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.
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, 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.