By Greg Doherty, Bolton & Company | July 1, 2016
Many liability insurance requirements in contract agreements can be problematic.
Over the last 15 years I have watched the dietary supplement industry mature in many ways, one of which is the increasing use of written contracts and agreements delineating responsibilities of the companies signing them.
So-called “supply chain contracts” are clawing to become the norm, with the increasingly complex supply chain responsibilities becoming more complicated every day. On balance, I think use of written agreements is a good thing, although it does make your busy day even busier.
From our vantage point, as an insurance broker for companies at every level of the supply chain, we are constantly asked to review the insurance provisions of contracts our clients are about to sign, or (unfortunately) have already signed. And it’s not always smooth sailing. At times, we find problematic requirements in these contracts. This article will review some of the more common problem areas we see.
Real Property Leases
The most common obstacle we see in leases is the requirement for “occurrence form liability insurance” for the lessee. The reality is that so-called “claims made” liability insurance is the only form of coverage available to the supplement industry (with a couple of minor exceptions not worth detailing here). We counsel our clients accordingly, and most often they can convince the landlord that this form of coverage is acceptable. On occasion, however, our client comes across a landlord or lender that will not negotiate this requirement under any circumstances, and duplicate coverage must be purchased to satisfy the other party.
Sometimes we see insurance requirement provisions in a lease that are just old—sometimes 40 years old. The insurance industry too has changed in the last 40 years and the types of coverage or limits of insurance structure simply are not in existence any longer. Nobody can comply with them.
My favorite and impossible insurance requirement is often hidden in the indemnification clause of the lease or contract. It’s usually phrased something like this: “Liability insurance will provide contractual liability insuring the lessees performance of the indemnity agreement contained in paragraph X.”
Sometimes it goes even further and requires the insurance to guarantee the policyholder’s performance with respect to any and all obligations the policyholder has assumed under the lease or contract. Of course, the liability insurance policy will not provide these guarantees, and under no circumstances can it be amended to do so. The policy is guided by its own terms, conditions and exclusions; it can’t be changed to do something it was never designed to do just because of a requirement in a contract that it is not even a party to.
Insurance Requirements of Big Retail
The likes of GNC, Vitamin Shoppe, the big box drug stores, many large and regional supplement distributors and grocery chains all have some kind of written vendors specifications and requirements with respect to insurance. Do not think for a minute that just because they are big that the insurance they ask you for is reasonable to protect them and you if you agree to work with them. Here are some examples.
Almost every contract or lease crossing my desk asks that 30 days’ notice of cancellation be given to the buyer. Sometimes we see the additional requirement of 30 days’ notice “in the event of a material change or reduction in coverage.” Of course, there is no definition of “material change or reduction in coverage.” While on rare occasion the insurance company may agree to the former 30-day notice provision, it will not agree to the latter.
Many large buyers will ask the supplier to provide insurance that cannot under any scenario inure to the benefit or protect the buyer. For example, they will ask for medical payments, a coverage of little import that is provided willingly by most liability policies as “window dressing.” (Note: medical payments are unrelated to legal liability payments for medical expenses from a product liability claim, for example.) Some of the carriers offering product liability insurance to a company do not offer medical payments coverage, leaving that company in violation of the requirement and no remedy to fix it.
Some buyers require the supplier to have fidelity coverage (i.e., employee theft or employee dishonesty) from which the buyer will derive zero benefit should there be a claim, such as an embezzlement. What if your company has opted not to purchase this kind of coverage?
As mentioned earlier, many liability insurance requirements we see in agreements are out of the Dark Ages of insurance, such as the requirement for so-called “split liability limits” contained in many agreements. For example, one of the big box drug chains requires $10 million per occurrence/$20 million aggregate from its supplement suppliers. Long ago, insurance could be structured this way, where the “per occurrence” and aggregate amounts were different. Today, commercial liability insurance is almost always offered so that the “per occurrence” and aggregate amount are the same. What this means is that the supplier is forced, at additional cost, to purchase $20 million per occurrence/aggregate to satisfy the requirement. It’s more insurance than the big box chain wants, but it’s the only way to get that $20 million aggregate.
How To Avoid These Contract Pitfalls
The takeaways from this article are elementary:
Don’t sign a document that you don’t thoroughly understand, as you may be agreeing to things that are difficult, or worse, even impossible to accomplish.
Where appropriate, talk to your trusted advisors and get their input in their areas of expertise (e.g., insurance broker, attorney, real estate advisor, etc.).