Most business owners do a good job of identifying and understanding the risk exposures that threaten their operations: property damage, business interruption, crime and cyber-crime, and liability for damages caused to others as a result of your actions. However, many business owners routinely overlook a serious risk exposure which they create on their own: contractual liability. This article spotlights the perils of contractual liability and offers pointers on controlling your organization’s exposure to such risks.
From an insurance perspective, contracts define what risks each party is willing to accept and the consequences for not satisfying those risks. By signing a contract or an agreement with a third-party, you are either transferring liabilities to the other party or you are being asked (or forced) to accept risk.
When it comes to contracts, there are three key risk management rules to follow:
1. Read all contracts and understand the risks you are being asked to assume.
2. Seek legal counsel to determine if the contract is in your best interest and to assist in negotiating to remove or modify unacceptable terms.
3. Consult with your insurance broker to identify provisions that may require additional insurance or exposures that may be uninsurable.
Asking your advisors to review contracts or agreements after you sign them is akin to trying to put a genie back in the bottle; there is little that can be done to undo a binding legal agreement. In a contractual liability situation, the key risk transfer provisions are the Indemnity Agreement, the Hold Harmless Agreement and insurance requirements.
When agreeing to Indemnity provisions, the “Limited Form” agreement is preferred as it minimizes your liability by obligating you only to the extent of your own fault. The other two forms require you to assume progressively higher levels of risk, both of which put you at a disadvantageous position.
The Intermediate Form requires you to assume all liabilities of the other party, except where the injury or damage is caused by the other party’s sole negligence. The Broad Form agreement exposes you to the highest risk by requiring you to assume an unqualified obligation to hold the other party harmless for all liabilities, even if the injury or damage is due to their sole negligence. A majority of states have enacted legislation prohibiting the use of broad form indemnity provisions; however, a few states still allow its use.
The Hold Harmless agreement usually accompanies indemnification clauses. While many believe the hold harmless and indemnification terms are interchangeable, they are in fact two distinctly different legal terms with different implications. The Hold Harmless Agreement stipulates that the party assuming the risk will not seek to recover damages from the other party. Once you enter into a Hold Harmless agreement, you close the door on sharing the burden of the damages with the other party; therefore, tread carefully when encountering Hold Harmless agreements.
Every contract has different insurance requirements, but be particularly alert to clauses requiring the purchase of additional coverages or higher limits than what you currently carry. Such requirements will obviously increase your transaction expenses, but more important, you may find it difficult or extremely expensive to comply with the requirements. Talk to your insurance broker before you sign such contracts.
In summary, it is important that all contracts be reviewed by legal counsel to identify the liabilities potentially being assumed. Your insurance broker can then determine what liabilities would be covered by existing insurance, what exposures require additional coverages, and what risks cannot be addressed by available insurance products. It is only at this point that you can make an informed decision to amend the contract or implement alternative risk management strategies.
This notice is provided as information only and should not be considered a legal opinion. If you have questions about this Client Advisory, please contact Seacrest Partners at 912-544-1900.