What is Contractual Liability?

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Contractual liability, in simple terms, is liability that is assumed by one party by signing a contract with another. Any time you sign a contract, you agree to do something for someone else or assume liability. More often than not, you also agree to hold them harmless and indemnify them should anything unforeseen happen. As a business, you will be entering into many types of contracts, whether a lease agreement for buildings or equipment, vehicle contracts, employment contracts, or even manufacturing contracts. Contractual liability is automatically covered under a standard ISO Commercial General Liability (or CGL) policy. Regardless of the reason, you should understand what you are signing, and what type of liability you have taken on.

What is an Indemnity Agreement?

An indemnity agreement, almost always found in the many contracts you will sign as a business owner, means that you will make the party whole again should there be a financial loss due to your negligence. You agree that if your actions cause a third party to sue the party you have entered into the indemnity agreement with, you will pay them back any losses they incur financially.

Examples of Contractual Liability

While contractual liability seems to be pretty self-explanatory, here are a few examples so that you can understand when you are impacted by it:

  1. Lessor/Lessee - Let's say you rent a piece of equipment from Martins Hardware, a tractor. You sign a lease with Martins that has a standard indemnification agreement within it. You are using it on a job and need to cross the street, and unfortunately, you hit a parked car with it. The owner of the parked vehicle can sue not only you but also Martins since they own the piece of equipment. The contractual liability here is that you will have to pay for or reimburse any expenses he incurred due to the lawsuit, damages and defense costs. If you have not been in a legal situation where you had to pay for defense costs, be aware that it can stack up very quickly. Often, it ends up in the tens or hundreds of thousands of dollars.
  2. Contractor/Subcontractor - You have signed a contract, of course including the indemnification language, with the project owner Smith Designs. You are building a new structure for them to house their equipment. They need some electrical work inside, and so you subcontract with Miller Electrical. Miller is negligent in making sure a wire is out of the way, and a visitor ends up tripping and getting severely injured, suing Miller, you, and Smith Designs. Because of the indemnification agreement in the contract with Smith Designs, you must pay, or reimburse them, for any damages or defense costs as a result of the lawsuit. Hopefully, you had the same agreement with Miller Electrical.

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Transferring the Risk

The best way to reduce risk when it comes to liability is to transfer it to someone else. Risk transfer is the basis of a contract and indemnity agreements. Transferring the risk in these situations only moves the liability from one party to another for that specific instance. It will only apply for the duration of the contract, and the particular reason for the contract. The best way to transfer risk is to purchase the right insurance coverage.

Contractual Liability Coverage

While most General Liability insurance policies provide coverage for contractual liability, they usually contain an exclusion. An exclusion is a part of the insurance policy that removes coverage. The contractual liability exclusion removes coverage for "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." Pay attention, though, because it also says it does not apply to: Liability the insured would have in the absence of the contract or Liability assumed under a contract that qualifies as an insured contract (an insured contract is one where you assume the tort liability for someone else, which is most often the case with contracts but be sure to check with your insurance agent)

Business Insurance

Running a business is challenging enough without having to worry about lawsuits, employee injuries or property damage. Having the right insurance gives you the peace of mind to focus on what matters - running your business.

The coverage you need depends on the type of business you run. A restaurant owner needs to be covered against customers possibly getting food poisoning while an accountant needs to be covered against calculation errors. CoverWallet's intelligent assessment system will identify the insurance you need based on your specific business, get you a policy that fits your budget, and do it all in less time than you think.

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