How to make sure your contracts are protecting your interests Featured

8:01pm EDT August 31, 2011
How to make sure your contracts are protecting your interests

When signing a contract with a vendor or supplier, you are most likely agreeing to terms that are either bringing on risk or passing on risk. Almost every company doing business has partaken in this for years, but have you ever examined what is actually written in your contracts and how your company is affected or exposed?

“A product will be handled by multiple parties throughout its life cycle while moving through the entire supply chain, manufacturing chain and distribution chain,” says Dennis J. Vogelsberger, CPCU, CWCC, a partner at Neace Lukens. “Sound business relationships are vital for smooth functioning and for getting the product out to market quickly. So how do you handle mishaps that inevitably occur, while still avoiding potentially contentious situations with suppliers and vendors?”

Smart Business spoke with Vogelsberger about how to make sure your company is protected by its contracts.

How can a company protect against taking on undue risks with suppliers and vendors?

The best way is to clearly spell out each party’s responsibilities in advance through various contractual agreements, which are typically required. Because injury and liability can be created at any point along the product’s path to the end consumer, it is important to create language that shifts the burden of responsibility to the party that has the greatest ability to mitigate the risk.

The portion of the contract that deals with risk transfer is critical. Contractual laws vary from state to state, and your attorney should advise you on those nuances. Also, every contractual agreement should be looked at individually. A generic agreement is not recommended, as relationships with vendors and suppliers can vary.

What are some commonly used provisions to accomplish contractual risk transfer?

Indemnity provisions may include one or more of the following obligations: to indemnify, or to reimburse the other in the event of a loss; to defend by paying for legal defense if a third party brings a claim; and to hold harmless — to exempt a party from responsibilities in the event of damages.

Before agreeing to an indemnification provision in a contract, check the wording against the coverage provided by your insurance policy, as many times the indemnification section in the contract is broader than the coverage in the policy. In that case, you would be responsible for the uninsured liability. This is important, as many policies will not cover the other party’s sole negligence, yet many contracts have this wording in them.

Another common provision is the exculpatory provision, which is a way to eliminate a company’s liability stemming from its own wrongful acts. It may be a simple statement in the contract requiring the other party to waive claims against you that result from the business being transacted. In theory, this shields you from potential lawsuits; however, courts may not enforce it. As a result, be very wary of accepting this type of provision.

What additional provisions should businesses be aware of?

The additional insured provision allows you to transfer risk by requiring the other party to list you on its insurance policy as an additional insured, and vice versa. This obligates its insurance carrier to defend and indemnify you as an additional insured, even though you pay no premium. Within this provision, other insurance requirements may also be stated, such as limits, type of policy form and what type of insurance is required.

It is not enough to get an e-mail stating you were added as an additional insured, or a certificate of insurance. You need to see the actual endorsement, as coverage for an additional insured can be drastically reduced to limit the insurance carrier’s exposure, leading you to be severely underinsured. The endorsement will spell out how you are covered and if there are restrictions or sublimits.

On the other side, if you are adding companies to your insurance policy to gain their business, be careful. Protect yourself by doing an annual aggregate contractual liability exposure analysis with your broker to understand all the liability that you have taken on.

For example, if you add 10 companies as additional insureds throughout the year and you only have $1 million in liability coverage, is that enough in the event of a claim? Or if you have a $900,000 claim, that leaves only $100,000 left for all the other additional insureds to tap in to, which can leave you woefully underinsured.

Finally, waiver of subrogation provisions can be critical. Subrogation is the process of one party’s insurance carrier seeking reimbursement from the other party for money spent if it believes that other party was at fault. If your insurance carrier is seeking reimbursement from your business partner, it has the potential to severely damage that business relationship. To avoid deteriorating partnerships, one or both parties can agree to waive their right of subrogation against the other before a loss occurs. As with the exculpatory provision, the waiver of subrogation may not hold up in court in the case of gross negligence or willful misconduct. Additionally, your insurance company, in some cases, will have the final say because it is paying the claim and/or trying to recover monies.

Just because you sign a contract doesn’t mean your insurance company will agree to the terms and cover a claim. Understanding these terms and provisions, as well as how to properly transfer risk, is a step toward limiting your company’s overall liability landscape.

We are not attorneys and are not recommending any legal advice. All contracts and the information above should be discussed with your counsel before implementing.

Dennis J. Vogelsberger, CPCU, CWCC, is a partner at Neace Lukens. Reach him at (216) 446-3324 or dvogelsberger@neacelukens.com.