If you’re a business owner in Texas, you know that along with the rewards come some significant risks. Practical management of business risks often involves the use of insurance to transfer financial loss exposures that a business couldn’t or doesn’t want to absorb.
Business contracts contain promises of performance, and parties are entitled to rely on those promises. When one party fails to perform as promised, or an unexpected event occurs, another party may be exposed to financial loss, either directly or indirectly. Insuring against financial risks is an additional guarantee against specific losses.
The business and commercial litigation attorneys at Fee, Smith & Sharp LLP in Dallas advise business owners on the risks they face in business deals and on negotiating contracts so their interests are adequately protected when things don’t go as planned.
Common Financial Risks Inherent in Business Contracts
Key financial risks in business contracts can arise from performance failures, operational issues, cash flow interruptions, and external factors. When financial loss occurs, some party or parties will be held liable.
A standard provision nearly universal in business contracts is an indemnity clause. Parties to a business contract do not want to assume certain financial risks they may be exposed to as a result of the business relationship.
Indemnity clauses allocate responsibility for losses and damages arising from specific events, providing certainty and predictability for all parties. Indemnity clauses typically address both direct liability (between contracting parties) and third-party liability (to non-contracting parties).
Depending on the type of business and the magnitude of financial loss exposures, a personal guarantee of financial responsibility may not be sufficient to achieve the desired level of protection. Identifying insurable risks and requiring insurance coverage assures that the means to compensate for economic losses will be available.
Business Contract Provisions that Protect Business Owners from Financial Loss
To avoid unnecessary business interruptions and costly litigation, indemnification clauses in business contracts should convey clear intentions with specific language.
If you are the indemnifying party, you want your liability to be explicitly stated and as narrow as possible. You want to limit the duration and extent of your liability exposure. If you are the indemnified party, you want all potential financial exposures adequately covered and to ensure there will be money available if needed.
Business owners should include the following provisions in contracts to appropriately allocate, limit, and insure liability for certain business losses.
Indemnification
Indemnification clauses shift the responsibility for certain types of financial losses from one party to another. Indemnity clauses need to be specific about the losses to be indemnified and limit the scope of liability to contain the risk.
Texas requires very specific language for an indemnity provision to be enforceable, making it very important for the correct language to be included in any indemnity provision.
Limitation of Liability
Limitation of liability clauses set a cap on the financial responsibility of a liable party. Limitation of liability clauses may exclude liability for certain types of damages and may contain industry-specific requirements. Exceptions to the cap restriction exist for certain types of conduct and third-party claims.
Insurance
This provision requires a party to maintain particular types of insurance to cover specific financial losses. The type and amount of liability insurance appropriate will depend on the level of risk exposure.
Typically, the provision will require minimal amounts of insurance coverage for specified risks. Preferred carriers and/or carrier financial ratings may be specified if carrier solvency is a concern. This clause should be consistent with the limitation-of-liability clause.
Insurance clauses may also include the following specifics with coverage requirements:
- Additional Insured
The party requiring insurance may want to be listed as an additional insured on the policy. Being an additional insured means a contractual right to the coverage, including notification of policy cancellation, but no right to change the policy terms or conditions.
- Severability of Interests
A severability of interests clause is important in an insurance contract that covers multiple parties. It keeps one bad apple from spoiling the whole bunch. Coverage is applied to each insured individually, and no insured’s behavior can void coverage for the other insureds.
- Waiver of Subrogation
Waivers of subrogation in insurance policies prevent insurers from seeking reimbursement for covered losses from the party responsible for the loss. These waivers are good for businesses, though insurance companies aren’t fond of them and must agree to include them.
Proof of Compliance
Trust, but verify. A proof-of-compliance provision requires a party to produce evidence that the required insurance is in effect. The requirement is usually satisfied by a request to the carrier, which issues a certificate of insurance. A certificate of insurance entitles the holder to notification of policy changes, but does not grant coverage under the policy.
Remedies
The remedies clause sets forth the parties’ rights of recovery in the event of a contract breach. This provision must be consistent with both the insurance coverage and the limitation-of-liability clauses.
Types of Insurance that a Business Contract May Require
Determining business risks and whether they can or should be insured are essential to incorporating the appropriate financial protections into a business contract. A clear understanding of the scope of work to be performed and the magnitude of the risk exposures helps to identify where insurance coverage is warranted.
In addition to general liability coverage for injury and damage to third parties, environmental liability, professional liability, cyber liability, employer liability, and excess liability are risks that may be cost-effective to insure against.
Insurance coverage for operational risks, such as business interruptions or equipment breakdowns, is appropriate in some contracts. Specialized business risks may require niche insurance coverage.
Do Your Business Contracts Adequately Protect You from Potential Financial Loss?
Business deals in Texas can be incredibly complex, and the stakes can be high. Appropriate risk allocation and adequate means to compensate for financial losses help avoid confusion, disputes, and delays. Requiring parties to insure financial losses promotes efficient performance and favorable business relations.
Successful business contracts contain clear language and built-in protections for the parties’ financial interests. If you’re a business owner in Texas, the commercial business litigation team at Fee, Smith & Sharp LLP can make sure your business contracts require the insurance necessary to protect your business.
