Court Interprets Scope of Indemnity Clauses Involving Deepwater Horizon Gulf Oil Spill

As the trial date for the sprawling Deepwater Horizon Gulf Oil Spill litigation date rapidly approaches, the federal district court has been busy issuing decisions to help refine the issues. Two of these opinion involved interpreting the scope of contractual indemnities-one of our favorite topics.

The first opinion involved cross-motions for partial summary judgment filed by BP and Transocean (RIG).  In re Oil Spill by the Oil Rig “Deepwater Horizon, 2012 U.S. Dist. LEXIS 9005 (E.D. La. 1/26/12). The claims arose from related litigation, In re Triton Asset Leasing GmbH, et al., that was instituted by RIG  as owner of the DEEPWATER HORIZON pursuant to the Limitation of Shipowners’ Liability Act, 46 U.S.C. § 30501, et seq to address claims filed against Transocean for personal injury, wrongful death, economic loss, property damage, etc. RIG, in turn, impleaded BP. The second related action was U.S. v. BP Exploration & Prod. Inc., et al., No. 10-4536 where the United States asserted claims for civil penalties under Section 311(b)(7) of the Clean Water Act  (“CWA”) and a declaration of liability for removal costs and damages under the Oil Pollution Act of 1990 (“OPA”). BP and RIG  were named as defendants  and filed cross-claims against each other.

As readers no doubt recall, predecessors to BP and RIG entered into a drilling contract in 1998 where RIG agreed to build a mobile offshore drilling unit (“MODU”) that BP agreed to hire for drilling activities on the outer continental shelf. The drilling contract contained several indemnity clauses allocating liability for certain risks and releasing the other party from claims associated with those risk. In particular, Articles 24.1 and 24.2 addressed pollution risks while Article 25.1  broadly defined the scope of the indemnity obligation. In general, Article 24.1 allocated to RIG for risks associated with pollution originating on or above surface waters with Article 24.2 allocating to BP pollution risk “not assumed by” RIG (i.e., pollution originating beneath the water’s surface). Article 25.1 generally applied to indemnity clauses that contained the phrase “shall protect, release, defend, indemnify and hold harmless” but did not apply “to the extent any such obligation is specifically limited to certain causes elsewhere in this contract.”

RIG asserted in its motion that BP was required under their drilling agreement to defend and indemnify RIG from claims and liabilities related to pollution originating below the surface of the water even if Transocean was strictly liable or if the pollution was caused by RIG’s negligence or gross negligence. RIG also asserted that the scope of BP’s indemnity obligation extended to compensatory damages, punitive damages, and statutory penalties. RIG argued that broad indemnity of Article 25.1 applied to Article 24.2, because Article 24.1 did not  contain language specifically limiting indemnity coverage to certain causes after it used the “shall protect” phrase. However, RIG admitted that the drilling contract did not provide indemnity for intentional or willful misconduct.

Meanwhile, BP denied that it owed indemnity for claims based on strict liability such as for claims under OPA or the CWA where RIG acted with gross negligence. Specifically, BP argued that the last sentence of Article 24.2 limited its indemnity obligation to instances where subsurface pollution is caused by Transocean’s “negligence or fault”, and because of this specific limitation Article 25.1. BP also argued that even if RIG’s interpretation was correct, contractual indemnities that purport to include gross negligence, punitive damages, or CWA civil penalties were unenforceable on public policy grounds. Finally, BP also argued that the indemnity clause was void if RIG breached the drilling contract or materially increased risks to BP.

After considering the language of the contract and the applicable law, the court agreed with RIG that Article 24.2 did not specifically limit the application of Article 25.1. The court said Article 25.1 provided broad indemnity coverage wherever the “shall protect” triggering phrase appeared. The court said the broad indemnity coverage would apply unless the exclusionary phrase “except . . . specifically limited” was contained in the particular indemnity provision. The court noted the specific exclusionary phrase appeared in Articles 22.3 and 23.1 but not in Article 24.2. Absent language that specifically limited Article 25.1, the court said it could be reasonably inferred that the parties intended that Article 25.1 would be fully incorporated into Article 24.2, and did not operate to exclude gross negligence, strict liability, or other causes or damages. The court also said this was consistent with the plain language of Article 24.2 providing that BP would  assume “any” liability not assumed by RIG in Article 24.1

Having ruled on the meaning of the indemnity, though, the court then said that RIG was not legally entitled to indemnity for the full range of liabilities listed in Article 25. The court said that cases holding that public policy prohibited a party from being indemnified for its own gross negligence were not applicable because the cases cited by the parties dealt with “release” or “exculpatory clauses”, and not indemnities. The court said there was a tension between the policy of freedom of contract, which weighs in favor of enforcing the indemnity, and a reluctance to encourage grossly negligent behavior, which weighs against enforcing the indemnity the freedom of contract. The reciprocal nature of these indemnity clauses arguably created an incentive for RIG to avoid grossly negligent conduct, or at least did not encourage RIG to act in a grossly negligent manner, the court said which favored enforcing the clause. In addition, the court said, the agreement reflected an attempt by sophisticated entities engaged in a potentially lucrative and obviously risky endeavor to allocate risk ahead of time, ostensibly in the hopes that some degree of certainty may be brought to the risks inherent in that undertaking.

The court found further support from OPA the primary source of the compensatory damages arising from oil pollution. The court observed that OPA section 2710 expressly permitted contractual indemnity but was silent if such indemnity may include gross negligence. In contrast, the court said, OPA section 2716(f)(1) states that a responsible party’s “guarantor” may raise as a defense that the responsible party acted with “willful misconduct,” but not gross negligence. The court acknowledged that while section 2716(f)(1) might involve different policy concerns it nonetheless served as another indication that OPA is not opposed to indemnification for gross negligence.

Thus, the Court held that if RIG committed gross negligence that caused pollution originating below the surface of the water, public policy would not bar its claim for contractual indemnity from BP. 16 However, the court explained its holding was limited to compensatory damages, and did not include any punitive damages which  might arise if Transocean is found grossly negligent.

RIG also asserted that CWA civil penalties should be covered by the indemnity because they were primarily remedial in nature. RIG also argued that the CWA section 1321 expressly allowed contractual indemnification and to the extent the statute does not apply, indemnification is allowable under OPA 2710. The court observed that CWA secton 1321(b)(7) imposes a civil penalty for discharges of a “harmful” quantity of oil discharges and that the penalties were increased for gross negligence or willful misconduct. The court also noted the legislative history and case law suggested that civil penalty provision has multiple goals, including restitution but that the primary objectives are to punish and deter future pollution. Thus, the court held that public policy invalidated the drilling contract’s indemnity clause to the extent it included civil penalties.

Finally, the court rejected RIG’s claim that BP had a duty to defend much like under an insurance policy. The court said while insurance contracts are a type of indemnity contract, the similarities were different (to quote Dale Berra-Yogi Berra’s son). The court said the purpose of an insurance contract is to distribute risk of loss across a large group, are usually not negotiated., and any ambiguities are construed in favor of the insured. By contrast, the court explained, an indemnity clause contained in a non-insurance contract is construed against coverage, because the agreement creates duties that differs or extends beyond those established by general principles of law. Such clauses are typically collateral or incidental to a contract that has a principal purpose other than risk shifting. The court said Article 25.1 did not contain any express language that the duty to defend was broader than indemnity. Since Article 25.1 listed the duty to defend in the same sentence as the duty to indemnify the court said this reflected that the duties to defend and indemnify are to be treated identically. Because these duties are co-extensive, and the extent to which RIG is owed indemnity was not entirely clear at the moment, the scope of the duty to defend also could be determined. Accordingly, the court held that BP’s duty to defend only required it to reimburse RIG’s defense costs after there has been judicial determination on the merits.

The second opinion involved cross-motions for summary judgment by both BP and Halliburton in a decision issued on January 31st. In re Oil Spill by the Oil Rig “Deepwater Horizon, 2012 U.S. Dist. LEXIS 10952 (E.D. La. 1/31/12). Halliburton asserted that BP was required to defend and indemnify Halliburton against any and all claims related to a blowout or uncontrolled well condition and relating to pollution and/or contamination from the reservoir. BP’ sought a ruling that it was not required to indemnify Halliburton for punitive damages, fines, or penalties. Additionally, BP opposed Halliburton’s motion on the grounds that Halliburton committed fraud, breached the contract, and/or materially increased risks to BP as indemnitor, and such acts discharge BP’s indemnity obligations

The indemnity provisions were contained in clause 19 of the agreement. Like the drilling contract between RIG and BP, the contract between Halliburton and BP contained reciprocal indemnities where Halliburton assumed certain liabilities for pollution emanating from its equipment above the surface. However, a significant difference was that BP expressly agreed in clause 19.7(a) to indemnify Halliburton for its gross negligence. BP did not dispute the language but focused on whether public policy permits such indemnification.

For the same reasons as in the RIG decision, the court said that if CWA civil penalties were indirectly asserted against Halliburton via equitable contribution or indemnity, BP would not have a contractual obligation to indemnify Halliburton for public policy reasons. Likewise, the court held that BP did not owe Halliburton indemnity for punitive damages.

Finally, BP alleged that Halliburton made fraudulent statements and fraudulently concealed material information concerning the cement tests it conducted, and that BP relied on these statements when it allowed Halliburton to pour the unstable cement slurry that led to the uncontrollable well and blowout. BP asserted that the language of the indemnity  did not extend to fraud, nor would public policy permit such indemnification, given that fraud involves willful misconduct exceeding gross negligence. Halliburton denied that it committed fraud and asserted that BP’s allegations were merely breach of contract claims cloaked as fraud. In any event, Halliburton argued that Clause 19.7 was broad enough to include fraud.

The Court agreed that fraud could void an indemnity clause on public policy grounds, given that it necessarily includes intentional wrongdoing. The Court also said that a mere failure to perform contractual obligations as promised did not constitute fraud. However, since there were material issues of fact,  the Court denied ruling on this aspect of the summary judgment motions.

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