To avoid unintended consequences when drafting insurance provisions in contracts, it is important to consider such provisions in light of the nature and availability of the policies which the contemplated transaction or project may require, as well as any indemnities that may be prescribed by the contract. This article considers several points to keep in mind when drafting insurance provisions in contracts.
Who will bear of responsibility of procuring the insurance required by the contract?
Ensure the contract clearly sets out which party has the responsibility for arranging the relevant insurances and the parties to be covered under the policies. Further, consider the basis upon which the insurance cover will be accessible by them. The person or person who procure the policies will be in privity of contract with the insurer. A "noted interest beneficiary" or a "third party beneficiary" is a party named in a policy who is not a contracting insured. For example, in a large project there may be hundreds of contractors and sub-contractors all working on the project at various times. None are referred to by name, rather as a contractor or sub-contractor. Parties who have a noted interest can enforce the policy directly against the insurer, by virtue of section 48 of the Insurance Contracts Act 1974 (Cth).
Does the contract include an indemnity? If so, how are the indemnity and the insurances intended to fit together?
Contracts often include indemnities. The basic principle of an indemnity is an agreement or promise by one party, to pay for damage and/or loss that may be suffered by another party. With regard to provisions in contracts requiring a party to procure insurance for a counterparty, where indemnities are also given, consideration must also be given to how the indemnity and insurance provisions are intended to work together. Is the insurance intended merely as a security for the performance of the indemnity, or is it intended to provide cover in respect of losses to which the indemnity would not apply? Checking all insurances relevant to the contract against all risks and indemnities that are to be entered into pursuant to the contract and understanding clearly the parties' intended allocation of risks, will provide some certainty as to how the insurances and indemnities fit together.
Consider insurance policy exclusions in light of the intention of the contract
It is most important to consider all exclusions from the relevant policies, to ensure that there are no unexpected uninsured liabilities. A particular exclusion to look for in reviewing liability insurances is what is known in the market as the "contractual liabilities" exclusion. This clause excludes cover for an assumed liability of the insured by warranty, indemnity, guarantee or agreement, to the extent that it exceeds the liability the insured would have had under the general law in respect of the conduct in question, assuming it had still taken place. The underwriting intention of the exclusion is not to exclude the primary form of liability to which the insurance intends to respond, merely because the liability arises by reason of the existence or terms of a contract. Underwriters, however, usually will not cover liabilities assumed over and above those imposed by the general laws of tort, statute and for breach of the basic contractual performance obligation, unless special terms are negotiated.
If it accords with the parties' intention, consider the inclusion of severability and non-imputation clauses in the relevant insurance
In circumstances where a policy of insurance will cover multiple insureds, it is worth considering the inclusion of severability and non-imputation clauses in insurance. Severability clauses mean that compliance and disclosure failures by one insured will not prejudice the rights of other insureds. Non-imputation clauses operate so that the knowledge of one insured cannot be imputed to another.
Limiting liability by reference to the insurance
Bear in mind that insurance always follows the liability: there are significant difficulties in attempting to make liability follow the insurance. It is, however, possible to impose a liability cap that is equal to the limit of indemnity under a policy. There is little point is requiring insurance above the amount of a contractual liability cap, since the insurer will never pay more than the insured's legal liability. In the UK decision of The Trustees of Ampleforth Abbey Trust v Turner & Townsend Project Management Limited  EWHC 2137 (TCC), the judge held that the limitation of liability clause in the contract in question be interpreted by reference to the professional indemnity insurance. The limitation of liability clause prescribed:
“Liability for any negligent failure by Us [TTPM] to carry out Our duties under these Terms shall be limited to such liability as is covered by Our Professional Indemnity Insurance Policy terms…and in no event shall Our liability exceed the fees paid to Us or £1million whichever is the less .”
The judge said that in the absence of any explanation as to why TTPM should have stipulated insurance cover of £10 million, despite a purported limitation of liability to less than £200,000, it would be unreasonable for the contract to limit liability in that manner. The judge held that the liability under the contract was limited to the £10 million insurance limit.
Never fall into the trap of stating, in a limitation of liability clause, that a party's liability shall be limited to the amount actually recovered under its liability insurance. Unless and until the insured is made liable, not entitlement under the policy can arise and no sum will be payable by the insurer. The effect, therefore, may be to provide the insured with a complete defence to any claim by the contract counterparty, by limiting its liability to risk.
Consider the adequacy of Certificates of Currency
It is quite common for insurance provisions in contracts to stipulate that the party organising the insurance provide Certificates of Currency to the other parties to the contract. Certificates of Currency are not insurance policies; rather, they provide a limited representation with respect to the policy that has been procured. Certificates of Currency will not show any gaps in cover or exclusions and provide only a bare outline of the cover. If parties have any concerns around the cover to be provided by a policy, sometimes brokers are able to negotiate with insurers for more detail on Certificates of Currency (for example, confirmation of the inclusion of non-imputation and severability provisions in the policy). Draft endorsements can also sometimes be sought should there be any particular matters the policy needs to address. Moreover, if issued by a broker, rather than the actual insurer, they will provide no basis for any legal recourse against the insurer, since the broker normally will be the agent of the insured, not the insurer. The take-away point in relation to Certificates of Currency is that they are not a substitute for the full policy wording. If possible, it is always preferable to have the full policy terms rather than a Certificate of Currency.
Maintaining insurance during a period
It is important to pay attention to the obligation to maintain insurance, throughout a prescribed period, usually construction and defects maintenance periods in the case of construction risks insurance or over the term of a lease for property and liability insurances. These are insurances which respond to events which happen during the policy period. In the case, however, of professional indemnity and other financial liability insurances, the policies respond to claims made upon the insured during the period of insurance, even though the relevant work may have been done before it commenced. For example, an engineer may make a design error in a project, which does not become apparent until several years after commissioning. The policy which was in force at the time the error was made will not respond, because no claim or awareness of a potential claim came to light during its period. For there to be insurance it is necessary for cover to be in place at the time the claim or the possibility of a claim first becomes apparent. This is referred to as "run off cover" and it is provided either by continually renewing the policy, or by an endorsement stating that it extends for a prescribed run off period, in respect of the work done. Run off cover is generally prescribed for a period of seven years. A period of seven years allows for the usual limitation of actions period for claims in contract (six years), plus one year to serve the proceeding.
Avoid cutting and pasting insurance clauses
While boilerplate clauses can be useful when drafting contracts, standard form insurance clauses often will not adequately address the intention of the contract and the parties. Insurance clauses should be drafted clearly and precisely, be contract-specific and tailored specifically to the intention of the parties.
Consequences of failing to obtain adequate insurance prescribed in a contract
If insurance provisions in contracts are not clearly drafted the parties are at a high risk of failing to obtain adequate insurance. This means that parties may be left without insurance cover and/ or in breach of contract. In that case, the measure of damages is that the defaulting party is effectively treated as the missing insurer, notwithstanding that the party claiming may have other insurance which covers it for the loss.
A case on point is Western Sydney Regional Organisation of Councils Group Apprentices v Statrona P/L (2002) 12 ANZ Ins Cas 61-530. Western Sydney Apprentices was the employer of an apprentice, Mr Hannaford, who suffered a serious injury while working at the premises of Statrona. Mr Hannaford sued Western Sydney Apprentices and Statrona for his injuries, said to have been occasioned by reason of their negligence. A complex series of third party notices were filed whereby the parties all claimed contribution from one another. There were several issues in dispute but, most relevant, was whether Western Sydney Apprentices was obliged to effect insurance to indemnify Statrona against the relevant liability. On appeal the Court found that there was a contract which obliged Western Sydney Apprentices to effect insurance to indemnify Statrona against liability. If Western Sydney Apprentices did not have such a policy, it was liable to Statrona for damages equivalent to the indemnity which the missing policy would have provided to Statrona, despite the fact that the latter had its own insurance in place upon which it was able to claim indemnity.
From the outset, drafting insurance provisions can appear quite straightforward. However, if care is not taken and regard not had to the parties intentions and the policies themselves, issues with insurance can arise. These issues can be complicated and costly to parties. Keeping insurance front of mind when drafting contracts may assist to avoid any nasty issues arising down the track.
Thanks to Fred Hawke for his help in writing this article.