Loss to Royalty Interest Not “Property Damage”

In Highlands Insurance Company v. American International Specialty Lines Insurance Company, No. V-01-111 (S.D. Tex. 2004), the United States District Court for the Southern District of Texas analyzed whether royalty holders’ claims of waste and drainage constituted “property damage” caused by an “occurrence” under a CGL policy.

The royalty owners had specifically asserted claims for breach of implied covenants and duties arising by operation of law and contended that the operator, Bridge Oil, had breached duties, including a duty to reasonably develop their lands and protect the leased premises from local or field-wide drainage. They also asserted separate claims for drainage and depletion of minerals underlying their lands, bad faith operation of a well, negligent or grossly negligent operation of a well, conversion, tortious interference and breach of their lease agreement. They allege that a well had been improperly completed or operated. They also added a loss of fractional shares of oil and gas to which they were entitled under the leases, which would have been produced had Bridge Oil not breached the lease agreements.

Three insurers provided insurance coverage to Bridge Oil at different times: Highlands Insurance Company, American International Specialty Lines Insurance Company, and Sphere Drake. Initially, each company denied Bridge Oil’s claims for coverage on the basis that the underlying plaintiffs had not alleged “bodily injury” or “property damage” caused by an “occurrence.”

After amendments in the pleadings, Highlands agreed to defend. Highlands filed suit against the other insurer contending that the third amended petition invoked all of the insurers’ duties to defend and that it was entitled to reimbursement.

The court agreed with the insurers who denied coverage. The court concluded that the royalty owners had not alleged any physical injury to or loss of use tangible property. Instead, the court found that the underlying royalty owners merely alleged losses to their royalty interests, which the court concluded were purely economic in nature, and did not constitute “property damage.”

Notably, the court also found that most of the royalty owners’ allegations did not assert an “occurrence.” Specifically, the court concluded that the allegations that both wells were improperly operated at excessive pressure differentials amounted to allegations of intentional conduct that could be expected to result in drainage.

The court found, however, that allegations that Bridge Oil failed to get a proper cement bond in completing one of the wells could constitute an “occurrence.” The court reasoned that this allegation did not allege voluntary and intentional conduct or allege conduct with reasonably foreseeable consequences. Thus, the court concluded that this allegation was an allegation of accidental conduct that amounted to an allegation of an “occurrence.”

Because of its ruling that there was no claim within the scope of coverage, the court did not address the application of various exclusions in American International’s and Sphere Drake’s policies.

Editor’s Note: Thompson Coe represented American International Specialty Lines Insurance Company.