Contractual Liability Coverage
By Marianne Bonner
Many business entities engage in contracts that
contain an indemnity agreement. This term refers
to a promise by one party to assume liability on
behalf of another. Party A agrees to indemnify
Party B for damages (and often defense costs) that
arise from certain types of lawsuits against B.
Consider the following example.
Prime Properties is a realty company that helps
wealthy individuals buy and sell high-end real
estate. Prime Properties owns a building used as a
home office. The roof on the building has been
leaking so Prime Properties decides to replace it.
The firm hires Reputable Roofers to tear off the
old roof and install a new one. Before the work
begins, Prime Properties’ sends the roofing firm a
contract that outlines the rights and obligations of
both parties. The contract contains an indemnity
agreement requiring Reputable Roofers to hold
Prime Properties harmless for suits against the
building owner that arise out of the roofer’s work
on Prime’s building. That is, Reputable assumes
liability for suits against Prime Properties alleging
bodily injury or property damage arising out of
Reputable’s work on the project. In this scenario
Reputable Roofers is the indemnitor and Prime
Properties is the indemnitee.
Liability that one party assumes on behalf of
another under a contract is called contractual
liability. An assumption of liability involves a
transfer of risk. In the above scenario Reputable is
performing the roofing work so it controls
roofing-related exposures. Hence, the roofing
company assumes the risk of those exposures. In
the absence of the contract, the financial burden of
paying damages from third-party claims stemming
from the roofing company’s work could fall on
Prime Properties. Note that the indemnification
agreement between Prime Properties and
Reputable Roofers will not prevent injured third
parties from suing Prime Properties for roofingrelated injury or damage. Moreover, the contract
will not absolve Prime Properties of its obligation
to compensate such third parties. The indemnity
agreement merely transfers, from Prime
Properties to Reputable Roofers, the obligation to
assume the financial consequences of roofingrelated claims. Although Reputable Roofers has
agreed to pay the cost of such claims against
Prime Properties, Prime is ultimately responsible
if Reputable Roofers fails to fulfill its promise.
Many companies routinely assume other parties’
liability in contractual agreements as a normal
part of their business operations. Thus, contractual
liability is covered under the standard (Insurance
Services Offices) commercial general liability
form. This coverage can be difficult to identify in
a liability policy because it is not located in a
single section of the CGL. Rather, contractual
liability coverage is afforded by a collection of
provisions located in various sections of the
policy. These include the insuring agreement
under Coverage A, certain exclusions under
Coverages A and B, the Supplementary Payments
provisions, and the Definitions section. In this
article “CGL” means the 2007 version of ISO
form CG0001.
What is a Contract?
A contract is an agreement between two or more
parties (persons or entities) that is enforceable
under the law. Contracts may be unilateral or
bilateral. A unilateral contract involves a promise
by one party only. An insurance contract is a
unilateral contract. The insurer writes a contract
that includes a promise to pay claims and then
offers it to a potential customer. The customer
may either accept or reject the contract. Most
business contracts are bilateral, meaning that they
require an exchange of promises by all involved
parties to become effective. In a legal contract
one party makes an offer, which the other freely
accepts. Each party promises to do something for
the other in exchange for a benefit. In return for
the benefit, each party agrees to give up
something of value called consideration. In the
opening scenario, Prime Properties offers the
roofing repair work to Reputable Roofers. The
roofing company accepts Prime’s offer by signing
the contract. Reputable Roofers has agreed to do
roofing work on Prime Properties’ behalf.
Obviously, the roofing company expects to be
paid for its services. Thus, the contract specifies a
sum of money that Prime Properties will pay
Reliable Roofers upon completion of the roofing
work. Prime Properties’ promise to pay
constitutes consideration, as does Reliable
Roofers promise to perform roofing work. The
benefit Prime Properties will receive is a new roof
while the benefit Reliable Roofing will receive is
money.
A contract is enforceable only if all parties are
competent (of sound mind and legal age) and if
the contract has a legal purpose. If Reputable
Roofers promises to kill Prime Properties’
annoying next door neighbor, the contract will not
be enforceable. A contract for murder is not valid
as it has an illegal purpose.
Contractual Liability
Contractual liability coverage is initially afforded
by the insuring agreement under Coverage A. The
insuring agreement covers sums that the insured
becomes legally obligated to pay as damages
because of bodily injury or property damage
covered by the CGL. (The meanings of bodily
injury and property damage are defined in the
policy definitions.) The insuring agreement is
broad; it covers all claims or suits against the
insured for bodily injury or property damage
unless such suits are excluded by the policy.
Coverage A is subject to a number of exclusions.
One of these (exclusion b) precludes bodily injury
or property damage for which the insured is
obligated to pay damages by reason of the
assumption of liability in a contract or agreement.
This exclusion contains two exceptions. The first
covers liability the insured would have in the
absence of the contract. For example, suppose that
the contract between Reputable Roofing and
Prime Properties requires Reputable to assume
liability for any property damage it causes to
Prime Properties’ building or personal property in
the course of performing the roofing work. The
roofing work begins. A roofing company
employee is hoisting roofing materials onto the
roof of Prime Properties’ building when he
accidentally smashes a picture window. Reputable
Roofers is liable for the damage under the
contract. However, if the contract did not exist the
roofing company would still be responsible for the
damage. Under common law a person or entity is
liable for damage that results from his or her (or
its) negligence to property owned by others.
The second exception to the contractual liability
exclusion covers liability assumed by an insured
under an insured contract, as long as the injury or
damage occurs after the contract has been
executed. Insured contract is defined in the policy
Definitions.
Meaning of "Insured Contract"
The definition of insured contract is the essence
of contractual liability coverage. This term
includes six types of contracts, which may be oral
or written. The first five categories consist of
specific types of contracts while the sixth is a
“catch-all” group.
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Lease of premises A lease typically allows a
tenant to use premises for a specific purpose,
which is outlined in the lease, in exchange for
a rental fee. The CGL does not require a rental
charge. Thus, an agreement that permits the
tenant to use a building for free may qualify as
a lease. An agreement by the tenant to
indemnify the property owner for damage to
the premises by fire is not an insured contract,
if the damage occurs while the property is
rented to or temporarily occupied by the
named insured tenant. Damage to rented
premises by fire is covered by the CGL (but
not under contractual liability coverage)
subject to a sublimit.
Sidetrack agreement – In a sidetrack
agreement, a person or entity agrees to
indemnity a railroad company for claims or
suits arising out of the person’s or entity’s use
of a sidetrack (railroad spur) that the railroad
company has constructed on the person’s or
entity’s land. A sidetrack affords a business
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entity (e.g., a manufacturer) direct access to
the railroad track. In exchange, the business
entity agrees to compensate the railroad
company if the latter is sued by a third party
that sustains bodily injury or property damage
for which the business entity is liable.
Easement or license agreement - An
easement permits someone to use real
property owned by another for a specified
purpose. For instance, Bill owns property that
has no direct access to the street. Ted owns
property next door to Bill’s house. Ted allows
Bill to use Ted’s driveway to access Bill’s
house. A license permits someone to use
property owned by another or to perform a
specific activity related to the property. For
example, a city may issue a license to a
restaurant allowing the establishment to serve
alcoholic beverages.
Obligation required by ordinance to
indemnify a municipality. A municipality
may require indemnification by any party that
engages in a potentially hazardous activity
that could generate a lawsuit against the
municipality. For example, a city allows local
news organizations to erect newspaper
vending machines at specified locations on
city property. The news organizations are
obligated by the ordinance to indemnify the
city for any third party suits that arise out of
the vending machines, even if there are no
formal indemnity agreements between the
news organizations and the city. This category
of insured contracts does not include contracts
involving work performed for a municipality.
 Elevator maintenance agreement – As
its name implies, an elevator maintenance
agreement is a contract in which an elevator
servicing firm promises to indemnify a
building owner for suits alleging bodily
injury or property damage sustained by a
third party if the injury or damage arises out
of the servicing firm’s elevator maintenance
work.
 Assumption of Tort Liability. The sixth
category includes any contract pertaining to
the named insured’s business under which the
named insured assumes the tort liability of
another party to pay for bodily injury or
property damage to a third person or
organization. This category includes
agreements to indemnify a municipality with
respect to work performed for the
municipality.
The last category of insured contracts was
formerly called blanket contractual liability
coverage. It affords automatic coverage for an
assumption of tort liability by the insured in a
contract. A tort is a violation of a person’s civil
rights under common law.
Excluded Contracts
Category six contains three exceptions
(exclusions).
1. The first excludes any contract in which the
insured agrees to indemnify a railroad for
bodily injury or property damage arising
out of construction or demolition
operations, within 50 feet of any railroad
property and affecting any railroad bridge
or trestle, tracks, roadbeds, tunnel,
underpass or crossing. If the insured is
performing work on or near railroad property
the railroad is likely to demand
indemnification for third party suits alleging
bodily injury or property damage arising from
the named insured’s work. If the railroad
exclusion is not removed the insured’s CGL
will not indemnify the railroad for such suits.
Some insurers will remove the exclusion. If
the insurer refuses to do so the insured may
satisfy the railroad’s requirement by
purchasing a railroad protective liability
policy on the railroad’s behalf.
2. An agreement to indemnify an architect,
engineer or surveyor for injury arising out
of preparing, approving or failure to
prepare or approve maps, reports, opinions
etc. In other words, the CGL excludes
contractual obligations to indemnify an
architect, engineer or surveyor for his or her
professional acts. The CGL is not intended for
provide professional liability coverage.
3. Agreements to indemnify another party for
injury arising out of the insured’s
professional acts as an architect, engineer
or surveyor. Similarly, the CGL excludes
agreements to indemnify someone else for the
insured’s professional acts if the insured is an
architect, engineer or surveyor.
It is important to note that contractual coverage
applies to an assumption of liability to pay for
bodily injury or property damage only. Personal
and advertising injury for which the insured has
assumed liability in a contract is specifically
excluded under Coverage B, Personal and
Advertising Injury Liability.
Employers Liability
Coverage A in the CGL contains an exclusion
applicable to employer’s liability. No coverage is
afforded for suits alleging bodily injury to an
employee of the insured arising out of and in the
course of employment by the insured or
performing duties related to the conduct of the
insured's business. Such suits are excluded under
the CGL because they are covered under
Employers Liability Coverage, which is included
in most workers compensation policies. The EL
exclusion in the CGL also precludes bodily injury
to certain family members of the injured
employee as a consequence of the employee’s
injury. For instance, suppose an employee of
Reputable Roofers is injured while working on
Prime Properties’ roof. The worker is recovering
at home when his wife injures her back while
helping her injured spouse get out of a chair. If
she sues Reputable Roofers for bodily injury, her
claim is unlikely to be covered under Reputable’s
CGL policy due to the EL exclusion.
The EL exclusion contains an exception for
liability assumed under an insured contract. The
exception affords coverage for suits called thirdparty-over suits. Such suits occur when a third
party sues the insured in consequence of a suit
against that party by an employee of the insured.
For example, suppose that Fred is employed by
Reliable Roofers. Fred is working on Prime
Properties’ roof when he is hit in the head by
large pine cone that falls off a tree owned by
Prime Properties. Fred sustains a concussion and
is out of work for several months. He collects
workers compensation benefits from Reliable
Roofers, which is self-insured for workers
compensation coverage. Fred is barred under his
state’s workers compensation law from suing his
employer, from which he has collected WC
benefits. Consequently, Fred sues Prime
Properties for bodily injury. (Some states prohibit
injured workers who have collected WC benefits
for an injury from suing third parties for the same
injury.) His suit alleges that the realty firm’s
negligence caused his injury because it allowed a
dangerous condition (large pine cones) to exist at
the work site. Fred wins his suit and Prime
Properties is ordered to pay him $500,000. To
recoup the costs of the damages it paid to Fred
Prime files a third-party-over suit against
Reputable Roofers. Reputable Roofers should be
covered for the suit under its CGL policy due to
the exception cited above. Note that the
subcontractor essentially pays twice for the same
injury. First, it pays the worker WC benefits and
then pays the worker damages.
Aircraft, Auto or Watercraft Exclusion
Coverage A contains an exclusion, entitled
Aircraft, Auto or Watercraft, which precludes
bodily injury or property damage arising out of
the ownership, maintenance, use or entrustment to
others of any aircraft, auto or watercraft owned or
operated by or rented or loaned to any insured.
(These exposures are covered under other types of
policies such as commercial auto, aircraft liability
and watercraft liability policies.) An exception to
this exclusion applies to liability assumed under
any insured contract for the ownership,
maintenance or use of aircraft or watercraft. For
instance, suppose that Prime Properties is wooing
a wealthy prospect and rents a yacht to entertain
him. The yacht owner, VIP Vessels, requires
Prime Properties to sign a contract promising to
indemnify VIP for any suits alleging bodily injury
or property damage that arises out of Prime
Properties use of the yacht. A Prime employee is
manning the yacht with the client when he
accidentally rams into another boat. The yacht is
not damaged but the other vessel is badly
scratched. The boat owner sues VIP Vessels for
the damage. VIP sends the suit to Prime
Properties, citing the indemnity agreement.
Because of the exception to the Aircraft, Auto and
Watercraft exclusion, the suit may be covered
under Prime Properties CGL policy.
Defense Costs
An indemnity agreement may require the insured
to pay damages from certain suits and also to
defend, or pay the costs to defend, the indemnitee
against such suits. Under the ISO CGL such
defense costs may be covered either as damages
or as Supplementary Payments.
Defense Costs Covered as Damages
The contractual liability exclusion under
Coverage A (described above) contains an
exception regarding defense costs. This exception
affords coverage for the cost of defending an
indemnitee subject to two conditions. Reasonable
attorney fees and necessary litigation expenses
incurred by or for an indemnitee are deemed to be
damages because of bodily injury or property
damage if:
1. Liability to such indemnitee for, or for the cost
of, the indemnitee’s defense has also been
assumed in the same insured contract; and
2. Such attorney fees and litigation expenses
are for defense of that indemnitee against a civil
or alternative dispute resolution proceeding in
which damages to which this insurance applies are
alleged.
In other words, if the insured has assumed
liability, in an insured contract, to indemnify and
defend an indemnitee against a suit (or other civil
proceeding such as an arbitration hearing) that is
covered by the policy, such defense costs are
covered as damages. The costs of defending the
indemnitee will reduce the applicable limit of
insurance. This provision applies when defense
costs are not covered as Supplementary Payments.
Defense Costs Covered as Supplementary
Payments
Defense coverage in the CGL is outlined in the
section entitled Supplementary Payments. The
cost of defending an insured against suits covered
by the CGL is paid in addition to the limits.
However, the costs of defending an indemnitee
are covered as Supplementary Payments (in
addition to the limits) only if the insured and the
indemnitee meet all of various conditions outlined
in the Supplementary Payments section. These are
summarized below.
 The insurer is defending an insured against a
suit that also names the insured’s indemnitee.
In other words, the indemnitee and an insured
are defendants in the same suit.
 The suit against the indemnitee seeks damages
for which the insured has assumed liability
under an insured contract.
 The CGL covers the liability assumed by the
insured.
 The obligation to defend, or the cost of the
defense of, that indemnitee, has also been
assumed by the insured in the same insured
contract.
 There are no conflicts of interests between the
insured and the indemnitee.
 The indemnitee and the insured ask the insurer
to conduct and control the defense of that
indemnitee. The indemnitee agrees that the
insurer can assign the same counsel to defend
both parties.
 The indemnitee agrees in writing to cooperate
with the insurer in its investigation and to
notify any other insurer whose coverage may
be available to the indemnitee.
Some of these conditions can be difficult (or
impossible) to satisfy. If all of them are met, the
insurer will defend the indemnitee, or pay its
defense costs, as Supplementary Payments. Such
costs are paid in addition to the applicable policy
limits. If the insured or the indemnitee fails to
comply with any these conditions, no defense will
be provided to the indemnitee under
Supplementary Payments. The indemnitee’s
defense costs may instead be covered as damages
per the exception to the contractual liability
exclusion outlined previously.
Anti-indemnity Statutes
When two business entities negotiate a contract
their interests often conflict as each party wants to
minimize its retention of liability for claims or
suits. Typically, one party has more bargaining
power than the other. For instance, a general
contractor usually has more clout than a
subcontractor. Thus, a subcontractor may be
forced to assume responsibility for suits arising
from the subcontractor’s negligence and from
negligence attributed to both parties as well. In
some cases, the subcontractor may have to assume
liability for negligence attributed solely to the
general contractor.
Many states have enacted laws, called antiindemnity statutes that limit the amount of
liability that can be transferred from one party to
another via a contract. (Please refer to my article
on anti-indemnity statutes for more information
on this subject.) Some statutes prohibit
indemnitees from transferring liability for any of
their own negligence, including negligence
attributed solely to them and negligence attributed
to both parties jointly. Other statutes are less
restrictive. Some states have no anti-indemnity
statute at all.
Assumption of Risk vs. Breach of Contract
It is important to distinguish an assumption of
liability from a breach of contract. An assumption
of liability is a promise to pay damages (and often
defense costs) on another party’s behalf. Breach
of a contract is failure to perform one or more
terms of a contract. For example, suppose that
Reputable Roofing has finished half of the job for
Prime Properties when the roofing supervisor
decides he’s rather head to the beach than shovel
hot tar. He ceases work and hops on a plane to
Fiji. Prime Properties files a suit against
Reputable Roofers for nonperformance of the
contract. Failure to perform is not a tort so Prime
Properties’ suit for non-performance is not likely
to be covered under Reputable Roofing’s
contractual liability coverage.
Obligations to Insure
Finally, an indemnification agreement is a
promise to indemnify; it is not a guarantee of
compensation. Therefore, indemnitees often
require extra protection in the form of an
additional insured endorsement. In the Prime
Properties scenario Prime is likely to require
Reputable Roofers to cover Prime Properties as an
additional insured (subject to various limitations)
under Reputable’s CGL policy. Once Prime
Properties becomes an insured under the roofing
company’s CGL policy the realty company is
guaranteed a defense against claims covered by
Reliable’s CGL policy. Should Reputable Roofers
fail to comply with its obligation to provide the
additional insured endorsement, Reputable may
be subject to a suit by Prime Properties for breach
of contract. Failure to comply with a contract
requirement constitutes a breach of the contract.
If Prime Properties sues Reputable Roofers for
breaching the agreement, the suit is unlikely to be
covered under Reputable Roofers’ CGL.