It is understood that anytime an Entity (your business) contracts with a third-party (vendors, tenants, suppliers, etc.) there are risks. When crafting the contract, there are three essential elements to keep in mind:
Preceding all else, the contract must contemplate the nature of the contracted activity and consider what could potentially go wrong, where the responsibilities for the activity should reside and who is in the best position to control them. In addition, determine if the third-party has the ability to manage the risk. In the event of a loss, can the third-party absorb the cost?
Risk evaluation logically leads to the need to classify risk. Some activities are inherently more dangerous than others. The company putting a new roof on your property obviously is exposed to greater danger than that of the individual delivering food to office workers. A well-constructed risk management program will organize risks accordingly. This classification system then becomes the template for establishing insurance requirements that will be spelled out in the contract. Avoid a one-size-fits-all approach. It is unfair, illogical, and will lead to unnecessary delay (or cancellation) of the proposed agreement.
Risk Avoidance, Transfer and Acceptance
The intended transfer of risk is to require the third-party to hold your Entity harmless by use of an indemnification agreement arising from the third party’s activities, use of their products or the use of your facilities. The best way to ensure that a risk has been transferred is to insist on strong indemnification language in the contract. This language should take into account the nature of the risk and spell out the appropriate level of insurance required of the third-party. Included in the indemnification section of the contract should be language obligating the third-party to defend your Entity, employees, officers and agents and is intended to be interpreted as broadly as possible in your favor.
As insurance requirements are often a sticking point during contract negotiations, it is recommended that the third-party be advised early of what their obligations will be. This will accomplish two goals: first, it will eliminate any questions the third-party may have about the nature of the insurance requirement. Second, it provides the third-party the opportunity to forward the requirements to its insurance agent for approval and processing, thereby eliminating delay and time to resolve any questions that may arise.
Contract Insurance Compliance
The end result of all this effort is to ascertain that the third-party has, in fact, obtained the necessary insurance and that it remains in force throughout the term of the contract. A Certificate of Liability Insurance (COI), issued by the third-party’s insurance agent, is the typical means of conveying this information. Often, the COI is accompanied by insurance policy endorsements indicating that the third-party’s insurance coverage addresses specific requirements detailed in the contract. It is important to remember the COI conveys information only about insurance that exists at the time the COI is issued.
As insurance policies are typically written for one year or less, the expiration date of the policies detailed on the COI must be monitored, and a new COI must be requested prior to expiration. The goal is to maintain a continual state of risk transfer from yourself to the third-party. This requires procedures be established, either internally or through an outside compliance service, to address and manage ongoing contract compliance.
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