THE CGL POLICY AND CONTRACTUAL LIABILITY
A construction industry perspective
By Douglas R. Holmes
How the concept of “contractual liability” is treated in conjunction with the standard ISO commercial general liability (CGL) policy has been a continuing source of confusion for policyholders, certificate holders, and insurance agents and brokers. This article aims to help clarify how contractual liability is addressed from the standpoint of construction liability policies issued under the standard ISO CGL. However, observations and examples have applicability to other commercial policyholders in different fields that use the current ISO CGL Form (CG 00 01 04 13) for their general liability policy.
Contractual liability explained
In its broadest sense, contractual liability—or in other words, a liability based on a contract—is simply a promise made that may be subject to court enforcement. The contract can be either written or oral.
If, for example, I agree to trim a tree in your yard for $500 and receive $200 down but decide not to perform the services requested, I am in breach of contract. You can elect to sue me for the $200 I kept without performing the service. As it applies to a construction agreement, the contractor—more specifically, a building contractor—assumes liability to perform specified services, such as building a room addition or a full house, or in the case of a subcontractor, more specific services on behalf of the general contractor.
There are other insurance options that can be used to cover contractual/tort obligations excluded under the ISO CGL policy. These include a requirement by the owner, developer, or public entity mandating that the contractor post a performance bond.
Oftentimes in a construction agreement, the contractor or the subcontractor (either one acting as the indemnitor) agrees to indemnify and/or hold the other party, the indemnitee, harmless. In such an arrangement, the indemnitor may also agree to provide a legal defense to the indemnitee as part of the arrangement. This type of contract results in the indemnitor assuming the financial risk of loss suffered by the indemnitee.
In addition to indemnification agreements or clauses described above in a typical construction contract, the contractor assumes other obligations—for instance, performing specific services by a certain deadline, installing specific products or materials, performing services in an appropriately safe and workmanlike manner, paying subcontractors and material providers money owed for the project, providing a building protection from the elements during and after construction, providing construction management, offering advice, and fulfilling other typical obligations involved in a construction agreement.
Contractual liability insured
A contractual liability insurance policy protects a policyholder from liabilities an insured undertook or assumed when entering into a contract beyond what is covered in the ISO CGL. In this article, we are discussing primarily construction contracts, but a contractual liability insurance policy can cover other commercial situations.
The policy is designed to cover damages to a third party for a contractual obligation assumed by the policyholder that resulted in an accidental loss for which the policyholder is responsible under the contract. In this case, the policyholder is the indemnitee and the insurance company is the indemnitor. The insurance company does not assume the indemnitee’s liability, but covers the monetary losses the third party suffers as a result of the indemnitee’s assumed liability under the contract.
A contractual liability insurance policy can be a stand-alone document or it can be accomplished by an endorsement to the CGL. The contractual liability policy or endorsement will typically schedule the contracts subject to indemnification. However, the obligation can be blanket, without listing individual contracts. These types of policies are expensive and are rarely used with small and medium-sized contractors.
A contractual liability policy may be required in large private and public work projects such as freeway construction, the development of tract homes, or installation of major utility or transmission lines. They are rarely utilized in smaller or mid-market policies. These policies may exclude various intentional acts, such as job abandonment, intentional breaches or other factors.
There are other insurance options that can be used to cover contractual/tort obligations excluded under the ISO CGL policy. These include a requirement by the owner, developer, or public entity mandating that the contractor post a performance bond. The insurance company acting as a surety assumes the contractual or other obligations of the contractor stated in the bond in the event of inadequate performance, job abandonment, or even nonpayment of subcontractors. Although the surety will indemnify the beneficiary of the bond, the errant contractor is liable to reimburse the surety.
Another option that is becoming increasingly popular is for the contractor to purchase errors and omissions coverage, either as a stand-alone policy or as an endorsement to the CGL policy. Sometimes this policy can be combined with pollution coverage. This type of policy covers contractual and tort obligations that are not covered in the CGL policy. Also, it’s possible to include, based on the wording of the E&O policy or endorsement, the removal and replacement of defective construction and products not covered under the “your work” and “your product” exclusions.
Contractual liability and the CGL policy
Although there is an exclusion for contractual liability contained in the ISO CGL in Section I-COVERAGE-A- Paragraph 2. Exclusion b. Contractual Liability, the ISO CGL contains two related exceptions:
- Liability for damages the insured would have incurred in the absence of the contract or agreement.
- Liability assumed in an agreement that is an “insured contract.”
The “insured contract” functions as the exception to the exclusion for contractual liability. In order to be covered, the bodily injury or property damage must occur after the insured signed the contract and the obligation that is assumed in the contract is considered within the definition of an “insured contract.” The coverage for a contract that qualifies as an “insured contract” is blanket, in that the particular contracts do not need to be scheduled.
The definitions section of the insured contract includes leased premises (with a fire-legal exception), a sidetrack agreement (a short-track railroad maintenance obligation), an easement or license agreement (with some exceptions), an agreement to indemnify a municipality but not perform actual work for the municipality (usually related to permit issuance), and an elevator maintenance agreement.
In addition to the aforementioned legacy contracts incorporated from prior versions of the ISO CGL, the most important one is “paragraph f,” containing a blanket contractual clause in which the policyholder in conjunction with his business (for example, construction) assumes the tort liability of another without any particular restriction. Generally, tort liability is a legal obligation imposed by law other than contractual liability. It can be thought of as negligence.
It is not accurate to say that the CGL does not cover contract liability. It in fact does so as an exception to an exclusion. Oftentimes, a certificate holder will have a laundry list of policy requirements, including a troublesome one that asks if the policy excludes contractual liability. Bear in mind that nobody is going to issue a policy, especially to the small to mid-market contractor, that covers all potential contractual obligations the policyholder assumes in a construction project.
If asked the question by the potential certificate holder, the proper answer is “yes, for an insured contract, as defined in the policy.”
Douglas R Holmes, together with his partner Robert J Anderson Jr., formed Shield Commercial Insurance Services, Inc., in 2004. Operating out of their Palm Desert office, Shield provides access to commercial liability, workers comp and other insurance products in 38 states for small and medium-sized contractors. Products are sold through appointed retail brokers nationwide. Holmes is also a licensed attorney with consultation and litigation experience in insurance coverage, liability, and work comp. He can be reached at email@example.com.