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Watch Your Back


Volume 13, No. 2, First Quarter 2007

By Robert L. Carson, Jr., CPCU, ARM

Do you remember watching “Starsky and Hutch” on TV and when they would raid some den of iniquity one would say to the other, “I’ve got your back”? Those need to be bywords for writing insurance specifications, i.e., “Watch your back.” The worst kinds of claims are those that come in the back door, at least that is the case in the energy industry. Take for example the International Association of Drilling Contractors’ (IADC) standard drilling contract. In it the drilling contractor indemnifies, releases from liability and holds the operator (the owner of the well) harmless for damage to the drilling contractor’s drilling rig, except for damage caused by an unsound location or by environmental damage. (The former means damage caused by the ground giving away and the rig collapsing into the hole. The latter involves extra wear and tear to the rig caused by some corrosive or caustic materials [such as H2S] getting into the mud [the circulating fluid] and causing unusual damage to the equipment.) Such an indemnification protects the operator from having to pay for the rig if, for instance, there is a blowout (for which the operator always assumes liability.)

As further protection, at another point in the contract each party agrees to waive their insurer’s right of subrogation against the other party in areas where each has indemnified the other. What this appears to mean is that, among other things, the drilling contractor has waived his rig insurer’s subrogation right for damage to the rig. An alert risk manager will recognize that there is a hole in the dike and, in a present day impersonation of Hans Brinker, he will stick his finger in it, i.e., he requests that the contract be changed to say that his obligation to pay for rig damaged by an unsound location is excess of any insurance carried by the drilling contractor. (Actually, until 2003, that is what the contract itself said.) This saves the day. Almost.

Remember that subrogation has been waived where one party has indemnified the other. The drilling contractor has indemnified the operator for damage to the rig except for unsound location. So, if there is no indemnification for sound location claims then there is no waiver of subrogation (as required later in the contract.) And, although the contractor has subsequently agreed to go to his insurance first, the insurer can subrogate against the operator. The back door was left open. (This, by the way, is not the only instance in the drilling contract where you can feel a draft.)

The moral of this entire story is when you ask to have subrogation waived do not ask that it be waived only on a certain policy nor on just the insurance specified nor just where someone has held you harmless. ASK THAT INSURANCE BE WAIVED ON ALL INSURANCE CARRIED WHETHER OR NOT SUCH INSURANCE IS REQUIRED BY THE CONTRACT. You never know what policy is going to pay. In the oil & gas industry it could be a liability policy, a control of well policy, a drilling rig policy, a platform policy, a workers’ compensation or employer’s liability policy. In the construction business there are an equal number of places a subrogation suite can arise. I imagine in all other businesses there are just as many back doors. The answer is to just have subrogation waived on all insurance carried. Make insurance be the end of the claim.

This leads to another chapter in the indemnification protocol. Many times you will see contracts that call for three layers of protection from claims. Initially, one party indemnifies the other from liability for injury. Next, the indemnitee is added as additional insured to the insurance policy; lastly, subrogation is waived. (The last two are usually referred to as “Naming and Waiving”.) This action is akin to wearing belt and suspenders with coveralls. Let’s analyze what all this means.

If you are held harmless you do not have to be named additional insured or have subrogation waived. There is no subrogation available for the insurer because the indemnitor has waived his rights to go against the indemnitee. (You have to be very careful, however, that there is not an Anti-Indemnity law on the books in your state. Texas, Louisiana, New Mexico and Wyoming have such that applies directly to the oil & gas business. Other states have ones that apply to the construction industry, while other states just flat reject indemnification for sole negligence as being against public policy.) Some parties will be hesitant to fully indemnify another party but see no harm in “Naming and Waiving.”

Therefore, to back up the indemnification, or to replace it if there is a statutory problem or if the other party has just refused to do so, you need to be named additional insured. The insurance carrier cannot subrogate against its own insured (except in rare instances.) In the case of being named an additional insured on a property policy, some brokers/agents may baulk at the idea, saying that there is no insurable interest. The response to such a denial is to state that if one has the vulnerability to be held liable, he has an insurable interest.

The last item, waiving subrogation should just about close all the vents. However, if only subrogation is waived without either of the other two actions (indemnification and/or naming), you still have an exposure. The other party, i.e., the one that only waived subrogation, has just waived his insurer’s rights. He has not waived his own, so the waivee is not totally off of the hook, (unless he has used wording in the agreement that forces the other party to go first to his insurance.) He can come back against you for the loss. Why would he do that? There are several reasons. One is that claims on his policy make his premiums go up; he may carry a big deductible; or he may not have enough limit and needs you to fill in the shortfall. (As a side note, on the flip side of the coin, don’t let the other party say that they would never let the insurer subrogate against you because you are such a great customer or because you are a valued contractor, etc. The facts are they will have nothing to say about it. When the insurer pays the claim they have full right to go against whomever caused the loss, and you are not a valued customer of the insurance company.)

To make a final check, let’s review what we have done: a) Make certain that you are indemnified, check the laws of your state to make certain indemnities are not prohibited; b) Be named an additional insured on the policies in question, including property policies; c) Have insurance waived on all policies carried.

Okay, are we all finished? Not quite yet. There is one last thing that needs to be tended to. Have the other party’s Insurance Certificate verify that insurance has been waived. Even though you have said such in the contract, if the insurer has not granted permission in the insurance policy for the insured to waive the insurer’s rights without notification (which the policy usually does) and if the insured has not subsequently notified or asked permission, the insurer may still subrogate. This leaves you with a breach of contract suit against the other party, and that can take years to settle.

So, when you think that you have covered all the bases, when all of your ducks are in a row, when you check and double check, you still better make certain that your back is covered, because that’s where you can get a big surprise.