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.
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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