How to Make Sure the Indemnification and Additional Insured Provisions in Your Next Contract Deliver the Protection Your Company Expects

James S. Carter

Carter, James S.Many companies rely on indemnification and additional insured provisions in their contracts for protection against losses arising from a contractual relationship. Indemnification provisions insulate the company from certain losses by requiring the other party to assume and to indemnify it against those losses. Additional insured provisions add another layer of protection by requiring the other party to arrange for the company to become an insured under the other party’s insurance policies. Ideally, indemnification provisions and additional insured coverage should work together when losses occur to furnish the level of protection the company expected when it entered into the contract.

Unless company representatives read the insurance policy that provides the additional insured coverage, documents_compare_shutterstock_234757165however, they may have little idea how the additional insured coverage works. A recent decision by the Supreme Court of Texas arising out of the Deepwater Horizon oil spill incident illustrates how the interplay between additional insured coverage and wording in an underlying contract can operate to frustrate an additional insured’s expectations of coverage.

In the case, BP and Transocean entered into an oil drilling contract that contained an indemnification provision. Under the provision, Transocean agreed to indemnify BP for surface pollution, while BP agreed to indemnify Transocean for subsurface pollution. In addition, Transocean agreed to add BP as an additional insured under Transocean’s insurance policies. The policies extended additional insured coverage to any person to whom Transocean was “obliged” to provide coverage in an “Insured Contract,” defined as a contract in which the insured assumes the tort liability of another.

In the aftermath of the Deepwater Horizon incident, BP sought insurance coverage from Transocean’s insurers for both surface and subsurface pollution. The issue before the court was whether BP was entitled to coverage for those liabilities that BP had assumed.

The court began by examining Transocean’s insurance policies. BP contended that the policies did not expressly limit the additional insured coverage. The court noted, however, that a policy can incorporate by reference the underlying contract. To accomplish this, the court explained, it is enough that the policy “clearly manifests” an intent to include the contract as part of the policy; no “magic” words are necessary.

Transocean’s policies did not expressly state that they incorporated the drilling contract. The court, however, found that Transocean’s policies clearly manifested an intent to incorporate the drilling contract. In reaching this conclusion, the court emphasized that the policies conferred coverage by reference to an “Insured Contract” (i.e., the drilling contract, because in it Transocean assumed losses for surface pollution) that obliged Transocean to procure coverage for BP as an additional insured.

One question is whether any reference to a contract in an insurance policy is enough to incorporate any limits from the underlying contract? Not always. The court distinguished a case that found that an additional insured endorsement that referred to a written contract, as opposed to an insured contract, did not incorporate a restriction on additional insured coverage tied to the indemnity obligations in the underlying contract. The court also distinguished situations where an endorsement to the policy or a certificate of insurance specifically identifies the additional insured. These are situations, the court reasoned, that may obviate the need to refer to the underlying contract.

Having found that Transocean’s policies incorporated the drilling contract, the court then examined the drilling contract to see if it placed any limits on the scope of additional insurance coverage. It focused on the following provision: “[BP], its subsidiaries and affiliated companies . . . 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.” (Emphasis in decision.)

BP argued that the emphasized clause narrowly excluded workers compensation from the additional insured coverage, while Transocean and its insurers argued that it broadly limited the coverage to those losses assumed by Transocean. The meaning of the clause hinged on whether a comma was supposed to follow the term “Compensation.” In the end, the court ruled against BP, finding that the provision limited coverage to those liabilities that Transocean assumed.

The enormous financial costs associated with a disaster of the magnitude of the Deepwater Horizon incident highlight the importance of indemnification provisions and additional insured coverage. It is thus essential that a company carefully analyze the proposed additional insured coverage and its relationship with the underlying contract, including the indemnification provisions therein, before entering into the contract by considering the following questions:

  • Does the insurance policy itself contain any provisions that limit the scope of additional insured coverage?
  • Does the policy contain wording or an endorsement that can be read as incorporating by reference the underlying contract?
  • Does the underlying contract contain any provisions that can be construed as limiting the scope of additional insured coverage?

It may also be beneficial to consult with experienced insurance coverage counsel to ensure that the indemnification provision and additional insured coverage work in tandem to meet the company’s coverage expectations.

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