What is contractual liability insurance?

What Is Contractual Liability Insurance?

Contractual liability insurance protects your business against liabilities that you assume when entering into a contract.1 This includes an indemnity agreement in which you assume financial responsibility on behalf of someone else for claims of third party bodily injury and property damage.

Contractual liability insurance may be achieved in three ways:

  1. In a general liability policy through an exception to an exclusion for contractual liability in the ISO CGL form2
  2. Via a separate contractual liability policy or endorsement
  3. Through a performance surety bond 

Because many common contracts contain indemnity agreements, contractual liability should be verified by reading your general liability policy – not simply by requesting a proof of insurance (COI).

This article describes indemnity agreements and contractual liability coverage in the commercial general liability policy and how to find relevant language in your insurance policy. 

I didn’t stay at a Holiday Inn Express last night – I’m not a lawyer and this isn’t legal advice – so you should check with your personal or business attorney before entering into any agreements.

What Is An Indemnity Agreement?

An indemnity agreement – aka “hold harmless” – is a contractual risk-transfer obligation by one party to indemnify another party from financial loss due to claims of liability from third party bodily injury or property damage. 

Indemnity agreements are common in construction. 

In a construction contract that is directly between a contractor and a client, the contractor providing indemnification is known as the indemnitor, and the client being indemnified is the indemnitee

In a construction contract between a general contractor (GC), a sub-contractor and the client, the GC may be both an indemnitor and indemnitee, with respect to the client and the sub-contractor, respectively. 

The GC is seeking indemnification from the sub-contractor to avoid financial loss in a vicarious liability situation. The sub-contractor is most likely indemnifying both the GC and the client.

Below is sample hold harmless language from a construction agreement between a contractor and a municipality:

Sample Hold Harmless Language:

"The Contractor shall defend, indemnify and hold the County, its officers, officials, employees and volunteers harmless from any and all claims, injuries, damages, losses or suits including attorney fees, arising out of or in connection with the performance of this Agreement, except for injuries and damages caused by the sole negligence of the County."

In a hold harmless the indemnitor assumes the financial obligations that arise from the indemnitee’s liability in the course of the contract… 

The example above is known as a limited form hold harmless because the contractor is assuming liability unless it is caused by the sole negligence of the municipality.

Indemnification language may require that you reimburse defense costs or even defend that party.

Is Contractual Liability Included In General Liability?

Contractual liability coverage in the ISO CGL form (CG 00 01 04 13) is addressed through through an exception to the exclusion for contractual liability in Section 1, Coverage A, Part 2, b below.

What is contractual liability insurance?
Coverage for contractual liability in the CGL is provided through an exception in (2) to an exclusion for contractual liability.

Contractual liability is excluded, however there is an exception for an “insured contract” which is defined later in the CGL policy. 

An insured contract includes a building lease, sidetrack agreement, elevator maintenance agreement, etc. and other legacy contracts that go back to the 1970s. 

The reference to an indemnity agreement appears in item “f” which refers to “that part of any contract or agreement pertaining to your business under which you assume the tort liability3 of another party to pay for “bodily injury” or “property damage” to a third person or organization”

Contractual liability insurance claim example

Contractual Liability Insurance Example

ABC Properties hires Sesame Solar Company to install a commercial solar system on the roof of one of their buildings. 

Sesame Solar agrees to indemnify and hold ABC Properties harmless for any bodily injury or property damage as a result of its work. ABC Properties also requires Sesame Solar to endorse it as an “additional insured” on its commercial general liability policy. 

Sesame Solar acts as a general contractor and subcontracts out solar installation to Phat Sun Solar, a solar installation contractor. Sesame Solar requires Phat Sun to indemnify and hold Sesame Solar harmless in the event of any bodily injury and property damage caused by Phat Sun. 

In the course of the installation, an employee of Phat Sun drops a solar panel on the roof of the building, puncturing the rubber membrane roof. During the next rain storm water leaks into the building through the roof and causes $50,000 of interior property damage in a tenant space in ABC Properties’s building. 

The tenant sues the landlord, ABC Properties, and Sesame Solar, the solar general contractor for the interior damages to its tenant space. ABC Properties tenders the lawsuit from the tenant to Sesame Solar and also files a claim with Sesame Solar’s general liability insurance company for the roof damage.

At trial it is determined that Phat Sun Solar, the solar installer, was 40% responsible for the puncture. 

The trial also determined that Sesame Solar had left debris scattered on the roof which caused the employee of Phat Sun Solar to trip and drop the solar panel, puncturing the roof.  The court determined that Sesame Solar was 60% responsible for the damage. 

The court awarded the tenant and landlord $100,000 for the repairs of the roof and interior space. 

Sesame Solar was required to pay 60% of the damages ($60,000) for the repairs and Phat Sun Solar was required to pay 40% of the damages ($40,000) which satisfied the award of damages to the landlord and tenant. 

Immediately after trial, Sesame Solar enforces the indemnity agreement with Phat Sun Solar to recover the $60,000 of damages it has paid to the landlord and tenant. 

As Phat Sun Solar had “assumed the liability” of Sesame Solar, Phat Sun was contractually liable to indemnify Sesame Solar and therefore pay $60,000 that was paid for damage to ABC Properties and partially to the tenant. 

Summary

It’s important to reiterate that an indemnity agreement is not insurance… 

An indemnity agreement is a risk-transfer method and the indemnity provided through a hold harmless is only as good as the indemnitor’s ability to pay.4 Certain exclusions, such as action over can cause huge problems by eliminating coverage for certain bodily injury claims.

As such, you should verify that the indemnitor’s insurance covers contractual liability and that you are listed as an additional insured. 

Note that contractual liability and additional insured status are different things. Some state laws are more hostile toward indemnity agreements than others. Separately, some are specific about the nature of granting of additional insured status through a doctrine called “privity of contract“. 

Even if contractual liability coverage is included through the exception to the exclusion described above, it is possible that an exclusion may exist elsewhere in the policy. 

To avoid potential coverage issues, construction agreements in which one party agrees to hold another party harmless should verify whether their insurance provides such coverage, or excludes it entirely.

Footnotes

  1. For a contract to be binding and enforceable by law it must contain four elements: 1) Both parties must be competent and have the capacity to enter into the agreement. For instance, minors are not considered competent to enter into binding contracts, nor is a mentally incapacitated person. 2) Both parties must want to enter into the agreement (i.e. the agreement is mutual and not under duress). This is sometimes referred to as a "meeting of the minds". 3) There must be a valid offer by one party and acceptance of that offer by the other party. 4) Consideration: This is the value that each party brings to the contract (i.e. one party agrees to provide labor and materials in exchange for money from the other party). A contract cannot be based on something illegal... And while some contracts (such as the sale of real estate) must be in writing, a contract can still be binding even if there is no written agreement (i.e. oral agreement). Example: An electrician gives you a quote to install some new LED lighting in your home. You agree to the quote and give the electrician a $500 deposit to complete the $2,500 job - but the electrician never shows up to install the lights... You try to reach the electrician but get no response. You may make a contractual liability claim against the electrician (breach of contract) because the electrician failed to perform our agreement.
  2. This exception is provided in the ISO CGL form (CG 00 01 04 13) Section 1, Coverage A, Part 2, b.
  3. Tort liability means a liability that would be imposed by law in the absence of any contract or agreement. It may be thought of as "negligence".
  4. It's important to verify that the indemnitor has the insurance they claim to have.
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