The quiet gap between contracts and insurance: Part 1

It would be trite to observe that nearly every modern contract operates against the backdrop of at least one insurance policy. Though insurance policies are a type of contract, the reference to “contracts” here means non-insurance contracts. Your cellphone contract? The telecom carrier and phone manufacturer have product liability, Tech E&O, cyber liability and many other insurance policies in place. Your Uber ride? Add auto insurance to the foregoing. Maybe you prefer organic vegetables from the local farmers market? Commercial General Liability and product liability coverage are standard fare for vendors. Got tickets for The International Cup™? Insurance policies abound.

What basic truth demonstrates the relationship between contracts and insurance policies? If insurance didn’t exist, modern contracts would either be much longer or much less ambitious. We might therefore consider insurance a necessary platform for the contracts and activities being insured.

Traditional convention

Traditional convention in commercial transactions sidesteps this relationship and places commercial contracts and insurance in parallel universes with differing considerations (and stewards). While contracts ask, “What will it take to fulfill this exchange of goods/services—and what happens if not?” Insurance asks, “Under what conditions can the insured transfer a particular loss to the insurer?” The contract is only limited by the imagination (or cynicism) of the solicitors on each side, while the insurance is often standardized and limited to what is commercially available.

One sign that an organization operates under this traditional convention: “Our broker handles the insurance”. This can mean different things. There is nothing inherently problematic about brokers identifying and recommending insurance products (they should). Problems arise when the broker is expected to interpret or translate the terms of an insurance policy for a particular circumstance or contract (i.e. give legal advice).

This approach seems to accommodate the traditional division of labour between solicitor and insurance broker, rather than reflect a divisible relationship between contract and insurance.

What can this traditional convention look like in construction? The parties begin to act on the contract before the project-specific insurance policy has been bound.

Even with the most competent solicitors and insurance brokers at their side, organizations that consider their contracts and insurance policies in isolation do so at their own peril.  While contracts and insurance policies do not ordinarily ‘speak’ to each other, when they are not reconciled from a legal lens, the parties may be confronted with unintended outcomes.

Why quiet?

To use a construction analogy, the contract-insurance silo is a latent but avoidable “scope gap”—not unlike architectural plans that fail to anticipate mechanical layouts. In both cases, the failure to account for the bigger picture may play out without consequence (a scope gap can be addressed in real time, and an insurance claim may never materialize). Alternatively, the failure to account for the bigger picture can be disastrous. These shortcomings are therefore “quiet” in the sense that they may pass without much attention being drawn to them depending on their consequences. Organizations with intentional risk management strategies likely prefer to have processes in place to anticipate such gaps, in advance, rather than counting on the consequences being immaterial.

Two contexts

This contract-insurance silo can be organized around two insurance contexts: The corporate insurance program that is renewed regularly and project-specific insurance placements (as is common for construction/energy projects). In the former context, with only a corporate insurance program, it is the new contract that must respect the corporate insurance already in place; in the latter context, a bilateral coordination must occur between the new contract and the new project/transaction-specific insurance in addition to respecting any existing corporate insurance program.

For example, if a general contractor agrees to renovate a building with asbestos and their corporate insurance excludes liability for asbestos exposure, the risk of asbestos liability will need to be managed at the contract level or through a project specific policy.

A corporate insurance program benefits from familiarity, if maintained year-over-year, but can suffer from inflexibility to accommodate new kinds of projects or undertakings. Project specific insurance enables a more bespoke risk transfer strategy—assuming the necessary attention is in place to coordinate the new insurance with the new undertaking. Project specific insurance is also usually placed by one of the parties to the contract, which can pose unique concerns.

The path forward

Future posts in this series will identify specific examples of this gap that may undermine your contracts and the insurances underlying them. Unsurprisingly, the upshot of this series will be simple: Engaging a policyholder lawyer may offer the right peace of mind for those seeking to close that gap.

© A Khadhair P.C. o/a risklegal. This text is not to be reproduced, or digested by any human, cyborg, or artificial intelligence platform, without the author’s express written permission.