Practical Tips for Avoiding Contract Disputes: Part II

Editor’s Note: This article is the second of a two-part series. This part examines the role business insurance plays in contract negotiation and dispute resolution. Part I in November discussed how to minimize contractual disputes.

Insurance matters. Insurance exists to cover you in those moments when the unforeseen happens.

However, it is crucial when negotiating contractual terms to consider the consequences of insurance clauses from a practical and economic standpoint. Namely, you want to be sure that the scope of your insurance policy matches the contractual terms before agreeing to be bound by them. Not knowing whether your policy’s coverage extends to the limits of what the contract requires can leave your company at unnecessary risk.

Avoiding these costly misunderstandings and ensuring that your company is not caught off guard by agreeing to contractual terms outside of its policy limits are achieved by making sure that your broker is an informed participant in your contract negotiations. 

A few common insurance clauses may contain traps for the unwary. The following should be examined closely.

Errors and Omissions (E&O) Insurance

While every business already should have commercial general liability (GCL) coverage, which triggers if a third-party suffers a bodily injury or property damage as a result of completed work, if no third-party property damage or bodily injury occurs but a financial loss does, GCL is not applicable. An E&O policy is designed to pick up the financial exposure your company may be held responsible for in these cases.

For example, if your company performs work on a client’s production line, and the line stops, causing a business interruption, you may be presented with a bill. An E&O policy can be used to pay this bill, up to the policy’s limits.

However, not all shops carry E&O insurance, and it is important to be aware of whether or not this coverage is contained in your policy. If you do business in the U.S., it is expected that you will have E&O coverage.

Contracts often will state that the E&O coverage requested by your customer remains in effect for a three-year period. Knowing your policy, or confirming its scope with your broker, will help you to avoid making false representations regarding your coverage in contractual dealings.

Property Insurance

Clauses related to property insurance often are outlined in contracts and purchase orders, and you should be aware that they sometimes state that the contractor is legally liable for the replacement cost of property, equipment, and tools over which the contractor is responsible.

The effect of such clauses is that they require payment of the full replacement price of the contractor’s property, equipment, and tools, and also those of any subcontractors.

It is important to note that if the contract requires a contractor to be responsible for replacement cost, it does not account for older property, tools, and equipment. This may result in a gap in your insurance coverage, as your policy may not cover the replacement cost of older items, but simply provide for coverage of the actual cash value.

The difference can be a costly one, and before you agree to a term that obligates your company to pay for the replacement value of tools, you need to ask the following questions:

• Does the company currently have this coverage?
• Does it make financial sense?

A policy will be more expensive if it encompasses replacement value rather than just the actual value of the property, tools, and machinery to be insured. Accordingly, you may want to negotiate your way out of including such terms in your contract, or suggest that coverage extend only to the actual cash value of these items.

Certificates of Insurance

Many contracts state that a refusal to pay contractors will result if they do not have certificates of insurance from their supply chain. The last thing you want is to not get paid because you did not collect these certificates within the five-day period prior to the start of the job.

It is advisable to have the certificates of insurance before the job starts. You also should insist that any subcontractor that wants to work for you name your company as an additional insured party on the policy. This means that if there is a claim against you based on work your subcontractor has done, your company’s name on the policy would ensure some control over the payment once it is issued by the insurance company.

Inclusion on the policy also gives your company the right to speak directly to the insurance company in the event of a claim.

In addition, if your subcontractor’s policy is set to be canceled by its insurance company, or if it failed to make a payment, you would be informed by the insurance company. It is therefore worthwhile to consider negotiating for the inclusion of your company on your subcontractors’ insurance policies in all contractual agreements.

While these examples represent only a few of the provisions that touch upon issues related to insurance that may arise during the course of your contract negotiations, they serve to highlight the importance of discussing your contractual obligations with your insurer to ensure not only that you are covered, but that you are informed of your options and potential exposures.

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Tip: Know the limits of your policy and coverage when negotiating contracts.