Professional indemnity insurance - top five contract issues requiring caution

A well-written contract signed and agreed by the parties involved can be your first (and last) line of defence in mitigating disputes. 

Aon Liability Manager - Professional Risks Kristene Crook says Aon has seen liability claims fall away or settle for well below the disputed amount based on the strength of the contract. She says industry standard is best (ACENZ, NZS3910, NZIA, etc) when writing a contract because it is widely accepted as insurable by the insurance market. Caution is required if a client insists on special conditions or bespoke contract terms. 

We asked Kristene to tell us the top five contract issues that companies should be wary of when looking at professional indemnity insurance.     

1. Amending duty of care, performance, and warranty clauses, and introducing higher performance standards or warranties 

Duty of care standards at common law measure negligence against the skill, care and diligence that should be reasonably expected from an ordinarily competent professional. Contracts that seek a higher duty or amend the reasonable negligence test can potentially create liability beyond the common law. 

Insurance policies generally cover liability in negligence based on statute and the common law. Assuming a higher level of liability can fall outside of insurance cover.

2. Extending duration of liability

Insurers rely on defences provided by statute. Contracts that seek liability beyond the Building Act and under the Limitation Act will generally fall outside of insurance cover. 

3. Indemnities or hold harmless

These can be very problematic as they essentially provide the client with a promise that they will be compensated in the event of a loss.

They have the potential to introduce undefined losses (losses not usually defined under liability clauses) and can make it more difficult to defend. This is because the trigger is that the client suffers a loss, and the consultant has promised to pay (the trigger is the loss, rather than any negligence or defined act).

4. Amendment or exclusion; limitation of client liability

In contract, it is fair to agree a liability amount in case of a breach of the contract terms. Contracts that are one sided, i.e. they only apply to the client and not both parties or have very low limitations for the client if they cause a breach or loss, can result in insurers being unable to fully recover or seek contribution from the client for their share of the loss.

Most insurance policies have subrogation clauses. These state that you must not prejudice insurers’ ability to join or seek contribution from other parties. 

5. Liability for subconsultants

Contracts can require the consultant to be liable for any type of loss arising from their subconsultants’ actions. Insurance generally provides cover for the consultants’ vicarious liability for the actions of its direct third parties such as subconsultants. Vicarious liability usually covers most losses involving third party subconsultants and contractors to the extent that the consultant is found liable for their actions (they had a duty of care).

However, the consultant may not have the same level of liability to other third parties, such as independent contractors and financiers. Therefore, it is important to try and avoid full liability in favour of vicarious liability, and only to direct subconsultants (not to other parties). It is important to have contracts in place with these parties so that they have clearly defined obligations similar to the obligations in the consultant’s contract. 

Summary 

• Remember that you must not impact insurers’ rights to subrogate or recover losses from any other party.
• In this context, liability insurance means professional indemnity insurance. 
• The basic promise of insurance is to indemnify third-party claims for compensation arising from a loss suffered by the third party, and connected with the insured business activities, due to negligent action or inaction of the insured. 
• Most insurance policies limit contract liability to liability in statute and the common law measure (case law and precedent). 
• Contract law is complex and requires careful consideration. It is recommended that input is sought from a commercial contract law specialist when negotiating contract terms outside of industry standards.

Find out more about ACE New Zealand contracts and contract guidelines here

This article was brought to you in paid partnership with Aon.