Contractual Liability Insurance

What Is Contractual Liability Insurance?

Contractual liability insurance protects against liabilities that the policyholder has assumed from entering into a contract of any nature.

Understanding Contractual Liability Insurance

Contractual liability involves the financial consequences emanating from liability, not the assumption of the indemnitee's liability itself. Once the indemnitee accidentally causes or allegedly causes injury or damage to a third party, the indemnitee is still answerable for that liability. Thus, liability to a third party for injury or damage cannot be assumed by anyone other than the one who caused the injury or damage. What is being transferred by the indemnitor to the indemnitee instead are the financial consequences (i.e., money damages) of the determined indemnitee's liability.

Contractual liability insurance indemnifies the policyholder from liabilities that may be expressly stated in the contract or may be implied by the nature of the obligations listed in the contract. A common phrase found in contracts states that one party agrees to hold another party harmless for any injuries, accidents, or losses that occur while the contact is in effect.

For example, a construction company working on a city government building may be required to hold the city harmless if someone were to be injured on the construction site. The construction company has agreed to assume liability and indemnify the city. A contractual liability insurance policy would protect the contractor from losses that the building contract protects the city from.

Another important aspect of the contractual liability is understanding that the true meaning of the terms "hold harmless," "indemnify," and "defend" differ. These terms are common in contract language. "Hold harmless" means an agreement to assume the financial consequences of another's liability. "Indemnify" means to reimburse damages and defense costs but it does not include the obligation to defend. If an indemnitee wants to be defended, it must say so in its contract.

Indemnification agreements are common additions to real estate contracts, such as one between a lessor and lessee. A business that rents an office in a strip mall, for example, has to sign a lease contract. This lease will likely state that the business has to hold harmless the landlord from losses, damages, and other liabilities that may occur as a result of the actions (or inaction) of the business.

Contractual Liability Insurance Limitations

Numerous companies have general liability policies that protect them from the many risks that they face in day-to-day operations; however, these policies may exclude coverage in some instances. Such an exclusion may apply to contractual liability, since this type of liability has been added to the overall risk profile of the company and may not have existed had the company not agreed to the contract.

An exception to a general liability policy’s contractual liability exclusion would also include a liability assumed under an insured contract. A contractual liability insurance policy fills the gap created by the commercial general liability insurance policy’s exclusion.