Contracts are a normal part of doing business, particularly for professional services firms. They establish the scope of your services, responsibilities, fees and obligations to your clients.

But signing a contract can also change your legal responsibilities.

Certain contractual terms can result in your business accepting liabilities that it may not otherwise have had at law. The problem? Your insurance policy may not automatically cover those additional obligations.

Understanding contractual liability and checking how a contract interacts with your insurance before you sign it, is an important part of managing this risk.

What is Contractual Liability? 

Contractual liability broadly refers to liability that you assume because you have agreed to it under a contract.

For example, a contract may require your business to indemnify another party, accept responsibility for certain losses or meet a particular standard of performance.

Some of these responsibilities may simply reflect liabilities that would already apply to your business at law. Others, however, may extend your responsibility beyond what would ordinarily apply if the contract did not exist.

It is this additional or assumed liability that can potentially create issues from an insurance perspective. 

Does Professional Indemnity Insurance cover Contractual Liability? 

Professional Indemnity Insurance is intended to cover claims arising from your professional services, subject to the terms, conditions and exclusions of your policy. However, most policies contain limitations around contractual liability.

Generally, your insurer will not accept additional liability simply because you have agreed to it under a contract.

This doesn’t mean that signing a contract automatically excludes a claim. If you would have been legally liable for the loss regardless of the contract, your policy may still respond.

The potential gap arises when a contract makes you responsible for more than you would ordinarily be liable for at law. That additional liability may not be covered by your insurance. 

Contract Clauses that can affect your insurance

When reviewing a professional services contract, pay particular attention to clauses that may alter or increase your liability, including:

• Indemnity and hold harmless clauses 

• Standards of care 

• Warranties and guarantees 

• Releases and waivers 

• Liquidated damages 

• Insurance requirements 

These clauses aren’t necessarily problematic, but their wording can affect the extent of liability your business assumes and whether that liability is covered by your insurance.  

What should you do before signing a contract?

The best time to identify potential contractual liability issues is before you sign.

Once the contract has been executed, your business may already be legally bound by its terms, regardless of whether your insurance responds.

Before entering into a new contract

1. Read the entire contract carefully. 
   Don’t focus solely on the commercial terms such as fees, scope and deadlines. Pay particular attention to indemnities, warranties, liability provisions, releases, insurance requirements and standards of care.
    
2. Obtain appropriate legal advice.
   Your solicitor can help you understand the legal effect of the contract, identify onerous provisions and advise whether particular terms should be negotiated or amended.
    
3. Speak with your insurance broker before signing. 
   Your insurance broker can review the relevant insurance requirements and liability provisions against your existing insurance program and identify areas where your cover may not align with the obligations being proposed.
    
4. Consider whether problematic terms can be negotiated. 
   Contracts aren’t always presented on a ‘take it or leave it’ basis. Depending on the circumstances, particularly onerous indemnities or liability provisions may be able to be amended to achieve a more reasonable allocation of risk.
    
5. Understand any remaining uninsured exposure. 
   There may be circumstances where insurance isn’t available for a particular contractual obligation. If your business chooses to proceed regardless, it’s important to understand the potential financial exposure you’re accepting.

Your contracts and insurance should work together

Contracts are ultimately a way of allocating risk between parties. Insurance is one of the tools businesses use to manage that risk. 

The two should therefore be considered together.

For professional services businesses, even a seemingly routine client contract can contain clauses that materially alter your exposure.

Taking the time to review the contract, obtain appropriate legal advice and speak with your insurance broker before signing can help you identify potential issues before you become legally bound by them.