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By JARED ZOLA, a partner and insurance coverage deputy practice leader in Dickstein Shapiro's New York office, where he is also the co-leader of the firm's oil and gas production liabilities insurance initiative; and KENNETH BERLINE TROTTER, an insurance coverage associate in Dickstein Shapiro's Washington, D.C. office and national co-leader of the firm's property and business interruption insurance initiative

Natural gas exploration and drilling companies have significantly increased shale gas operations at least in part as a result of advancements in horizontal drilling and hydraulic fracturing methods, making it more economically feasible to extract gas from shale formations.

Although aggressive shale gas production presents tremendous business opportunities, it also presents significant potential risks. Accordingly, energy companies should carefully consider their potential risks and maintain appropriate insurance coverage to protect their assets.

Insurance is available to cover a variety of risks, including damage and loss resulting from man made and natural disasters. Of particular interest to energy companies is insurance for property damage and loss caused by operational risks, such as well blowouts, and environmental concerns.

For example, if a blowout occurs, energy companies may sustain significant damage to their own property, losses due to business interruption and exposure to third-party liability claims.

In addition to the risks and losses associated with well blowouts, numerous environmental concerns may arise out of allegations that drilling and extraction operations cause contamination of the environment--specifically, underground sources of drinking water.

Finally, there are allegations that vibrations and subterranean pressure changes associated with hydraulic fracturing cause damage to or alteration of the underground and surface geology--even causing earthquakes.

Given these risks, and the extent of the losses and expenses that could be incurred, it is essential that energy companies carefully consider the purchase of appropriate insurance coverage.

Moreover, companies should also carefully consider agreements with other companies involved with the relevant project speaking to indemnification of losses and liabilities or the procurement of insurance. Companies should not assume that they are protected by insurance maintained by another company involved with project operations at a particular drilling site.

APPLICABLE INSURANCE COVERAGES

With the above considerations in mind, the following are some of the more important coverages available to energy companies engaged in drilling and hydraulic fracturing activities:

First-party property coverage pays for physical damage to the policyholder's property; the extra expenses incurred addressing the effects of a covered loss, such as a well blowout; and the costs incurred in establishing the extent of the loss.

Many property insurance policies are sold on an "all risk" basis, meaning that they cover losses to real property caused by any peril not expressly excluded.

Because of the breadth of coverage afforded by an "all risk" policy, once a policyholder shows that it has suffered a loss, the burden of proof shifts to the insurer to prove that the loss is not covered. By comparison, a second type of property insurance--a "named peril" policy--covers only those perils expressly listed.

Business interruption coverage reimburses the policyholder for the amount of gross earnings minus normal expenses that the policyholder would have earned but for the interruption of the policyholder's business as a result of damage to covered property. If a business purchased such coverage, the business may seek as recoverable business interruption losses the expected but not realized profit from the natural gas that would have been extracted in connection with a specific shale play but for the interruption resulting from damage to covered property.

Operator's extra expense coverage reimburses the insured for costs that energy companies incur when regaining control of a well blowout, redrilling expenses, damages paid to third parties for harm caused by seepage and pollution and costs for remedial clean-up measures. Such policies also may provide coverage for liability for damage to third-party equipment under the operator's care, custody or control.

Directors' and officers' (D&O) coverage reimburses companies and their directors and officers the costs incurred defending against and resolving claims of wrongful acts, including allegations that they failed to disclose any environmental and financial risks associated with natural gas fracturing operations. Companies should be aware that many D&O policies define "claim" much more broadly than the receipt of a lawsuit--a definition that often includes any written demand for monetary or nonmonetary relief.

General liability coverage may be implicated if, for example, a third party brings a suit alleging property damage due to vibrations and subterranean pressure changes associated with hydraulic fracturing.

In most instances energy companies will seek coverage for fracking-related claims and liabilities under the property damage liability or bodily injury liability coverages of their general liability (GL) insurance policies. Stacks of GL policies typically are purchased by corporate policyholders, the first-responding policy (in the event of a liability) being "primary," and the additional "excess" policies affording coverage ("attaching") sequentially when loss is incurred that meets or exceeds the indemnity limit of the next lowest policy in the stack.

Under the primary policy, the policyholder typically is entitled to have its defense provided by the insurer if the allegations of a relevant third-party claim present the mere possibility that the claim is covered by the insurance policy's terms. The primary GL insurer's duty to defend its policyholder is thus broader than its duty to indemnify a liability and arises when the suit against the policyholder is instituted--not when a judgment is entered or a settlement is struck.

Although standard-form GL insurance policy language obliges the insurer to defend a suit only, courts in many jurisdictions have found that non-judicial proceedings begun with letters from governmental agencies can represent suits for relevant purposes, if those letters are sufficiently coercive.

For example, if a policyholder hires an attorney to protect its interests upon receipt of an action-forcing letter from the Environmental Protection Agency, the expenses incurred may be payable under the primary GL insurance policy's duty to defend.

Other coverages an energy company may consider purchasing include environmental liability policies, professional (engineering) liability policies, hull & machinery policies and crime (fidelity) policies.

When a policyholder makes a claim for coverage, insurers may raise challenges, such as policy exclusions or defenses, to the availability of coverage.

Whether or not an exclusion or defense applies, however, will depend on the specific facts, the language in the policy and the law of the applicable jurisdiction.

For example, some insurers may assert that a "pollution exclusion" forecloses coverage of a fluids migration claim under a liability policy. However, the applicability of the exclusion may depend on the period of time during which the policy was in force, the specific language of the exclusion and the body of law that applies. Accordingly, without further inquiry and analysis, policyholders should not assume that an insurer-asserted coverage defense precludes coverage.

Pursuing an insurance claim may be a complex and challenging process. Policyholders should consider obtaining the assistance of coverage counsel who, because there are many issues that can significantly affect the existence or amount of recovery under an insurance policy, can help the policyholder comply with policy requirements and present its claim to maximize protection under the insurance policies in light of any coverage issues.

May 1, 2011

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