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Contractual risk transfer explained

Posted on 26th July 2022 by

There are a number of different contract clauses that can transfer risk and liability from one party to another, including but not limited to: contractual risk transfer, hold harmless, waiver of subrogation and vicarious liability.

In our article we look at contractual risk transfer. What is it and why it’s important, especially in sectors such as construction and trades, where outsourcing specific tasks to subcontractors is common practice.

 

What is contractual risk transfer? 

It’s important to ensure you’re not held liable for mistakes made by a subcontractor. A contract that clearly states which party is responsible for certain aspects of a project before work begins could save your company time and money in the event of legal action.

Contractual risk transfer is a legally binding way of transferring risk to the party that is in the best position to control the risks related to the specific service provided.

For example, if you are a housebuilder and you hire in an independent electrician for the wiring, the electrician is the best person to accept the risk and responsibility for that aspect of the project. After all, he/she is the expert in that field, so if something isn’t correct with the electricals it makes sense they should be held responsible.

Contractual Risk Transfer diagram of an example for trades sector

 

Key components of contractual risk transfer 

Common forms of contractual risk transfer include an indemnification clause and a hold harmless agreement, that work together so that the subcontractor is held responsible for any claims or losses resulting from their work on behalf of the hiring party (main contractor).

You may also stipulate the subcontractor names you on their insurance policy as an additional insured. If something then goes wrong with the subcontractor’s work, you as the hiring party (main contractor) could be covered by the subcontractor’s policy if your company is sued for damages.

Contractual risk transfer typically has three common components:

  1. Hold harmless agreement – This important part of contractual risk transfer outlines the third party’s responsibilities to defend any other involved party when the third party’s actions have resulted in damage or injury. It helps ensure that subcontractors and suppliers are contractually liable for their own negligence, errors and omissions should a claim be filed against you the hiring party (main contractor).
  2. Insurance procurement clause – Requires the third party to obtain adequate insurance, including a certificate of insurance in case it is required for presentation.
  3. Waiver of subrogation – This clause indicates that if the third party’s insurance pays a claim related to your work, the insurance company waives the right to chase you for damages.

 

Who requires the protection provided by a contractual risk transfer?

Contractual risk transfer is important in many industries as a way for businesses to manage and mitigate their risk exposure.

It is commonplace in the construction industry and in manufacturing, but can also be found in technology, professional services and property. It is particularly important for manufacturing and technology business contracts with suppliers and distributors as it can affect product liability insurance policies.

If you are required to sign a risk transfer contract it is advisable to consult a legal specialist. Thorough due diligence is advisable to ensure you do not have unfair liability placed on your business.

 

Note: Caunce O’Hara does not offer vicarious liability insurance.

 


Sources:

https://www.travelers.com/resources/business-topics/business-continuity/what-is-contractual-risk-transfer

https://www.cbiz.com/insights/articles/article-details/contractual-risk-transfer-an-overview-key-terms

https://www.reschini.com/wp-content/uploads/2015/05/The-Reschini-Group-Contractual-Risk-Transfer.pdf

www.busbystone.com/contractual-risk-administration/