Ruminations gets a lot of requests for postings about insurance issues, especially about those issues that affect how one prepares a lease, purchase contract or mortgage. So, to satisfy that “demand,” here are some thoughts about Contractual Liability Coverage: often requested; rarely understood. It’s complicated. Grab a handle and hang on.
The major problem with Contractual Liability Coverage is its name. Before explaining that proposition, we all need to get on the same page. Contractual Liability Coverage is insurance for damage arising out of a tort, not for damage arising from breach of a contract. Yes, it covers torts, not contracts.
Consider three parties – the Insurer, the Policyholder; and a Third Party with whom the Policyholder has engaged in a (covered) contractual arrangement. We’re not talking about just any contract; we’re talking about one that, in addition to whatever motivated the Policyholder and the Third Party to sign it in the first place, also calls for the Policyholder to indemnify the Third Party for certain tort actions against the Third Party arising out of the subject matter of the contract.
Let’s say the Insured is an oil company and the Third Party is an off-shore oil drilling company. Let’s also say that the oil company, to induce the drilling company to perform a risky operation for the primary benefit of the oil company, insists that the oil company indemnify it from any and all claims, etc. arising out of the drilling company’s operations at the oil company’s “really, really deep well.” Now, that could come to a whole lot of money should the “really, really deep well” blow up. So, the drilling company might insist that the oil company obtain insurance as a way to enhance the oil company’s credit should a claim be made.
Would the oil company’s Commercial General Liability (CGL) insurance policy cover the oil company’s assumed risk?
Before we forget our promise at the beginning, what’s wrong with the name: “Contractual Liability Insurance”? What’s wrong is that it doesn’t explain itself. True, it covers liability arising out of a contract. It isn’t true, however, that it insures the kind of liability anyone first thinks of when it comes to a contract – performance. It covers tort liability that someone assumes solely because of a contract. So, why isn’t it called “Tort Liability Assumption Insurance”? I don’t know.
Now, back to the subject at hand. The primary coverage in a CGL policy is for the insured’s liability for causing personal injury or property damage. That’s what “Coverage A” is about. CGL insurance policies also cover personal and advertising injury liability (Coverage B) and Medical Payments (Coverage C). Here, we’re going to stick to Coverage A.
Coverage A is a promise by the insurer that it will pay what its insured is legally obligated to pay to the party asserting the actual injury to person or property. In the case of our oil well explosion, the claims are against the drilling company. They might also be directly against the oil company (the one that owns the well), but we’re talking about the ones asserted by injured parties against the drilling company. Why should the oil company’s insurance company pay for those claims? The drilling company isn’t its insured. The oil company is. The only reason the oil company is being asked to cover those claims (on top of those directly against itself) is that the oil company’s contract with the drilling company requires the oil company to pick up those claims.
Now, it would seem from our explanation of CGL coverage that the oil company’s insurance company is off the hook in the first place. After all, the CGL policy is designed to cover claims directly against an insured, not ones transferred to the insured through a contract. If a CGL policy covered those “transferred” or “vicarious by way of contract” liabilities, an insurance company could be covering 100’s of unexpected insureds, each one of which that would have become something like an additional insured by reason of having contracted with the policyholder.
Insurance policies can be a little obtuse. Insurance companies know that, and fear that case law will extend policy coverage beyond the expected risks. So, the standard CGL policy, while spending relatively few words to explain exactly what it covers, spares no ink when it comes to listing its “Exclusions,” what it doesn’t cover. The common Insurance Services Office’s CGL policy (2007 form) lists 16 specific exclusions from coverage. The second one [prosaically labeled as Exclusion (b)], is the Contractual Liability exclusion. So, if you didn’t already know that the insurance policy wasn’t going to cover claims against someone who isn’t the insured, Exclusion (b) is intended to make it crystal clear. Not really!
It is a little disingenuous to say that Exclusion (b) “excludes” coverage for claims that aren’t made directly against the insured because Exclusion (b) has two exceptions. Yes, there are two exceptions to the exclusion. The second exception is where the insured is obligated to assume the liability because it is party to what is called an “insured contract.” The first exception is where the insured would have had the liability anyway even if there were no contract. Go figure! That’s how insurance companies like to write their policies. Why be clear when you can be obtuse?
So let’s go over that again. The common liability insurance policy covers personal injury and property damage claims directly against the insured, but not claims that are against others parties unless the insured has contractually obligated itself to be liable for such a claim under what is known as an “insured contract.”
The coverage for this kind of claim, i.e., claims that are exceptions to the policy’s exclusion of claims made against parties who aren’t the insured, is limited. It is limited to the insured’s contractual obligation to indemnify or hold another party harmless for claims made against the indemnified party. And, not just any kind of claims – not claims made by the insured itself, and not claims that would have been covered had they been made against the insured itself.
Now, even though there are some kinds of coverage than will apply even if the insured agrees to extend its own insurance coverage to certain third parties after the “accident,” not here. When it comes to Contractual Liability Coverage, the agreement to indemnify must have been in force before the incident.
Also, there are only six kinds of “insured contracts,” the kind that Contractual Liability Coverage will cover: (a) real property leases (but not for what a property insurance policy would cover); (b) (railroad) sidetrack agreements; (c) easement or license agreements, but not in connection with construction or demolition operations on or within 50 feet of a railroad; d) an obligation, as required by ordinance, to indemnify a municipality except in connection with work for a municipality; (e) elevator maintenance agreements; and (f) “that part of ANY OTHER CONTRACT OR AGREEMENT pertaining to [the insured’s] business … under which [the insured] assume[s] the tort inability of another to pay damages because of ‘bodily injury’ or ‘property damage’ to a third person or organization. Tort liability means a liability that would be imposed by law in absence of any contract or agreement.”
Insured Contracts DO NOT INCLUDE certain railroad related situations, but more importantly do not include indemnification for professional liability. So, by example, if a property owner contractually agreed to indemnify its “architect, engineer or surveyor for injury or damage arising out of:” what architects, engineers, and surveyors do as their prime activities, the property owner’s CGL insurance policy won’t provide insurance coverage to the property owner to cover that indemnification.
Now, the example about an oil well blow-out might be too hypothetical. So, here is the most common situation. A property owner engages a construction company to put up a building. Their contract requires the contractor to indemnify and hold the property owner harmless if an employee of the contractor gets injured on the job (and to cover the owner’s defense costs). If the contractor has Contractual Liability Coverage, its own insurance company will defend and cover the claim.
With the preceding explanation of Contractual Liability Coverage, one might ask: so, how does this differ from naming the Third Party as an additional insured on your own policy? An additional insured has the very same coverage under the policy that the named insured has under the policy. Contractual Liability Coverage might not cover the sole negligence of the other party on the contract. The scope of coverage to an additional insured is controlled by the specific wording of the additional insured endorsement. The coverage afforded to an insured through its Contractual Liability Coverage is limited to the insured’s exposure under the provisions of its “insured contract.”
In trying to explain Contractual Liability Coverage, we’ve trampled over a myriad of exceptions, interpretations, intelligent court rulings, not so intelligent rulings, jurisdictional differences, and lot and lots of complications like that. As a result, no one whose sole understanding of this form of coverage comes from this explanation should expect to opine accurately as to what is or will be covered. That’s what insurance professionals are for. Use them. Don’t use this explanation as a substitute for using an insurance professional.