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 2015).

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 claim arises.

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 additional insured.

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 another insured.

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.

Conclusion:

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 insurance clauses:

  • Get a copy of the insurance policy from the other party
  • Consider the issue of eroding limits
  • 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 agreement
  • 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.