Critical Checkpoints for Contractual Liability
Risk is a given in any business. Taking on the risk of others need not be. Yet, contracts routinely contain language that transfers risk. Signing such documents without having them reviewed first by an attorney and your insurance broker is risky business.
From an insurance perspective, contracts define what risks each party is willing to accept and the consequences for not satisfying those risks. Understanding common contract terms and practicing critical checkpoints help protect a company’s bottom line.
The two traditional tools for transferring risk are insurance contracts and all other business contracts. They often intersect because business contracts are generally created to define expectations and distribute, limit, or exclude certain risks. Use the following topic areas as a checklist for preliminary business contract review.
Scope
A contract should clearly define the rights and responsibilities of both parties. It should state the expectations in language that concisely summarizes the scope. Not only should the language be clear enough for an uninvolved third party to comprehend, it should also describe the means for changing the scope.
Liability
Liability, property damages, and indemnification are closely related subjects. Part of the purpose of a contract is to allocate risk to the party best able to control that risk. When a contract limits liability, it defines the damages for which the liable party can be held accountable. From the claimant’s perspective, limitation of liability places a cap on the damages that may be recovered from the party at fault. Indemnification provisions distribute risk and cost among the parties to the contract. Without careful review, a contract signer may be agreeing to assume risk over which the other party has greater control. Be watchful for “sole negligence” terms and “hold harmless” agreements that eliminate or transfer the liability to other parties. This is critical to reducing assumed liability.
Payment
Contracts should specify payment in terms that are free of ambiguity. The contract should define compensation expectations for both parties. Terms of payment should be clearly outlined so the agreement is understood by all parties.
Insurance
Insurance is a critical checkpoint for contractual liability. General liability is designed to pay for the bodily injury and property damage the named insured is legally obligated to pay. It must be reviewed from the perspective of both parties. Policy limits and endorsements related to insurance coverage are usually specified in the contract. Are there obtainable insurance gaps that need to be covered?
Before signing, have your insurance broker review policy terms, limits of coverage, and special conditions relative to the contract and the potential exposure it presents. Also, be sure vendors and subcontractors involved in the agreement have applicable, adequate, and responsive coverage. It is standard practice to ask for certificates of insurance as evidence of coverage.
Some contracts require an “additional insured” approach to coverage. Ask your insurance broker to explain the pros and cons. Decide which party’s insurance should include the additional clause and who should cover the cost.
Statutes
Contracts make provision for governing law. Interpretation of the contract depends on the state law specified. It is important to note when a contract makes reference to a specific law or regulation; it is as if the entire law or regulation is stated within the contract.
This is just one of many reasons why an attorney’s review of a contract prior to signing is critical for limiting liability.
Subrogation
Subrogation is a principle of fairness and a recovery process for the purpose of making the responsible party pay a debt. A subrogation clause gives the insurance company that has paid a claim the right to take legal action against a third party responsible for a loss. In common law, the right of subrogation does not depend on an express statement in an insurance policy or contract. With some exceptions, contracting parties can waive subrogation rights within a contract before a loss occurs. In most states, however, an insured cannot give away or release the subrogation rights of an insurer after the loss has occurred. Here again, contractual review by an attorney and insurance broker is recommended.
Review
This article provides only a partial list of critical checkpoints for contractual review. Its intent is to raise awareness of some of the areas in which risk may be recognized and remedied before signatures are applied to contracts. Because statutory and contractual language is complicated, those trained in recognizing legal and insurance risk implications are the best counsel for contract review.