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Contractual Indemnification & Professional Liability Policies

The underwriters' intent in providing professional liability coverage is to protect the insured from financial loss from liability the insured may sustain from its negligence in providing professional services. The underwriter's intent is not to provide coverage for any other liability, including liability the insured may have assumed under contract.

Virtually all professional liability policies contain a contractual liability exclusion similar to the following:

This policy does not apply to any claim based on or resulting from an insured's liability under any contract; provided that this exclusion will not apply to liability which would attach to an insured in the absence of a contract.

The contractual liability exclusion is designed to ensure that no coverage is provided unless the liability will attach in the absence of the contract, i.e. by order of a court.

What is liability assumed under contract? It is an agreement, typically defined in hold harmless or indemnification provisions in contracts, whereby one party to the contract agrees to indemnify or hold harmless the other party under certain circumstances. The problem is that sometimes a party will agree to almost anything in order to get a contract signed, for example from an impressive client, and agree to provisions that go well beyond the reasonable. These types of agreements are typically not covered by professional liability coverage.

Professional liability policies cover errors in the provision of services, and policies typically use terms such as wrongful acts or negligence to define what errors mean. However, liability assumed under contract can include actions of the insured that are not negligent and can also include the negligence of other parties transferred under an indemnification provision. Underwriters are not typically willing to cover this, and it is not reasonable for insureds to be expected to provide this protection to others.

Despite the risks, insureds can be lulled into providing broad indemnification to large attractive clients during contract negotiations. This can be a significant coverage issue for insureds willing to provide broad indemnification to an entity which they have or are establishing a business relationship with since they will probably have no professional liability coverage for the exposure.

An example might help. An insured might agree to indemnify another party, typically a prospective client, for their (the insured's) actions. If the indemnification provision is not limited to negligent actions, the client could make a case that any action, including the expected provision of professional services, warrants indemnification by the insured. Thus the client could demand indemnification from the insured on a claim that does not involve any negligence on the part of the insured. In fact, it might even involve negligence on the part of the client, and the insured would have to pay for it. This is not covered.

Underwriters are not willing to provide coverage for this situation. Underwriters expect that the courts can and will determine if there is negligence on the part of the insured, and the professional liability policy will respond in that case.

One method, which has been suggested by certain underwriters, is for insureds to work with their legal counsel to eliminate indemnification provisions from their contracts for professional services. This ensures that the only forum for determining whether negligence has occurred is the court system.

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