Insurance Advisory Newsletter Volume 9 – Importance of insurance clause in contracts- April 2022
Insurance clauses are routinely overlooked in commercial contracts. We observe that a detailed insurance clause has become a norm in the commercial contracts. The basic purpose of an insurance clause is to relegate as well as mitigate the risks associated with the services or goods being provided or received under the agreement. Insurance clauses can aid in keeping the unintended consequences arising out of contractual breaches at bay and to safeguard you against any legal fallout.
KEY CONSIDERATIONS IN AN INSURANCE CLAUSE
• SCOPE OF THE TRANSACTION:
The negotiating parties must clearly identify the scope and nature of the business transaction, the insurable risks arising out of the transaction and the coverage limits to appropriately seek as well as accept insurance requirements under the agreement.
• INDEMNIFICATION OBLIGATIONS: The indemnity obligations agreed under the agreement should be kept in mind while seeking insurance coverages. For instance, where the agreements seek indemnity for infringement of intellectual property, it would be advisable to seek coverage for this exposure under the insurance policy being procured.
• PARAMETERS TO NEGOTIATE INSURANCE CLAUSE: The key to negotiating an insurance clause depends on some important parameters such as: ➢ The revenue generated/ticket size of the business engagement: The insurance requirements should be finalised on the basis of the revenue being generated from the business engagement. ➢ The market and economic risk exposure of the parties involved: The party imposing insurance obligations can negotiate insurance clauses depending upon the nature of risk likely to be incurred through the concerned engagement. ➢ Type of industry: Different industries have different statutory insurance requirements, such as, industries dealing with hazardous substances are mandatorily required by law to possess a Public Liability Insurance and an All-Risks Insurance is indispensable for a construction contract. ➢ The size, turnover, and capability of the parties: A party can negotiate insurance clauses based on the size and turnover of its business. ➢ Consequences of non-compliance with insurance obligations: If service provider/supplier agrees for an insurance obligation but fails to procure or present evidence for the insurance policies the same shall be construed as a breach of contractual obligation by the service provider/ supplier.
• COVERAGES AND LIMITS: The clause should clearly detail the specific policies, coverages sought and limits for each policy.
• COST CONSIDERATION: The insurance clause should clearly spell out which party shall be bearing the cost for procuring and maintaining the insurance policies.
• ADDITIONAL INSURED: If a party is a service or product recipient, it must ensure that its name is included as an ‘additional insured’ in the service or goods provider’s insurance policies. A service provider, on the basis of the size of the transaction, should be able to ascertain whether it would want to include such service or good recipient’s name as an additional insured.
• CONTINUITY IN COVERAGE: The party complying with the insurance requirement needs to ensure that the insurance policies remain valid during the term of the agreement. However, the parties may agree for a tail period for keeping the insurance policies valid post termination of the agreement.
• BEST RATING: Insurance clauses in US based transactions may require the other party to have insurance policies with AA, or AM Best Rating. Indian insurance companies are regulated by the Insurance Regulatory and Development Authority (“IRDA”), which follows its internal rating standards to license the insurance companies, hence such rating is not applicable in India.
• NO MATERIAL CHANGES OR DISCONTINUATION OF POLICIES WITHOUT CONSENT: The insured should seek consent of the other party/ ies, seeking such insurance, and must inform them of any material changes or discontinuance of the insurance policy.
• WAIVER OF SUBROGATION: The client contracts may ask for a “Waiver of Subrogation” endorsement in the insurance policies. “Waiver of subrogation” essentially means that the insurer of the insured cannot pursue any claims against the third party who has erred the insured. This needs to be negotiated and agreed at the time of policy placement.
• MAPPING US VIS-À-VIS INDIA INSURANCE PRODUCTS: Many Indian companies have a global presence, especially in the United States of America. Such US based documents may use US insurance jargon which doesn’t work when dealing with Indian insurance policies and industry practice. It is advisable for Indian companies to take formal expert help to map the insurance requirements stipulated by such US entity versus the insurance products available in India.
BEST PRACTICES POST ACCEPTING AN INSURANCE OBLIGATION
➢ Keep the certificates of insurances handy and readily available.
➢ Update and keep the insurance policies valid by timely payment of premiums.
➢ Do not share policy copies except the coverage letters with any individual or entity without having in place necessary confidentiality and non- disclosure documents.
➢ If contractually agreed, inform the insurance company if an entity is to be added as an ‘additional insured’.
➢ Inform the insurance company of any potential claim or claim- like situation with your vendor/customer (potential dispute).
