Gulf Oil Spill: Liability Insurance Coverage Implications

August, 2010

by Amy R. Paulus and Ilene M. Korey and Mark D. Paulson and Kathleen A. Johnson and Amber N. Oleson and Elizabeth Jozefowicz

Catastrophes test the boundaries of liability insurance coverage, particularly where the claims and energy of the plaintiffs' bar have the potential to challenge the scope of coverage under the typical Commercial General Liability ("CGL") policy. While we expect to see claims brought against policyholders central to the spill, such as BP, Halliburton, Transocean and related players, the "downstream" potential of liability claims may herald coverage disputes under liability policies in manners not previously contemplated by the underwriters.

Third Party Liability Claims and Natural Resource Damage Claims

The spill, the disbursement and the clean-up will certainly lead to third party liability claims. The majority of the third party liability claims will seek compensation for property damage and bodily injury from exposure to oil, other pollutants or toxins. As with toxic tort bodily injury claims, however, exposure claims may also give rise to claims of fear of bodily injury, under which damages may be sought for emotional distress and medical monitoring. As with tort related claims, there will likely be further bodily injury and property damage claims asserted under product liability theories. Products impacted by oil, or the clean up itself, may also lead to claims under third party liability policies.

While there will most certainly be pollution-related claims, just as with any environmental catastrophe, there may also be claims for damage to natural resources. This is especially true here considering the nature and scope of the spill. Claims for damage to, destruction of, or loss of use of natural resources will require a monetary allocation of the destruction or loss.

Where injuries to natural resources have occurred as a result of releases of hazardous substances or oil as a result of natural resource injury, or as a result of implementation of a response action, damages are recoverable. Often, the EPA will coordinate with the Department of the Interior to assess the natural resource damage, and ultimately calculate the monetary cost of restoring natural resources injured from releases of hazardous substances or discharges of oil. Damages to natural resources are evaluated by identifying the functions or "services" provided by the resources, determining the baseline level of the services provided by the injured resource, and quantifying the reduction in service levels as a result of the contamination. Consequently, there may be third party liability claims made against insureds for their property damage liability for damages to natural resources.

Coverage Issues Arising From The Spill Will Implicate A Variety Of Occurrence-Based And Claims-Made Liability Policies

Clearly, bodily injury and property damage claims against business owners will implicate commercial general liability coverage. For example, one can readily predict claims against restaurant owners by patrons who claim to have been sickened by oil-contaminated food. Or, on a larger scale, one can predict coastal property owners' claims for property damage from oil-contaminated beaches against the target defendants such as the well operators, the manufacturer of the malfunctioning blow-out preventer, and those contractors who installed the pipeline and worked on the rig.

In addition to claims implicating occurrence-based general liability coverage, oil spill claims will also undoubtedly implicate claims-made coverage and the notice/reporting requirements attendant to such coverage. For example, shareholders have already sued the board of directors for BP for allegedly negligently managing their company and hiding safety problems, which allegedly contributed to the oil spill. Because a board member may be personally liable for the negligence of his company, such a claim could implicate the board members' directors and officers' liability coverage, which is typically claims-made and reported. Similarly, errors and omissions coverage may come into play, for example, if claims are made against any engineers, surveyors or architects for professional negligence. Professional malpractice claims may also be made against the various and many environmental contractors involved with the cleanup, to the extent that any recovery effort fails. As with director and officers' liability coverage, errors and omissions coverage is typically written on a claims-made basis.

Policyholders with operations likely to draw pollution-related claims may have environmental impairment liability ("EIL") coverage which is also typically written on a claims-made basis. For many years now, insurers have offered EIL coverage to complement general liability coverage, which generally excludes coverage for pollution-related bodily injury and property damage claims. Relatedly, small business owners without obvious risk for pollution claims may, for the first time, receive pollution-based claims and realize that they have no coverage under their standard general liability policy. In turn, these unprotected business owners may make a claim against their insurance broker for failing to discuss and procure pollution coverage for them. Any such small business owners' claim against its insurance broker for failing to procure sufficient coverage would most likely implicate the broker's own errors and omissions coverage, also usually written on a claims-made basis.

Given the wide array of coverages potentially implicated by the Gulf Oil Spill, and the possible availability of claims-made coverage for several types of spill-related claims, timeliness of notice, tenders, and reporting to insurers and co-insurers will be vitally important.

Coverage Issues From The Spill Will Likely Implicate A Host Of Policy Exclusions

Ultimately, we are certain to see a multitude of liability claims testing the scope of CGL and other kinds of liability coverage. Accordingly, it will be as important as ever in the context of this multi-jurisdictional catastrophe to remember that precisely how exclusions are enforced can vary greatly depending upon which state court interprets the policy language. For example, current CGL policies typically contain an absolute pollution exclusion or total pollution exclusion. However, the absolute pollution exclusion has been interpreted differently by many of the states most impacted by the spill, such as Louisiana, Texas, Mississippi, Alabama, Georgia and Florida. Further, how any given court may decide whether the damage is caused by a "pollutant" or an "irritant" unfortunately may differ based upon the state.

Some CGL policies issued to insureds in the oil and gas industry include additional exclusions which may come into play for damage caused by "fuel" or "MTBE". Within some CGL policies issued in the oil industry, exclusions for contractual liability, explosion hazards, and professional liability also may be involved here. CGL policies often exclude property damage claims for injury to or destruction of property arising out of any liability assumed under any contracts. Oil well policies often exclude property damage claims for injury or destruction of property caused by the well out of control expense; or for injury or destruction of property for work or operations performed on any oil or gas lease at locations within the limits of any town or city; other oil well and tankers policies include exclusions for leaks.

The application of intentional act exclusions must also be examined. These exclusions typically exclude coverage for claims arising out of intentional acts, misconduct, willful, wanton or reckless behavior or any activity that is in violation of any statute or instruction of any government body or public policy. Along those same lines, the CGL policy excludes damages expected or intended by the insured. CGL policies further typically exclude coverage for hazards, conditions, risks or losses known to the insured before the effective dates of the policies. Other potentially applicable exclusions may include the "owned property" exclusion excluding any loss resulting from damage to property owned or occupied or rented to the insured. Policy limits and aggregate limits may also pose limitations on the extent of insurance coverage for the multitude of expected claims.

Liability Coverage Litigation Has Already Started . . .

Certain Underwriters at Lloyd's of London ("London Market Insurers") filed a declaratory judgment action on May 21, 2010 in Texas federal court seeking a declaration that no additional insured coverage is owed to BP, and others, under policies issued to Transocean with respect to pollution claims arising out of the blowout and fire on the DEEPWATER HORIZON oil well in the Gulf of Mexico.¹ Specifically, London Market Insurers allege that no coverage is owed for BP's current and future pollution liabilities related to oil emanating from the DEEPWATER HORIZON because the policies provide coverage to BP only for surface pollution from substances in Transocean's possession, and liabilities that originate above land and water. The complaint further alleges that BP's liabilities fall outside the scope of the additional insured protection, "[b]ecause liabilities BP faces for pollution emanating from BP's well are from below the surface and from BP's well . . . ." Presently, no party has answered and/or otherwise responded to the declaratory judgment.

What else can we reasonably expect in terms of liability coverage disputes in the near future? While it has been widely reported in the press that BP is self-insured, the liability insurers for the other main players will surely have to navigate the myriad coverage issues presented. Much will certainly be litigated about this historic oil spill as the story continues to unfold, but it is nevertheless useful to consult the lessons of the past to identify key liability insurance coverage issues that may rise to the fore. For that, we examine the liability coverage disputes that arose from the EXXON VALDEZ tanker disaster.

The liability coverage dispute from EXXON VALDEZ arose under Exxon's Global Corporate Excess policies. Exxon's policies provided catastrophic coverage, and granted coverage for such risks as first-party property losses, marine liabilities, and general third-party liabilities. On August 4, 1993, Exxon filed a lawsuit in Texas state court seeking coverage under its policies and for extra-contractual damages for alleged violations of the Texas Insurance Code. The insurance underwriters responded with a similar suit filed in New York federal court on August 30, 1993. Both cases addressed this pivotal issue: did the underwriters have a contractual duty to pay for a portion of the expenses that resulted from the grounding and subsequent release of oil from the EXXON VALDEZ? According to the underwriters' complaint, the overarching coverage issues included, but were not limited to, the following:

• Whether oil pollution is covered by the Exxon policies considering the fact that the policies excluded coverage for pollution from any tanker;
• Whether Exxon had a legal duty or obligation to cleanup the oil pollution under applicable law, or whether it acted as a volunteer;
• Whether Exxon engaged in a pattern of false and/or fraudulent presentation with
regard to its claims and misrepresented issues of coverage and intent; and
• Whether the EXXON VALDEZ grounding occurred as the result of willful, wanton, reckless and/or intentional misconduct, which cannot be covered under the Exxon policies and applicable law.²

Although the EXXON VALDEZ coverage dispute eventually settled after three-plus years of litigation, chances are that many similar issues may be litigated in any coverage dispute involving the DEEPWATER HORIZON.

Important Claims Handling, Choice Of Law And Forum Considerations

The liability claims originating from the DEEPWATER HORIZON oil spill will be unprecedented both in terms of complexity and number. It is expected that this spill will generate thousands of claims and will be unlike any other disaster in history.

From a liability coverage standpoint, it is important to remember that declaratory judgment and other coverage lawsuits may not be heard in any of the states surrounding the Gulf of Mexico. The location of the insured, where the policy was issued, where the premiums were paid or where the policy designates coverage actions are to be heard, will impact which state's laws will be applied to the coverage issues. Accordingly, choice of forum and choice of law considerations must be closely examined, especially since many of the Gulf states' laws differ dramatically with regard to coverage and maritime law may apply to certain issues such as proximate causation. The interaction between the individual state laws, maritime law, and federal funding from OPA and the $20 billion BP Fund, have yet to be determined. As such, there may be set-offs that apply to claims reported to you. New laws or statutes may also be enacted which could impact these claims. Moreover, some states have stringent claims handling regulations that require certain activities within short time frames, i.e., 30 days to respond to a bodily injury claim in Florida.

As the ramifications of the Gulf disaster continue to emerge and evolve, Clausen Miller's Liability Coverage Practice Group is prepared to assist the insurance industry in responding to the coverage and claims handling challenges that will follow. Clausen Miller attorneys have extensive experience in these types of claims nationwide, and we are ready to help analyze your coverage issues.

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¹ Certain Underwriters at Lloyd's, London, et. al. v. BP plc. et al., No. 10-01823 (S.D. Texas May 21, 2010).

² See, e.g., Youell v. Exxon Corp., 74 F.3d 373 (2d Cir.1996); James Walsh, Environmental Coverage Issues Under Maritime Insurance Policies, 7 U.S. F. Mar. L.J. 1 (1994)

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