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. 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 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.