Insuring Liability for Third-Party Claims Seeking Lost Profits
November 2005
When it comes to liability insurance policies
that provide coverage for technology, media, Internet liability, and/or network
security liability risks, the forms in the market today vary, sometimes dramatically,
from one to the next. Indeed, there are some 40+ issues to consider whenever
reviewing one of these policies, and these issues are addressed differently
from one insurer's form to the next.
by Michael
A. Rossi
Insurance Law
Group
Given the number of differences, it is not possible for us to discuss everything
that should be considered in the forms, generally speaking, let alone in one
article. However, this article will begin a series of articles intended to explore
certain issues in depth. Look for additional articles in this column at Commercial Insurance,
Cyber Insurance. Issues not addressed in this column—a lot of issues—will be discussed at the Tech-eRisk
2006 Seminar series in March and April 2006, just as they were during Tech-eRisk
2005 and Tech-eRisk 2004.
This article is devoted to the issue of insuring third-party claims seeking
lost profits. To be clear, this article is not about coverage for the insured's lost profits, or a claim seeking disgorgement
of the insured's profits. This article addresses the situation where the insured
causes a third party to sustain lost profits, and that third party makes a claim
against the insured seeking to be compensated for those lost profits.
Do You Need Coverage for Third-Party Claims Seeking Lost Profits?
Some may say that coverage for such risk is not needed, because their company
uses consequential damages waivers and limitation of liability clauses in their
contracts. Put simply, that belief is misplaced, for a number of reasons.
First, such clauses do not protect against claims by persons with whom the
insured is not in privity of contract. Downstream users of the insured's products
or services are one example. Members of the general public are another.
Second, for some types of contracts (e.g., some contracts with public entities)
and in some jurisdictions outside the United States, such clauses cannot be
used.
Third, for some highly profitable contracts, a party will delete or otherwise
limit such clauses in order to get the deal done (e.g., to "make the sale").
Fourth, even when such clauses are in a contract, a court, in certain circumstances,
can rule that the clauses are not enforceable. One example is in the event of
reckless conduct by a party (reckless conduct, by the way, is insurable in most,
if not all, U.S. states).
In brief, if you are buying liability insurance for technology, media, Internet
liability, and/or network security liability risks, it is important to try to
get coverage for claims seeking lost profits.
Policy Variations Addressing Third-Party Lost Profits Claims
The policies currently available in the market vary with respect to how they
deal with this issue. Set forth below are examples of how various forms address
the issue.
Some forms address the issue by excepting from the definition of "damages"
or "loss" "loss of profits." The policy language does not expressly limit the
phrase to loss of profits by the insured, or by some other limited class of
persons. Accordingly, a policy written this way could be interpreted to exclude
some coverage for all types of third-party lost profits claims. Indeed, if you
ask the underwriters whose forms are written this way, they will tell you that
that is the intent of the exclusionary language. They believe that that risk
should be managed by the insured, by way of consequential damages waivers and/or
limitation of liability clauses in the insured's contracts. (As noted above,
however, an insured cannot fully protect itself against third-party lost profits
claims in such a manner.)
Some forms address the issue by excepting from the definition of "damages"
or "loss" loss of profits sustained by the insured, or an additional insured
or indemnitee of the insured. This language is express, and should be inapplicable
to third parties who are not in privity
of contract with the insured. Underwriters who use this language have the same
intent as that noted above, with one difference. These underwriters recognize
that an insured cannot prevent third-party lost profits claims by parties with
whom the insured is not in privity of contract. Therefore, loss of profits sustained
by such parties is not excepted from the definition of "damages" or "loss."
At least one form does not address the
issue in the definition of "loss" or "damages" at all. Instead, the form addresses
the issue near the end of the form, in a place where one would not ordinarily
think to look for it. The form provides that if the insured faces a claim for
lost profits because a particular contract does not contain a consequential
damages waiver and/or limitation of liability clause, the insurer may deny coverage
for the lost profits part of the claim if the insurer, in its discretion, believes
that the absence of such clauses from the contract was not reasonable.
The rest of the forms in the market are variations of the above. Some except
loss of future profits, apparently intending to preclude an insured from using
the insurance policy proceeds to arrange a settlement with the claimant instead
of compensating a claimant for its true injury. And some do other things.
What Should Insureds and Brokers Do?
For smaller insureds and the brokers who service them, where off-the-shelf
wordings cannot be negotiated, the point of this article, and the rest of the
articles in this series, as well as the Tech-eRisk seminar series, is to help
them make informed decisions between nonnegotiable policy forms that vary on
so many different issues. If coverage for third-party lost profits claims is
important to the insured, the insured should consider buying (and the broker
should consider recommending) the policy that provides the broader coverage
for third-party lost profits claims. When making purchasing decisions, however,
the insured and broker must balance this issue with all the other issues created
by the variations in the forms sold in the market.
For larger insureds and the brokers who service them, where it is possible
to negotiate changes to off-the-shelf policies, the point of this article is
to help them understand what enhancements to request to their policy forms.
They should understand the various different wordings discussed above, and try
to negotiate the most favorable. For example, if an insurer will not amend its
form to limit the exception to loss of profits by the insured, then offer a
fall-back to get the narrowest exception possible. The key is to listen to what
the underwriter is saying when they are saying "no" to the policy wording change
request, and then come up with a solution that both addresses the underwriter's
concerns as well as the insured's concerns.
Concluding Remarks
The policy forms that have developed over the past several years to address
technology, media, Internet liability, and network security liability risk differ
greatly from one insurer's form to the next. Insureds and brokers must therefore
take the time to review the policies carefully, understand the differences,
and make informed buying decisions where they cannot negotiate the wording,
and negotiate the wording where they can. This series of articles along with
the Tech-eRisk seminar series are designed to help educate insureds and brokers
to do just that.
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