Construction Contracting Series: Contractual Liability – Are You Really Covered?
Contractual liability coverage is a crucial component of your construction company's general liability insurance policy. It's designed to cover the financial liability you assume under broad or intermediate form indemnities in your contracts with clients. But have you taken the time to fully understand what this coverage entails? More importantly, do you even have it?
The Challenge of Indemnities
Construction contractors often face the difficult challenge of accepting unlimited financial liability for bodily injury and property damage claims that arise from their client’s negligence. Clients typically push contractors to accept broad or intermediate form indemnities in their contracts. Here’s the difference:
Broad Form Indemnity: The contractor assumes financial responsibility for claims arising from the client’s negligence, including when the client is 100% at fault (sole negligence).
Intermediate Form Indemnity: The contractor assumes financial responsibility for claims arising from the client’s negligence, unless the client is solely at fault (up to 99% client negligence).
In reality, there’s little difference between the two. If a claim is successful, a contractor—especially a small or mid-sized one—could face financial ruin without proper insurance protection and contract negotiation skills. To make matters worse, these indemnities usually require contractors to also cover the client’s defense costs, even if the claims are groundless or fraudulent.
An Example of Contractual Liability Coverage
Consider the widely used ISO (Insurance Services Office) Commercial General Liability (CGL) policy CG 00 01. This policy provides coverage for a contractor’s liability for bodily injury, property damage, and legal defense that arise from an indemnity in a construction contract. Coverage is provided through an exception to an exclusion (yes, it can be as confusing as it sounds!).
However, not all insurance providers use the standard ISO language. Some have their own versions of coverage terms, which may affect how much protection you actually have under your CGL policy.
A Real-World Scenario
Here’s an example:
Article 25 – Indemnity “Contractor shall defend, indemnify, and hold harmless the Owner and their employees for all claims for bodily injury and property damage arising in any way out of the Work.”
This broad form indemnity obligates the contractor to accept financial responsibility for claims arising from the client’s negligence—including sole negligence—and to pay for the client’s defense costs.
Now, imagine a contractor with a basic $2 million CGL policy and a $4 million excess/umbrella policy, totaling $6 million in coverage. During the course of work, a severe injury occurs, and the client is found to be solely responsible for the accident. A jury awards the injured party $10 million, and the client’s defense costs add another $500,000 to the bill.
The contractor’s insurance policies provide contractual liability coverage, so the client files suit against the contractor, demanding the full $10.5 million per the indemnity clause. Unfortunately, the contractor’s insurance only covers $6 million, leaving them personally responsible for the remaining $4.5 million. For many contractors, this would mean bankruptcy.
The Uninsurable Risk of Broad Form Indemnities
The scenario above highlights a crucial issue: the indemnity in Article 25 created an uninsurable obligation. In today’s litigious environment, juries often award large settlements, and the contractor is left to pick up the pieces. Contractors must take steps to protect themselves by negotiating limitations to their liability.
Limiting Your Liability
Here’s an example of how contractors can limit liability through negotiation:
Article 26 – Limitation of Liability
"Contractor’s total liability under this contract, including the liability and defense costs assumed in Article 25 – Indemnity, shall be limited to an amount not to exceed $1,000,000 in the aggregate."
"This limitation shall survive the contract."
By limiting liability to $1 million, the contractor’s obligation is now insurable under their CGL policy. In the event of a claim, the contractor’s insurance would cover the $1 million limit, reducing the risk of catastrophic financial loss.
Key Considerations for Contractual Liability Coverage
When reviewing your CGL policy’s contractual liability coverage, keep the following in mind:
Policy Language: Does the policy require prior review and approval of the indemnity clauses in your construction contracts by your insurance provider?
Broad Form Indemnity Exclusions: Does the policy exclude coverage for broad form indemnities? For instance, ISO Endorsement CG 24 26 2004 Edition eliminates coverage for broad form indemnities.
Intermediate Form Indemnity Exclusions: Does the policy exclude both broad and intermediate form indemnities? For example, ISO Endorsement CG 21 39 2004 Edition completely removes contractual liability coverage for indemnities in construction contracts.
Protecting Your Business
It’s essential to work closely with your insurance broker or agent to fully understand the details of your contractual liability coverage. Request a written description of what your policy covers, including any exclusions or conditions. Ensure that everyone in your company responsible for negotiating contracts is aware of these details so they can avoid assuming uninsurable risks.
Additionally, make it a standard practice to only accept commercial terms and conditions—and other risks—that are insurable. As one contractor from Toledo, Ohio famously put it: “There is no price for bad terms.”
By understanding your contractual liability coverage and negotiating contracts that protect your business, you can avoid costly mistakes and safeguard your company’s financial future.
