 The issue was whether the insurance provisions in the Drilling Contract limited the scope of insurance coverage extended to BP as an additional insured.
The Drilling Contract had standard “knock-for-knock” or mutual indemnity obligations for personal injury and property damage.4 Pollution liabilities were allocated between Transocean and BP based upon the source and conveyance of the subject pollution.5 Transocean agreed to indemnify BP for pollution occurring above the surface, regardless of fault, and BP agreed to assume and/or retain liability for all other pollution.6 As is standard in the industry, Transocean was required to carry insurance policies that named BP as an additional insured for liabilities assumed under the terms of the Drilling Contract. Transocean’s policies extended insured status to any “person or entity to whom the ‘Insured’ is obliged by oral or written ‘Insured Contract’ … to provide insurance such as afforded by [the] Policy.”7 The parties did not dispute that BP was an additional insured under the Transocean policies or that the Drilling Contract was an “Insured Contract” triggering coverage. Rather, the parties focused on the scope of the policy coverage; specifically, the extent to which the Drilling Contract’s risk allocations could limit BP’s coverage, as an additional insured, under Transocean’s insurance policies.8
BP argued that under Evanston Insurance Co. v. ATOFINA Petrochemicals, Inc., 9 the extent of coverage should be ascertained exclusively from the four corners of the Transocean insurance policies and not from the terms and conditions of the Drilling Contract.10 BP contended that, as an unconditional additional insured, its worldwide operations are automatically covered for all “liability imposed by law,” which includes subsurface pollution from the explosion.11
Challenging BP’s broad interpretation, Transocean and its insurer12 argued that BP’s analysis disregarded that BP is an “Insured” only by the status conferred by the Drilling Contract, and, thusly, the coverage extended is limited to the risks assumed in the Drilling Contract.13 Transocean and the insurers relied on Urrutia v. Decker,14 in which the Texas Supreme Court held that “Texas law has long provided that a separate contract can be incorporated into an insurance policy by an explicit reference clearly indicating the parties’ intention to include the contract as part of their agreement.”15 Applying the Urrutia exception to BP’s four-corner analysis, Transocean and its insurers contended that the Drilling Contract was incorporated into the Transocean insurance policies by the policy language that limited additional insured status to “where required” and as “obliged.”16 Stated simply, Transocean and its insurers argued that the Drilling Contract required Transocean to name BP as an additional insured only for the above-surface pollution risk that Transocean assumed, and, as a result, BP lacked additional insured status for subsurface pollution.17
The court incorporated the Drilling Contract into the insurance policy by using Texas contract law which looks to the parties’ intent as expressed by the words that they chose to effectuate their agreement.18 The court then examined the policy language and found that BP is not named in any of the insurance policies, nor was there any evidence that expressly included BP as a blanket additional insured in the insurance endorsement or certificate.19 Nonetheless, the court went on to find that the policies conferred coverage by reference to the Drilling Contract, in which “(1) Transocean assumed some liability for pollution that might otherwise be imposed on BP (making that contract an “Insured Contract”) and (2) Transocean is “obliged” to procure insurance coverage for BP as an additional insured (making BP an “Insured”).”20 The court agreed with Transocean and the insurers that the use of “where required” and “as obliged” in the additional insurance coverage sections of the insurance policies referenced the Drilling Contract’s additional insured clause, thereby limiting the scope of coverage.
The additional insured provision in the Drilling Contract read as follows,
[BP], its subsidiaries and affiliated companies, co-owners, and joint venturers, if any, and their employees, officers, and agents shall be named as additional insureds in each of [Transocean’s] policies, except Workers’ Compensation for liabilities assumed by [Transocean] under the terms of this contract. 21
The court reasoned that the plain language of the provision makes it apparent that BP’s status as an insured is “inexorably linked” to the extent of Transocean’s indemnity obligations. The real issue from the provision was whether (a) the italicized portion was intended to be narrow and specific, thus applying only to workers’ compensation policies covering Transocean’s employees; or (b) the provision exempted only workers’ compensation policies from the general additional insured obligation and imposed a limitation on the general insurance obligation that is contiguous with all of Transocean’s contractual indemnity duties.22
Regarding the limitation of additional insured status to liabilities assumed in the contract, BP’s argument focused on a missing comma. BP argued that the missing comma following the word “compensation” suggested that its coverage as an additional insured extended to the full limit of the policy and was not limited by liabilities assumed by Transocean, except with respect to workers’ compensation coverage. The Texas Supreme Court found BP’s construction “unreasonable,” as such an interpretation would render the words “for liabilities assumed by [Transocean] under the terms of this contract” meaningless.
The court further reasoned that Transocean and the insurers’ construction of the provision was the most reasonable because it is “in harmony with the allocation of liabilities in the contract, gives meaning to all the language the parties employed, and is consistent with the standard use of such language and the purpose of such clauses.”23 Further, the court stated that additional insured provisions are commonly phrased in terms that extend coverage to insurance policies while exempting workers’ compensation from coverage.24 The court also opined that “a manifest purpose of an additional insured clause is to provide supplemental protection when the additional insured may be sued for conduct within the contractor’s scope of risk.”25 After applying this reasonableness construction to the additional insured provision in the Drilling Contract, the court held that BP is an additional insured only as to liabilities assumed by Transocean under the Drilling Contract.26 Additionally, because Transocean did not assume liability for the risk of subsurface pollution, Transocean had no obligation to name BP as an additional insured for subsurface pollution.27
Not wanting to lose a good fight, BP further argued that the provision cannot limit its additional insured status to the extent of Transocean’s indemnity obligations because the Drilling Contract’s indemnity and insurance provisions are separate and independent.28 Disagreeing with BP’s argument, the court stated that BP was consolidating duty with scope and Texas courts have long recognized that “contractual duties to indemnify and to maintain insurance may be separate and independent.”29 The court found that the Drilling Contract required Transocean to name BP as an additional insured only for the liability Transocean assumed under the contract; thus, Transocean had separate duties to indemnify and insure BP, but the scope of indemnity and insurance only extended to pollution above the surface, as specifically allocated or assumed in the Drilling Contract.30.
The court concluded by stating that:
Texas law has long allowed insurance policies to incorporate other documents by reference, and policy language dictates the extent to which another document is so incorporated. The policies here provide additional-insured coverage automatically where required and as obligated by written contract in which an insured has agreed to assume the tort liability of another party. Because BP is not named as an insured in the Transocean policies or any certificates of insurance, the insurance policies direct us to the additional-insured provision in the Drilling Contract to determine the existence and scope of coverage. Applying the only reasonable construction of that provision, we conclude that, as it pertains to the damages at issue, BP is an additional insured under the Transocean policies only to the extent of the liability Transocean assumed for above-surface pollution.31
After Deepwater Horizon, if the language of an insurance policy incorporates by reference another contract that dictates the status and scope of coverage, the court will give that contract effect, but only to the extent allotted for by the insurance policy. Moving forward, the precedent established by Deepwater Horizon should reduce disputes among operators and contractors alike who seek additional insured status subject to limiting language in the insurance policy that incorporates an underlying services contract. The parties should pay particular attention to the policy’s language to determine the extent to which a court will look to the underlying services contract to ascertain the scope of coverage as an additional insured.
Select Cases after Deepwater Horizon
In 2017, the Fifth Circuit of the United States Court of Appeals was tasked with resolving a dispute between ExxonMobil (“Exxon”) and its contractor, Electrical Reliability Services (“ERS”).32 An employee of a subcontractor of ERS was injured and filed suit against Exxon and ERS.33 Exxon settled the suit and sought reimbursement from ERS and its insurer based on a theory that ERS had a contractual obligation to indemnify Exxon because Exxon was an additional insured under ERS’ insurance policy.34 In 2012, the district court held that ERS’ insurer breached its obligation by failing to provide coverage and reimbursement to Exxon.35 Thus, the district court awarded Exxon over $3 million.36 On appeal, the Fifth Circuit vacated and remanded the district court’s holding in light of the Texas Supreme Court’s decision in Deepwater Horizon. 37
On remand, the district court determined that Deepwater Horizon had no effect on its decision and reinforced its prior ruling.38 In a second appeal the Fifth Circuit agreed with the district court and held that Deepwater Horizon did not interfere with the original judgment because there was no language in the insurance policy or the contract that suggested the parties intended the scope of the indemnity provision to govern or limit the scope of the insurance provision in the policy.39 Thus, the parties’ intent “as expressed in the writing itself” differed from the parties’ intent in Deepwater Horizon because the contract Exxon and ERS executed focused on the duty of indemnification and not the scope of liability.40.
Also in 2017, in North American Capacity Insurance Co. v. Colony Specialty Insurance Co., the U.S. District Court of Page 9 • Winter 2018 the Southern District of Texas held that the insurer’s argument that a separate contract can be incorporated into an insurance policy by reference to that document in light of Deepwater Horizon was unpersuasive. The court noted that the policies that the insurer referenced did not contain any specific references to the separate contract.41
In 2016, The Fifth Circuit was faced with an umbrella insurer’s argument that pursuant to Deepwater Horizon, a subcontract that accounts for “additional insureds” should be incorporated into the policy.42 In EMJ Corp. v. Hudson Specialty Insurance Co., the Fifth Circuit rejected the insurer’s argument by finding that Texas law was not applicable because the case was in diversity and Mississippi law applied.43 The Fifth Circuit stated that “[t]he Texas Supreme Court arguably modified the traditional rule when it decided Deepwater Horizon” and a Mississippi court reaffirmed the traditional rule in 2014.44 The traditional rule in Mississippi is that “mere references to extrinsic documents in a contract do not incorporate the terms of that document into the contract.”45
In another 2016 decision, the United States District Court in the Southern District of Texas determined that Deepwater Horizon “does not present an intervening change in the controlling law; it does not expressly overrule any previous case law.”46 In Lexington Insurance Co. v. ACE American Insurance Co., the court followed the traditional construction principles in Urrutia and ATOFINA after reinforcing the court’s language in Deepwater Horizon that “[o]ur application of these foundational principles in Urrutia and ATOFINA guides our analysis of the policies and Drilling Contract at issue here.”47
In 2015, the Fifth Circuit held that based on the precedent set by Deepwater Horizon, insurance policies that incorporated a $5 million limit as referenced in a master service could be used to determine the scope of coverage. In Ironshore Specialty Insurance Co. v. Aspen Underwriting, Ltd., the “Insured Contract” provision was essentially the same as Transocean’s in Deepwater Horizon. 48 The Fifth Circuit was asked to determine what effect the Texas Supreme Court gave to the “Insured Contract” provision because Transocean’s provision had language that added additional insureds “where required by written contract.”49 Ultimately, the Fifth Circuit found that the “best reading” of Deepwater Horizon is that “each provision standing alone was an independent basis for the decision.”50 Like in Deepwater Horizon, the Fifth Circuit held that the “Insured Contract” provision at issue in Ironshore Specialty Insurance Co. was sufficient to incorporate the master service agreement’s coverage limitation to risks assumed.51
The law surrounding additional insured coverage in underlying service contacts is evolving in Texas. Some courts have interpreted the Deepwater Horizon holding narrowly and have attempted to distinguish the case by using the specific language from the Transocean policy. Other courts have continued applying the traditional principles set forth in Urrutia and ATOFINA. As a final takeaway, it should be noted that indemnity and additional insurance clauses in oil and gas service contracts are not always harmonious. Additional insurance clauses in an insurance policy may afford more protection than an indemnity clause in a service contract obligates a party to provide. Carriers may want to ensure congruity in the two documents to avoid a dispute like that in Deepwater Horizon .
 470 S.W.3d 452 (Tex. 2015).
 Id. at 455
 Id. at 456-457.
 Id. at 457.
 Id. at 458.
 Evanston Insurance Co. v. ATOFINA Petrochemicals, Inc. 256 S.W.3d 660 (Tex. 2008).
 Id. at 459.
 The insurers were Ranger Insurance, Ltd. (primary policy) and “four layers of excess insurance from a multitude of additional insurers.” Id. at 457.
 Id at 459.
 992 S.W.2d 440 (Tex. 1999).
 Id. at 442.
 In re Deepwater Horizon, 470 S.W.3d at 459.
 Id. at 464; Gilbert Tex. Constr., L.P. v. Underwriters at Lloyd’s London, 327 S.W.3d 118, 126 (Tex. 2010).
 Id. at 465 (emphasis added).
 Id. at 466.
 Id. __________________________________________ Page 10 • Winter 2018
 Id. at 467.
 Id. at 468.
 Id. at 469.
 ExxonMobil Corp. v. Elec. Reliability Servs., Inc., 868 F.3d 408 (5th Cir. 2017).
Id. at 411.
 Id. at 417.
.Id. at 417-418.
 N. Am. Capacity Ins. Co. v. Colony Specialty Ins. Co., 2017 WL 3447107 at 5 (S.D. Tex. 2017).
 EMJ Corp. v. Hudson Specialty Ins. Co., 833 F.3d 544, 555 (5th Cir. 2016).
 Id.; citing Woodruff v. Thames, 143 So.3d 546, 555-55 (Miss. 2014).
 Lexington Ins. Co. v. ACE Am. Ins. Co., 192 F. Supp. 3d 712, 715 (S.D. Tex. 2016).
. Ironshore Specialty Ins. Co. v. Aspen Underwriting, Ltd., 788 F.3d 456, 462 (5th Cir. 2015).