Effective risk management is an important goal in any contract negotiation, particularly when the parties’ performance under the contract exposes them to potential third party claims for bodily injury, property damage, and other alleged injuries. One tool in the bag of effective risk management is contractual risk transfer: the process by which one party transfers the potential liability from particular risks to another party by specific contract provisions. By effectively implementing contractual risk transfer and risk management measures, you can minimize your client’s liability to third parties, and you may be able to positively impact your client’s own insurance coverage profile.
This article highlights several simple contractual risk management and risk transfer provisions that should be in every contracting party’s toolkit, including broad form indemnification, additional insured status, primary and noncontributory coverage requirements, and maximizing available limits of liability. Although you may not be able to incorporate each of these provisions into every contract, effective use of one or more provisions can dramatically reduce your client’s exposure to third party liability.
I. Include A Broad Indemnification Clause
One of the most basic contractual risk management tools is the requirement of indemnification. Contractual indemnification provisions should be written as broadly as possible[1] and should explicitly obligate the counterparty to (1) indemnify and hold your client harmless in the event of any loss or damage to a third party arising out of performance of the contract, and (2) provide a complete defense to your client against any claims by third parties.
The contract’s indemnification clause should not be confused with – and is not replaced by – the insurance coverage requirement in the contract. The contract should clearly state that the indemnification requirement is a separate, distinct and independent legal obligation from the requirement to provide insurance coverage. Indemnification provisions shift financial responsibility for legal liability from your client to the counterparty, regardless of whether insurance coverage is available for that liability. Consequently, a broad indemnification clause is especially useful because it may require the counterparty to accept more liability than is ordinarily covered by the insurance policy. As a result, an indemnification provision is an essential risk management tool that provides protection in the event that the counterparty fails to obtain the insurance required by contract, or if all the third party claims are not covered by available insurance.
II. Require That Your Client Be Named As An Additional Insured
Simply requiring the counterparty to have liability insurance only provides insurance coverage to the counterparty; there is no insurance coverage under that policy for your client. But if your client is named as an “additional insured” under the counterparty’s liability policy, your client will now be able to access the insurance coverage available under that policy. “Additional insured” requirements are commonplace in construction contracts, but such provisions can be a useful risk transfer technique in almost any contractual context.[2] Rather than merely obtaining indemnification from your counterparty (often after the expenses are incurred), as an additional insured, the counterparty’s insurer has a duty to defend claims made against you that are within the scope of coverage provided by the policy, and that defense obligation typically attaches immediately after notice is provided to the insurer.
To obtain additional insured status, (1) the contract must have a provision requiring the counterparty to designate your client as an additional insured under its liability insurance policy, and (2) your counterparty must have an endorsement to the policy that expressly extends coverage under that policy to your client as an additional insured. For example, the contract might simply provide that:
All liability insurance policies of [the counterparty] shall name [your client] and its successors and assigns as additional insured.
Based upon this requirement, the counterparty must have or obtain an endorsement to the relevant liability policy that either specifically identifies your client by name as an additional insured, provides additional insured status based upon the relationship of the parties (e.g., lessors, property managers, etc.), or provides additional insured status on a “broad form” basis. A typical broad form additional insured endorsement contains the following general language, which includes as an additional insured:
any person or organization to whom or to which you are required to provide additional insured status in a written contract or written agreement executed prior to loss.
The sample contract provision and sample broad form additional insured endorsement demonstrate why neither alone is sufficient to ensure coverage as an additional insured; each provision explicitly or implicitly refers to the terms of the other document as part of the criteria for obtaining additional insured status. Thus, it is imperative that the contract and policy include corresponding language that will ensure your client’s ability to access the coverage under the counterparty’s liability policy.
Remember that designation as an additional insured does not increase the limits of liability available for claims covered by the applicable policy. In the event of a claim against your client and the counterparty that is covered under the policy, both parties share the available limits. Also, note that additional insured status typically terminates when the counterparty completes the work required under the contract. If an extended period of additional insured coverage is necessary and appropriate under the circumstances, specific provisions for “ongoing” or “completed operations” coverage must be included in both the contract and the applicable policy.
III. Obtain Coverage That Is “Primary And Noncontributory”
Requiring additional insured status for your client is an effective way to transfer risk of liability arising from third party claims, but that requirement alone will likely only serve to provide concurrent primary insurance coverage with your client’s own existing liability policy; it does not substitute the counterparty’s primary insurance coverage for your client’s existing policy. In the event of a covered claim, the two insurance policies are required to provide primary coverage to your client, and the insurers will separately negotiate (or litigate) the appropriate allocation of covered costs. If the goal of your risk transfer efforts is to shift all liability for a covered claim to the counterparty’s insurer up to the required limits of its policy, you will need to specify that insurance coverage under the counterparty’s policy is provided on a “primary and noncontributory” basis. “Primary and noncontributory” does not mean your client’s liability policy will never be required to respond, or that there has been some pre-claim determination of the scope of coverage or the percentage of fault between potentially responsible parties. The phrase “primary and noncontributory” in this context means that your client’s liability policy will not need to contribute either on a pro rata or equal shares basis to a third party claim when covered as an additional insured under the counterparty’s policy. This provision establishes a priority of insurance coverage when two policies cover the same insured for the same loss – i.e., requiring the counterparty’s insurance policy to respond first up to its limits of liability, and preserving your client’s own liability policy as additional coverage in the event the limits of the first policy are exhausted.[3]
To implement this risk transfer mechanism, you must specifically state in the contract that your client’s additional insured status is on a “primary and noncontributory” basis, and confirm that “primary and noncontributory” coverage is provided by the counterparty’s policy.[4] That may require the counterparty to obtain an endorsement to its insurance policy so that it is clear this scope of coverage is available to your client as an additional insured.
For example, consider including a provision in the contract stating that:
all above-mentioned insurance policies shall be primary and noncontributory to any other insurance or self-insurance maintained by [your client].
Because this requires that the counterparty’s insurance company agree to forgo any right of contribution it may have against your client’s insurer, it is essential that the counterparty’s insurance policy contain appropriate provisions reflecting this waiver of contribution.[5] In April 2013, the Insurance Services Office, Inc. (ISO) introduced a new form endorsement that provides coverage to an additional insured on a primary and noncontributory basis, subject to certain conditions, as follows:
This insurance is primary to and will not seek contribution from any other insurance available to an additional insured under this endorsement provided that:
a. The additional insured is a Named Insured under such other insurance; and
b. You are required by a written contract or written agreement that this insurance be primary and not seek contribution from any other insurance available to the additional insured.
With these contract and policy provisions in place, the counterparty’s insurer has the initial obligation to defend and indemnify your client for a covered claim up to the available limits of liability of the policy, and your client’s insurance coverage becomes additional insurance in the event the liability imposed exceeds those available limits.
IV. Maximize The Available Limits Of Liability
Even if you have required the counterparty to obtain insurance naming your client as an additional insured on a primary and noncontributory basis, the risk remains that your counterparty’s policy limits may be too low to absorb the potential liability exposure. Consequently, contract language that maximizes the limits of liability available to your client under the counterparty’s insurance policy is another important risk transfer tool. Such language focuses on the dollar limits your counterparty’s policy must have, specifying an appropriate amount of insurance as a minimum, keeping in mind that the total limits of the policy could be shared between the counterparty and your client in the event of a covered claim against both parties.
For example, consider the following:
The [counterparty] shall at its own expense, procure and maintain in effect during the term of this agreement the following minimum insurance coverage, with carriers acceptable to [your client]:
Commercial General Liability insurance providing coverage with limits of not less than one million dollars ($1,000,000) for each occurrence with an annual aggregate of not less than three million dollars ($3,000,000).
By specifying a minimum amount of insurance coverage rather than a stated dollar amount, the contract sets a floor for the limits of liability that the counterparty must obtain, and also contemplates situations in which the counterparty already has liability insurance with limits in excess of the required minimum. In order to benefit from the higher limits of the existing policy maintained by the counterparty, consider including the following provision:
The required limits of liability are the minimum amounts that must be obtained by [the counterparty], and in the event [the counterparty] has or obtains applicable policies with limits in excess of the required minimums, the full amount of the limits shall be available to [your client] in the event of a claim covered by the policy.
By setting a floor and leaving the ceiling open, you may have increased your client’s coverage as an additional insured to the counterparty’s full policy limit.
Conclusion
Including specific contract provisions to transfer risk to the counterparty or its insurer is an effective risk management tool that will reduce or eliminate your client’s exposure to liability for claims by third parties, positively impact your client’s own insurance coverage profile, and dramatically increase the power of your contracts.
[1] An indemnification clause may be deemed enforceable even where it indemnifies against losses caused by your client’s own negligence, so long as this intention is expressed clearly and unequivocally in an agreement between the parties. See, e.g., Mantilla v. NC Mall Assocs., 167 N.J. 262, 272-73 (2001); Sherry v. Wal-Mart Stores E., L.P., 67 A.D.3d 992, 994-95 (N.Y. App. Div. 2d Dep’t 2009); Hackman v. Moyer Packing, 423 Pa. Super. 378, 383 (Pa. Super. Ct. 1993). Note, however, that indemnification in certain construction-related contracts is specifically governed by statute. See, e.g., N.J.S.A. 2A:40A-1 (prohibits indemnifying for sole negligence); NY CLS Gen. Oblig. § 5-322.1 (prohibits indemnifying for negligence in whole or in part); 68 Pa. Stat. § 491 (prohibits indemnifying certain design professionals).
[2] It is important to distinguish between an “additional insured” and an “additional named insured.” Although the rights and obligations of an “additional named insured” may be greater under the insurance policy, being designated an “additional named insured” may negate certain insurance coverage that is otherwise available to an “additional insured” under the terms and conditions of the typical liability policy. Therefore, opt for “additional named insured” status only if you have identified a specific reason to do so.
[3] Additional insured status and noncontributory coverage may also be available under the counterparty’s excess/umbrella insurance policies. However, the priority of coverage issues under those circumstances present a more complicated legal and factual analysis that is beyond the scope of this article.
[4] Although it is becoming more commonplace, particularly in construction contracts, insurance policies providing coverage for additional insureds on a “primary and noncontributory” basis is not a standard insurance industry practice.
[5] If both your client and the counterparty have the 1998 or later edition of the ISO CGL form policy, the primary and noncontributory requirement is satisfied by a provision found in the Other Insurance terms of the policies, and nothing further is required. In fact, under these circumstances, the specified contractual requirement is not necessary. However, because of varying proprietary policy forms and manuscript endorsements in use in the insurance market, specifying the “primary and noncontributory” requirement in the contract and confirming that such coverage is provided under the applicable policy may be considered a “best practice.”
Published April 22, 2014.
