When negotiating your organization’s contracts, you may be tempted to assume that including an insurance provision requiring your counter-party to maintain adequate policies covering their obligations to you is relatively unimportant. You may assume that your counter-party has sufficient financial resources to cover those obligations. But do so at your peril. Including a contractual insurance provision is a powerful but sometimes overlooked tool for managing your risk exposure from failure by your counter-party to fulfill their obligations to you – including indemnification obligations.
The Legal and Business Rationale
At its core, a contractual insurance provision is a risk transfer mechanism. By requiring your counter-party to maintain insurance, you are not only ensuring that they have the financial resources to meet their obligations, but also that a reputable third-party insurer stands behind those obligations. This is especially critical for indemnification provisions, where your counter-party promises to cover losses or liabilities you may incur as a result of their actions.
From a legal perspective, these provisions create an additional layer of security. If your counter-party defaults or becomes insolvent, the insurance policy can provide a direct source of recovery. From a business standpoint, such provisions demonstrate prudent risk management, reassure stakeholders, and can even facilitate smoother contract negotiations by addressing concerns about financial exposure.
Key Risk Mitigation Benefits
- Financial Security: Insurance ensures that funds are available to cover losses, damages, or liabilities arising from the contract, reducing the risk of non-payment due to your counter-party’s financial distress.
- Enhanced Enforceability: Insurance provisions can make indemnification and other obligations more meaningful, as they are backed by an insurer with the resources to pay claims.
- Operational Continuity: By mitigating the financial impact of adverse events, insurance helps maintain business operations and relationships, even in the face of unexpected losses.
- Reputational Protection: Prompt and adequate compensation for losses can help preserve your organization’s reputation and customer relationships.
From Clause to Cashflow: Efficient and Adequate Recovery Through Insurance
Well-crafted contractual insurance provisions do more than simply require the existence of insurance; they can facilitate a direct path to recovery that can obviate the need for protracted and expensive legal disputes between the contracting parties. A primary goal frequently is to minimize financial exposure and safeguard interests by establishing a clear framework for accountability. This proactive approach carries the potential to transform the insurance from an asset of your counter-party into a reliable financial backstop for your own organization, preserving capital and the commercial relationship.
Practical Considerations for Negotiation: Building a Robust Insurance Provision
To ensure that your contract provides adequate protection, thought should be given to the exact types, terms, and conditions of the required coverage, as well as to the commercial practicability of achieving these.
1. Coverage Types
The contract should explicitly name the necessary types of insurance based on the specific risks of the engagement. Common types of insurance policies and coverages include – but by no means are limited to – the following:
- Commercial General Liability
- Professional Liability (Errors & Omissions)
- Property
- Workers’ Compensation
- Business/Commercial Automobile Liability
- “Cyber” Insurance
- Excess/Umbrella Liability
While such coverages are frequently included, it is essential to tailor insurance requirements to the specific subject matter of the contract and the distinct risks of loss or liability it may present.
2. Critical Clauses and Endorsements
Beyond specifying policy types, consideration should be given to specific clauses that confer direct rights and streamline the recovery process; some common types of clauses include the following:
- “Additional Insured” Status: This is typically viewed as a crucial step that confers direct rights to you under their policy.
- Primacy and Non-Contribution: This type of clause is designed to protect your own insurance program, and typically contains verbiage to the effect that the counter-party's insurance is “primary and not in excess or contributing as with respect to any other insurance.”
- Waiver of Subrogation: This clause prevents the counter-party's insurer from suing your organization to recover those funds after paying a claim.
- Separation of Insureds: Also known as a “severability of interests” or “cross liability” clause, this ensures that if your counter-party breaches a policy condition, the insurer cannot deny coverage to you as an additional insured.
- Right to Policy Documentation: The contract should grant you the right to obtain and review not just a certificate of insurance (COI), but also copies of relevant policy endorsements and the policy itself to verify coverage.
- Financial Rating: The value of insurance is only as good as the insurer’s ability to pay. Specify minimum financial strength ratings for acceptable insurers.
- Mandate Notice of Changes: Include provisions requiring prompt notice of policy cancellation, non-renewal, or material changes.
There are myriad other considerations, including parameters around the minimum coverage limits, and any special endorsements needed to cover indemnification obligations.
It is also critical that you understand how your own organization’s insurance may respond to risk and potential losses and liabilities.
Conclusion
Requiring your counter-party to maintain appropriate insurance is a practical, effective way to manage risk and protect your business interests. However, the details are paramount.
It is critical to discuss with legal counsel in advance the specific objectives you intend to achieve through the insurance provisions. Rely on experienced counsel, in partnership with your own insurance team, to help you evaluate the risks and determine the best way to negotiate and document these protections in your contracts.
