What Is Contractual Liability Insurance?

Many people struggle to understand contractual liability insurance because it is a tricky subject with a few layers. It is a legal contract between the policyholder and the insurance company. According to the contract, if the policyholder causes any damage to any third-party property, the insurance company compensates for that.

If you are a small business owner working on third-party contracts, you must know the contractual liability. In this blog, we have explained the contractual liability meaning and how contractual liability insurance works.

What is a Contractual Liability Insurance Policy?

Before we understand what contractual liability insurance is, let us understand what contractual liability is.
 

When a contractor signs a contract with a client, he or she or the business automatically agrees to pay for any damages caused to the client during the course of service. Take an example.
 

You are a construction company and signed a contract with a client for home renovation. While working on the tasks, you mistakenly damage their electrical connections, and the client needs to change the entire circuitry. In this case, you will have to pay for the entire expenses.

In such a scenario, if you have contractual liability insurance coverage, the insurance company will bear the cost (depending on the extent of coverage).

How Does a Contractual Liability Insurance Work?

If you are running a business that works on a contractual basis with other businesses, you should consider getting contractual liability insurance. As we already mentioned, contractual liability can be a bit tricky for the first-timers to wrap their heads around. So, here is an example to make it easier for you to understand.
 

Mrs. Megha started her art classes on a rented property that belonged to Mr. Akshay. They signed a contract where Mr. Akshay put a clause requiring Mrs. Megha to indemnify Mr. Akshay if her business causes any sort of damage to a third party person, which may lead to lawsuits or compensation.

Now, one fine morning, a parent comes to drop her son at Megha’s art class and trips on a broken floor and injures her arm. The parent demands compensation from both Mr. Akshay and Mrs. Megha for they knew about the broken step and did not bother to fix it. Mr. Akshay and Mrs. Megha both come to an agreement with the victim and pay their equal shares to compensate for the damage.

After this incident, Mr. Akshay invokes the indemnity clause in the contract, and Mrs. Megha compensates Mr. Akshay for his share of the payment for the third-party damage. Mrs. Megha also had contractual liability insurance that reimburses her for making all the compensatory payments.

Few Important Terms Related to Contracts

When signing a contract, you may come across some jargon. Understanding these terms is crucial to protect your business from any liability. We will try to explain the terms referring to the preceding example of Mrs. Megha’s art class.
 

• Indemnify: It means to compensate the first party — the landlord or the person who gave you the contract — for their liabilities that appeared because of your business. For example, Mr. Akshay is the first party who was indemnified by Mrs. Megha for his share of compensation to the injured parent.
  
  
• Hold Harmless: A hold harmless agreement means that you are responsible if something goes wrong while under contract, not the property owner or the first contractor. In the previous context, Mr Akshay was held harmless from any liabilities arising from your business.
  
  
• Lessor and Lessee: If you are hiring a car, the car owner who gave the car for rent will be mentioned in the contract as the ‘lessor’, and you will be addressed as the ‘lessee’.

Why Should Small Businesses Have Contractual Liability Insurance?

Small or medium-sized businesses often come across pitfalls. And if the business is in its nascent stage, the effects of these hiccups can disrupt the business, primarily its financial flow. Therefore, business owners seek SME insurance plans.

Contractual liability insurance is a type of SME insurance plan that can save you from major financial burdens. Here is an example:
 

Suppose a client wants to move its office space to a different location and hires a moving and packing company to take care of the material transfer. The moving and packing company hires you as a third-party contractor. If anything goes wrong during the property transfer, the main client will sue the moving and packing company, and the latter will sue you for indemnification.

If you do not have contractual liability insurance, you will have to pay for the damages, which will surely result in a financial burden.
 

We should mention that having general liability insurance may not come into effect if you have signed a contract that mentions hold harmless and clears the original contractor of all liabilities. A contractual liability insurance will be your only saviour.

Contractual Liability Insurance Coverage: Inclusions and Exclusions

Inclusions:

This contractual liability policy covers the following types of contracts:
 

• Service Contract
• Product Contract
• Any other Contract
   

It covers financial loss arising from Risks/Events mentioned in the policy wording, which generally includes any insurable incidents, risks, or conditions.
 

Exclusions:

The policy does not cover verbal or oral contracts and contracts that are unconditional or deemed. Also, contractual liability insurance excludes the following:
 

• Any liability arising due to illegal activities or unlawful conduct
• Criminal act
• Any unexplained loss or damage
• Liabilities arising from deliberate misconduct and wilful or intentional damage to property.
• Any damage that existed before the signing of the contract
   

This is a general idea of what the contractual liability insurance does not cover. It is not an all-inclusive list, and insurance buyers are strongly advised to read the inclusion and exclusion of the policy before purchasing.

Conclusion

Contractual liability insurance policy is a protection plan for business owners, but it comes with its set of advantages and limitations. Carefully read the contract as well as the policy documents before signing the dotted lines.