One of the first lawsuits implicating insurance coverage for a fracking-related claim is under way in Ohio. Warren Drilling Co., Inc. v. ACE American Ins. Co., No. 2:12-cv-425 (S.D. Ohio 2012) will be the first case to determine how insurance coverage applies to the controversial drilling technique of hydraulic fracturing (or “fracking”). While future cases will certainly present different facts and unique arguments, the outcome of the case will set the stage for how courts are going to approach insurance coverage for fracking-related liability.
The case arises from an insurer’s refusal to defend or indemnify its insured, a drilling company, after drilling activities contaminated a nearby homeowner’s water well. In 2006, Warren Drilling entered into a contract with natural gas producer Equitable Production Company (EQT) to conduct drilling operations in West Virginia. Warren Drilling procured a commercial general liability policy from ACE American Insurance which included an Energy Pollution Liability Extension (EPLE) endorsement as well as an Underground Resources and Equipment Coverage (UREC) endorsement.
In 2008, a homeowner who lived close to the drilling operations became aware that his water well had been contaminated by the hazardous fracking fluid used by the drillers. EQT was notified of the problem in October 2008, but Warren Drilling did not receive notice until late 2010 when the homeowner filed suit against EQT and Warren Drilling.
Upon receiving notice of the claims, Warren Drilling promptly notified its insurer, but ACE refused to defend or indemnify the driller. Warren Drilling eventually retained its own law firm to defend the action and, after amassing over $100,000 in legal fees, the case was settled with the homeowner. Following the settlement, Warren Drilling sued EQT for indemnification and sued ACE for its refusal of coverage.
Warren Drilling claims that ACE breached its contract and acted in bad faith by refusing to defend the driller in the case brought by the homeowner and by refusing to indemnify the driller for its losses from that case. Warren Drilling cites both the EPLE and the UREC endorsements as grounds for coverage and has incorporated its letter to ACE and ACE’s response denying coverage into its complaint. The pleadings and the letters provide some insight into the arguments that each side is positioned to make.
The case hinges on the applicability of the EPLE endorsement and the UREC endorsement.
The commercial general liability policy issued to Warren Drilling generally excludes coverage for bodily injury or property damage caused by pollutants. However, the EPLE endorsement reinstates coverage for a pollution incident, but only if the discharge of pollutants (1) was unexpected and unintended; (2) commenced abruptly and instantaneously; (3) commenced at or from a site owned by, occupied by, or at which the insured was performing operations; (4) was known by the insured within 30 days of the commencement of the discharge; and (5) was reported to the insurer within 60 days of the commencement of the discharge. ACE argues that Warren Drilling failed on all five conditions.
Neither party detailed its arguments regarding the first three conditions but, as the case progresses, the discussion of the first two conditions will prove particularly interesting for production companies, drillers and insurers. Whether fracking results in an “unexpected and unintended” discharge of pollutants and whether the discharge commenced “abruptly and instantaneously” will likely apply universally to incidents of fracking pollution. Courts have repeatedly affirmed that it is the discharge of pollutants, not the harm to person or property that must be expected and intended. See e.g. United States Fidelity & Guaranty Co. v. Star Fire Coals, Inc., 856 F.2d 31 (6th. Cir. 1988). In order to prevail, Warren Drilling will have to show that it did not intend nor did it expect the fracking fluid to be discharged into the ground water. While Warren Drilling may satisfy this condition, it could have a more difficult time convincing the court that the discharge of the pollutants was abrupt and instantaneous.
In their letters, the parties devoted most of their discussion to the time limits of the fourth and fifth conditions in the EPLE endorsement. The time limits work in conjunction with the “abrupt and instantaneous” requirement to avoid coverage for gradual releases of pollutants. ACE stated that Warren Drilling’s two year delay in realizing and reporting the incident to ACE precluded coverage. Warren Drilling characterized the time limits as mere “technical hurdles” that did not require strict obedience and whose breach did not prejudice ACE and therefore did not bar coverage.
In Ohio, courts have held that where a time limit is a condition precedent to coverage it must be complied with and the insurer need not be prejudiced by the delay to refuse coverage. American Employers Ins. Co. v. Metro Regional Transit Auth., 12 F.3d 591 (6th Cir. 1993). Other courts, as cited by ACE, have found that time limits for special coverage endorsements are not subject to the prejudice exception afforded to general notice requirements in a policy. See e.g. Venoco Inc. v. Gulf Underwriters Ins. Co., 175 Cal. App. 4th 750 (2009). Overcoming the reporting time limits could be a challenge for Warren Drilling.
Although Warren Drilling is not likely to find coverage under the EPLE endorsement, it also argues that the UREC endorsement provides coverage.
The policy excludes coverage for damage to “personal property in the care, custody or control of the insured,” but the UREC endorsement modifies this exclusion by allowing coverage for property damage included within the definition of “underground resources and equipment hazard.” The endorsement defines “underground resources and equipment hazard” as including “property damage to… oil, gas, water and other mineral substances which have not been reduced to physical possession above the surface of the earth.”
In its letter to ACE, Warren Drilling argued that the UREC endorsement applies to the homeowner’s water well because the endorsement includes coverage for property damage to water below the surface. ACE countered that Warren Drilling is applying an overly broad reading to the endorsement and that because the endorsement modified an exclusion that applies only to “personal property in the care, custody, or control of the insured,” the endorsement also applies only to personal property within the control of the driller. While the UREC endorsement is intended to modify an exclusion for damages to “personal property”, it modifies it in such a way that apparently includes coverage for property damage to any water below the surface, which would include the homeowner’s water well. This potential ambiguity may be Warren Drilling’s best opportunity, but the argument ultimately depends on the court’s reading of the policy.
Warren Drilling v. ACE American Insurance will shed light on how courts may approach the applicability of insurance coverage to fracking-related claims. Insurers, upstream producers, and drilling companies should pay close attention to the case as the outcome could be an indication of the long-term implications of fracking liability on insurance coverage.
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