Summary: In terms of insurable liability, there are several ways that the insured can become legally obligated for damages: (1) through negligence—the insured's or that of someone for whose actions the insured bears the responsibility; (2) through statute as in workers compensation or dram shop laws; and (3) through assuming liability.
It is with assumed liability—including assuming the liability of another—that this discussion is concerned. As an example of this: if A becomes liable to C, a third party, then B (who has assumed A's liability) will pay damages to C for A.
The contractual liability coverage under the commercial general liability coverage form (insured contract) is the basis of the discussion.
Topics covered: Legal basis Contractual liability insurance Insured contracts Contracts not considered insured contracts Indemnify v. pay on behalf of Contractual liability limitation
Legal Basis
When one party agrees with another that the other shall be free from liability (that is, held harmless) in given circumstances, or that the other party will be indemnified for liability incurred, the first party (the indemnitor) has assumed the liability of the other (the indemnitee).
Some situations wherein this type of agreement could arise are: a person leasing or using property or equipment agrees to hold harmless the owner of that property or equipment; a subcontractor agrees to hold harmless the general contractor; the manufacturer of a product agrees to hold harmless the seller of that product. Additionally, many other business transactions involve assumptions of liability in one form or another; purchase order agreements, maritime agreements, and service agreements are some of the more common. An employer may even find itself liable to its own employees where they are able to lodge claims against another entity and the employer has assumed that other entity's liability.
As an illustration of the assumption of liability—a contractor is to put up a building. The contract between the builder and the owner includes an agreement to the effect that the contractor will save and hold harmless the owner against liability in connection with the construction. A third party is injured at the site and brings suit against the owner. The ultimate obligation to pay any judgment or settlement then falls upon the contractor; in agreeing that the owner will be held harmless, the contractor has assumed this liability.
Hold harmless agreements, sometimes referred to as contracts of indemnity, are so generally used in contracts and other legal agreements as to subject almost every organization or entity to their provisions at some time or another. The consequences of such assumption agreements may range from an innocuous agreement to be responsible for one's own negligence to contractual obligations so serious in nature as to be adjudged "contrary to public policy." Assumption agreements are not always readily identified, often appearing as one of numerous clauses in a lengthy contract. It is sometimes difficult to make the party who has accepted such a condition understand that this is an assumption of liability and that it places that party in a potentially difficult situation for which insurance protection is needed.
Though courts do scrutinize these transfers of responsibility, they are quite generally upheld and enforced as long as the parties to the agreement express in clear and unequivocal terms the intent to shift liability, and if this does not run counter to any statute or public policy. Those who find themselves responsible for liability that they have assumed in this way are often baffled that what they thought of as a private agreement freeing another party from liability imposes the burden upon themselves. What they have not understood is that the courts will not permit a private agreement between two parties to interfere with the legal rights of a person or organization who is not a party to the agreement; that is, an injured party's rights to compensation will not be inhibited simply due to a contract between two other entities.
Note that, sometimes, contracts do not contain any specific assumptions of liability, but provide that the insured shall purchase liability insurance for the other party or that the other party shall be made an additional insured under the insured's liability insurance. These constitute performance agreements on the part of the insured. Though the intended result may be the same, such agreements do not represent contractual assumptions of liability. A careful distinction must be maintained between an insured's contractual obligation to provide goods or a service or a performance (not covered), and an insured's contractual obligation to take on the liability exposure of the other party (covered under an insurance policy's terms).
Contractual Liability Insurance
The existence of an agreement to assume the liability of another almost always creates a companion need for contractual liability insurance.
Contractual liability insurance is a built-in feature of the various forms providing premises and operations liability coverage. In the 1973 comprehensive general liability policy (without the broad form endorsement), such protection is limited to assumptions falling under one of the categories defined as "incidental contracts." Under the broad form endorsement, contractual liability coverage is on a blanket basis by way of extending the definition of incidental contract to include "any oral or written contract or agreement relating to the conduct of the named insured's business". There are, of course, exclusions on the endorsement that limit the scope of this blanket contractual coverage, but coverage is there nevertheless.
Contractual liability coverage is written on a blanket basis under the current ISO commercial general liability coverage form in that, coverage exists for liability assumed in a contract that is an "insured contract" (a defined term). Insured contracts are discussed later, and for more information see Commercial General Liability Definitions and CGL Coverage Form—Coverage A.
Contractual liability insurance is concerned with liability that is assumed (under certain circumstances). Contractual liability insurance generally does not have any applicability to the liability that results from a breach of contract.
For example, see the case of Olympic, Inc. v. Providence Washington Insurance Company, 648 P.2d 1008 (Alas. 1982) The Alaska Supreme Court stated that "liability assumed by the insured under any contract refers to liability incurred when one promises to indemnify or hold harmless another, and does not refer to liability that results from breach of contract". Also note that this case was quoted by the United States District Court for the Eastern District of Louisiana as asserting the point that "an agreement that clearly expresses the intention to shift liability can certainly be construed as holding a party harmless from the consequences of his or her own negligence"; namely, an insured contract by definition in the general liability form. (This case is Deville v. Conmaco/Rector, L.P., 2010 WL 4003996 (E.D.La.). As another example, there is Dreis & Krump Manufacturing Company v. Phoenix Insurance Company, 548 F.2d 681 (7th Cir. 1977), wherein the Federal court of appeals noted that "liability assumed under any written contract means a specific agreement between the insured and some third party whereby the insured agrees to indemnify the third party …."
On the other hand, there is the case of Vandenberg v. Superior Court of Sacramento County, 982 P.2d 229 (Cal. 1999). In this case, Vandenberg had leased land for a period of time and when the lease expired, the owner wanted to sell the land. It was discovered that the soil and groundwater were contaminated and the owner blamed Vandenberg due to using the land for an auto sales and service facility. Vandenberg and the owner of the land arbitrated the dispute, and the arbitrator awarded the owner $4 million. Vandenberg sought indemnification from his insurers but they declined coverage, saying that the arbitrator awarded damages for breach of lease (a contractual cause of action) and contractual damages were not covered by the CGL form. When Vandenberg sued, the trial court found in favor of the insurers; an appeals court reversed that decision and so, the California Supreme Court was called upon to finally decide the question.
The supreme court framed the issue basically as whether the CGL form that covers sums that the insured is legally obligated to pay as damages may cover losses arising from breach of a contract; the answer was yes. The court noted that the general rule was that damages from an insured's nonperformance of a contract are not covered under the CGL form; but, as the appeals court said, the general rule is not a universal bar to insurance coverage whenever a contract is involved. The supreme court agreed with the appeals court that, when there is property damage, the focus of a judicial inquiry should be the nature of the risk or peril that caused the injury and the specific policy language. In this case, the court decided that a reasonable layperson would understand the policy language "legally obligated to pay as damages" to refer to any obligation that is binding and enforceable under the law, regardless of whether this is pursuant to contract or tort. Therefore, the "legally obligated" language was broad enough to include responsibilities arising from a contract.
This California case did recognize limited exceptions to the general rule that tort damages are not recoverable for breach of contract and, indeed, the supreme court said that the Vandenberg ruling was a narrow one; however, both insureds and insurers should be aware that, in certain courts, policy language and the nature of the damage and risk involved in a claim might expand contractual liability insurance beyond its generally accepted scope.
Do note that most other jurisdictions today continue to adhere to the tort/contract distinction in rejecting coverage for claims based on breach of contract.
Insured Contracts
The current commercial general liability forms provide the blanket contractual liability coverage approximating the coverage available under the 1973 broad form comprehensive general liability endorsement. Coverage under the current CGL form is arrived at by way of an exception to exclusion (b), contractual liability. The exclusion eliminates coverage for bodily injury and property damage for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement. There are two exceptions to the exclusion listed on the CGL coverage forms: (1) liability assumed under an agreement qualifying as an "insured contract" (a defined term) provided that the bodily injury or property damage occurs subsequent to the execution of the contract or agreement; and (2) liability that the insured would have in the absence of the agreement.
Coverage for assumed liability under an insured contract is determined by the coverage form definition of that term; the term is defined to mean several kinds of assumed liability and contains no provision requiring such agreements to be in writing. Insured contract means:
a. A contract for a lease of premises. However, that portion of the contract for a lease of premises that indemnifies any person or organization for damage by fire to premises while rented to the named insured or temporarily occupied by the named insured with the permission of the owner is not an insured contract.
b. A sidetrack agreement.
c. Any easement or license agreement except 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. An example is an agreement to protect a city from legal jeopardy in exchange for licensing to perform a particular function; say the insured's permit to operate a hardware store in the city limits obliges the insured to protect the city from legal liability arising out of the store's operation. There is coverage. An example of the exception to this item is in the same hardware store's contract with the city to maintain all of its riding mowers and the terms of the contract call on the insured to protect the city from legal liability for bodily injury or property damage caused by a malfunctioning mower. The insured will need products and completed operations coverage along with the contractual liability insurance. (Of course, part f. of the insured contract definition includes indemnification of a municipality in connection with work performed for a municipality, but products and completed operations coverage should still be purchased especially since part f. comes into play when the assumption of liability is the assumption of tort liability to pay damages for BI or PD to a third person or organization.)
e. An elevator maintenance agreement.
f. That part of any other contract or agreement pertaining to the named insured's business (including an indemnification of a municipality in connection with work performed for a municipality) under which the named insured assumes the tort liability of another party to pay for bodily injury or property damage to a third person or organization. Tort liability means a liability that would be imposed by law in the absence of any contract or agreement.
Paragraph f. of the insured contract definition pertains to coverage of tort liability assumed for another person or organization. The fact that the assumption of liability under agreements enumerated in parts a. through e. is set off from that under part f. suggests that coverage under the former group is not limited to those contracts under which the named insured assumes the tort liability of another. Therefore, parts a. through e. of the definition imply that contractual liability coverage under the CGL form applies to liability assumed by the named insured, not only for liability stemming from tort, but also from such things as warranties, which are contractual in nature. But no matter which part of the definition is applied, contractual liability coverage is for BI or PD to another in accordance with the insuring agreement of the CGL form; breach of contract or the failure of the insured's product to live up to its warranties or representations will not trigger the CGL coverage.
The second part of the exceptions to the contractual liability exclusion applies to liability "that the insured would have in the absence of the contract or agreement." This makes coverage certain in situations that could otherwise be a source of conflict between insurance companies and insureds. An example is an insured contractor who agrees to hold harmless and indemnify a railroad owner for any bodily injury or property damage arising out of a contract if injury occurs within 50 feet of the railroad. However, if the insured would have been liable in the absence of the contract—for example, the insured's own negligence caused the accident—the insured will nevertheless have the coverage he needs in his relationship with the railroad.
Contracts Not Considered Insured Contracts
The definition of insured contract also makes clear what exposures are not intended to be within the scope of coverage. The current definition limits the excluded contracts to those that fall within the sway of paragraph f.
The definition states that paragraph f. does not include that part of any contract or agreement that indemnifies a railroad for bodily injury or property damage arising out of construction or demolition operations within 50 feet of any railroad property and affecting any railroad bridge or trestle, tracks, road-beds, tunnel, underpass, or crossing. Railroads often require contractors who are to perform work within 50 feet of railroad property to agree to hold the railroads harmless for any claims or lawsuits that may arise in connection with the work. This part of the insured contract definition makes the point that the CGL form is not meant to apply to such claims or lawsuits. The wording in part c. of the definition pertaining to easements or license agreements adds strength to this reluctance on the part of insurers to cover railroad liability exposures.
If the insured needs insurance coverage in its dealings with railroads, there is CG 00 35, the railroad protective liability coverage form; see Railroad Protective Liability Insurance. Or, the insured might want to consider endorsement CG 24 17, contractual liability—railroads, an endorsement that deletes the exclusionary language relating to railroads that is found in the definition of insured contract.
Another exposure not included within the definition of insured contract relates to the professional liability of architects, engineers, and surveyors. The excluded exposure precludes coverage in two cases.
The first case is when the insured, who may or may not be an architect, engineer, or surveyor agrees to indemnify an architect, engineer, or surveyor for injury or damage arising out of "preparing, approving or failing to prepare or approve maps, shop drawings, opinions, reports, surveys, field orders, change orders or drawings and specifications; or giving directions or instructions, or failing to give them, if that is the primary cause of the injury or damage." Primary cause is not defined in the policy, but presumably if faulty directions are involved in, but are not primarily the reason for damage, the provision would not apply.
The second case is when the insured is an architect, engineer, or surveyor and assumes liability for injury or damage arising out of its rendering or failure to render professional services for others (including the services as itemized previously). The purpose of this exclusion is to prevent the insurer from covering losses that should be insured under a professional liability policy.
Another exposure not considered to be an insured contract is that portion of the contract for a lease of premises that indemnifies any person or organization for damage by fire to premises while rented to the named insured or temporarily occupied by the named insured with permission of the owner. For more discussion of this item, see CGL Coverage Form—Coverage A, under the subheading of Fire Damage Coverage.
Note that, unlike the contractual liability coverage of the old broad form endorsement, the coverage under the current CGL forms is not subject to a third party beneficiary exclusion. Briefly, this exclusion precluded the payment of losses, as assumed under contract, to third party beneficiaries (such as members of the public who are not direct parties to a contract) when such losses arise out of work for public authority. Its purpose was to avoid the automatic obligation to pay claims to injured members of the public simply because an insured has obligated itself to be responsible under contract. This does not, of course, necessarily prevent the payment of claims, since such actions by claimants in tort would still be covered.
Indemnify versus Pay On Behalf Of
One last comment on contractual assumptions of liability; the wording of each agreement should be carefully scrutinized by a lawyer to determine when the obligation shifts from A to B. Is B obligated to step in whenever claim is made against A, taking over defense of the claim from the outset? Or is B required only to indemnify, i.e., reimburse, A for A's expenses in providing its own defense and for judgment, if any, against A? Clarification on this point is crucial in determining when B's contractual liability insurer is required to act since any misunderstanding can lead to bad feelings and law suits between A, B, and B's insurance adviser when, after the fact, it was determined that B would be required only to indemnify and B's insurance remained aloof until after A had paid for the defense and the settlement of the claim.
Contractual Liability Limitation
For insureds without a need for blanket contractual liability coverage, ISO makes available an endorsement—CG 21 39—to the commercial general liability forms that limits contractual liability coverage about to the level of the 1973 general liability policy's incidental contracts coverage. For more information on this endorsement, see CGL Endorsements.
Includes copyrighted material of Insurance Services Office, Inc., with its permission.
Original publication: May 10, 2011
Updated April 21, 2014