Protecting Your Business from Contractual Risk

Protecting Your Business from

Contractual Risk

The last thing you need is a contract that voids your insurance or loads you down with responsibility you can’t, or shouldn’t, take on. Whether you are the business asking vendors to sign a contract or the vendor signing, it’s imperative to know the contents of all your contracts. Just as important is working with your insurance broker/risk manager and your attorney to develop a strategy to transfer risk and avoid risk when appropriate.

A written agreement can help avoid misunderstandings, surprises and legal proceedings – but only if you know and understand exactly what it says.

This guide will help you:

■ Understand how contracts fit into your overall risk plan ■ Identify and eliminate language that can significantly increase

your exposure ■ Learn why outlining the specific responsibilities of each party is

so important ■ Discover the best ways to tailor insurance specifications to avoid

costly liabilities

It addresses contractual risk considerations from the perspective of working with vendors and subcontractors, as well as from the viewpoint of the vendor or subcontractor.

It is often said that a contract isn’t worth the paper it is printed on. That could not be further from the truth.

Table of Contents

3 | PROTECTING YOUR BUSINESS FROM CONTRACTUAL RISK

Contractual Risk Transfer.......................................................................... 4

Contract Types ......................................................................................... 4

Importance of a Signed Contract .............................................................. 5

Indemnification ....................................................................................... 5

5 Primary Contractual Risk Transfer Types ................................................. 6Requiring Specific Insurance Coverages .................................................................... 7 Additional Insured Provisions .................................................................................... 8Waivers of Subrogation ............................................................................................. 9Indemnity Provisions ................................................................................................. 9Unambiguous Responsibilities .................................................................................. 9

Hiring Party Risk Transfer Plan Elements ................................................. 10

Hiring Party Contract Considerations ...................................................... 10Indemnification/Hold Harmless .............................................................................. 11Unambiguous Responsibilities of Parties ................................................................. 11Required Insurance Policies & Corresponding Limits ................................................ 12Additional Insured (AI) Status .................................................................................. 13

Hired Party Contract Review ................................................................... 14

Insurance Program Red Flags ................................................................. 15

Conclusion ............................................................................................ 16

Contractual Risk TransferContractual risk transfer is the shifting of responsibility from one party to another in a contract. Frequently, you will be asked to sign a Hold Harmless or Indemnity Agreement by a hiring entity whose risk manager understands the risk management process.

Your insurance policy will defend you for your negligent acts up to the limit of insurance you carry and subject to the terms, conditions and exclusions of the insurance policy. However, it’s important to note that by signing a broadly worded indemnification agreement, you are likely agreeing to indemnify the other party to a greater extent than the protection provided by your insurance policy.

Contract TypesContracts can be created in many forms. The flow of your operations will help you decide which type of contract is best suited for your organization. The final decision should be determined in concert with your insurance broker/risk manager and your attorney. The following are the three primary types of contracts:

■ Formal■ Letter Agreement■ Work Order/Purchase Order

NOTE: We don’t recommend signing the vendor’s standard contract, which will have a lot of language to protect them – some of which may be unfair or an insurability problem for your insurance program.


By signing a broadly worded indemnification

agreement, you are likely agreeing to indemnify

the other party to a greater extent than the protection provided by your insurance policy.

Importance of a Signed ContractWhatever form of agreement you use, you need to make sure it is signed by both parties because it is unenforceable without the signatures of all parties.

A properly structured contract:

■ Outlines expectations■ Protects both parties■ Sets price paid for service■ Is a legally binding agreement

Both courts and insurers consider the written contract; therefore, a well-written contract is critical. Every word means something. Insurance policies are constantly tested in the courts, and any given word can become the subject of a judge’s ruling or how a jury understands the contract.

IndemnificationIndemnification allocates the risk and expense in the event of a breach, default, negligence or misconduct by one of the parties.

■ Shifts potential costs from one party to another■ Typically states one party will indemnify the other party (also hold

harmless and defend) but often will be a mutual indemnification wherein each party indemnifies the other for their respective negligence

■ Protects the indemnified party against losses from third-party claims related to the contract


Insurance policies are constantly tested in the

courts, and any given word can become the

subject of a judge’s ruling or how a jury understands

the contract.

Two Parties

■ Indemnitor gives protection to the other party■ Indemnitee receives protection from the other party

An indemnification agreement determines who is going to pay who, when and for what.

There are various degrees of indemnification to consider and negotiate with the indemnitor. It is always important to consult with your attorney who can review the applicable state law. It is recommended that you do not invalidate your risk transfer strategy by exceeding the permissible statutory level of risk transfer.

5 Primary Contractual Risk Transfer TypesTo transfer liability from one party to another, contracts include dedicated sections – often called clauses or provisions – that describe the subject of risk and liability. Because contracts are a negotiated agreement, there are a number of ways to transfer liability during the drafting process.

The five primary types of contractual risk transfer are:

1. Requiring Specific Insurance Coverages 2. Additional Insured Provisions3. Waivers of Subrogation4. Indemnity Provisions5. Unambiguous Responsibilities

Each type of contractual risk transfer has unique advantages and disadvantages, and you should examine each one to determine what’s right for your business. For example, many states have laws that limit some types of indemnification, and some types may be outlawed entirely.


Each type of contractual risk transfer has unique advantages and disadvantages, and you should examine each one to determine what’s right for your business.

An indemnification agreement determines

who is going to pay who, when and for what.


When determining the type of risk transfer that’s best for your organization, consider the following questions:

■ How can I establish the best working relationships with others?■ What types of risk transfer are most common in my area and industry?■ What type of risk transfer offers me the most financial protection in this scenario?■ Who will review my contract to ensure it is both legal and in my best interest?

1. REQUIRING SPECIFIC INSURANCE COVERAGESThere are many instances where other parties – vendors, cities, partners, investors, etc. – may require specific insurance

coverages as part of a contract. These are required to help protect both parties from damages, reduce risk exposure and

create a greater sense of trustworthiness between the parties. Coverages may also be required as part of a qualification

process.Common insurance coverages in contracts include:

■ General Liability■ Auto Liability■ Workers’ Compensation/Employer’s Liability■ Directors & Officers Liability (D&O)■ Cyber■ Errors & Omission (E&O)■ Property

2. ADDITIONAL INSURED PROVISIONS

An additional insured provision is a form of risk transfer that allows one party to obtain insurance coverage under another party’s policy. The party that’s added as an additional insured then has direct access to the insurance policy without having to pay any premiums or deductibles.

These provisions protect a party that may be exposed to risks that result from the named policyholder’s operations. Using both additional insured provisions and indemnity provisions can provide a form of backup risk transfer. Then, if an indemnity agreement is found to be unenforceable for any reason, an additional insured may find coverage by making a claim under the named insured’s policy.

Although additional insured provisions usually only function as a secondary form of risk transfer, businesses need to examine a number of key issues:

■ Additional insured status may not be available for every type of insurance. For example, professional liability policies usually will not name another party as additional insured, whereas general liability policies usually will.

■ Establishing appropriate insurance limits. If the job is small, requiring a $10,000,000 limit may exclude small contractors from performing the task – even when they are the most appropriate choice. Conversely, requiring $1,000,000 for a general contractor hired to construct a multi-story office building is far too low for the exposure to loss.

■ Obtain proof of insurance in the form of a Certificate of Insurance to verify coverage and the policy’s limits. It is also wise to request a copy of the additional insured endorsement, as there may be restrictive language included not otherwise made known by the certificate.

Whether you’re asking for additional insured status from a vendor or responding to a bid request, consult with your insurance broker to determine the best approach.


Using both additional insured provisions and indemnity provisions can provide a form of backup risk transfer.

3. WAIVERS OF SUBROGATION

Essentially, waiver of subrogation voids an insurer’s right to mitigate losses by collecting from responsible parties. This provision should prevent your vendor’s or subcontractor’s insurer from filing an action of recovery against your organization. It can protect your insurance limits and future premium rates by not allowing the vendor or subcontractor to recover damages paid from your policy.

■ Transfers more risk to insurers by limiting the insurance carrier’s ability to reclaim funds

■ Can minimize the risk of lawsuits and allow each party’s insurance to cover the losses

■ Can protect your insurance limits and future premium rates

4. INDEMNITY PROVISIONS

Limited or Comparative requires an indemnitor to protect an indemnitee from losses involving the indemnitor’s own negligence. In other words, you are responsible for whatever percentage you contributed to the loss.

Intermediate requires an indemnitor to protect an indemnitee from all related losses, unless it was the sole negligence of the indemnitee. For example, the agreement may call for complete indemnification by the indemnitor if the indemnitor was only 1% negligent.

Broad or Absolute requires an indemnitor to protect an indemnitee from all losses, even if the loss was the result of the indemnitee’s sole negligence. Whether sole negligence can be passed to another party is determined by individual state laws. Some states deem it is against public policy to transfer one’s sole negligence to another party. Do not rely on whether the state prohibits this practice and seek the broadest contractual coverage in your Commercial General Liability (CGL) or other liability policy.

5. UNAMBIGUOUS RESPONSIBILITIES

Ensuring contract terms are specific and clear in regard to which party is responsible for what is the best way to protect both parties. Contracts with clear expectations, roles and responsibilities between the parties will be easiest to resolve should there be an issue, perhaps even helping to keep conflicts out of court.


Hiring Party Risk Transfer Plan Elements When partnering with your attorney on any contract, be sure to take an active role in understanding what the contract will entail. Even the best attorney will not have the extent of knowledge of your business as you – and this knowledge is key to an effective and thorough contract.

Contract areas to carefully consider as the hiring party:

■ Scope■ Payment■ Warranty Provisions■ Damages, Limits of Liability & Indemnification■ Insurance■ Governing Law & Jurisdiction■ Dispute Resolution■ Intellectual Property■ Standard of Care■ Terms & Conditions

Hiring Party Contract Considerations To reiterate from earlier in this guide, we don’t recommend signing the vendor/subcontractor’s standard contract, which will have a lot of language to protect them – some of which may be unfair or an insurability problem for your insurance program.

Contract must include four main elements:

1. Indemnification/Hold Harmless2. Unambiguous Responsibilities of Parties3. Required Insurance Policies & Corresponding Limits4. Additional Insured (AI) Status


Even the best attorney will not have the extent

of knowledge of your business as you – and this knowledge is key

to an effective and thorough contract.

1. INDEMNIFICATION/HOLD HARMLESS

As mentioned earlier in this guide, contracts often include an indemnity agreement, also known as a hold harmless agreement, as a means to transfer the risk of future losses or damages from one party to another. As the hiring party, what should you do when confronted with an agreement requiring you to indemnify the other party for sole negligence?

■ Contact your insurance broker to see if you have proper coverage. ■ Renegotiate the contract to eliminate the sole negligence provision.

2. UNAMBIGUOUS RESPONSIBILITIES OF PARTIES

To understand the importance of defining responsibilities, please consider the required elements of negligence:

■ Duty to perform■ Breach of duty■ Breach is cause of damages■ Must be some form of damages

If there is no duty to act, then negligence cannot occur. The unambiguous description of responsibilities helps determine whose duty it was to perform an action. In other words, by assigning responsibility you are creating the duty to perform. The detailed description of each party’s responsibility is the glue that binds the indemnitor to the signed agreement. Absent the “glue,” the courts may not impose the duty to perform on the indemnitor, thus making the indemnification agreement unenforceable.

Assigning Responsibility

The party with the most control over the risk should be the party assuming the risk. Consider who the responsible party would be for:

■ Safeguarding a job site after hours■ Securing private data against a breach■ Disturbing a known environmental contaminant


Specific Examples

In a snow plowing contract, who will be responsible for keeping the area free of ice should there be a subsequent re-accumulation of ice?

If you are a manufacturer, have you clearly defined the specifications of the parts you are buying from suppliers and advised them of the tolerances you require?

Think about your company and what contracts you have in place with your vendors. You can be as specific as you want to be, subject of course to contractual negotiations and ultimate agreement.

3. REQUIRED INSURANCE POLICIES & CORRESPONDING LIMITS

This aspect of your overall risk transfer plan requires considerable analysis.

Minimum Recommended Coverage

■ Commercial General Liability (CGL)■ Workers’ Compensation/Employer’s Liability■ Auto Liability■ Property

Additional Coverage Considerations

■ Umbrella/Excess■ Professional/Errors & Omissions (E&O)■ Pollution■ Cyber■ Crime■ Builders Risk■ Other

Insurance liability limits generally start at $1,000,000 but can be $20,000,000 or even higher, depending on the project or engagement. If the endeavor involves long-haul trucking or the construction of a $200,000,000 building, substantial limits are in order. Whereas, if you are seeking a small contractor to change a light switch, $1,000,000 may be acceptable, depending on availability of contractors. Ultimately, it is a business decision of the insured to determine their acceptable limit requirement.


When tailoring limits and coverage one must be cognizant of the potential risk of loss and the cost of the required insurance as a proportion to the monetary size of the contract. In summary, offer reasonable requirements that balance your need for protection but allow for a broader mix of qualified subcontractors. Since there are many scenarios, consult with your risk manager to draft appropriate insurance specifications for your attorney to use when drafting the contract.

4. ADDITIONAL INSURED (AI) STATUS

Requiring your vendors and subcontractors to name your business as additional insured in your contract is an essential step.

Additional insured (AI) status is granted via endorsement to the CGL or other applicable liability policy. It is granted on either a blanket or specific company basis. Blanket AI is the most common form. In lieu of blanket AI coverage, a policy may list each firm receiving AI status individually.

AI status comes in many forms. The responding vendor may need to contact their broker for a strong policy endorsement. It is advisable to include these elements:

■ Ongoing operations, products and completed operations■ Primary and non-contributory

Warning! Most blanket AI endorsements only apply to the direct parties to the contract. If the contract calls for you to name another party who is not party to the contract, a CG2038 additional insured endorsement is needed. As most blanket AI endorsements do not extend to third parties, we recommend you consult with your attorney for guidance.


Warning! Most blanket additional insured endorsements only apply to the direct parties to the contract.

Offer reasonable requirements that

balance your need for protection but allow for a broader mix of qualified

subcontractors.

Hired Party Contract ReviewAs a hired party, you must read and understand the contract word for word. Pay particular attention to:

Indemnification – Broadly worded indemnity agreements bind you to responsibility beyond the scope of your insurance. Your limits may be exceeded or an uninsured event can arise. Negotiate the least restrictive form of indemnity.

Scope – Ensure the scope is unambiguous, specific and as narrow as possible. Negotiate the scope of your responsibilities to what you can reasonably deliver.

Limitation of Liability – You want to have a limitation of liability in your contract; your liability is capped at a certain threshold, whether that’s the amount of your fee, your insurance limits, etc.

Waiver of Consequential Damages – You want to avoid being responsible for damages beyond the immediate damage you may have caused. For example, you do not want to assume responsibility for lost profit.

Waiver of Personal Liability – Liability should be limited to your business and not extend to your personal assets.

Insurance Requirements – Consult with your broker to determine if your insurance program meets the insurance required.

Guarantees & Warranties – Make sure you can live with listed parameters and consult with your broker on how your insurance coverage works. Many policies exclude guarantees and warranties.

Other Considerations – Have a brainstorming meeting with your team and professionals to reduce the risk of missing an important element.


Insurance Program Red FlagsCoverage

Carry the broadest form of contractual liability, which simply means that there’s no restrictive endorsements on the policy. The unendorsed Commercial General Liability (CGL) policy provides the broadest form of contractual liability coverage. Eliminate any insured vs. insured exclusions and action over exclusions in your policy, and do not allow them in your vendor’s contracts.

Limitation

Avoid Contractual Liability Limitation (CG 21 39). This limitation alters the definition of “insured contract” by removing provision “f” – “That part of any other contract or agreement pertaining to your business under which you assume the tort liability of another party to pay ‘bodily injury’ or ‘property damage’ to a third party or organization.” By removing provision “f” the insurer has eliminated broad form contractual liability in the unendorsed CGL policy.

Essentially, there is no contractual liability coverage if this endorsement is present except in limited expressly named cases. Your vendors and subcontractors should not have this endorsement in their policy.

Amendment of Insured Contract

Avoid Amendment of Insured Contract (CG 24 26). This endorsement adds wording “provided the bodily injury or property damage is caused in whole or in part by you or by those acting on your behalf.” If this endorsement is present, there is no coverage if you assume the sole negligence of others. While not as severe as CG 21 39, it should be avoided if possible.

Endorsements

Avoid any other endorsement which seeks to amend the definition of an insured contract or limit the circumstances under which contractual liability will apply.

Exclusions

Do not allow exclusions in your vendor’s policy that would allow their insurer to decline a claim. For example, if you hire an excavator, it is unacceptable to allow an exclusion for explosion caused by excavating. If you subcontract out daycare operations, it is unacceptable to allow your vendor to have an abuse and molestation exclusion.


Eliminate any insured vs. insured exclusions and action over exclusions in your policy, and do not allow them in your

vendor’s contracts.

It cannot be stressed enough – transferring your contractual risk and being properly insured will keep your business in business.

Be sure to partner with your insurance broker/risk manager and attorney when developing your strategy.

About CBIZ Insurance Services, Inc.At CBIZ Insurance Services, Inc., we’re passionate about providing strategic solutions that will drive employee engagement and build a dynamic and thriving workplace culture. This isn’t cookie-cutter consulting.

Our team of forward-thinking risk control professionals will support and collaborate with you to develop an actionable plan designed to supplement your risk management strategy by addressing your specific business hazards. You can count on us – with over 25,000 clients and 300 associates nationwide – as your trusted advisors committed to your success.

To learn more, visit us at cbiz.com/insurance.

The information contained herein is for general information purposes only. CBIZ Insurance Services, Inc. (“CBIZ”) does not make any warranties of any kind about the completeness or accuracy of this information. Any action you take upon the information in these materials is strictly at your own risk. CBIZ is not liable for any losses and damages from the use of this information.

© Copyright 2020. CBIZ, Inc. NYSE Listed: CBZ. All rights reserved.

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Protecting Your Business from Contractual Risk