By Kirsten Shepard, CIC, CISR Elite, Senior Risk Management Consultant – Contractual Risk Transfer, OneGroup
A contract is a formal agreement between two or more parties that creates binding obligations to perform or refrain from certain actions. While contracts establish these obligations, they also introduce potential risks to your organization. Therefore, each time your organization enters into a contract, it should:
- Evaluate the risks the agreement may pose
- Decide whether to accept or transfer those risks
- Determine the method of financing those risks, be it through your organization or the contractor
It’s crucial to scrutinize the terms of any contract thoroughly. While some contracts may appear to contain standardized language, they could include commitments your organization should avoid. We recommend a detailed review to anticipate potential scenarios affected by the contract, such as:
- Scope of Work: What will the contractor be responsible for?
- Potential Losses: What types of losses might occur?
- Financial Impact: What’s the “worst-case scenario” in terms of financial loss?
- Protection Measures: How can you safeguard your organization?
Particular attention should be paid to clauses like Limitation of Liability, Hold Harmless, Indemnity, and Insurance. These clauses can obligate you to indemnify another party for property or liability losses. Should you find a contract’s provisions unfavorable, we advise seeking legal counsel.
Transferring risk to other entities helps manage and reduce losses. When feasible, your organization should endeavor to transfer risk through contractual agreements. For example, you might require a vendor to assume all liability for a product they sell to your organization, a term typically embedded in the contract. Your ability to transfer risk often depends on your bargaining power and the nature of the business involved.
Hold Harmless and Indemnity Agreements
Hold harmless and indemnity agreements are essential tools for risk transfer. These may be labeled as hold harmless, waiver and release, save harmless, or indemnity agreements within a contract. Always read contracts meticulously, as these terms can be included without explicit labeling.
In a hold harmless agreement, one party agrees to assume the liability of another. Although often used interchangeably, hold harmless and indemnity agreements differ in the scope and manner of risk transfer. Hold harmless agreements typically pertain to claims between the contracting parties, such as property damage or consequential losses like lost income. These agreements often accompany indemnity agreements because third parties may still file negligence claims against any involved party.
Indemnity agreements shift the responsibility to cover third-party claims. They ensure one party (the indemnitee) can seek reimbursement from another (the indemnitor) for losses, claims, and expenses related to third-party damage claims. A well-crafted indemnity agreement should clearly outline the allocation of responsibilities.
Insurance as a Risk Financing Method
Requiring contractors or service providers to purchase insurance is a practical way to finance loss payments. However, insurance has its limitations and exclusions. For instance, professional liability policies may only cover the insured’s negligence.
When transferring risk, ensure the other party understands the transfer and has the financial resources or suitable insurance to cover potential losses. An indemnity agreement does not absolve your organization from liability; rather, it mandates that the other party covers related costs. If the indemnitor lacks financial stability or insurance, your organization may still be liable.
Including your organization as an additional insured on the contractor’s liability policy offers several advantages:
- Defense and Costs: The insurer must defend and cover your organization’s defense costs if sued.
- Obligations: The insurer remains obligated regardless of the named insured’s financial status.
- Personal Injury Coverage: Typically included under general liability.
However, additional insured status is not a replacement for a hold harmless and indemnity agreement, as insurance policies have limitations and may not cover all claims.
Combining hold harmless and indemnity agreements with insurance provides comprehensive financial security for your organization.
For more information please contact:
Kirsten Shepard, CIC, CISR Elite
315-418-4955