Contractual liability insurance
Fact-checked with HomeInsurance.com
Business owners often sign contracts with third-party groups, whether it’s an office lease, employment agreement or equipment rental form. When you sign a standard business contract, you often agree to assume certain liabilities. As a business owner, understanding contractual liability insurance and what it covers is important, because it affects your business from a legal standpoint. Keep reading to learn more about contractual liability insurance, how it works and who needs it.
What is contractual liability insurance?
A contractual liability insurance policy legally and financially protects business owners from the liabilities they assume when signing a contract with a third party. Most general liability policies exclude bodily injury and property damage liability. This is where contractual liability coverage comes into play.
If a business is found responsible for another person’s injuries or property damage based on the contractual terms with another party, a contractual liability insurance policy would cover any related claims against the business. Some businesses need contractual liability insurance because they sign contracts where they assume 100% of the risk.
Contractual liability insurance differs from other forms of business insurance because it only applies when there is risk transfer. It doesn’t cover liabilities when a business itself is the primary risk, as there are no other parties involved in that scenario. In that case, general liability insurance would cover most liability claims.
One common misconception about contractual liability insurance is that it protects your business from contract-related lawsuits. But despite what the name states, contract insurance does not apply to lawsuits related to breach of contract or failure to adhere to certain contractual agreements, like project deadlines and budgets.
What is an indemnity agreement?
An indemnity agreement is a legally binding statement in a contract that transfers liability from one party to another. Essentially, it’s an agreement where one party promises to reimburse the other for the cost of liability claims that arise from a third party, regardless of which party was at fault. Indemnity agreements can also be called hold harmless agreements.
There are two parties involved in an indemnity agreement: the indemnitor and the indemnitee. The indemnitor is the party that promises to reimburse the other. The indemnitee is the party that is being indemnified, or compensated, by the indemnitor. Most states have laws around the type and amount of risk that can be transferred from the indemnitee to the indemnitor.
When a business signs an indemnity agreement, having contract insurance is beneficial. It protects the business financially if a liability claim is brought by a third party. If the indemnitor is found to be fully responsible and they don’t have insurance, the business would have to pay out-of-pocket to cover the third-party losses.
How does contractual liability insurance work?
Contractual liability insurance only comes into play when there is a third-party liability claim on the table. If a claim is opened, the indemnitor can use their contractual liability insurance to pay bodily injury or property damage losses to the third party on behalf of the indemnitee, up to the monetary limit stated in the contract.
If your business gets involved in a third-party contractual liability claim, you would open a claim with your insurance company as usual. Based on the outcome of the claim, your insurance policy could cover the losses or agree to a settlement with the plaintiff. Contractual liability insurance policies have a coverage limit, which is the highest amount of money your insurance company will pay.
If the indemnitor is also responsible for paying a portion of the settlement, your business would then be responsible for reimbursing them per the terms outlined in the indemnity agreement. This is because your business assumes 100% of the risk when working with a contractor.
Here’s an example of contractual liability insurance at play. Imagine you rent a retail store, and one day a customer trips over a loose floor panel. Both you and the landlord knew that the panel was loose, but it never got fixed. The customer sues your business and your landlord for their injuries, claiming it was your joint responsibility to seal the floor panels.
In this case, you and your landlord would each be partially responsible for paying the customer’s medical bills and lost wages, if their injury kept them out of work. But because you signed an indemnity agreement with the landlord, your business would legally have to reimburse the landlord for their portion of the settlement.
Who needs contractual liability insurance?
Any business that contracts with other companies or individuals should consider purchasing contractual liability insurance. Third-party liability lawsuits can be expensive, and they’re often unexpected. Although it’s not legally required, this type of business insurance can protect your business legally and financially.
Here are some businesses that should strongly consider contract liability insurance:
- Businesses that rent a public storefront
- Businesses that rent an office space
- Construction companies
- Service-based businesses, like electricians and plumbers
Contractual liability insurance is often more beneficial for companies that could not easily afford the cost of a liability lawsuit out-of-pocket, like a small business. The more contracts you have, the more important it is to carry contract liability insurance. If you’re not sure if your business is under any indemnity agreements, review existing contracts to understand the terms and conditions.
- Contractual liability insurance protects business owners from assumed liability when they sign an indemnity agreement with a third party.
- Contract insurance only covers bodily injury and property damage liability claims.
- Contractual liability insurance isn’t legally required, but it’s a smart investment for businesses that have multiple contracts.
Liability lawsuits can hurt your company financially. And even if you have general liability insurance, it probably doesn’t cover bodily injury or property damage claims when there is a contract involved. Contractual liability insurance can come in handy for businesses that have indemnity agreements with third parties. Any company that has contracts with third parties should consider contract insurance for extra protection.