As a business owner, you need to be on the lookout for indemnification clauses in every agreement you sign, or you could be in for a surprise.
Indemnification clauses are the language in a contract that creates the transfer of risk. Brian Chance, vice president of claims and services at ECBM Insurance Brokers and Consultants, says that can be costly if you’re the party taking on risk in the agreement.
“You could become responsible for paying for things you didn’t anticipate, that were not budgeted, or that you didn’t build into your pricing for the work you performed,” he says. “It could create a liability that you aren’t prepared to handle.”
Smart Business spoke with Chance about how to avoid getting more than you bargained for in a contract.
What is the most common mistake people make when navigating contracts?
People sign agreements every day in the regular course of their business, and they don’t read all the fine print that can be in a contract. Contracts can be a page long, or they can be 25 pages long. Many times, people won’t read the nonbusiness transaction-related information in a contract.
For example, if I’m hiring you to paint my house, I might read the part of the contract that discusses what room you’re going to paint, what kind of paint you’re going to use and how much I’m going to pay you to do it, but I may not read the other stuff in that contract you give me. That ‘other stuff’ is where the problem lies.
What types of problems can occur in a contract?
When you sign a contact with an indemnification provision in it, you could become obligated for many different kinds of liability and payments you wouldn’t normally anticipate. If the contracts are ordered properly, those transfers of risks and costs are valid. After you discover the problem you can’t say, ‘I didn’t read the whole thing, so you can’t hold me accountable for this.’ Once you’ve signed it, you’re stuck with what the agreement says. The scary thing about an indemnification provision is it can cause you to become responsible for things you didn’t do or didn’t cause to happen simply by signing a piece of paper.
What can business owners do to ensure they don’t fall into that trap?
The most important thing is to read the entire contract before it’s executed. Second, don’t assume that a contract that is sent to you on a standard form is just like all the other contracts that look just like it and that you’ve signed in the past. Third, consult with someone who has experience at reading those types of agreements. It may be your insurance broker or attorney.
Why is professional help needed to read contracts?
You need someone who is experienced at reading the contract to help you realize what it is that you are being asked to do. Business owners can assume responsibility for many unusual and/or problematic things that someone looking at it logically wouldn’t ever think was possible. So you need someone who is experienced at reading contracts to help you understand exactly what you are being asked to be responsible for. A typical example of an unpleasant surprise is if you agree to be responsible to pay reparations for something that is not your fault. Signing contracts without consulting with someone who understands how they work can directly impact your bottom line.
How can contract mishaps affect your bottom line?
First, you can be responsible for something you didn’t expect to be responsible for and didn’t consider in your pricing. Second, if you sign contracts without someone advising you, you could be taking on legal responsibility for things for which you don’t have insurance coverage. By creating responsibility for yourself, you could be creating an uninsured liability. You may have to pay out of your own pocket because you agreed to do something your insurance policy won’t cover.
It’s one thing to take on responsibly for something your insurance carrier will pay for; it’s something else altogether to take on responsibility for something you have to pay for out of your own pocket.
How can a business owner become better at navigating contracts?
You have to read things you’re asked to sign. Many things you are asked to sign contain indemnification agreements that you wouldn’t naturally expect to be there. For example, you could sign a purchase order for something and it could contain an indemnification agreement.
Look for clauses in the contract that use the words ‘indemnify,’ ‘defend’ and ‘insurance.’ Phrases containing those three words are typically where you will find the problematic language in an agreement. That doesn’t mean it won’t be somewhere else, but most of the time the troublesome language is in those areas.
Work with a consultant, broker or attorney who can help you understand how to read contracts.
And last, take classes from local insurance societies that can educate you on contractual indemnification.
Brian Chance is vice president, claims and services, for ECBM Insurance Brokers and Consultants. Reach him at (610) 668-7100 or firstname.lastname@example.org.