Entering into agreements involves its fair share of what-ifs. There may be a chance that things don’t go as planned. Mistakes may be made by one party that leaves both parties on the hook, one party may cause damage to the other party’s equipment, or one party may become bankrupt, leaving the other party unable to recover the costs and fees owed under the agreement. These are realities of business that keep commercial lawyers busy and ready for action!
Risks come in different forms depending on the industry and the nature of the commercial relationship. However, there are ways to mitigate these risks. This article sheds light on the role of a very common contractual provision in distributing, managing and limiting risk- minimum insurance coverage clauses.
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How do legal agreements deal with risk?
Agreements typically include a range of clauses to limit and distribute risk. The two main types typically involved are indemnity and insurance clauses.
Indemnity clauses
Indemnity clauses are used to specify a range of mistakes, incidents or outcomes, and state which party will be responsible for covering the costs of the other, should these things occur. Simply put, indemnity clauses assist with distributing risk.
Insurance clauses
Insurance clauses effectively limit the potential impacts of such risks. Insurance clauses generally require the parties to take out certain kinds of insurance that cover their operations. These minimum insurance requirements transfer risk away from the contracting parties themselves and onto insurance companies, which can effectively pool and manage risk across many clients. Commonly, insurance clauses will include requirements for Public Liability insurance and/or Professional Indemnity insurance.
These clauses are used to provide a financial safety net in the event of a claim related to the contract. Rather than bearing the full brunt of losses themselves, their insurance steps in to cover damages up to the agreed limit. This protects them from large payouts that could severely impact a business’ cashflow and operations.
Insurance clauses are generally included for the benefit of the other party. They offer security to the other party by ensuring compensation will be available if the insured entity causes them damage or fails to make payments required under the agreement. Without adequate cover, they may struggle to recoup losses if the liable party lacks the means to pay claims in full.
Insurance clauses also serve a secondary purpose, that is, for the other party to safeguard that the insured party is running their business sustainably and solvently. For instance, a party may be required to take Workers’ Compensation insurance, Salary Continuance insurance, or certain insurances required by professional organisations. This promotes a balanced and secure commercial relationship, as both sides can enter the agreement with greater confidence that the other will have the funds to continue doing business into the future.
What is the ideal minimum cover?
Deciding on the minimum insurance coverage is a balancing act. It depends on the scope of the risks being taken on, while also fitting within the budget constraints of each party.
Larger entities may have more commercial exposure to risk, while smaller entities or sole traders may have more to lose at a personal level. Larger entities can have more negotiating power, but they are also likely to have a bigger insurance budget than smaller entities, so they may be expected to shoulder more of the insurance burden.
Types and limits commonly vary substantially across different industries and contracts. In industries with a large volume of customers, or those operating in public spaces, substantial third-party insurance requirements may be essential. This may take the form of Public Liability insurance, which covers third-party injuries and property damage that occur in the course of business. Or it could mean getting Product Liability insurance, which covers the consequences of defective goods being sold to customers.
If you’re in the business of providing professional services, modest amounts of Professional Indemnity insurance may be required to protect you against claims resulting from errors, omission or breach of duty. Where there is a possibility that the risks generated by the commercial relationship may result in claims well after the relationship has ended, retrospective or run-off insurance may also be required.
You may be able to determine appropriate cover amounts by doing industry research, as certain minimums may be the expectation in certain industries. Regulations and professional organisations may also impose minimums required within their industry, and these should be considered when agreeing on appropriate minimum coverage.
Examples of minimum insurance coverage requirements
It can be tricky at first to know the right levels of insurance that are appropriate for everyday commercial relationships. You may even be caught off guard if you’re expected by counterparties to have a higher level of coverage than you would otherwise have taken out for yourself given your risk profile. But don’t worry, there’s plenty of information out there to help parties prepare in making such assessments.
We can begin by looking at regulatory and professional requirements for particular industries:
- Tasmanian architects must hold a minimum of $1 million in Professional Indemnity insurance (per claim)**.
- An electrician operating in Queensland must hold at least Public and Products Liability with a minimum coverage of $5 million, and Consumer Protection Insurance of at least $50,000***.
You can use these figures as benchmarks either when drafting agreements to make sure professionals are meeting industry standards, or as a way to determine the right amount of insurance for a particular industry. You may even wish to go beyond these minimums when dealing with well-established parties.
There are also publicly-available resources that can be used to guide, such as the Tasmanian Treasury’s guide to help government departments decide on appropriate minimums when contracting on particular projects with private operators. It includes guidance on a range of projects and associated risks and provides helpful ranges of coverage across different insurance types.
Each business should refer to their State/Territories regulatory requirements prior to purchasing cover.
Conclusion
Well-structured insurance clauses don’t just protect you from financial losses. They also strengthen the trust and reliability that form the foundation for successful business relationships
While this article mentions some big numbers, the actual costs of insurance can be manageable. When you weigh them against the potential expenses from mishaps or unforeseen events, investing in insurance makes a lot of financial sense for any business budget.
BizCover makes it easy for small businesses to compare multiple policies from different insurers, helping them understand the cost of a specific level of cover while being able to purchase cover in minutes.You might find that switching could actually lower your costs, making it easier to meet your contractual obligations for less.
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** Source for information can be found here.
*** Source for information can be found here.
