You’ve found the right consulting firm for a project and reached agreement on scope, schedule, and fee. There are just a few nitty-gritty contract details to work out.
Life is good.
Until you get that call: “We need to talk about the contract. We can’t agree to some of this stuff – it’s uninsurable.”
Does that mean all coverage under the policy is void? That the firm has substandard insurance? Is it just a negotiating tactic to secure more favorable terms? Could it even be an ominous sign that the firm won’t stand behind its work if something goes wrong?
These ideas are understandable, but wrong.
Consultants and their insurers stand ready to defend the work and pay for damages caused by negligence. But they can’t become the guarantors of all risks associated with project ownership. A contract that shifts all project risk to the design team may sound like a good idea in theory, but in practice may lack coverage under the firm’s professional liability insurance.
In this article, we’ll look at a few common “insurability” problems in owner-drafted agreements and show how they might be remedied.
But first, some disclaimers: This article talks in general terms about professional liability insurance, but you need to understand that no standardized or generic policy form exists. There are as many as 60 markets – with 60 different policy forms – in the U.S. The provisions discussed here are “industry standard” to the extent that any “standard” can be said to exist, and we’ll treat them as such for simplicity’s sake.
Also, this article discusses general legal concepts, but isn’t legal advice. Consult with legal counsel when drafting contracts to ensure they use language that’s likely to be enforced as intended in your jurisdiction.
How Professional Liability Coverage Works and What ‘Uninsurability’ Means
Consulting firms purchase professional liability insurance to cover damages caused by negligent performance of professional services by the firm or its employees. When consultants talk about “uninsurable” contract clauses, they’re usually referring to promises that aren’t fully covered under their firm’s professional liability insurance policy.
It’s easy to understand why someone would want to negotiate for insurable contract terms.
But why should you care how a firm pays for damages caused by employee error? What does it matter whether the money comes from an insurance company or the design firm?
Why It Matters to Project Owners
Insurability matters because your agency wants to be made whole – promptly – if negligence causes loss or damage.
First, you want to be sure there will be funds to make it right.
Design consultants typically don’t retain a large pool of assets, whether cash or property, that could be sold to satisfy a judgment. In this respect, they’re quite different from construction contractors, who must stay well capitalized to maintain bonding capacity. A large claim might not only exceed ability to pay, but put the firm out of business.
Second, you want claims resolved expeditiously with minimal legal expense.
Only 2% to 5% of all civil cases go to trial. This means that the vast majority are settled out of court. Experienced litigators know it’s hard to settle cases when the defendant is uninsured. All joking about stingy insurance companies aside, it’s much easier to negotiate a settlement with an insurance company than an uninsured consultant.
Therefore, insurability is in the best interests of both parties. Sometimes, though, it conflicts with a public agency’s other interests. Let’s look at two examples of uninsurable contract clauses that often crop up in owner-drafted contracts for professional services.
Uninsurable Clause No. 1: Elevated Standard of Care (Perfection is Impossible)
Naturally, you want the best possible design for the project. Sometimes public owners express that desire by imposing an extraordinarily high standard of care: “Consultant shall perform all services in accordance with the highest standard of care …”
Though the desire for perfection may seem reasonable, such language creates insurability and practical problems.
First, the law doesn’t require consultants to perform perfectly or to produce error-free work because there’s no such thing as a perfect design, plan, etc. Instead, the law imposes a duty to exercise the same degree of skill, care, and judgment exercised by members of the same profession under similar circumstances. This standard applies even in the absence of a contractual promise to that effect.
Consultants who agree to a higher standard are making a promise that lacks coverage under their professional liability policy.
Presumably, you’ve selected a responsible and capable consultant who wants to make you happy and maintain a good reputation. Adding “highest” standard of care isn’t going to make him or her work “harder” or do “better.” But it will create an insurance coverage dispute where none needs to exist.
Tip: Try This Language Instead
Consultant shall perform services with the care and skill ordinarily used by members of the same profession practicing under similar circumstances at the same time and in the same locality.
Uninsurable Clause No. 2: Indemnification
Many agreements require the consultant to indemnify the project owner; that is, to compensate the owner for certain types of damages. Some indemnity clauses, however, aren’t covered by professional liability insurance. Thus, negotiating an uninsurable indemnity clause may turn out to be a Pyrrhic victory if there aren’t funds to back the promise.
For example: Consultant shall defend, indemnify, and hold owner harmless from and against any and all damages, claims, causes of action, or allegations in any way arising out of or relating to consultant’s services on the project.
This language illustrates two common insurability problems in owner-drafted indemnity clauses.
Duty to Defend. Professional liability coverage includes defense for the insured but doesn’t pay to defend other parties.
This is another major difference from construction contractors. Contractors accept the obligation to defend the owner because they can add your agency as an additional insured on their commercial general liability (CGL) policy. Consultants don’t have this option.
The firm will, however, almost certainly be named as a co-defendant in a third-party lawsuit. While its insurance company won’t pay to defend your agency, it will vigorously defend the firm’s services. This will help you defeat claims that arise from the firm’s services.
Some jurisdictions obligate a consultant who agrees to defend the owner to pay as soon as a claim is made and whether or not the consultant turns out to have done anything wrong. The firm and its insurer will defend the work and pay for damages deemed to be caused by negligence. But the firm can’t become the guarantor of all risks associated with project ownership. One of those risks is the cost of defending against meritless claims.
Finally, there seems to be a persistent belief that some professional liability policy, somewhere, offers coverage for a firm’s promise to defend the project owner. To my knowledge, there is no U.S.-based professional liability insurance policy that offers substantive coverage for a consultant’s contractually assumed obligation to defend the owner.
Indemnity for Damages Not Caused by Negligence. Professional liability insurance doesn’t cover damages that don’t rise to the level of negligence. For an indemnity clause to be insurable, the consultant’s duty must be limited to damages caused by negligent performance.
OK, so what’s a non-negligent error?
Years ago, a certain type of fire retardant-treated plywood was commonly specified for roofs. Long after these projects were completed, it turned out the plywood degraded over time and roofs leaked.
Claim after claim ensued. To the owners of the wet and ruined contents of these structures, the decision to specify this product was an error. But was it a negligent error? No, because the decision to specify the product was reasonable at the time it was made.
Tip: Try This Language Instead
Get rid of the defense obligation and limit the duty to indemnify to damages caused by negligent acts, errors, or omissions.
In some jurisdictions, it’s not enough to strike the word “defend;” you may have to add language that negates any obligation to defend, e.g. “indemnify (but not defend).” Also remove references to defending a “claim,” “cause of action,” or “allegation.”
The finished clause might read: Consultant shall indemnify and hold harmless (but not defend) owner from and against damages to the extent caused by consultant’s negligent acts, errors, or omissions in the performance of consultant’s professional services on the project.
Courts subject indemnity clauses to special scrutiny, so they may need to be worded in a particular way to be enforceable in the applicable jurisdiction. Check with your legal counsel to make sure you’re using the correct magic words.
“But We Don’t Have a Problem Getting Consultants to Sign Our Contract!”
Maybe you’ve never gotten pushback about uninsurable contract terms. Maybe you have and moved on to a consultant who signed a contract containing uninsurable provisions.
The “extra” protection such language seems to provide is worthless without the financial security that professional liability insurance provides. That’s why insurable contract language really is in the best interest of project owner and design professionals alike.