In part one of our two-part series on the legal implications of hydraulic fracturing (“fracking”) for drillers, published in the January 2013 issue of National Driller, we provided an up-to-date nationwide review of fracking-related litigation in order to illustrate various third-party litigation risks undertaken by those engaged in the practice. With these risks in the forefront of our minds, here in part two we suggest some practical steps drillers should take to minimize the risks associated with fracking.
First and foremost, the driller must procure a sufficient amount of insurance coverage to offset the risks it faces. Second, the driller should consider including the following risk-shifting contractual mechanisms in its contracts with others (referred to below as “subcontractors”):
1. Requiring subcontractors to indemnify the driller for all third-party claims;
2. Requiring subcontractors to include the driller as an additional insured on their own policies;
3. Contractually obligating subcontractors to comply with all relevant laws and regulations. We take each mechanism in turn.
Indemnification Clauses
Indemnification clauses are the most commonly utilized risk-shifting mechanism. They are found in many drilling contracts. Such provisions shift risk by contractually obligating one contracting party to indemnify the other contracting party against claims for property damage or personal injury arising from any mistake or error made during the drilling process. Stated another way, the driller can require its subcontractor to assume sole responsibility for a loss, regardless of who is at fault. Additionally, the indemnification provision may also require the subcontractor to pay the bill for any liability on the part of the driller, including defense costs arising out of a drilling-related claim.
It should be noted that there is an enormous body of law devoted to the proper execution and precise wording of such indemnification provisions. Suffice it to say, an indemnity provision must be very clearly written. And while such provisions are undoubtedly helpful to the party entitled to indemnification (the “indemnitee”), they do not provide the indemnitee unfettered peace of mind because such provisions are strictly construed against the indemnitee in most jurisdictions1 and, depending on the claim made and the jurisprudence of the jurisdiction in which the claim is asserted, the provision may not be enforceable at all.
For example, where a party seeks to outright exculpate itself by shifting a loss arising solely out of the party’s own negligence (i.e., the driller seeks to shift losses arising solely out its own negligence), many jurisdictions, by statute or based on common law jurisprudence, will refuse to enforce the clause.2 Other jurisdictions, meanwhile, will construe the clause narrowly.3 Furthermore, a number of courts refuse to enforce provisions that seek to indemnify any party’s “gross negligence.”4 In fact, even if the court is willing to enforce indemnity provisions encompassing “gross negligence,” a number of jurisdictions refuse to permit indemnification for a party’s punitive conduct (e.g., reckless, depraved and intentional acts).
The most recent high-profile example arises out of the Deepwater Horizon oil spill in the Gulf of Mexico. There, Halliburton and Transocean obtained rulings from the District Court requiring indemnity from BP for third-party claims of negligence and gross negligence against Halliburton and Transocean.
While those rulings undoubtedly shifted many billions of dollars of potential losses to BP, the court simultaneously found that public policy precluded enforcement of indemnity for punitive damages claims.5
Finally, depending on the jurisdiction, contracting parties may incorporate a “pass through” indemnity provision that requires one party to indemnify the other (e.g., the driller) for the other party’s separate indemnity obligations. For example, a driller may have entered into a separate contract with the owner requiring the driller to indemnify the landowner. Theoretically, the driller could contractually require its subcontractor to assume the driller’s indemnity obligation to the owner through a “pass through” clause. However, courts may not enforce this clause or, at a minimum, may strictly construe it against the driller.6
Insurance
Beyond indemnity clauses, drillers must first obtain their own requisite Environmental and/or Commercial General Liability insurance with proper endorsements to cover the risks identified in Part I of our article. This is essential because, as discussed above, there are no guarantees in risk shifting. Even if an indemnity clause is deemed enforceable, it is worthless if the subcontractor ends up being bankrupt or otherwise nonviable. Therefore, the driller must first protect itself by purchasing its own insurance with proper coverage and sufficient limits.
The driller should also demand that the entities with whom the driller contracts procure their own insurance, with sufficient limits, and further mandate that said party add the driller as an “additional insured” on that insurance policy. To ensure compliance, the driller should mandate in the contract that it be provided with sufficient proof of such insurance demonstrating the existence of the contracting party’s insurance and the additional insured endorsement to that policy naming the driller. This proof may be in the form of a certificate of insurance, the requisite endorsement and/or a copy of the complete policy.
Beyond the obvious advantages to being added as an additional insured on your subcontractor’s policy, there is also the added benefit that additional insured status may increase the likelihood that the court will enforce the indemnity clause between the parties. This is so because courts have found that the driller’s contractual requirement that it be named as an additional insured is further evidence that the driller intended to be indemnified. Stated another way, if there is a question regarding whether the subcontractor intended to indemnify the driller, a requirement that the subcontractor add the driller to its policy as an additional insured reinforces the driller’s position.
In addition to the issues of scope and enforceability of indemnity agreements that we have been discussing, there is potential for a number of additional unforeseen problems that can arise even where the indemnity agreement is found enforceable and the contractor is named as an additional insured. For example, almost all insurance contracts include “other insurance” clauses, which are meant to protect an insurer where another insurance policy exists covering the same loss. In these
situations, the indemnitor’s insurer may point to the fact that the indemnitee maintains “other insurance” through the driller’s own policy and, as a result, the indemnitor’s insurer is not obligated to insure the driller.
Like virtually all risk-shifting issues, this issue is jurisdiction-specific. On one hand, some courts will ignore this “other insurance” clause and honor the parties’ agreement to shift the risk to the indemnitor, thereby implicating only the subcontractor’s insurance policy.7
Other courts may require that both insurers split the loss in some way.8
Compliance With Existing Laws
“Compliance With Existing Laws” is a typical, straightforward clause found in most contractor-subcontractor contracts. While there are various types of laws that one could explicitly include in a contract (e.g., employment, tax and other laws), it is critical in the hydraulic fracturing context that the driller specifically require its subcontractors to comply with all federal, state and local environmental laws and regulations. Given that state environmental laws and regulations currently control the practice, the contract should specifically list and identify all such laws and regulations.
Conclusion
There is no way for the driller to completely eliminate litigation risks given the key role the driller plays in the hydraulic fracturing process. However, there are various contractual steps the driller should take to minimize those risks. The first and most important step occurs well before a contract is proposed. That step is to retain a skilled and competent attorney who completely understands the potential risks involved in fracking, as well as the risk-shifting laws of the relevant jurisdiction.
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1See e.g., Mejia v. Trs. of Net Realty Holding Trust, 304 A.D.2d 627 (N.Y. App. Div. 2d Dep’t 2003).
2See e.g., WYO. STAT. ANN. §30-1-131; AL. STAT. § 45.45.900; ARIZ.STAT. § 32-1159; CAL. CIV. CODE §2782; CONN.GEN. STAT.; 6 DEL. C. § 2704; FLA.STAT. §725.06 (2007); GA. CODE ANN. §13-8-2; HAW.REV.STAT.§ 431:10-222; Idaho Rev. Stat. § 29-114; IND. CODE ANN. § 26-2-5-1; KY. REV. STAT..§371.180; LA REV.STAT.ANN.§ 9:2780; MD.ANN. CODE, CTS.& JUD. PROC. § 5-401; MASS. GEN. LAW. ANN. 149, § 29C; MICH. COMP. LAWS §691.991; Ill. 740 ILCS 35/1; N.J. Stat. §2A:40A-1; S.D. Codified Laws §56-3-18; W.Va. Code §55-8-14.
3See e.g., Greer v. City of Philadelphia, 568 Pa. 244 (Pa. 2002); Hershey Foods Corp. v. General Elec. Serv. Co., 422 Pa. Super. 143 (Pa. Super. Ct. 1992); Nabholz Constr. Corp. v. Graham, 319 Ark. 396 (Ark. 1995); Fed. Pac. Elec. v. Carolina Prod. Ent., 298 S.C. 23 (S.C. Ct. App. 1989); Slater v. Cent. Plumbing & Heating Co., 275 Mont. 266 (Mont. 1996); Heil Valley Ranch, Inc. v. Simkin, 784 P.2d 781, 783 (Colo. 1989).
4See e.g., Crown Central Petroleum Corp. v. Jennings, 727 S.W.2d 739, 741-42 (Tex. App. Houston 1st Dist. 1987).
5In re Oil Spill by the Oil Rig “Deepwater Horizon” in the Gulf of Mexico, on April 20, 2010, MDL No. 2179 Section J, 2012 U.S. Dist. LEXIS 168755 (E.D. La. 2012); see also Northwestern Nat’l Casualty Co. v. McNulty, 307 F.2d 432 (5th Cir. Fla. 1962) (public policy against indemnity for punitive damages).
6See, Bernotas v. Super Fresh Food Mkts. Inc., 581 Pa. 12 (Pa. 2004).
7See e.g., Wal-Mart Stores, Inc. v. RLI Ins. Co., 292 F.3d 583 (8th Cir. Ark. 2002).
8See e.g., Pecker Iron Works v. Traveler’s Ins. Co., 99 N.Y.2d 391 (N.Y. 2003); United States Fidelity & Guar. Co. v. CNA Ins. Co., 208 A.D.2d 1163 (N.Y. App. Div. 3d Dep’t 1994).
