How To Reduce Claims When You Must Assume Liability In A Contract

The Party Not In Power Assumes Liabilities

 

Most tech companies enter into contracts with project owners or managers that specify the terms of the work including which party is responsible when things go wrong.

The most common provisions that govern professional liability insurance (errors and omissions liability insurance) and general liability insurance risk factors and the transfer of risk in these contracts are known as Bodily Injury and Property Damage Indemnity, Pure Economic Loss Indemnity, Intellectual Property Indemnity, Breach of Privacy Indemnity, Consequential Damages and Limitation of Liability.

The types of losses that are specified in these contractual provisions may or may not be covered by a tech company’s general liability insurance or professional liability insurance depending upon the exact contractual language as well as the insurance policy language.

In most cases, a particular project for tech work will have one party that is larger and more powerful and that will control the terms of the contract negotiation. This is known as the “party in power.” The “party in power” usually provides the contract form that is presented to the “party not in power.” This contract form usually requires the “party not in power” to assume most of the liabilities that could occur. As a result, the “party not in power” is also known as the party that is assuming the liability under the terms of the contract.

The “party not in power” is typically a small one or two man tech company that is performing work for a large company.

Strategies for Party Not In Power that Must Assume
Liabilities under the Contract

All is not necessarily lost by the party to the contract that is assuming the liabilities. Such party may be able to negotiate contract changes that can result in a more level playing field. The negotiating tips that are outlined in the sections below may be helpful.

Bodily Injury and Property Damage Indemnity

Most tech work performance contracts contain a general indemnification/hold harmless provision that requires the “party not in power” to indemnify and hold harmless the “party in power” against certain third party claims and lawsuits where a third party (someone other than the two parties to the contract such as an end user of the tech work) alleges that they have suffered damages.

The purpose of an indemnification/hold harmless provision is that the indemnitor (usually “party not in power”) agrees to accept the specified liability as well as legal defense on behalf of the indemnitee (usually “party in power”).

The most common type of general indemnity agreement deals with responsibility for damages to a third party for “bodily injury” or “property damage.”

Sometimes the provision dealing with indemnification for “bodily injury” and “property damage” can be too broad and heavy handed to protect the interests of the “party not in power.”

Negotiation tips:

  • If the indemnification provision uses terms such as “any and all liability,” try to amend this to “bodily injury” and “property damage.” Limiting the indemnification to “bodily injury” and “property damage” will eliminate responsibility for lawsuits involving breach of contract, intellectual property infringement and breach of privacy.
  • Narrow the definition of “property damage” to exclude damage to “data.” It is important to note that the insurance industry has taken this approach under the most recent General Liability forms.
  • Limit the indemnity for “bodily injury” and “property damage” arising “directly” from your conduct and eliminate the term “indirectly.”
  • Limit the indemnity to your “negligent” acts, errors and omission instead of “any” acts errors or omissions.
  • Limit the indemnity for “bodily injury” and “property damage” “to the extent caused by your negligence” or “in whole or in part caused by your negligence.”
  • If you can’t negotiate the above-mentioned concessions, try to limit your total liability to that which is covered by your General Liability insurance and Professional Liability insurance policies. Or, if this approach is not successful, try to negotiate a monetary cap for damages such as $100,000.

Pure Economic Loss Indemnity (Other than
Bodily Injury and Property Damage)

Tech companies that are the “party not in power” often assume liabilities under broadly written indemnity provisions that make them responsible for liabilities that go way beyond “bodily injury” and “property damage” “to a third party.”

It is quite likely that many tech product or service failures result in damages to third parties that are not associated with “bodily injury” and “property damage.” These additional types of damages are broadly referred to as pure economic loss damages. Many of these types of lawsuits involve causes of action for breach of warranty or breach of contract. These causes of action are typically excluded by most General Liability insurance policies but may be covered by Professional Liability insurance policies.

Negotiation tips:

Attempt to limit liability to claims alleging “bodily injury” and “property damage.” If you are successful with this maneuver, you may have eliminated all of your indemnity risk for economic damages not associated with “bodily injury” and “property damage.”

  • Try to limit your total liability to that which is covered under your General Liability insurance and Professional Liability insurance policies.
  • To the extent that the above approach is not successful, try to negotiate a monetary cap for damages such as $100,000.

Intellectual Property Infringement Indemnity

Many tech work contracts contain an indemnity provision for intellectual property violations arising out of the work. Intellectual property violations include offenses such as infringements of copyright, patent, trademark, tradename, etc.

Negotiation tips:

  • Try to remove any specific provisions dealing with intellectual property infringement indemnity.
  • Limit the indemnity to not apply to situations where the intellectual property violation is caused “solely” by the other party or “in whole or in part” (better outcome) by the other party.
  • Limit the indemnity to not apply to situations where you are making a product to comply with the specifications required under the contract, where another party alters or modifies your product without authorization or where another party commingles your product with another product.
  • Limit the indemnity to patent infringement only. Furthermore, patent infringement may be limited to U.S. patents only as opposed to patents in other countries.

Breach of Privacy Indemnity

Invasion of privacy and identity theft claims can arise out of tech work where a tech product or service fails resulting in release of confidential information such as bank account numbers, credit card numbers, social security numbers, medical records, etc.

Many contracts for tech work contain a specific indemnification provision for these types of violations where confidential information is being collected. In addition, more generalized indemnity provisions can capture these types of claims if the general indemnity provision is not limited to claims for “bodily injury” and “property damage.”

Negotiation tips:

  • Attempt to remove any specific provision dealing with breach of privacy indemnity from the contract.
  • Limit the indemnity to not apply to situations where the breach of privacy is caused “solely” or “in whole or in part” (better outcome) by the other party.
  • Limit the indemnity to only apply to the extent covered by your General Liability insurance or Professional Liability insurance.
  • Place a monetary cap on the indemnity such as $100,000.

Consequential Damages Waiver Clause

You should attempt to add a provision to your work contracts stating that you are not liable for any consequential damages arising out of the failure of your tech product or service or any other breach of contract or warranty. An example of consequential damages would be any loss of profits or extra expenses incurred by the other party over and above the actual failure of your tech product or service itself.

Negotiating tips:

  • Attempt to insert a consequential damages waiver clause into your tech work contract.
  • Make sure that your consequential damages waiver clause is not overridden by the indemnity provisions.
  • To the extent that you are not successful in negotiating the addition of this clause, try to limit your liability with a limitation of liability clause.

Limitation of Liability Clause

A limitation of liability clause is often found side by side with a consequential damages wavier clause in tech work contracts. While the consequential damages waiver clause eliminates certain liabilities, the limitation of liabilities clause limits liabilities to a certain monetary cap.

Negotiation tips:

  • Attempt to insert a limitation of liabilities clause into your tech work contract.
  • Set the monetary cap to a sum of money that relates to the contract such as a dollar amount to be paid for a one-time project or an annual amount to be paid for an ongoing project.
  • Make sure that your limitation of liabilities clause is not overridden by the indemnity provisions.

*Some of the information for this article comes from articles written by Michael Rossi and available on www.irmi.com in the Cyber Insurance column. These parts are reproduced with permission of the publisher, International Risk Management Institute, Inc. Dallas, Texas from www.irmi.com. Further reproduction prohibited. Visit www.irmi.com for free practical and reliable risk and insurance information.

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How To Reduce Claims When You Must Assume Liability In A Contract
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