Contracts provide an ideal opportunity for the efficient
allocation of risk, and insurance clauses can cover much of this
ground, often with no concessions from your client. This
opportunity can be lost when the clause does not really fit the
particular transaction, or where the coverage is not available when
later required. Even a carefully drafted clause may be worthless,
if the parties do not turn their minds to how it will apply to the
specific circumstances and avoid some common traps, as discussed
below. For a more thorough discussion, please sign up for our
upcoming CBA webinar "Negotiating and Drafting Effective Risk
Allocation: Integrated Liability and Insurance Clauses" (Fall
Insurance certificates and erosion of limits:
Many insurance provisions require the delivery of insurance
certificates, presumably confirming the required insurance coverage
is in place. However:
Certificates rarely contain key
provisions, such as critical exclusions.
While they identify policy limits,
they give no indication of whether or not those limits have been,
or are at risk of, being eroded. It does not matter what coverage
the policy provides, if its limits have been exhausted when the
If multiple claims arise against a Named Insured, as a result of
a defect, one or two settlements could quickly erode the policy
limits, leaving nothing to pay any future claims against the
Subsequent modifications/cancellation: The
subsequent modification or cancellation of a policy can also be a
problem. Clauses often contemplate that the insurer will be obliged
to advise of material changes, but frequently it is not endorsed on
the policy, and is therefore ineffective.
Additional insured: Adding a party as an
"additional insured" is probably the most commonly used,
and a largely misunderstood, risk allocation provision. There are
two common misconceptions which often result in these clauses not
achieving their desired goal. First, unless otherwise provided, the
"additional insured" endorsement will provide that the
party is only added for vicarious liability (i.e. the Named
Insured's acts and omissions). It is far better if the
endorsement makes the company an additional insured with respect to
all claims arising from or relating to
the nature of the business being transacted, which will then cover
claims arising from the company's negligence. The second common
misconception is that it is always good to be an additional
insured. For many errors and omissions policies, as well as some
general liability policies, this is not the case. These policies
may contain an "insured versus insured" exclusion, which
removes coverage for any claims asserted by one insured against
Stand Alone Policies: One solution to some of
these issues is having a dedicated policy. Whether this is
practical will vary from business to business. The construction
industry frequently uses dedicated, project-based policies. These
are intended to avoid disputes relating to who is at fault,
ensuring the project can continue to completion when a claim does
arise. It is also a good example of the economically efficient
allocation of risk. Other businesses have similar opportunities.
For example, while dedicated policies may not be as common in
supply agreements, it is an option worth exploring. Another option
to consider may be excess or umbrella policies, which may or may
not be dedicated.
So are your insurance clauses priceless or worthless? The answer
is they can provide great value at little or no cost to your
client. The value is often determined by thoughtful drafting, with
a full appreciation of the transaction and the potential traps
noted above. Consider the following when drafting or reviewing
Get a copy of the insurance policy
from the other party
Consider the issue of eroding
For larger contracts, the clause
should include full details of what the insurance policy(ies)
should and should not include
Consider drafting the additional
insured endorsement and including it as a schedule to the
Have the insured's broker or risk
manager confirm in writing that the insured party can comply with
the requirements of the insurance clauses
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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