UNDERSTANDING LIABILITY AND INDEMNIFICATION

Liability for injury or damage is up to the courts, if and how insurance responds is a different issue

The CGL policy isn’t a magic

blanket; it just does what the insured would

want it to do in a lot of situations.

By Paul Martin, CPCU

People who are not a part of the insurance industry frequently misunderstand the way liability works. After a car accident, for example, they say things like, “I’m not liable for the damage.” They don’t appreciate the fact that their opinion, or the opinion of others, has nothing to do with whether someone has a legal obligation to pay for damage or injury after an accident. At the end of the day, whether someone is liable in tort cases is what the court or the jurors in a lawsuit decide.

But not all liability claims, such as auto accidents, go to court. In fact, few do. The liability adjusters for the insurance companies make educated guesses about how things would go if they did go to court, based on the evidence and the testimony of witnesses. Sometimes, the legal venue, such as the county where the parties live is considered in whether to settle a claim or not. Often, the amount that the claim can be settled for versus the costs of defending a lawsuit, should one be filed, is balanced to reduce the overall costs to the insurance company.

Insurance professionals for the most part understand these subtleties about torts, but sometimes individuals, like the non-insurance public, can misunderstand how liability works in other ways.

Indemnification agreements used in commercial contracts are an area where liability, private contracts, and liability insurance are mixed into a complex situation. Businesses frequently enter into indemnification agreements for good reasons. One business may be selling another business’s products and will want to be made whole if the customer sues the store rather than the manufacturer of a defective product. A contractor who hires other contractors doesn’t want to have to pay the damages created by the subcontractor’s work.

These are easy circumstances to understand, but they don’t tell the whole story. You see, the store selling products and the hiring contractor can still be liable for injury or damage. Just because they signed an agreement doesn’t change tort law. The indemnification agreement doesn’t touch the actuality of whom a court can hold responsible. Most of the time, yes, the indemnitor pays damages and attorney’s fees on behalf of the indemnitee, but the agreement between the two doesn’t magically make liability disappear for the indemnitee. If the indemnitor didn’t have the money or insurance, like that found in the Commercial General Liability (CGL) policy, they can still be held responsible for paying.

Consider how the CGL policy is designed to respond to actual liabilities and indemnification agreements. First, the Coverage A—Insuring Agreement agrees to pay sums that the insured becomes legally responsible to pay for bodily injury or property damage caused by an occurrence within the coverage territory and within the policy period. In addition, the CGL will pay for the defense of the insured. This is an incredibly broad promise.

Next, the policy lays out the exclusions applicable to the agreement. One of the early exclusions is titled “Contractual Liability.” This exclusion outlines that the policy will not pay for bodily injury or property damage for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement. This exclusion makes sense. The insurance company doesn’t want to assume the costs of promises that the insured made for their own torts.

However, this exclusion includes some important exceptions. First, the exclusion says that the exclusion doesn’t apply to situations in which the insured would have been held responsible, despite the contract. Then the exclusion outlines that it doesn’t apply if the contract itself falls into a category that the policy describes as not applicable.

The CGL has a definition of these excepted contracts called, “insured contracts.” The definition specifically describes six types of contracts that are “insured contracts.” When you consider each, they make sense.

The first is a contract for the lease of premises. Imagine that you are the owner of a property, and you decide to lease it to another person. If that lessee decides to do something that is dangerous or negligent, and that activity gets someone hurt, you as the owner could be accused of negligence and injury simply because the property belonged to you. It makes sense that the tenant’s insurance policy would protect you based on what their insured did when occupying the premises. The lessee’s insurance makes you, the lessor, whole and protects you.

The next type of insured contract is a sidetrack agreement. This is an unusual situation in which a business owner contracts with a railroad to build and maintain a railroad line onto the business owner’s property for the benefit of the business owner. This risk isn’t hard to see. The railroad doesn’t want to have to pay for liabilities associated with an arrangement that was designed to benefit the property owner. If something goes wrong, let the sidetrack owner/requester pay for it. The railroad doesn’t want the risk.

The third transfer of liability by contract that the CGL covers is when the contract involves an easement. Easements are contractual arrangements when one party lets another party use their property for a specific purpose. Imagine a driveway or a power line. One party owns the property but lets the other party use it for mutual benefit. If the beneficiary of the easement causes a loss, the one granting the easement shouldn’t be punished. Thus, the logic of the insured contract coverage of the assumption of liability.

The fourth type of insured contract is when the insured is required to indemnify a municipality. These situations could involve permits or other licenses. Consider a business is remodeling, but the work requires encroaching on a city-owned sidewalk; the permit to do the work requires the business to obtain a permit that includes an indemnification for the city.

The fifth type of insured contract is an elevator maintenance contract. These agreements are decades-old understandings between elevator owners and the companies that maintain them and grant them local permits. The elevator company simply insists, by contract, that the owner of the elevator will pay for damages, if any.

The last type of insured contract is probably the most important to most insureds. It encapsulates all the other types of contracts that an insured may enter where they assume the liability of another business. These could include contractors, lessors of leased equipment, vendors of the insured’s product, or anything else imaginable. This part of the definition of “insured contract” is by far the most important and broad.

Even with all the coverage provided by the CGL policy to cover transfers of liability by contract, it doesn’t diminish the fact that insurance is one thing, and liability is another. The CGL policy isn’t a magic blanket; it just does what the insured would want it to do in a lot of situations. Insurance producers should understand this fact and be prepared to educate customers on how liability works and how insurance policies may respond. Liability for injury or damage is up to the courts. If and how insurance responds to that is a very different issue. Smart insurance producers understand the difference. n

The author

Paul Martin, CPCU, is director of academic content at The National Alliance for Insurance Education & Research headquartered in Austin, Texas. Paul works to develop, maintain, and deliver quality educational programs for the organization. Paul has over three decades in the insurance and risk management industry.